The right of private parties to sue aiders and abettors under federal securities fraud statutes has been a hotly debated issue in recent months. And, there is good reason for vigorous public debate. If such a right of action were available to securities class action plaintiffs, it could potentially expose mutual fund advisors, accounting firms, law firms, and a wide range of other secondary actors to liability for securities fraud. This, of course, would have far reaching implications for the institutional investing community. Not only would it greatly expand liability exposure for investment advisors and similar actors, it could also create an environment ripe for numerous large and complex securities class action suits.
When the Dodd-Frank Act passed into law earlier this summer it failed to give private litigants the power to sue aiders and abettors under federal securities fraud laws. Despite the best efforts of democratic Senator Arlen Spector and Representative Maxine Waters, the final version of the bill merely authorized a study by the Government Accountability Office (GAO) into the propriety of an aiding and abetting private right of action. The study must be presented to Congress within a year of the Act's enactment.
Although the Congressional/Executive process on aiding and abetting may take years, the same issue has been evolving in the courts for quite some time now. And, a watershed decision on the matter may be upon us. In June the U.S. Supreme Court granted certiorari to review the decision of the Fourth Circuit Court of Appeals in Janus Capital Group, Inc. v. First Derivative Traders, 78 U.S.L.W. 3271 (U.S. June 28, 2010)(No. 09-525). In the Janus Capital case, investors in a collection of mutual funds sued the holding company for the funds (Janus Capital Group) and the funds' investment advisor (Janus Capital Management) alleging that the mutual funds were managed in a way that was not consistent with what was reported in their prospectuses, which resulted in a loss to investors. The U.S. District Court in Maryland dismissed the case holding that neither of the defendants actually made or prepared the prospectuses. But, in May 2007, the Fourth Circuit Court of Appeals reversed the District Court's ruling finding that the investors asserted a viable claim under Section 10(b) because the defendants helped to draft and disseminate prospectuses with misleading statements. The Supreme Court is scheduled to hear the case on December 7, 2010.
Pursuant to Supreme Court rulings in First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) and Stonebridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S.Ct. 761 (2008) there is no aiding and abetting liability in private actions under Section 10(b) of the Securities Exchange Act of 1934. Only "primary violators" may be sued for securities fraud, which does not include, according to Stonebridge, service providers. However, the Fourth Circuit's opinion in Janus Capital appears to take great strides to expand the scope of "primary violator" by elevating otherwise secondary actors like Janus Capital Group to the status of primary violators.
It is difficult to say for sure how the Supreme Court will rule in the Janus Capital case. But, it appears likely that they would overturn the Fourth Circuit. If the Morrison v. NAB case decided earlier this summer is any indicator, the Court seems poised to dilute the potency of securities fraud litigation. Limiting the number of actors in the chain of securities fraud liability would certainly move in-step with the Court's decision in Morrison to leave investors in foreign traded securities without recourse in U.S. courts. Despite a plea by the Obama Administration in May not to grant certiorari in the Janus Capital case, the Court moved forward. It may be looking to both clarify and strengthen its previous decisions on the aider and abettor private right of action.
While the outcome of the Janus Capital case is still unknown, if the Court does in fact uphold the Fourth Circuit's opinion the implications could be varied. Some commentators have predicted a deluge of securities class action suits against the spectrum of actors who may be affiliated with a fraudulent prospectus. Still, others have argued that the Fourth Circuit's opinion addresses only actors who took a direct role in the fraud by both drafting and disseminating allegedly fraudulent materials. The truth on this matter is anyone's guess. At least one thing is true, however. The question of whether there will be a significant expansion of liability under the securities fraud laws, and, therefore, a substantial expansion of the securities class action universe could be decided in December 2010.