(June 2006, Business & Securities Litigator)
Reprinted by permission from Securities Regulation Law Journal
, Vol. 34, No. 1 (Spring 2006)
by Jonathan D. Polkes and Matthew L. Mustokoff
On September 3, 2003, New York
Attorney General Eliot Spitzer announced his investigation of market timing
and late trading in mutual funds. The investigation centered around allegations
that several mutual funds permitted market timing and late trading by hedge
funds, in contravention of the mutual funds’ prospectuses and to the detriment
of the funds’ long-term shareholders. In the wake of Mr. Spitzer’s investigation,
the Securities and Exchange Commission and various state attorneys general
have, to date, settled fraud cases with over thirty-five mutual funds,
hedge funds and financial institutions for an aggregate amount in excess
of $3.2 billion.
It did not take long for class
plaintiffs to commence parallel civil proceedings. The Judicial Panel on
Multi-District Litigation has referred approximately 170 market timing
class and derivative actions to a panel of three judges on the Federal
District Court for the District of Maryland for consolidated pretrial proceedings.
One of these Judges, J. Frederick Motz, recently issued the first decision
in the market timing cases resolving motions to dismiss, inter alia
claims brought under Section 10(b) of the 1934 Securities Exchange Act
and Rule 10b-5. In re Mutual Funds Investment Litigation
re Janus Subtrack
), 384 F. Supp. 2d 845 (D. Md. 2005).
As discussed in more detail below,
because the market timing cases provide a completely novel factual context
in which to test Rule 10b-5 jurisprudence, Judge Motz was compelled to
take a fresh look at certain previously well-established concepts. In particular,
the Court revisited the doctrines of: (i) Blue Chip Stamps v. Manor
 which established the standing requirements for plaintiffs
under Section 10(b); (ii) Central Bank of Denver, N.A. v. First Interstate
Bank of Denver, N.A.
 which extinguished aiding and abetting liability
in private Section 10(b) actions; and (iii) Basic, Inc. v. Levinson
and Affiliated Ute Citizens v. U.S.,
 which set forth circumstances
in which the element of reliance may be presumed.
How the Court interpreted and applied
each of these well-known doctrines in an unprecedented factual setting,
is the subject of this article.
The Allegations of Market Timing and Late Trading Fraud
Market timing is a form of arbitrage
that involves the rapid purchases and sales of mutual fund shares. Traditionally,
mutual funds are perceived of as long term investments, and the quick trades
engaged in by market timers may cause dilution in the value of shares held
by long term shareholders. This dilution is the result of, among other
things, increased transaction costs incurred by the funds, as well as a
disproportionate share of losses suffered by long term shareholders on
days when the fund’s net asset value (“NAV”) declines, after the market
timers have exited the funds and profited from their sales.
Thus, while market timing is not
illegal per se
, many mutual funds in their prospectuses restrict
the rights of investors to market time. Moreover, problems arise when,
as alleged by regulators and the plaintiffs, mutual funds allow certain
favored investors to market time with knowledge that this activity may
harm other investors. As explained by Judge Motz, “[a]lthough market timing
itself may be lawful, it nevertheless is prohibited by Rule 10b-5 if it
is engaged in by favored market insiders at the expense of long-term mutual
fund investors from whom it is concealed and who have a right to rely upon
its prevention by fund advisers’ and managers’ good faith performance
of their fiduciary obligations.”
Late trading is a specific form
of market timing that regulators have declared to be illegal. This practice
involves the placing of orders to purchase or sell mutual fund shares after
the close of the New York Stock Exchange trading session at 4:00 p.m. ET,
but receiving the price based on the prior NAV already calculated as of
4:00 p.m. Late trading enables the trader to profit from knowledge of post
4:00 p.m. market-moving events that are not incorporated into that day’s
complaint identifies three specific categories of defendants - and the
theory of liability as to each is very different. First are the mutual
funds, their trustees and their advisors (the “fund defendants”) that
were alleged to have misleadingly represented in their prospectuses that
market timing and late trading are restricted or prohibited. They were
also alleged to have selectively enforced these prohibitions by allowing
favored investors - mostly hedge funds - to engage in market timing, often
in exchange for additional investments in other mutual funds controlled
or managed by the same fund defendant.
