Lawyer Liability After Central Bank -

Civil Claims Against Lawyers and Other Secondary Actors

 

Course #2 from a cluster of courses on the topic,

Enron & WorldCom - Do Lawyers Pay When Shareholders Lose?

YouKnowItAll.com

©A. Hawkins 2004

 

Suitability

This course is suitable for any interested lawyer.  The course on Cases to Central Bank is recommended as background.

 

Scope

This is one of a cluster of courses on liability stemming from securities violations and loses of investors.  Individual lawyers may be exposed to liability, but any firm with which such a lawyer practices, and any lawyer who practices with the firm, may suffer consequences. 

 

Table of Contents

Transcript of United States Supreme Court Oral Argument

 

SEC v. Zandford  June 3, 2002

 

Cases

SEC v. Zandford  June 3, 2002 (U.S. 2002)

SEC v. U.S. Environmental  155 F.3d 107 (2nd Cir 1998)

Ziemba v. Cascade International  256 F.3d 1194 (11th Cir. 2001)

In re Software Toolworks  50 F.3d 615 (9th Cir. 1994 amended 1995)

Anixter v. Home-Stake  77 F.3d 1215 (10th Cir. 1996)

Shapiro v. Cantor  123 F.3d 717  (2nd Cir 1997)

Wright v. Ernst & Young  152 F.3d 169 (2nd Cir. 1998)

Suez Equity v. Toronto-Dominion Bank 250 F.3d 87 (2nd Cir. 2001)

Brown v. Benchmark  94 F.3d 650  (9th Cir. 1996 Memorandum)

Bell v. Holmes  76 F.3d 388 Fed. Sec. L. Rep. P 99,039 (9th Cir 1996 Memorandum)

FMC v. Boesky  36 F.3d 255 (2nd Cir 1994)

Arnold v. Hills, Renault  36 F.3d 1102 (9th Cir. 1994 Memorandum)

Hayes v. Arthur Young  34 F.3d 1072 (9th Cir. 1994 Memorandum)

Teague v. Bakker  35 F.3d 978 (4th Cir. 1994)

 

The Process

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This course is primarily a case study which relies on the words of the courts which are quoted so that you may read them yourself.  The teacher has selected  quotations, deleted original emphasis, added the authors emphasis, and moved citations to footnotes. Commentary by the teacher is included in the text and in footnotes. Five asterisks ( * * * * * ) identify each new case, If a case doesnÕt interest you, just search for * * * * * to find the next one. This also helps if you wish to go back to reread a case.

There are three kinds of footnotes. 

1. Footnotes by the court retain the courtÕs original number.  Our footnote is a footnote to that number. 

2. Footnotes that move citations to the footnotes are intended to make the material more readable. Our footnote has the courtÕs citations.

3. Footnotes that contain some of the authorÕs commentary.

 

If you read this course online, your browser will probably let you click on a footnote number to go to the footnote and click on the number in the footnote to return to the text.  Some browsers will show the footnote if you hold your curser over the footnote number without clicking  If you print the text, you may wish to staple the footnotes separately so you may easily refer to them. They are at the end because of technicalities of the internet.  This is a Microsoft Word document displayed as a web page. You may copy it into a word processor to print it if you like.  If you have any problems, let us know.

 

Optional Telephone Conference

The teacher is available for an optional personal telephone conference on the substance of this course.  If you have a question about the application of the material in this course to a particular case, or would just like to visit about this topic, you may do so.  A brief basic phone conference is $20 per course.  If you would like to schedule a phone conference, email or call YouKnowItAll.com.

 

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Issues: Does 10b cover theft if securities are sold to generate the cash that is stolen?  Did OÕHagan[1]  limit 10b?

 

As you read Zandford, consider the expansive variety of situations in which deception and misconduct have something to do with a security.  For example, estates and trusts often have securities.  If a lawyer, executor, trustee, or accountant is involved in undisclosed misconduct that has some connection to securities, is 10b violated? 

 

SEC v. Zandford  June 3, 2002 (U.S. 2002)

 

Justice Stevens delivered the opinion of the unanimous Court.

