Secondary Liability Gets Personal: The WSJ and Bill Lerach

The Wall Street Journal ran an editorial, a lead editorial, on Saturday, decrying the recommendation by the SEC that the government weigh into In re Charter (we have discussed this case here) on the side of shareholders.  That is the case that involves the definition of primary liability under Rule 10b-5.  Oddly, the editorial contained no real legal analysis (except for a few vague inapposite references to Central Bank) and mostly amounted to a diatribe about Bill Lerach, the dean of the plaintiffs class action bar. 

Why did the editorial use Lerach analysis rather than legal analysis?  Because, as we will discuss in a day or so, those opposing Charter have a hard case on the merits.  Charter, at the end of the day, addresses whether anyone other than the issuer (and perhaps officers and directors) can be liable under Rule 10b-5.  The 8th Circuit, interestingly, answered by agreeing that others could.  The court extended liability to anyone who made a misstatement or "cause[d]" a misstatement to be made.  The court, however, went on to apply the test in a way exonerated anyone not directly involved in the drafting process, including vendors and other third parties who otherwise facilitated the fraud.  

To understand this approach, let's look at an example.  Assume a vendor agrees, in return for a bribe, to provide the issuer with documentation of a material transaction that in fact never occurred.  The company then reflects the transaction on its financial statements, committing securities fraud and harming investors.  Under Charter (and Credit Suisse), the vendor providing the false documentation is not subject to liability under Rule 10b-5 despite the sham nature of the transaction, the bribe, and the direct relationship to the fraud committed by the issuer.

To contend that this level of involvement in the fraud is aiding and abetting, the mere providing of assistance, is far fetched.  It directly causes the fraud, something covered by the "scheme to defraud" language in Rule 10b-5.  At the same time, it is the case that courts are rightfully nervous about extending antifraud liability to vendors, suppliers, and other persons or entities doing business with a company that commits securities fraud.  The test adopted in Simpson by the 9th Circuit, however, makes it clear that vendor liability will rarely if ever occur for transactions that have economic substance.  So, if it's not the merits, what is it?  In the case of the Wall Street Journal, it's personal.