Second, the complaint identifies
the hedge funds and other arbitrageurs which allegedly conducted and profited
directly from the market timing transactions (the “trader defendants”).
They were alleged to be liable under Rule 10b-5, even though they did not
themselves make any of the actionable misrepresentations or omissions in
the mutual funds’ prospectuses. Rather, these defendants were alleged
to have participated in an ongoing scheme to defraud mutual fund investors
by entering into clandestine agreements with the fund defendants to engage
in prohibited market timing trades. Some trader defendants were also alleged
to have used specially designed trading platforms to place trades after
Finally, the complaint names certain
financial institutions which allegedly facilitated the trader defendants
by executing, clearing and financing the market timing transactions (the
“broker-dealer defendants”). Like the trader defendants, the broker-dealer
defendants were not alleged to have made fraudulent misrepresentations
or omissions themselves. Rather, plaintiffs alleged that these financial
institutions provided the trader defendants with execution of the mutual
fund transactions, financing, securities clearing, and access to trading
systems which allowed the trader defendants to market time and late trade.
Standing Under Rule 10b-5 For “Holders”: Blue Chip Stamps Reconsidered
As a threshold issue, the Court
addressed plaintiffs’ standing under Rule 10b-5. Plaintiffs purported
to bring claims on behalf of those shareholders who not only bought and
sold mutual fund shares, but also those who merely held shares during the
relevant period. Defendants argued that plaintiffs who simply held shares
of mutual funds during the class period, as opposed to bought or sold shares,
lack standing under the doctrine announced by the Supreme Court in Blue
In Blue Chip Stamps
Supreme Court held that only purchasers or sellers of securities may bring
a private action for damages under Rule 10b-5. In so holding, the Court
noted the “danger of vexatious litigation which could result from a widely
expanded class of plaintiffs under Rule 10b-5.” In particular, the
Court explained that without placing a limitation on the universe of potential
plaintiffs under the antifraud provisions of the federal securities laws,
an action under Rule 10b-5, insofar as it purports to protect an investor
have sold securities in the absence of fraud, “will turn
largely on which oral version of a series of occurrences the jury may decide
to credit, and therefore no matter how improbable the allegations of the
plaintiff, the case will be virtually impossible to dispose of prior to
trial other than by settlement.” Thus the Court adopted the purchaser-seller
holding requirement to limit Section 10(b) claims to those who have at
least dealt in the security to which the allegedly fraudulent misrepresentationsor omissions relate - an “objectively demonstrable fact in an area of
the law otherwise very much dependent upon oral testimony.”
Eschewing a mechanical application
of the purchaser-seller rule, Judge Motz “question[ed] whether Blue
bars suits under Rule 10b-5 by persons who held (but did
not purchase or sell) mutual fund shares during a relevant class period
when profits were allegedly being siphoned off from the funds by market
timers and late traders.” Emphasizing the distinctive nature of plaintiffs’
theory of damages which, unlike in more conventional securities fraud cases,
does not focus on the drop of a stock price on a given trading day but
rather the gradual dilution of share value over a period of time, the Court
expressed concerns about “elevat[ing] rule over principle.” As Judge
Motz elaborated, plaintiffs’ claims are fundamentally different from the
claims in the typical securities fraud case:
Here, the prudential consideration
that led the Supreme Court to adopt (in my view wisely) the Blue Chip
rule - the risk of vexatious, manufactured litigation - does
not exist because holder plaintiffs by definition held mutual fund shares
during the period that the value of the shares was diluted by late trades
and market timing. Their claims are not based upon an inherently speculative
inquiry into their subjective state of mind but upon the concrete fact
of their continued share ownership. In this respect, the present case differs
not only from the Blue Chip Stamps
paradigm in which a plaintiff
alleges he decided not to purchase a security because of a misrepresentation
- but also from other holder actions in which a plaintiff alleges he would
have sold but for a misrepresentation. Here, plaintiffs do not seek damages
for the non-consummation of a hypothetical transaction but for value diminution
and associated damages they suffered while holding their shares.