 

The Securities and Exchange Commission (SEC) filed a civil complaint alleging that a stockbroker violated both ¤10(b) of the Securities Exchange Act of 1934[2]  and the SEC's Rule 10b-5, by selling his customer's securities and using the proceeds for his own benefit without the customer's knowledge or consent. The question presented is whether the alleged fraudulent conduct was "in connection with the purchase or sale of any security" within the meaning of the statute and the rule.

 

I

 

Between 1987 and 1991, respondent was employed as a securities broker in the Maryland branch of a New York brokerage firm. In 1987, he persuaded William Wood, an elderly man in poor health, to open a joint investment account for himself and his mentally retarded daughter. According to the SEC's complaint, the "stated investment objectives for the account were 'safety of principal and income.' " The Woods granted respondent discretion to manage their account and a general power of attorney to engage in securities transactions for their benefit without prior approval. Relying on respondent's promise to "conservatively invest" their money, the Woods entrusted him with $419,255. Before Mr. Wood's death in 1991, all of that money was gone.

 

In 1991, the National Association of Securities Dealers (NASD) conducted a routine examination of respondent's firm and discovered that on over 25 separate occasions, money had been transferred from the Woods' account to accounts controlled by respondent. In due course, respondent was indicted in the United States District Court for the District of Maryland on 13 counts of wire fraud in violation of 18 U.S.C. ¤ 1343. The first count alleged that respondent sold securities in the Woods' account and then made personal use of the proceeds.  Each of the other counts alleged that he made wire transfers between Maryland and New York that enabled him to withdraw specified sums from the Woods' accounts. Some of those transfers involved respondent writing checks to himself from a mutual fund account held by the Woods, which required liquidating securities in order to redeem the checks. Respondent was convicted on all counts, sentenced to prison for 52 months, and ordered to pay $10,800 in restitution.

 

After respondent was indicted, the SEC filed a civil complaint in the same District Court alleging that respondent violated ¤10(b) and Rule 10b-5 by engaging in a scheme to defraud the Woods and by misappropriating approximately $343,000 of the Woods' securities without their knowledge or consent. The SEC moved for partial summary judgment after respondent's criminal conviction, arguing that the judgment in the criminal case estopped respondent from contesting facts that established a violation of ¤10(b).(FN1)[3]  Respondent filed a motion seeking discovery on the question whether his fraud had the requisite "connection with" the purchase or sale of a security. The District Court refused to allow discovery and entered summary judgment against respondent. It enjoined him from engaging in future violations of the securities laws and ordered him to disgorge $343,000 in ill-gotten gains.

 

The Court of Appeals for the Fourth Circuit reversed the summary judgment and remanded with directions for the District Court to dismiss the complaint.[4]  It first held that the wire fraud conviction, which only required two findings (1) that respondent engaged in a scheme to defraud and (2) that he used interstate wire communications in executing the scheme did not establish all the elements of a ¤10(b) violation. Specifically, the conviction did not necessarily establish that his fraud was "in connection with" the sale of a security.[5] (FN2)[6]  The court then held that the civil complaint did not sufficiently allege the necessary connection because the sales of the Woods' securities were merely incidental to a fraud that "lay in absconding with the proceeds" of sales that were conducted in "a routine and customary fashion."[7]  Respondent's "scheme was simply to steal the Woods' assets" rather than to engage "in manipulation of a particular security."[8]  Ultimately, the court refused "to stretch the language of the securities fraud provisions to encompass every conversion or theft that happens to involve securities."[9]  Adopting what amounts to a "fraud on the market" theory of the statute's coverage, the court held that without some "relationship to market integrity or investor understanding," there is no violation of ¤10(b).[10]

 

We granted the SEC's petition for a writ of certiorari,[11]  to review the Court of Appeals' construction of the phrase "in connection with the purchase or sale of any security." Because the Court of Appeals ordered the complaint dismissed rather than remanding for reconsideration, we assume the allegations contained therein are true and affirm that disposition only if no set of facts would entitle petitioner to relief.[12]  We do not reach the question whether the record supports the District Court's grant of summary judgment in the SEC's favor a question that requires all potential factual disputes to be resolved in respondent's favor.(FN3)[13]  We merely hold that the allegations of the complaint, if true, entitle the SEC to relief; therefore, the Court of Appeals should not have directed that the complaint be dismissed.

