INTRODUCTION I. STONERIDGE: THE SCOPE OF THIRD-PARTY LIABILITY AND THE ROLE OF RELIANCE II. THE PROPORTIONALITY PROBLEM A. Remedial Overbreadth B. Culpability and Securities Fraud C. Section 21D(f) III. TOWARD A NEW CONCEPTION OF DUTY "WITHIN" RELIANCE A. The Road Not Taken: The "In Connection With" Requirement B. Rediscovering Duty C. Defining Duty for Purposes of Third-Party Liability IV. APPLYING DUTY A. Attribution B. Involvement in the Disclosure Itself C. Scheme Cases D. Other Uses of Duty V. LEGISLATIVE REFORM CONCLUSION INTRODUCTION
In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. (1) the Supreme Court addressed whether two third-party participants in a fraudulent scheme, engineered by a corporate issuer, faced liability in a private securities lawsuit for harm caused by the issuer's false and misleading corporate disclosures. Though the inquiry would seem to be a matter of determining whether the participants' deceptive, behind-the-scenes conduct constituted a "primary" violation of the antifraud prohibition found in SEC Rule 10b-5, (2) the Court instead answered by interpreting the reliance element of the plaintiffs' cause of action. The Court held that there is no reliance, and hence no liability, when the link between the third party's actions and the resulting misrepresentation by the issuer is too remote or attenuated)
Conduct, reliance, and proximity, however, are conceptually distinct; by blending them together, Justice Kennedy's opinion makes something of a doctrinal mishmash. The dish is tasty enough to those who dislike strong securities class actions, with abundant probusiness dicta adding ample spice. (4) But the recipe has few serious academic defenders, even among those who like its outcome, (5) and has been the object of disgust for those who do not. (6) The standard account is that the Court was, yet again, showing its reflexive antipathy toward private securities class actions, throwing whatever was at hand into the pot in order to achieve a business-friendly result. As we shall see, most lower courts have read Stoneridge as doing little more than truncating third-party liability via an especially strict reliance requirement.
My sense is that both courts and commentators have paid too much attention to the dicta and too little to the holding. Though I, too, would have decided the case differently, the substance of the academic criticism and the unimaginative way lower courts have read and applied the Court's teachings are too simple. In Stoneridge, as in the two other most recent Supreme Court decisions addressing securities class actions, Tellabs (7) and Dura Pharmaceuticals, (8) the Court articulated a more moderate test than it might have, even though all three held for the defendants. Pure antipathy toward securities class action plaintiffs presumably would have led to more extreme holdings, which suggests that something different is going on.
In this Article, I offer a novel reading of Stoneridge. (9) There is a respectable idea at work in the opinion, which we can refine. The Court's choice of reliance as the crucial element indicates the Court's comfort with having different liability outcomes in Rule 10b-5 cases depending on whether the action is an SEC enforcement or criminal prosecution (where reliance is not required) or private litigation (where it is). (10) Why might such a distinction make sense? One possible answer comes by considering the extraordinary nature of the liability in private fraud-on-the-market cases, which is based on the aggregate claims of all those who bought or sold from the time of the alleged primary misrepresentations to the date of corrective disclosure. This figure can be staggeringly large, yet disconnected from any meaningful reliance-in-fact requirement. Even if the underlying conduct was wrongful, making a defendant pay such a large amount can seem severely disproportionate. By contrast, in SEC enforcement actions, the monetary penalty varies based on a set of factors specifically tied to the gravity of the wrongdoing. (11) In Part I, I expand on this idea and make my main argument: that by emphasizing remoteness and attenuation in the context of private securities litigation, Stoneridge reinvigorates the idea of duty as a limitation on liability to open-market investors in order to constrain the unique liability risk that defendants face.
In Part II, I explore the risk of disproportion and make two claims. First, fraud-on-the-market liability is an extraordinary remedy because it creates a potential recovery different from, and in excess of, normal conceptions of provable reliance damages. Second, a hard look at the key elements of a Rule 10b-5 action--including scienter--shows that securities fraud bears enough resemblance to negligence in terms of indeterminacy and precaution costs that a duty-based analysis makes sense. Later in Part II, I also consider how Congress has tried to address the disproportionality problem explicitly. Section 21D(f) of the Securities Exchange Act, added as part of the Private Securities Litigation Reform Act of 1995 (PSLRA), purports to impose a proportionate liability regime, drawn from similar reform efforts in tort law at the state level. (12) My argument is that this provision fails to do its job, thereby justifying judicial concern.