The Court added that to apply the
Blue Chip Stamps
rule and permit suit by purchasers and sellers
of mutual fund shares but not holders would have the “supremely ironic
effect” of discriminating against those plaintiffs who suffered the greatest
damage - namely, the long-term shareholders who may have purchased their
shares well before the class period, but whose shares were exposed to the
allegedly dilutive effect of market timing for more protracted periods
The Court, ultimately, was troubled
that a uniform “national forum” in which “all who are similarly damaged
are similarly treated” would be denied if Blue Chip Stamps
interpreted to bar the holders’ claims under federal law and force holders
to seek redress in state court. Thus the Court allowed the holders’ claims
to proceed at this stage of the litigation. In so doing, however, Judge
Motz avoided a direct collision with Blue Chip Stamps
. Rather than
abrogate the purchaser-seller rule, the Court held that because plaintiffs’
claims were brought on behalf of a “mixed” class, or one comprised of
both purchasers and holders, the holders’ claims were sufficiently pled
with respect to standing and could proceed for the time being. As the
Court explained, “[p]laintiffs have asserted claims on behalf of a class
that includes purchasers, as well as holders, and on that basis alone their
claims survive defendants’ Blue Chip Stamps
while the Court was unwilling to recognize an exception to Blue Chip
outright, it nonetheless refused to apply Blue Chip Stamps
to dismiss the holders’ claims under the circumstances here, suggesting
that strict adherence to the purchaser-seller rule would work an injustice.
Scheme Liability Claims Under Rule 10b-5(a) and (c)
Turning to the merits of the plaintiffs’
Section 10(b) and Rule 10b-5 claims, the Court denied the motions to dismiss
the claims against the fund defendants. Plaintiffs alleged that the fund
defendants failed to disclose that their funds allowed market timing and
late trading by a select group of investors. These claims were brought
pursuant to subsection (b) of Rule 10b-5 which prohibits misrepresentations
and omissions of material fact. Thus the Court had little trouble applying
this traditional prong of Rule 10b-5 to the allegations.
Neither the trader defendants nor
the broker-dealer defendants, however, were alleged to have had anything
to do with the mutual fund prospectuses, nor were they alleged to have
made any false statements or omissions. Therefore, the claims against the
trader defendants and the broker-dealer defendants were not based on subsection
(b), but rather what is known as “scheme” liability under subsections
(a) and (c). Subsection (a) prohibits employment of a “device, scheme,
or artifice to defraud,” while subsection (c) prohibits engaging in an
“act, practice or course of business which operates or would operate as
a fraud or deceit.” These subsections of Rule 10b-5 address a category
of non-representation-based fraudulent conduct that is analytically distinct
from the more familiar, garden-variety misrepresentations and omissions
proscribed by subsection (b) of the rule.
The Rule 10b-5(a) and (c) claims
in this case exemplify a growing trend by securities fraud plaintiffs to
rely on the “scheme” liability prongs of the rule in an effort to evade
the proscription against aiding and abetting liability recognized by the
Supreme Court in Central Bank of Denver, N.A. v. First Interstate Bank
of Denver, N.A.
 In Central Bank
, the Court held that a plaintiff
in a private damages action brought under Section 10(b) cannot recover
against a party alleged merely to have aided and abetted another party’s
violation of the statute. In so holding, the Court reasoned that permitting
aiding and abetting claims would allow a plaintiff to impermissibly establish
a claim “without any showing that the plaintiff relied upon the aider
and abettor’s statements or actions,” thereby allowing plaintiffs to
circumvent the reliance requirement of Rule 10b-5.