 

II

 

Section 10(b) of the Securities Exchange Act makes it "unlawful for any person [t]o 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 [SEC] may prescribe."[14]  Rule 10b-5, which implements this provision, forbids the use, "in connection with the purchase or sale of any security," of "any device, scheme, or artifice to defraud" or any other "act, practice, or course of business" that "operates as a fraud or deceit." [15]  Among Congress' objectives in passing the Act was "to insure honest securities markets and thereby promote investor confidence" after the market crash of 1929.[16]  More generally, Congress sought " 'to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.' "[17]

 

Consequently, we have explained that the statute should be "construed 'not technically and restrictively, but flexibly to effectuate its remedial purposes.' "[18]  In its role enforcing the Act, the SEC has consistently adopted a broad reading of the phrase "in connection with the purchase or sale of any security." It has maintained that a broker who accepts payment for securities that he never intends to deliver, or who sells customer securities with intent to misappropriate the proceeds, violates ¤10(b) and Rule 10b-5.[19]  This interpretation of the ambiguous text of ¤10(b), in the context of formal adjudication, is entitled to deference if it is reasonable.[20]  For the reasons set forth below, we think it is. While the statute must not be construed so broadly as to convert every common-law fraud that happens to involve securities into a violation of ¤10(b),[21]  neither the SEC nor this Court has ever held that there must be a misrepresentation about the value of a particular security in order to run afoul of the Act.

 

The SEC claims respondent engaged in a fraudulent scheme in which he made sales of his customer's securities for his own benefit. Respondent submits that the sales themselves were perfectly lawful and that the subsequent misappropriation of the proceeds, though fraudulent, is not properly viewed as having the requisite connection with the sales; in his view, the alleged scheme is not materially different from a simple theft of cash or securities in an investment account. We disagree.

 

According to the complaint, respondent "engaged in a scheme to defraud" the Woods beginning in 1988, shortly after they opened their account, and that scheme continued throughout the 2-year period during which respondent made a series of transactions that enabled him to convert the proceeds of the sales of the Woods' securities to his own use.  The securities sales and respondent's fraudulent practices were not independent events. This is not a case in which, after a lawful transaction had been consummated, a broker decided to steal the proceeds and did so. Nor is it a case in which a thief simply invested the proceeds of a routine conversion in the stock market. Rather, respondent's fraud coincided with the sales themselves.

 

Taking the allegations in the complaint as true, each sale was made to further respondent's fraudulent scheme; each was deceptive because it was neither authorized by, nor disclosed to, the Woods. With regard to the sales of shares in the Woods' mutual fund, respondent initiated these transactions by writing a check to himself from that account, knowing that redeeming the check would require the sale of securities. Indeed, each time respondent "exercised his power of disposition for his own benefit," that conduct, "without more," was a fraud.[22]  In the aggregate, the sales are properly viewed as a "course of business" that operated as a fraud or deceit on a stockbroker's customer.

 

Insofar as the connection between respondent's deceptive practices and his sale of the Woods' securities is concerned, the case is remarkably similar to Superintendent of Ins. of N. Y. v. Bankers Life & Casualty Co.[23]  In that case the directors of Manhattan Casualty Company authorized the sale of the company's portfolio of treasury bonds because they had been "duped" into believing that the company would receive the proceeds of the sale.[24]  We held that "Manhattan was injured as an investor through a deceptive device which deprived it of any compensation for the sale of its valuable block of securities."[25]  In reaching this conclusion, we did not ask, as the Fourth Circuit did in this case, whether the directors were misled about the value of a security or whether the fraud involved "manipulation of a particular security."[26] In fact, we rejected the Second Circuit's position in Superintendent of Ins. of N. Y. v. Bankers Life & Casualty Co.,[27]  that because the fraud against Manhattan did not take place within the context of a securities exchange it was not prohibited by ¤10(b).[28]  We refused to read the statute so narrowly, noting that it "must be read flexibly, not technically and restrictively."[29]  Although we recognized that the interest in " 'preserving the integrity of the securities markets,' " was one of the purposes animating the statute, we rejected the notion that ¤10(b) is limited to serving that objective alone.[30]

 

Like the company directors in Bankers Life, the Woods were injured as investors through respondent's deceptions, which deprived them of any compensation for the sale of their valuable securities. They were duped into believing respondent would "conservatively invest" their assets in the stock market and that any transactions made on their behalf would be for their benefit for the " 'safety of principal and income.' " The fact that respondent misappropriated the proceeds of the sales provides persuasive evidence that he had violated ¤10(b) when he made the sales, but misappropriation is not an essential element of the offense. Indeed, in Bankers Life, we flatly stated that it was "irrelevant" that "the proceeds of the sale that were due the seller were misappropriated."[31]  It is enough that the scheme to defraud and the sale of securities coincide.

