Stoneridge, the Chamber of Commerce, and Invalidating Rule 10b-5

As oral argument in Stoneridge approaches, we take the opportunity to point out some of the more interesting positions taken by the various litigants filing briefs in the case.  Today, we note the argument of the Chamber of Commerce, with the organization filing a brief on behalf of Respondents.  A copy of the brief can be found at the DU Corporate Governance web site.

The 8th Circuit in Stoneridge glossed over the apparent contradiction between the use of the word "deceptive" in Section 10(b) and the phrase "scheme" liability in Rule 10b-5.  To the extent the term deception applies only to vendors in Stoneridge, somehow "scheme" liability likewise must be so limited.  Yet limiting those engaged in a scheme to those with affirmative disclosure obligations would seem inconsistent with the meaning of the term.

The Chamber of Commerce addressed the issue head on.  Rather than devise a limiting definition of scheme liability, the organization went further and essentially argued that scheme liability was invalid. 

• "Examination of the provisions of the 1933 and 1934 Acts shows that the Sec. 10(b) implied action should not be extended to create private civil claims for 'scheme' liability.  First, it would improperly override the limits on the express civil claims created by Congress.  Second, it would undo Congressional decisions that only the SEC and the Justice Department may sue defendants for participating in a scheme. .  . . Third, 'scheme' liability does not satisfy the established reliance and loss causation elements necessary for primary liability in a Sec. 10(b) private cause of action."

In one respect, the language was diplomatic, merely asking that an implied right of action not be extended to scheme liability.  But it was a small step to an obvious conclusion:  Rule 10b-5 itself is invalid.  After all, to the extent subsections (a) and (c) are struck down as beyond the scope of Section 10(b), can what's left of the rule remain in place?  A copy of the brief can be found at the DU Corporate Governance web site.  The brief was written by the National Chamber Litigation Center and Sidley & Austin. 

Comments

[Herrick Lidstone]

I have found your debate on Stoneridge to be quite informative, and this is my second post on the subject. I think that first it must be noted that this is only one of three unrelated but amazingly similar cases. The others are Regents of the University of California, et al. v. Credit Suisse First Boston (USA), Inc., Fed. Sec. L. Rep. (CCH) ¶94,173 (5th Cir. 2007), which arose out of the Enron-Nigerian barges fake sale and Simpson v. AOL Time Warner, Inc., Simpson, 452 F.3d 1040, 1048 (9th Cir. 2006), pet. for cert. filed (Oct. 16, 2006) (No. 06-650), where Homestore.com “bought revenue” by engaging in the same type of round-trip transactions that took place in Charter and Credit Suisse. In Simpson, the 9th Circuit found the secondary actor liable under Rule 10b-5, where in Credit Suisse, the 5th Circuit found the secondary actor not to be liable, as did the 8th Circuit in Stoneridge.

I think that it must also be noted that in none of these cases were the secondary actors innocent dupes. Some of the evidence shows clearly that they knew what they were doing and how they were helping the primary bad actor – Charter, Enron, and Homestore.com. But in no case did they make any public disclosures or representations that were then included in public disclosures. In no case were the secondary actors involved in the offer, purchase, or sale of securities. And in no case did the secondary actors have a duty to speak. As the Supreme Court said in Chiarella v. United States, 445 U.S. 222, 234 (1980), “When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak.”

While the secondary actors were clearly bad guys in each of those cases and I would argue had a moral duty to blow the whistle, I do not see that they had a legal duty when they were not otherwise engaged in relevant securities transactions. We will be interested in the oral arguments and anxiously waiting for the decision. Thanks for keeping us informed.