Ever since the Supreme Court barred
aiding and abetting liability in Central Bank
a little over a decade
ago, plaintiffs have relied increasingly upon Rule 10b-5(a) and (c) to
hold secondary actors accountable for their role in an alleged fraud, arguing
that while these secondary actors may not themselves have made actionable
representations, either by misstatement or omission, they are nevertheless
liable for primary violations of Section 10(b) through their manipulative
or deceptive acts
In their motion to dismiss, the
trader and broker-dealer defendants argued that, at most, plaintiffs had
alleged that these outside financial institutions were aiders and abettors
of the mutual funds’ fraudulent omissions, and that plaintiffs’ scheme
liability claims were a thinly veiled attempt to avoid the rule of Central
. Plaintiffs, in response, contended that scheme liability is a
valid form of primary liability under Section 10(b), and that it is enough
to plead that the trader and broker-dealer defendants were part of the
mutual funds’ fraudulent scheme, even if they made no misrepresentations
or omissions themselves, and that such participation constituted more than
mere aiding and abetting. In support of their position, plaintiffs relied
heavily on District Judge Melinda Harmon’s decision in In re Enron
Sec., Deriv. and ERISA Litig
. In Enron
, the Southern District
of Texas court held that a secondary actor is liable under Rule 10b-5(a)
and (c) if it, acting with others, “creates a misrepresentation,” even
if it does not initiate the misrepresentation, sign the document containing
the misrepresentation, or disseminate the misrepresentation.
In articulating a different standard
for scheme liability than the standard set forth in Enron
, the Court
stated that for liability to attach defendants “must themselves have been
co-designers of the scheme or have ‘committed a manipulative or deceptive
act in furtherance of the scheme.’” Judge Motz noted the lack of
judicial clarity on the bounds of scheme liability, commenting that “different
courts have viewed the demarcation between what constitutes a mere facilitatingact and a manipulative act somewhat differently.” Ambiguity in the
case law notwithstanding, the Court summarily rejected the trader defendants’
position that they were mere “secondary actors,” explaining that “the
trader defendants are alleged to have been involved in the fraudulent scheme
from the outset and to have been at least one of its architects.”
The Court added that “it is the trader defendants who received the profits
that were siphoned off from the mutual funds as a result of late trades
and market timed transactions. These are not the activities of a mere aider
and abettor but those of a primary participant in the unlawful conduct.”
Accordingly, with the exception of one trader defendant, the Court denied
the trader defendants’ motions to dismiss the Rule 10b-5 claims.
With respect to the broker-dealer
defendants, the Court remarked that they “stand in a different position”
than the trader defendants. As the Court explained, these defendants
are not alleged to have been the “direct beneficiaries of the scheme’s
proceeds,” and their “mere knowledge” that they were executing, clearing
or financing market-timing and late trading on behalf of their customers
is not sufficient to render them liable under Rule 10b-5; rather, something
inherently “manipulative or deceptive” is required. Avoiding application
of any bright-line test, the Court analyzed the Rule 10b-5(a) and (c) allegations
against each individual broker-dealer defendant, yielding different results.
Judge Motz found that the pleadings
against several of the broker-dealers were insufficient to state claims
under Rule 10b-5 (a) and (c). The Court noted that while the allegations
against these financial institutions demonstrate that they may have been
aiders and abetters to a market timing scheme, they do not charge that
they “orchestrated the [allegedly fraudulent] scheme or committed manipulative
or deceptive acts in its furtherance.” Accordingly, the Court found
that the fraud claims against these broker-dealers fail under Central
By contrast, the Court found that
the allegations against two other broker-dealers stated claims sufficient
to survive a motion to dismiss. In so holding, the Court focused on the
allegations that Bank of America provided Canary - the first hedge fund
to settle criminal charges with the New York Attorney General at the outset
of the market timing scandal - with an electronic trading system that permitted
Canary to place mutual fund trades as late as 8:30 p.m. The Court also
pointed to the allegations that one of the broker-dealers gave a network
of brokers access to its electronic mutual funds trading system in order
to place late trades and disabled the time stamp function on the system
so that there was no record of when the trades were placed. As the
Court stated, while “mere financing or clearing of transactions, even
with knowledge that they are part of a fraudulent scheme, are insufficient
to subject a person to Rule 10b-5 liability under Central Bank
the alleged acts of these broker-dealers “are ‘manipulative or deceptive’
on their face” and suggest that these institutions “participated in initiating,
instigating and orchestrating the [allegedly fraudulent] scheme” - a hallmark
of primary liability.
