Attorney Says SEC May Retain Ability to Allege Scheme Liability

Securities Law Daily
By Rachel McTague
January 30, 2008

A Securities and Exchange Commission trial counsel Jan. 29 contended that in the wake of the U.S. Supreme Court's recent decision rejecting scheme liability in private securities fraud actions, the SEC may still have leeway to charge third parties who assisted an issuer in a securities fraud under a scheme liability theory, as primary violators.

Speaking at a District of Columbia Bar program, Robert Pommer, said, "The inclination from the commission's standpoint would be to pursue primary liability claims in the first instance. ...I guess what remains to be seen is how the case [will be decided] ... subsequent to Stoneridge."

On Jan. 15, in Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc., the high court ruled 5-3 that the suppliers and customers whose alleged nonpublic deceptive acts helped a cable television company cook its books may not be held liable by investors as primary violators under the antifraud provisions of the 1934 Securities Exchange Act . The suppliers/customers allegedly documented sham transactions with the issuer in such a way as to mislead the issuer's auditor, thus allegedly becoming part of the issuer's scheme.

Pommer made his remarks at a luncheon sponsored by the District of Columbia Bar Association's Corporation, Finance and Securities Law Section; Broker-Dealer Regulation and SEC Enforcement Committee; and the Litigation Section of the Investor Rights Committee. He said that he was speaking only on his own behalf.

Secondary Actors

"First and foremost, in this case, the Supreme Court confirmed the SEC's authority to sue secondary actors," Pommer said. The court clearly distinguished between permissible SEC actions and private rights of action, he noted. Stoneridge "could be viewed as a mandate to the SEC that we should continue to aggressively pursue secondary actors who aid and assist others in the fraud," he remarked, adding that this is particularly so in light of the fact that the Justice Department and the SEC alone are "left to do so." Under Supreme Court precedent, private parties may not pursue aiding and abetting claims in securities fraud actions.

Pommer pointed to the SEC's enforcement action last year charging a number of employees of or agents for vendors that supplied U.S. Foodservice Inc., a subsidiary of Royal Ahold (Koninklijke Ahold N.V.), with aiding and abetting violations for signing and returning materially false audit confirmations sent to them by the company's auditors. The SEC pursued those secondary actors "as aiders and abettors of USF's larger fraud," he emphasized, adding, "I would suspect that we would continue to pursue those types of claims."

Charging Decisions

In an SEC enforcement action, Pommer explained, "[y]ou're always faced with a charging decision--[whether] you charge as a primary violator or aider and abettor. There are different elements to aiding and abetting claims." He continued, "The scienter standard for aiding and abetting claims is different in different jurisdictions. Our initial inclination is, if we have a choice, to plead primary liability. Sometimes we plead in the alternative. I think part of the confusion is that someone who is primarily liable is also aiding and abetting other people in participation in a larger fraud. So, often times, we plead it both ways." Following the Stoneridge decision, Pommer said, "I would ... suspect that we would look to scheme liability and just not plead everything."

After Stoneridge, Pommer suggested, "[f]rom a going forward point, at least from my perspective, we can take those distinctions"--between SEC enforcement cases and private securities actions--"and still preserve our ability to seek scheme liability to go after aiders and abettors."

According to Pommer, from the SEC's standpoint, the Supreme Court could have handed down a ruling in Stoneridge that would have been "a lot worse," than the ruling it made. "The court rejected the actual holding of the Eighth Circuit, ... [which] held that there could be no liability under 10(b) without an actual misstatement or omission when there was a duty to speak," Pommer clarified. "If the Supreme Court had confirmed the decision on those grounds, it would have done serious damage to SEC enforcement actions. In fact, in rejecting that, the Supreme Court held that the conduct itself may be actionable."
In private actions under Securities Exchange Act Section 10(b), the plaintiff must show reliance, Pommer related. "I submit that the decision still holds for the proposition that the SEC has ... authority to pursue scheme liability, because, essentially, we do not have to prove reliance in our enforcement cases and the court did recognize that the conduct itself may be deceptive."