Part Ill puts forth my duty-based reading of what the Stoneridge Court was struggling to say with its emphasis on attenuation and remoteness. I explain that this kind of duty is different from the affirmative duty to speak, which is fairly narrow and circumscribed, and instead performs the tort law-like function of identifying a limited category of relational misconduct for which extraordinary fraud-on-the-market liability is deserved. Thinking of Stoneridge in this way gives meaning to portions of the opinion that otherwise might seem unintelligible, like the Court's distinction between defendants who inhabit the realm of commerce versus the realm of finance, and shows that there is, in fact, ample room for third-party liability in the right kinds of cases. Part IV explains that this perspective helps resolve the most common third-party liability problems, comparing and critiquing the overly restrictive way in which lower courts have responded to Stoneridge. In Part IV, I take a critical look at the "attribution" test for primary liability, which lower courts seem to assume has survived Stoneridge. Though that reading may be formally correct, I suggest that a duty-based reading obviates the need for it.
Because I do not expect to resolve the lingering confusion and inconsistency in current doctrine simply by reading Stoneridge differently, a further legislative fix is necessary. The cases are just too gerrymandered to operate fairly or effectively. So, in Part V, I suggest a revision of proportionate liability that is fair and workable in light of the analysis herein. With such a regime in place, concerns about excessive liability should diminish considerably, and with that, we can think in terms of expanding third-party liability beyond what the Court permits, including the restoration of aiding-and-abetting liability.
STONERIDGE: THE SCOPE OF THIRD-PARTY LIABILITY AND THE ROLE OF RELIANCE
In Stoneridge, plaintiffs alleged that two large vendors of cable television set-top boxes, Scientific-Atlanta and Motorola, had entered into deceptive transactions with a cable-system operator, Charter Communications, and backdated or falsified documents to disguise the sham. (13) Plaintiffs argued that by participating in Charter's scheme to inflate revenues with sham transactions, the vendors assumed responsibility for Charter's lies about its financial condition. This claim raised a host of interpretive questions, many of which the parties or the many amici addressed during briefing and argument. Had the two third-party defendants engaged in a deceptive device or contrivance of their own, rather than simply assisting Charter's? If so, was it in connection with the purchase or sale of a security? Did the plaintiffs adequately plead scienter, reliance, and loss causation? Of all these potential issues, the Court rested its holding solely on lack of reliance. (14)
In retrospect, this fixation on reliance seems to be a simple and predictable extension of the Court's 1994 holding in Central Bank of Denver v. First Interstate Bank of Denver, which radically narrowed the scope of third-party liability by excluding aiding-and-abetting liability as an acceptable claim under Rule 10b-5. (15) The fact that Stoneridge reads that way is hardly surprising, given that Justice Kennedy wrote both opinions and worked hard to make them seamless. But any seeming inevitability is hindsight bias at work: in fact, the two cases pose distinct issues and could readily support very different outcomes.
In Central Bank, the Court rejected aiding-and-abetting liability for a number of reasons, textual as well as policy-based, including fear of excessive litigation. (16) In dicta, the Court suggested, among other things, that aiding-and-abetting liability would allow defendants to be held "liable without any showing that the plaintiff relied upon the aider and abettor's statements or actions." (17) Later, the Court repeated that a person who employs a manipulative device can be found primarily liable, "assuming all of the requirements for primary liability under Rule 10b-5 [including reliance] are met," but emphasized that it was leaving open the question of the scope of primary liability (i.e., what kind of conduct exceeds mere aiding and abetting so as to fall within the scope of the prohibition). (18)
As commentators on Central Bank quickly pointed out, this emphasis on reliance was puzzling, (19) and in the cases that followed, plaintiffs took the perfectly sensible position that so long as there was some causal link between the third party's acts or omissions and the...