 

The Court of Appeals below distinguished Bankers Life on the ground that it involved an affirmative misrepresentation, whereas respondent simply failed to inform the Woods of his intent to misappropriate their securities.[32]  We are not persuaded by this distinction. Respondent was only able to carry out his fraudulent scheme without making an affirmative misrepresentation because the Woods had trusted him to make transactions in their best interest without prior approval. Under these circumstances, respondent's fraud represents an even greater threat to investor confidence in the securities industry than the misrepresentation in Bankers Life. Not only does such a fraud prevent investors from trusting that their brokers are executing transactions for their benefit, but it undermines the value of a discretionary account like that held by the Woods. The benefit of a discretionary account is that it enables individuals, like the Woods, who lack the time, capacity, or know-how to supervise investment decisions, to delegate authority to a broker who will make decisions in their best interests without prior approval. If such individuals cannot rely on a broker to exercise that discretion for their benefit, then the account loses its added value. Moreover, any distinction between omissions and misrepresentations is illusory in the context of a broker who has a fiduciary duty to her clients.[33]

 

More recently, in Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc.,[34]  our decision that the seller of a security had violated ¤10(b) focused on the secret intent of the seller when the sale occurred. The purchaser claimed "that Wharf sold it a security (the option) while secretly intending from the very beginning not to honor the option."[35]  Although Wharf did not specifically argue that the breach of contract underlying the complaint lacked the requisite connection with a sale of securities, it did assert that the case was merely a dispute over ownership of the option, and that interpreting ¤10(b) to include such a claim would convert every breach of contract that happened to involve a security into a violation of the federal securities laws.[36]  We rejected that argument because the purchaser's claim was not that the defendant failed to carry out a promise to sell securities; rather, the claim was that the defendant sold a security while never intending to honor its agreement in the first place.[37]  Similarly, in this case the SEC claims respondent sold the Woods' securities while secretly intending from the very beginning to keep the proceeds. In Wharf, the fraudulent intent deprived the purchaser of the benefit of the sale whereas here the fraudulent intent deprived the seller of that benefit, but the connection between the deception and the sale in each case is identical.

 

In United States v. O'Hagan[38]  we held that the defendant had committed fraud "in connection with" a securities transaction when he used misappropriated confidential information for trading purposes. We reasoned that "the fiduciary's fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities. The securities transaction and the breach of duty thus coincide. This is so even though the person or entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information."[39]  The Court of Appeals distinguished O'Hagan by reading it to require that the misappropriated information or assets not have independent value to the client outside the securities market.[40]  We do not read O'Hagan as so limited. In the chief passage cited by the Court of Appeals for this proposition, we discussed the Government's position that "[t]he misappropriation theory would not apply to a case in which a person defrauded a bank into giving him a loan or embezzled cash from another, and then used the proceeds of the misdeed to purchase securities," because in that situation "the proceeds would have value to the malefactor apart from their use in a securities transaction, and the fraud would be complete as soon as the money was obtained."[41]  Even if this passage could be read to introduce a new requirement into ¤10(b), it would not affect our analysis of this case, because the Woods' securities did not have value for respondent apart from their use in a securities transaction and the fraud was not complete before the sale of securities occurred.

 

As in Bankers Life, Wharf, and O'Hagan, the SEC complaint describes a fraudulent scheme in which the securities transactions and breaches of fiduciary duty coincide. Those breaches were therefore "in connection with" securities sales within the meaning of ¤10(b). (FN4)[42]  Accordingly, the judgment of the Court of Appeals is reversed, and the case is remanded for further proceedings consistent with this opinion.