Reliance: Fraud-On-The-Market Presumption Does Not Apply, But Affiliated Ute Presumption Does
The Court turned next to the element
of reliance. Insofar as the only misrepresentations or omissions pled in
the complaint involved the statements in the prospectuses from the mutual
funds, the issue arose as to whether it would be necessary to plead that
each individual plaintiff read the mutual fund prospectus and relied on
its statements about market timing. In arguing that reliance was adequately
pled with respect to all three groups of defendants, plaintiffs maintained
that actual reliance by the shareholders need not be alleged because two
judicially recognized presumptions of reliance are applicable on the facts
presented: the “fraud-on-the-market” presumption recognized in Basic
and the presumption for omissions-based claims recognized in Affiliated
. As discussed below, in determining whether the plaintiffs
were entitled to rely upon either of these “proxies” for pleading actual
reliance, the Court was confronted with arguments by the defendants that
the allegations in the complaint did not fit the conventional fact patterns
which typically lend themselves to application of these two frequently
invoked doctrines in Rule 10b-5 cases.
First, plaintiffs argued that they
were entitled to rely on the fraud-on-the-market presumption of reliance.
This presumption was first recognized by the Supreme Court in Basic
where the Court reasoned that investors that buy or sell stock at the price
set by the market do so “in reliance on the integrity of that price,”
and that because all publicly available information has been reflected
in that price, “an investor’s reliance on any public material misrepresentations
. . . may be presumed for purposes of a Rule 10b-5 action.” Importantly,
however, the Basic
Court emphasized that application of the fraud-on-the-market
presumption is not mechanical and may be rebutted by “[a]ny showing that
severs the link between the alleged misrepresentation and either the price
received (or paid) by the plaintiff, or his decision to trade at a fair
market price.” For example, when a plaintiff fails to plead the existence
of an efficient and developed market for the relevant security, the plaintiff
is not entitled to the presumption and must allege actual reliance.
Judge Motz quickly disposed of
plaintiffs’ fraud-on-the market contention. The defendants argued that
application of the Basic
presumption made no sense in the case of
mutual fund shares because fraud-on-the-market reliance may be presumed
only when there is a clear connection between the alleged fraud and the
market price of the security paid or received by the plaintiff. In the
case of mutual fund shares, defendants maintained, the share price, or
NAV, is a mathematical composite of the prices of the fund’s underlying
securities and is generally unaffected by information in the marketplace
about the fund itself. Persuaded by this argument, the Court held that
plaintiffs could not avail themselves of the fraud-on-the-market presumption:
The difficulty with [plaintiffs’]
contention is that the fraud on the market theory is based upon the proposition
that material misrepresentations or failures to disclose material facts
will result in inflated prices. Here, the effect of late trading and market
timing was to depress share value. Moreover, the fraud on the market theory
focuses on the point of sale whereas plaintiffs’ damage theory concentrates
on the dilution of share value over time.
Alternatively, plaintiffs invoked
the doctrine of Affiliated Ute
to evade the requirement of pleading
actual reliance. In Affiliated Ute
, the Supreme Court held that
in Rule 10b-5 cases premised on omissions by a defendant owing a fiduciary
duty of full disclosure to the plaintiff, “positive proof of reliance
is not a prerequisite to recovery”; rather, all that is required is that
the facts withheld by the defendant are material. Applying this principle,
Judge Motz reasoned that a potential mutual fund investor “might have
considered it important to know whether (and to what extent) favored investors
were being allowed to late trade in light of the fact that toleration of
the practice could increase fund expenses and have a substantial effect
upon future fund performance.”
