statement someone else makes may be your own: Primary liability under section 10(b) after Central Bank, The

St. John's Law Review, Fall 1997 by Blanchini, Patricia

The Supreme Court's elimination of aiding and abetting actions in Central Bank of Denver v. First Interstate Bank of Denver1 overturned thirty years of federal common law which had provided private plaintiffs with remedies against secondary participants in fraudulent securities transactions. Prior to Central Bank, investors could recover from secondary actors, such as lawyers and accountants, who provided only substantial assistance to the primary actor in violation of section 10(b).2 In the wake of Central Bank, however, investors who suffer loss due to securities fraud must scramble to find other remedies.

In Central Bank, the Supreme Court held that [b]ecause the text of [section] 10(b) does not prohibit aiding and abetting ... a private plaintiff may not maintain an aiding and abetting suit under [section] 10(b)."3 Nevertheless, the Court expressly recognized that the absence of aiding and abetting does not mean that secondary actors are completely free from liabilitysecondary actors can potentially still be held liable as primary violators.4 In response, private plaintiffs have tried to recharacterize what were once aiding and abetting violations as primary violations.

Ultimately, the fundamental question left unanswered by Central Bank is what actions of secondary actors in Rule 10b-5 violations constitute primary violations. With little guidance to be found within the Central Bank decision, several lower courts have struggled to define the boundaries of primary liability.

This Note attempts to determine the limits of primary liability. Part I outlines the provisions of the securities laws at issue in Central Bank. Part II discusses the decision in Central Bank and the Private Securities Litigation Reform Act of 1995. Part III discusses the fundamental distinctions between primary and secondary liability. Part IV introduces the post-Central Bank decisions which have addressed the limits of primary liability. Finally, Part V analyzes the post-Central Bank authority in order to define the primary violation after Central Bank and its effect on the jurisprudence of securities enforcement under section 10(b)/Rule 10b-5.

I. OVERVIEW OF INSIDER TRADING PRIOR TO CENTRAL BANK

A. Section 10(b) /Rule 10b-5

The Securities Act of 19335 (the "Securities Act") and the Securities Exchange Act of 19346 (the "Securities Exchange Act"), enacted in the wake of the 1929 stock market crash and in response to widespread abuses in the securities industry, are the primary federal securities laws dealing with fraud in the purchase and sale of securities. "The [Securities Act] regulates initial distributions of securities, [while the Securities Exchange Act] for the most part regulates post-distribution trading."7 Section 10(b)8 of the Securities Exchange Act is a "catchall provision"9 designed to deal with abuses of the securities laws and has thus been described as the general anti-fraud provision.lo Rule 10b-5(11) was promulgated by the Securities and Exchange Commission (the "SEC") in 1942 under section 10(b)'s grant of authority to the SEC to prescribe rules prohibiting any person from using or employing any manipulative or deceptive device in connection with the purchase or sale of any security.12

While neither section 10(b) nor Rule lOb-5 provide an express private remedy,13 federal courts have implied the existence of a private right of action for violations of Rule 10b-5.14 This private right of action was reaffirmed by the Supreme Court in Herman & MacLean v. Huddleston,ls where the Court held that the availability of an express remedy under other sections of the securities laws did not preclude defrauded investors from maintaining actions under section 10(b).16

Consistent with a broad interpretation of the securities laws and the willingness of the courts to imply a private right of action for violations of Rule 10b-5, the courts interpreted the securities laws to impose liability on secondary actors for aiding and abetting.

B. Aiding and Abetting and Pre-Central Bank Application

Aiding and abetting imposes liability on secondary parties who do not directly participate in an alleged wrongdoing, but who have played a substantial part in the fraudulent activity.17 Historically, aiding and abetting was used by private plaintiffs as well as the SEC to bring actions against accountants, lawyers, and others who assisted in violations of the securities laws.18

Congress did not expressly provide for aiding and abetting liability under section 10(b).19 As with the creation of any express private remedy,20 the concept of an aiding and abetting securities violation was derived from civil common law and criminal law doctrines.21 The leading case recognizing secondary liability for aiding and abetting was Brennan v. Midwestern United Life Insurance Co.22 The Brennan court held Midwestern, the defendant corporation, liable under Rule lOb-5 for aiding and abetting the fraudulent scheme of a securities broker.3 With knowledge of the fraudulent activity, Midwestern permitted the activities to continue by failing to report the broker.24 Acknowledging that nothing in the statute or legislative history indicated congressional intent to impose such liability, the court, relying on section 876 of the Restatement of Torts,25 nonetheless stated that "general principles of law should continue to guide the development of federal common law remedies under Section 10(b) and Rule 10b-5."26 Thus, the court in Brennan held that an aider or abettor could be jointly liable for participation in fraudulent activity even though the participants did not act in concert.27