 

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Issue:  Is an employee or underling liable under 10b for following orders?

 

Consider the implications for a lawyer, or for an employee of a law firm, who is following instructions of a client or a senior lawyer.

 

SEC v. U.S. Environmental  155 F.3d 107 (2nd Cir 1998)

 

Plaintiff-appellant Securities and Exchange Commission ("SEC") appeals from the June 18, 1996 order . . . dismissing, pursuant to Fed.R.Civ.P. 12(b)(6), the SEC's claim that defendant-appellee John Romano engaged in market manipulation in violation of Section 10(b) of the Securities Exchange Act of 1934  (" ¤ 10(b)"), and Rule 10b-5 thereunder ("Rule 10b-5").

We hold that Romano can be primarily liable under ¤ 10(b) for following a stock promoter's directions to execute stock trades that Romano knew, or was reckless in not knowing, were manipulative, even if Romano did not share the promoter's specific overall purpose to manipulate the market for that stock. We therefore vacate the order of the district court and remand for further proceedings.

Background

The following facts are taken exclusively from the SEC's amended complaint, which on a motion to dismiss at the pleading stage must be read in the light most favorable to the SEC.

Romano was employed as a trader and registered representative of defendant Castle Securities Corporation ("Castle"), a securities broker-dealer. Castle agreed to participate in a scheme whereby it and other defendants, including Romano, would manipulate upward the price of the stock of U.S. Environmental, Inc. ("USE"). At the direction of stock promoter Mark D'Onofrio ("D'Onofrio"), certain of the defendants or their nominees traded USE shares among themselves "for the purpose of creating the appearance of an actual market for trading USE shares" and thus raising USE's stock price. The complaint alleges that

Romano knowingly or recklessly participated in and furthered a market manipulation by:

(a) effecting offers, purchases, and sales of USE securities in return for promises of risk-free profit for engaging in such trades;

(b) effecting directed and controlled trades of USE securities;

(c) effecting "wash sales" and "matched orders"; and

(d) effecting trades involving undisclosed nominees.

 

Wash sales are "transactions involving no change in beneficial ownership" and matched orders are "orders for the purchase [or] sale of a security that are entered with the knowledge that orders of substantially the same size, at substantially the same time and price, have been or will be entered by the same or different persons for the sale/purchase of such security."[43]  The complaint states further that

Romano agreed to advise D'Onofrio continuously as Castle received buy and sell orders for USE shares during each trading day. Romano agreed to execute trades as directed by D'Onofrio, and Romano also agreed to move, or adjust, the price Castle quoted for USE shares at D'Onofrio's direction. In return, D'Onofrio assured Romano that Castle would receive a profit on the transactions D'Onofrio directed.

In a typical manipulative transaction,

(a) D'Onofrio would direct a buy order from one of the ... brokerage accounts controlled by the D'Onofrio group [consisting of stock promoters Ramon N. D'Onofrio, Richard Kirschbaum, and D'Onofrio] to a market maker other than Castle;

(b) D'Onofrio would arrange in advance that the other market maker would contact Romano at Castle to buy the same number of shares;

(c) D'Onofrio would alert Romano that the other market maker would be calling Romano for stock;

(d) D'Onofrio, specifying number of shares and price, would instruct Romano to sell shares of USE to the other market maker; and

(e) D'Onofrio would supply Castle with the specified number of shares at a discount, enabling Romano to complete the transaction at a price at which both Castle and the other market maker received a risk-free profit on the transaction, as had been prearranged with Castle ... and Romano.

 

Romano, Castle, and the D'Onofrio group "intentionally engaged" in such "manipulative conduct ... between September 1989 and December 1989." As a result of these manipulative trades, the price of USE stock rose from $.05 to approximately $5.00 per share in this period. In June or early July 1990, Castle sold approximately 15,000 shares of USE stock to retail customers at $6.00 per share. Between September 1989 and August 1990, Castle made a profit of approximately $175,000 as a result of its market-making activity for USE.