Significantly, the Court rejected
defendants’ position that plaintiffs’ claims were not pure omissions
claims because plaintiffs had also alleged that the fund defendants made
several affirmative misrepresentations in their prospectuses, including
statements that Janus enforces an excessive trading policy aimed at market
timers and does not accept trades placed after 4:00 p.m. The Court noted
that while “at a certain level of generalization” the Affiliated Ute
presumption of reliance does not apply when a plaintiff alleges both omissions
and affirmative misstatements, or so-called “mixed” claims, “a moreprecise and accurate statement of the rule is that the presumption applies
only where a plaintiff’s claim is primarily
based upon material
omissions.” Judge Motz concluded that the gravamen of the complaint
is the fund defendants’ failure to disclose that they were permitting
a select handful of investors to engage in market timing and late trading
in violation of their fiduciary duties to their shareholders, thereby triggering
application of the Affiliated Ute
Notably, the Court found the presumption
to apply as to the claims against the trader and broker-dealer defendants
as well, notwithstanding that these defendants had no direct relationship
with the plaintiffs, let alone a fiduciary relationship giving rise to
duties of disclosure. In rejecting the trader and broker-dealer defendants’
argument that they, unlike the fund defendants, said or did nothing upon
which plaintiffs could have justifiably relied, Judge Motz invoked Central
: “Because Central Bank
and its progeny recognize that
a person other than a defendant with whom the plaintiff directly dealt
may be held liable under Rule 10b-5, it necessarily follows that a person
who is a principal, and not merely an aider and abettor, in a fraudulent
scheme can be held responsible for his own acts committed in connection
with a scheme founded on misrepresentations and omissions.”
This articulation of the reliance
element in the Rule 10b-5(a) and (c) context, however, is difficult to
reconcile with the Supreme Court’s chief concern in Central Bank
that by recognizing aiding and abetting liability, a “defendant could
be liable without any showing that the plaintiff relied upon the aider
and abettor’s statements or actions,” thereby circumventing an established
element of Section 10(b) fraud. Viewing the issue through the lens
of this statement by the Supreme Court, Judge Motz’s reliance analysis
appears more of a departure from - rather than an adherence to - the
critical reasoning of Central Bank
that aiding and abetting liability
is fundamentally inconsistent with the requirement of direct reliance.
The distinctive character of market
timing and late trading - activities which up until now have been virtually
unexplored by the courts - required the Court in In re Mutual Funds
to revisit the contours of several judicial doctrines
construing Rule 10b-5 and to apply them in an unfamiliar context. The Court’s
holdings with respect to standing for non-purchasers and non-sellers, the
reach of scheme liability under Rule 10b-5(a) and (c) and presumptions
of actual reliance are significant and can be expected to influence not
only the emerging jurisprudence of mutual fund market timing, but application
of the securities laws in general.
* * *
- The other judges sitting
on this panel are Judge Catherine C. Blake and Andre M. Davis of the District
- 421 U.S. 723 (1975).
- 511 U.S. 164 (1994).
- 485 U.S. 224 (1988).
- 406 U.S. 128 (1972).
- Indeed, during the class
period, at least one SEC Administrative Law Judge expressly stated in proceedings
involving market timing that “[m]arket timing of mutual fund purchases
and sales does not violate federal securities laws.” In re Flanagan,
Rel. No. ID-160, 2000 WL 98210, at *5 (SEC Jan. 31, 2000) (emphasis added);
see also In re Market Timing Sys. Inc., Rel. No. IA-2048, 2002 WL
1979381, at **1-2 (SEC Aug. 28, 2002) (in a case relating generally to
the mutual fund market timing business, providing no indication that market
timing practices could be considered in any way fraudulent or improper);
First Lincoln Holdings, Inc. v. Equitable Life Assur. Soc’y of U.S.,
164 F. Supp. 2d 383, 391 n.9 (S.D.N.Y. 2001) (noting that market timing
“is not illegal”), aff’d, 43 Fed. Appx. 462 (2d Cir. 2002).