Dismissing SEC Actions

Moderator Larry Ellsworth, a partner at Jenner & Block LLP in Washington, noted that courts not infrequently dismiss the SEC's primary liability claims and permit the agency to pursue aiding and abetting claims, when the commission has sued in the alternative.
Pommer responded that in some instances, depending on what court is hearing the case, "[y]ou're left with the anomalous result that the scienter standard is higher for the aider and abettor than it is for the primary violator." "[E]specially when [the defendant was] aiding and abetting non-scienter based claims--are you imposing a far greater scienter standard for what are non-10(b) claims?" he asked.

Under Stoneridge, said Daniel S. Sommers, a securities class action litigator at Cohen Milstein Hausfeld & Toll PLLC in Washington, auditors will continue to be subject to primary liability in private securities fraud actions because, among other things, they can be charged with signing materially misleading statements.

Ellsworth said that he detected an increasing trend in the past several years in the number of reported cases in which courts dismissed SEC actions, a trend that he related to heightened pleading standards such as the loss causation pleading standard imposed by the high court in Dura Pharmaceuticals Inc. v. Broudo. Ellsworth reported that in 2000 and 2001, one case was dismissed each year; in 2002, no cases were dismissed; in 2003 through 2005 two cases were dismissed each year. Then, in 2006 and 2007, courts dismissed six and seven SEC cases, respectively.

However, Pommer contended that there has been "no distinguishable trend" relating to the dismissal of SEC cases on motions to dismiss.

Courts Looking "Intensely and Skeptically."

Meanwhile, Ellsworth urged that in the wake of Stoneridge, Dura Pharmeuticals, and the Page Securities Law Daily - Attorney Says SEC May Retain 2 of 3 Supreme Court's 2007 decision in Tellabs Inc. v. Makor Issues & Rights Ltd., "[j]udges are looking much more intensely and skeptically at pleadings in all cases". He then suggested a correlation between the change in pleading standards and the decreasing number of securities class action filings. Ellsworth pointed to statistics showing that securities class actions decreased by 50 percent between 2004 and 2007, and said that their numbers have been down every quarter for the last eight quarters until the fourth quarter of 2007, when developments in the market for mortgage securities brought an increase.

Howard S. Suskin, also a securities defense lawyer at Jenner & Block LLP, in the Chicago office, noted that in Tellabs, the court held that the inference of scienter that is pleaded must be cogent and at least as compelling as innocent explanations for the state of mind of the respondents. In Stoneridge, he said, the court clarified that a plaintiff must plead loss causation against the actual person who made the fraudulent statement.

Suskin suggested that despite changes in pleading standards, such recent developments mean that "[w]e're going to be in business again." Sommers agreed, saying that there is "no correlation" between the change in pleading standards and the number of cases filed. "I think pleading standards are not what is driving cases being filed or not being filed," he stressed.

Finally, Pommer contended that neither Dura nor Tellabs has an impact on SEC enforcement actions. As he did with Stoneridge, he sought to "distinguish[] why these [rulings] ... don't apply to us," the SEC.

For example, the notion of loss causation elucidated in Dura is not an element of SEC enforcement claims, he said. However, because of arguments advanced by defendants' counsel, the notion of loss causation "creeps in" to the litigation. In SEC v. Collins & Aikman Corp., last spring the U.S. District Court for the Southern District of New York discussed whether the SEC had met the pleading standards set in Tellabs, Pommer noted. The court analyzed the issue and then said that, in any event, the SEC met those standards, Pommer related.

In other comments, both Suskin and Sommers suggested that, in Sommers' words, "publicly traded companies are increasingly attempting to link good and bad news in the same announcement in an attempt to mitigate their liability under the loss causation standard" of Dura.