The SEC then commenced the instant action, alleging that defendants violated various provisions of the securities laws in connection with their manipulation of USE stock and other aspects of an illegal scheme involving USE. Romano moved, pursuant to Fed R. Civ. P. 12(b)(6), to dismiss the SEC's manipulation claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The district court granted the motion[44]  on the sole ground that the SEC had failed to allege that Romano was a "primary violator[ ]," as required by the Supreme Court in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A..[45]  Rather, the district court held that Romano was alleged only to be an aider/abettor of securities violations, because Romano "follow[ed] directions from D'Onofrio in carrying out buy or sell orders" and "did not himself make wash sales, match orders, or use undisclosed nominees to artificially affect the price of securities."[46]  The district court stated that "[e]ven if Romano knew that [the buyers and sellers] were D'Onofrio and undisclosed nominees of D'Onofrio, and hence knew that D'Onofrio was manipulating USE stock, he did not himself manipulate USE stock because he did not himself have a manipulative purpose."[47]  In a subsequent order certifying for interlocutory appeal "[t]he issue of what level of scienter is required before a person trading in securities can be said to manipulate the securities," the district court noted that "where ... manipulation is the basis of the claim, manipulative intent, and not mere knowledge or recklessness, is required before Rule 10b-5 is violated."[48]  On August 25, 1997, this court granted the SEC's motion for an interlocutory appeal pursuant to 28 U.S.C. ¤ 1292(b).

Discussion

In reviewing the district court's dismissal of the SEC's claim pursuant to Fed.R.Civ.P. 12(b)(6), we are "required to accept the material facts alleged in the complaint as true" and will vacate the dismissal "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of [its] claim which would entitle [it] to relief."[49]  Our review is de novo.[50]

Romano's principal contention on appeal, with which the district court agreed, is that he cannot be primarily liable under ¤ 10(b) for following a stock promoter's directions to execute trades that Romano knew, or was reckless in not knowing, were manipulative, where Romano did not share the promoter's ultimate "manipulative ... purpose" to raise the stock price. We disagree.

Under ¤ 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. ¤ 78j,

It shall be 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-

. . . . .

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe. 1[51]

In Central Bank, the Supreme Court held that private civil liability under ¤ 10(b) applies only to those who "engage in the manipulative or deceptive practice," but not to those "who aid and abet the violation."[52]  The Court observed that "[a]iding and abetting is a method by which courts create secondary liability in persons other than the violator [or violators] of the statute."[53]  We have noted further that a primary violator is one who "participated in the fraudulent scheme" or other activity proscribed by the securities laws.[54]

Under the foregoing standards, we believe that, as alleged in the complaint, Romano falls well within the boundaries of primary liability. As an initial matter, we disagree with the district court's view that "[e]ven if Romano knew that [the buyers and sellers] were D'Onofrio and undisclosed nominees of D'Onofrio, and hence knew that D'Onofrio was manipulating USE stock, [Romano] did not himself manipulate USE stock because he did not himself have a manipulative purpose."[55]  This view conflates the distinction drawn in Central Bank between primary violators and aiders/abettors based on conduct with the separate issue of scienter. We have noted that

 

[t]he Supreme Court in Central Bank did not in any way rely on the level of scienter at issue, but on the fact that aiding and abetting was not included within the terms of [the Securities Exchange Act of 1934].

. . . . .

[The] Court held that aiding and abetting claims fall outside of the scope of ¤ 10(b) altogether, without drawing any distinction between claims requiring intent and claims requiring only recklessness or some other level of scienter.[56]

Thus, whether Romano was a primary violator rather than an aider and abettor turns on the nature of his acts, not on his state of mind when he performed them.

 

A. Scienter

Of course, to establish Romano's liability under ¤ 10(b), the complaint must as a threshold matter allege that Romano acted with sufficient scienter.[57]  The complaint's allegation that Romano "knowingly or recklessly participated in and furthered a market manipulation by ... effecting 'wash sales' and 'matched orders' " and that he "intentionally engaged" in "manipulative conduct" is plainly sufficient to satisfy that requirement. It is well-settled that knowledge of the proscribed activity is sufficient scienter under ¤ 10(b).[58]  Therefore, the allegation that Romano executed trades that he knew were for a manipulative purpose sufficiently alleged scienter in a manner supporting ¤ 10(b) liability.