- 384 F. Supp. 2d at 856.
- See id. at 854.
- The Janus plaintiffs’
consolidated complaint names nineteen defendants. The fund defendants include
Janus Capital Group, Inc., Janus Capital Management LLC, Janus Distributors
LLC, Janus Investment Fund, and Janus Adviser Series. The trader defendants
include Canary Capital Partners, LLC, Canary Capital Partners, Ltd. (collectively,
“Canary”), Edward J. Stern, Gregory Trautman, Trautman Wasserman &
Co., Rydex Investments, Round Hill Securities, Inc. and Canadian Imperial
Bank of Commerce. The broker-dealer defendants include Bank of America
Corp. (“Bank of America”), Bear, Stearns & Co. (“Bear Stearns”),
CIBC, AST Trust Co., Prudential Securities, Inc. and Wachovia Securities,
- 421 U.S. 723.
- Id. at 740.
- Id. at 747.
- 384 F. Supp. 2d at 854.
- Id. (“A court-made
rule that is created in one context to implement a fundamental precept
should not be mechanically applied in a new context without asking the
threshold question whether the same principled considerations that gave
rise to the rule dictate a different rule under different circumstances.”).
- Id. at 854 n.6.
- The Court’s opinion leaves
open the possibility that it will revisit the issue of the holders’ standing
at a later stage of the litigation, perhaps at the class certification
stage or the damages stage.
- Id. at 855. The
Court further noted that because many of the mutual fund shareholders likely
participated in dividend reinvestment programs, it is probable that many
plaintiffs who purchased their shares prior to the class period nevertheless
fall within a class of purchasers during the class period. See id.
- Rule 10b-5(b) makes it
“unlawful for any person . . . to make any untrue statement of a material
fact or to omit to state a material fact necessary in order to make the
statement made, in the light of the circumstances under which they were
made, not misleading . . .”
- 511 U.S. 164, 188 (1994).
- Id. The Court in
Central Bank noted that Congress could have expanded Section
10(b) liability to aiders and abettors, but chose not to do so. Id.
at 176-77, 191.
- Id. at 180. The
Court further cautioned that, unless precluded, the boundless and “unclear”
limits of aiding and abetting liability could lead to inconsistent results
“in ‘an area that demands certainty and predictability.’” Id.
at 188 (quoting Pinter v. Dahl, 486 U.S. 622, 652 (1988)).
- 235 F. Supp. 2d 549, 692
(S.D. Tex. 2002).
- Id. The so-called
“creator” test employed by Judge Harmon was proposed originally by the
SEC in an amicus brief filed in 1998. The SEC’s amicus brief
submitted in Enron was initially written for the Third Circuit Court
of Appeals’ en banc review in Klein v. Boyd, 1998 WL 55245
(3d. Cir. 1998), rehearing en banc granted, judgment vacated (Mar.
9, 1998). Klein settled before the en banc panel could hear
the case. See Brief of the SEC, Amicus Curiae, Klein v. Boyd,
Nos. 97-143, 97-1261 (3d Cir. 1998).
- 384 F. Supp. 2d at 858
(quoting Cooper v. Pickett, 137 F.3d 616, 624 (9th Cir. 1997)).
- See id. One explanationfor the dearth of judicial precedent in this area is that prior to Central
Bank, subsections (a) and (c) of Rule 10b-5 were rarely, if ever, invoked
by plaintiffs. The reason for this, as one District Judge has recently
surmised, is that during the pre-Central Bank era of aiding and
abetting liability, the “path of least resistance” for a plaintiff alleging
a fraud involving multiple actors was to plead that one defendant misrepresented
or omitted a material fact and that the other defendants aided and abetted
the making of that misrepresentation or omission. In re Parmalat Sec.
