Stoneridge and Scheme Liability: The Views of Robert Prentice

Robert Prentice, the Ed & Molly Smith Centennial Professor of Business Law, McCombs School of Business, University of Texas at Austin, has made an appearance on this Blog before. He writes often in the corporate area, often with a pro-shareholder, pro-SOX outlook. His latest piece is no different. Titled SCHEME LIABILITY, FEDERAL SECURITIES FRAUD, AND JOHN WAYNE’S i-POD, the piece is a thorough examination of the issues in Stoneridge, the primary liability case currently pending at the Supreme Court.

The piece undertakes a number of highly useful tasks. It goes back in time and looks at the state of the law in 1934, analyzing both common law fraud and blue sky statutes. The piece concludes that common law fraud covered anyone who "participated" in the fraud. In fact, because of this standard, Congress had no reason to include aiding and abetting language in Section 10(b); secondary liability was already covered by the participation language. Only later did courts start to distinguish between primary and secondary actors. As he noted:

• The distinction between primary and secondary liability in intentional tort cases, which largely came into existence in 1966 and became important only in 1994, was essentially meaningless in 1934. Neither the common law of fraud nor blue sky laws nor any other pertinent antecedents to Section 10(b) meaningfully distinguished between primary and secondary liability for participants in an intentional tort. Unless the 1934 Congress had a crystal ball allowing it to divine what was going to happen in 1966 and 1994, it simply could not have foreseen a need to include an express provision for aiding and abetting liability in order to reach the actions of Merrill Lynch in the NBT or the vendors in Charter Communications.

He dredged up some language from an old 1940 Act case, Capital Gains Research Bureau, Inc., 375 U.S. 180, 197-99 (1963), where the Court stated: "It was understandable, therefore, for Congress, in declaring certain practices unlawful, to include both a general proscription against fraudulent and deceptive practices and, out of an abundance of caution, a specific proscription against nondisclosure." In other words, the broad language prohibited actions (deceptive practices) but was susceptible to an argument that it didn't include nondisclosure. Congress, to make sure that it also covered nondisclosure, provided a "specific proscription."

The article goes on to analyze Central Bank and Stoneridge. For Prentice, Stoneridge is not a hard case.

• There can be no reasonable doubt as to the validity of subsections (a) and (c) of Rule 10b-5, and no real question regarding the fact that they punish deceitful conduct as well as false representations and omissions. All objections to application of scheme and course of business liability blatantly ignore the wording of Section 10(b), the solid grounding of Rule 10b-5’s subsections (a) and (c) in the express language of Section 10(b), and repeated Supreme Court rulings approving these alternative routes to liability. The obliviousness of most lower courts to these considerations is a bit of a mystery.

Prentice has played a significant role in this process already, having been used by the 9th Circuit in Simpson to extend primary liability to vendors and has been distinguished by the 5th Circuit in the Enron case.   We shall perhaps learn what the Supreme Court thinks of his persuasive reasoning. 

Comments

[Francine McKenna]

"It will mean that people at companies like Motorola and Scientific-Atlanta will confront not civil liability (with any settlement amounts likely paid by D&O insurance policies) but criminal prosecution. This has already occurred, for example, with respect to backdating. The organizations that opposed Stoneridge on behalf of business will simply provide additional impetus to criminal prosecution of corporate officers and directors."

Positively brilliant!

Thanks for pointing out what to me seems an obvious and essential truth.