The provisions make it unlawful for any person to directly or indirectly: 1 "employ any device, scheme, or artifice to defraud"; 2 "make any untrue statement of a material fact or to omit to state a material fact"; or 3 "engage in any act, practice, or course of business" that operates as fraud or deceit on any person.

The legal background of primary and secondary liability under Section 10 b and Rule 10b-5 begins with Central Bank. Before this Supreme Court decision, lower courts allowed private actions for aiding and abetting securities fraud. Central Bank complicated fraud claims because it pronounced that a plain reading of Section 10 b yielded no private cause of action for aiding and abetting fraud.

For example, although the Court in Dirks v. SEC reversed the D. Circuit's finding that the petitioner had aided and abetted an insurance company's fraud, it did not reverse the circuit court's decision on the basis that a secondary fraud claim did not exist. Instead, Justice Powell, writing for the majority, found that Dirks "had no duty to abstain from use of the inside information that he obtained.

After a public building authority defaulted on secured bonds, the bond purchasers sued several defendants in connection with the bonds' sale. Most importantly, the buyers sued the bank that was trustee of the bond issues and alleged that the bank was secondarily liable under Section 10 b for aiding and abetting the other defendants' fraud.

But it did not. B Post-Central Bank Circuit Splits and Three Diverse Approaches to Defining Securities Fraud Liability Central Bank's proscription of secondary liability claims radically increased the importance of distinguishing primary violators from secondary violators. In eliminating private secondary actions, the Court complicated securities law and made no mention of what the divide should be between actionable primary claims and non-actionable secondary claims. The Second and Ninth Circuits hear the most securities litigation in the federal court system but these circuits are on opposite sides of the Section 10 b liability split.

Whereas the Second Circuit adopted the bright-line test in Shapiro v. Cantor,16 the Ninth Circuit applied the substantial participation test. The Bright-Line Test The majority of circuits adhere to the bright-line test for secondary liability. Circuit's finding that the petitioner had aided and abetted an insurance company's fraud, it did not reverse the circuit court's decision on the basis that a secondary fraud claim did not exist.

Instead, Justice Powell, writing for the majority, found that Dirks "had no duty to abstain from use of the inside information that he obtained. After a public building authority defaulted on secured bonds, the bond purchasers sued several defendants in connection with the bonds' sale. Most importantly, the buyers sued the bank that was trustee of the bond issues and alleged that the bank was secondarily liable under Section 10 b for aiding and abetting the other defendants' fraud.

But it did not. B Post-Central Bank Circuit Splits and Three Diverse Approaches to Defining Securities Fraud Liability Central Bank's proscription of secondary liability claims radically increased the importance of distinguishing primary violators from secondary violators. In eliminating private secondary actions, the Court complicated securities law and made no mention of what the divide should be between actionable primary claims and non-actionable secondary claims.

The Second and Ninth Circuits hear the most securities litigation in the federal court system but these circuits are on opposite sides of the Section 10 b liability split. Whereas the Second Circuit adopted the bright-line test in Shapiro v. Cantor,16 the Ninth Circuit applied the substantial participation test. The Bright-Line Test The majority of circuits adhere to the bright-line test for secondary liability.

Secondary actors are primarily liable under Section 10 b if they make a misstatement, know or should know that the misstatement will be communicated to investors, and are credited with making the misstatement that is publicly disseminated before investment decisions occur. The Substantial Participation Test Under the substantial participation test, primary violators do not have to make a misstatement; rather, a significant or substantial role in the misstatement is sufficient to constitute primary liability.

There is no requirement in the Ninth Circuit's test that the aider and abettor commit a manipulative or deceptive act or that the injured parties even rely on the substantial assistance given by the aider and abettor. For example, provided "a plaintiff can plead and prove scienter, a person can be a primary violator if he. Even assuming such a person knew of misrepresentations elsewhere To continue reading.

