Scheme Liability, Federal Securities Fraud, and John Wayne's i-Pod
61 Pages Posted: 17 Sep 2007 Last revised: 14 Jul 2008
Date Written: September 1, 2007
The Supreme Court held in Central Bank that if Congress had wanted to include an aiding and abetting form of secondary liability in Section 10(b of the 1934 Securities Exchange Act), it would have done so. Strictly construed, this is a defensible holding. After Central Bank, defrauded investors have been forced to (a) argue for a broad view of primary liability, and (b) assert "scheme liability" claims under subsections (a) and (c) of Rule 10b-5. Most lower courts have rejected both these approaches and thereby excused from liability many parties, particularly investment banks, that knowingly participated in issuers' securities fraud. This article initially demonstrates that Congress did not include an aiding and abetting provision as a form of secondary liability under Section 10(b) because it necessarily expected "aiding" or "aiding and abetting" of securities fraud to constitute a primary violation of Section 10(b) with or without any explicit mention in the statute. In 1934, the common law of fraud and virtually every statutory antecedent of Section 10(b) imposed liability upon those who "participated" in fraud. The law of intentional torts in 1934 made virtually no distinction between primary and secondary liability. Aiding and abetting as a form of secondary activity in the field of securities fraud was invented by the lower federal courts in 1966. It became meaningful only after 1994 when lower courts began applying Central Bank's reasoning in a narrow way. Lower courts have been able to justify their narrow interpretation of Central Bank's holding only by committing the anachronistic error of assuming that the law of deceit was the same in 1934 as in 1994. The Supreme Court has often warned against the making of such anachronistic errors. This article then demonstrates the unquestionable validity of "scheme liability" under subsections (a) and (c) of Rule 10b-5. The lower courts that have rejected scheme liability have misread Central Bank, ignored the plain language of both Section 10(b) and Rule 10b-5, and committed a host of other mistakes.
Keywords: Securities law, securities fraud, primary liability, scheme liability
JEL Classification: K22
Suggested Citation: Suggested Citation