Litig., 376 F. Supp. 2d 472, 497 (S.D.N.Y. 2005) (Kaplan, J.). Thus,
before Central Bank, litigants and courts alike paid little attention
to the distinction between the misconduct prohibited by subsection (b)
- i.e., misstatements and omissions - and the less recognizable
misconduct prohibited by subsections (a) and (c). To see how some courts
have addressed Rule 10b-5(a) and (c) claims in recent decisions, see,
e.g., In re Lernout & Hauspie Sec. Litig., 236 F. Supp.
2d 161, 173 (D. Mass. 2003) (denying motion to dismiss Rule 10b-5(a) and
(c) claims against venture capital fund for funding and operating sham
entities used by issuer to record revenue from bogus licensing contracts:
“The better reading of § 10(b) and Rule l0b-5 is that they impose primary
liability on any person who substantially participates in a manipulative
or deceptive scheme by directly or indirectly employing a manipulative
or deceptive device (like the creation or financing of a sham entity) intended
to mislead investors, even if a material misstatement by another person
creates the nexus between the scheme and the securities market.”); In
re Homestore.com Sec. Litig., 252 F. Supp. 2d 1018 (C.D. Cal. 2003)
(granting motion to dismiss Rule 10b-5(a) and (c) claims against business
partners of principal defendant Homestore based on scheme to inflate Homestore’s
revenues through a series of sham transactions: “No matter how a ‘scheme’
is defined, Central Bank dictates that only those participants who
commit ‘primary violations’ of the securities laws may be held liable;
those who merely facilitate or participate cannot . . . . [P]laintiff suffered
damages through its reliance on [Homestore’s] false or misleading statements,
not from the ‘scheme’ itself. . . . The principal ‘wrong’ alleged under
the rule is the statement, not the scheme.”); In re Global Crossing,
Ltd. Sec. Litig., 322 F. Supp. 2d 319, 335-37 (S.D.N.Y. 2004) (finding
primary violation sufficiently alleged when defendant-auditor allegedly
“masterminded” sham transactions and other misleading accounting practices
and played a “central role in the [ ] schemes, as their chief architect
and executor”: “It is apparent from Rule 10b-5’s language and the
case law interpreting it that a cause of action exists under subsections
(a) and (c) for behavior that constitutes participation in a fraudulent
scheme, even absent a fraudulent statement by the defendant . .
. .”) (emphasis added).
- Id. at 857.
- Id. at 857-58.
- The Court granted CIBC’s
motion to dismiss the Rule 10b-5 claim on the ground that plaintiffs failed
to plead CIBC’s alleged role as a trader with the requisite particularity
under Rule 9(b) of the Federal Rules of Civil Procedure and the Private
Securities Litigation Reform Act (“PSLRA”). See id. at 858 n.12.
- See id. at 858.
- Id. at 859-860.
- See id. at 860.
- See id. at 860-861.
- Id. at 862.
- 485 U.S. 224.
- 406 U.S. 128.
- Id. at 247.
- Id. at 248.
- See id.; see
also, e.g., Freeman v. Laventhol & Horwath, 915 F.2d
193, 198-99 (6th Cir. 1990) (presumption did not apply because market for
newly issued tax-exempt municipal bonds was not efficient); Binder v.
Gillespie, 184 F.3d 1059, 1064 (9th Cir. 1999) (presumption did not
apply because of inefficient market (decertifying class)); Krogman v.
Sterritt, 202 F.R.D. 467, 474-78 (N.D. Tex. 2001) (presumption did
not apply because OTC Bulletin Board was not an efficient market).
- 384 F. Supp. 2d at 863
- Affiliated Ute,
406 U.S. at 153-54.
- 384 F. Supp. 2d at 863.
- Id. at 863-64 (emphasis
- Id. at 862.
- Central Bank, 511
U.S. at 180.