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Recently, however, it has become common for plaintiffs to bring claims against secondary actors under a theory of direct 10b-5 liability, known as 'scheme' liability, that rests not on the making of any false or misleading statement or omission but on participation in a scheme to defraud. Within the last year, significant decisions have issued from the Ninth Circuit, the Southern District of New York, and the District of Massachusetts purporting to set the parameters for scheme liability as a cause of action under Rule 10b Even so, there is a lack of consensus among courts as to what such a cause of action entails or whether it even exists.

Beyond the legal debate, the validity of scheme liability as a cause of action under Rule 10b-5 has significant implications for business in the post-Enron world. Increasingly, aggressive plaintiffs' lawyers are casting a wide net when it comes to 10b-5 claims, capturing not only the professional advisors and gatekeepers that are traditional secondary actors but also arm's-length business entities and potentially anyone else who does business with a public company.

This is a significant expansion of liability under Rule 10b-5 with potentially far-reaching implications. This article examines the relevant background to the controversy over scheme liability, including the Supreme Court's ruling in Central Bank and its precursors, reviews cases analyzing scheme liability, and offers a view as to the viability of scheme liability as a cause of action under Rule 10b Background: The Parameters of Rule 10b-5 Liability The starting point for any discussion of anti fraud liability under the Securities Exchange Act is Section 10 b itself.

This section makes it unlawful 'to use or employ, in connection with the purchase or sale of any security any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Pursuant to this statutory mandate, the SEC promulgated Rule 10b-5, which contains three prohibitions. Under Rule 10b-5, it is 'unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, a to employ any device, scheme, or artifice to defraud, b to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading or c to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

The SEC, in announcing the adoption of Rule 10b-5 over 60 years ago, failed to shed much light on its intended scope. The Commission's short public statement made only the modest claim that Rule 10b-5 'closes a loophole in the protections against fraud administered by the Commission by prohibiting individuals or companies from buying securities if they engage in fraud in their purchase. However, some insight into Rule 10b-5's scope may be gained from the language of Section 10 b itself.

Hochfelder , U. In this regard, Section 10 b , by its terms, purports to address two forms of unlawful conduct: that which is 'manipulative' and that which is 'deceptive. Hochfelder, the Supreme Court overruled a Court of Appeals decision permitting claims for negligent conduct pursuant to Rule 10b-5 and, based on a close reading of the statutory language and legislative history of Section 10 b , held that scienter, or 'a mental state embracing intent to deceive, manipulate, or defraud' was required to establish a violation of 10b One year later, in Santa Fe Industries, Inc.

Green , U. The issue in Central Bank of Denver was whether liability under Section 10 b and Rule 10b-5 could extend to those who did not themselves commit a manipulative or deceptive act but who facilitated the commission of such an act by another person.

In ruling that liability under Section 10 b and Rule 10b-5 did not extend to those who merely 'aid[ed] and abet[ted]' another in the commission of a manipulative or deceptive act, the Court viewed as determinative the language of Section 10 b , which makes no mention of aiding and abetting.

Construing the scope of conduct prohibited by Section 10 b , the Court concluded that 'the statute prohibits only the making of a material misstatement or omission or the commission of a manipulative act. Consequently, aiding another's fraud was simply not within the scope of conduct prohibited by Section 10 b. Further supporting its decision, the Court noted, was the lack of any reliance placed by the plaintiff on an 'aider and abettor,' whose identity or role in the fraud typically is not publicly known.

Nor did the suppliers make any misstatements relied upon by the public or violate a duty to disclose. The suppliers prevailed on a motion to dismiss at the district court level, on the theory that no private cause of action exists under Rule 10b-5 for aiding and abetting a securities law violation. See Central Bank of Denver, N. First Interstate Bank of Denver, N. The Eighth Circuit affirmed the district court's decision on the strength of the Supreme Court's decision in Central Bank.

The Supreme Court granted certiorari to resolve conflicts within the courts of appeals concerning the breadth and application of its Central Bank decision. Simply stated, cries were heard from around the country after the Central Bank decision that a private cause of action should exist for aiding and abetting a securities law violation.

Nevertheless, Congress enacted the PSLRA without including any express or implied language that a private cause of action exists under Rule 10b-5 for aiding and abetting.

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