Although we need not rely on this point, we also note that the complaint's claim that Romano recklessly participated in the manipulation also alleges sufficient scienter.[59]

Moreover, as long as Romano, with scienter, effected the manipulative buy and sell orders, Romano's personal motivation for manipulating the market is irrelevant in determining whether he violated ¤ 10(b). Even if Romano were motivated by a desire to obtain compensation rather than by a desire to change USE's market price, as D'Onofrio was, Romano is liable under ¤ 10(b) if, with scienter, he effected the manipulative trades.

B. Primary Violator or Aider and Abettor

It is plain to us that the complaint alleged Romano to be a primary violator. Romano "participated in the fraudulent scheme,"[60]  i.e., the manipulation of USE's stock, by effecting the very buy and sell orders that artificially manipulated USE's stock price upward. Indeed, if the trader who executes manipulative buy and sell orders is not a primary violator, it is difficult to imagine who would remain liable after Central Bank.

In Central Bank, holders of defaulted bonds sued the issuer and others alleging primary liability under Rule 10b-5 and also sued the indenture trustee on the theory that the trustee aided and abetted the other defendants' violations by recklessly ignoring its oversight duties. The Supreme Court held that ¤ 10(b) "prohibits only the making of a material misstatement (or omission) or the commission of a manipulative act,"[61]  and it dismissed the claim against the trustee, who had done neither. Similarly, Shapiro v. Cantor,[62]  involved an accounting firm that allegedly aided and abetted a fraudulent omission by "preparing [ ] financial projections that were later included in the principal defendants' offering memoranda," which in turn failed to disclose that one of the principals was a convicted felon.[63]  We held in Shapiro that the accounting firm was not primarily liable, because "there exist[ed] no allegation that [its] projections misrepresented any financial fact" and the accounting firm in that case had no legal duty to disclose the information omitted from the offering memoranda.[64]

Romano, in contrast, did not simply fail to disclose information when there was no duty to do so, as in Shapiro, or fail to prevent another party from engaging in a fraudulent act, as in Central Bank, when there existed no duty to prevent such. Rather, Romano himself "commi[tted] a manipulative act,"[65]  by effecting the very buy and sell orders that manipulated USE's stock upward.

Finally, it is of no relevance that D'Onofrio, not Romano, masterminded the USE stock manipulation and that D'Onofrio's group "directed" Romano to effect the illegal trades.

The absence of ¤ 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device ... may be liable as a primary violator under 10b-5.... In any complex securities fraud, moreover, there are likely to be multiple violators....[66]

 

Like lawyers, accountants, and banks who engage in fraudulent or deceptive practices at their clients' direction, Romano is a primary violator despite the fact that someone else directed the market manipulation scheme. The Supreme Court in Central Bank never intended to restrict ¤ 10(b) liability to supervisors or directors of securities fraud schemes while excluding from liability subordinates who also violated the securities laws. In sum, the complaint alleges that Romano is primarily liable under ¤ 10(b) and Rule 10b-5 for the manipulation of USE stock.

. . . The Private Securities Litigation Reform Act of 1995 ("Reform Act"), enacted after Central Bank, provides that, in SEC actions, "any person that knowingly provides substantial assistance to another person in violation of a provision of [15 U.S.C. Chapter 2B, which includes ¤ 10(b) ], or of any rule or regulation issued under this chapter [including Rule 10b-5], shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided."[67]  Thus, unlike private plaintiffs, the SEC now has authority to assert aiding and abetting claims under ¤ 10(b).[68]  It remains unclear, however, whether the SEC could bring aiding/abetting claims in cases based on conduct occurring prior to the enactment of the Reform Act.[69]  Because the SEC did not make this argument before the district court or on appeal, however, we do not address this alternate ground for vacating the district court's dismissal.[70]

Conclusion

For the reasons set forth above, the order of the district court is vacated and remanded.

 

Several cases involve lawyers or accountants who provided information to corporations or their employees, who in turn made representations which were based on, or affected by, the information of the lawyers or accountants, and cases in which lawyers or accountants prepared or reviewed documents which contained representations. Courts differ about the effect of Central Bank on these situations.

 

* * * * *

Issues:  ZiembaÕs facts provide insight.  Both a law firm and accounting firm are among the defendants.

 

Ziemba v. Cascade International  256 F.3d 1194 (11th Cir. 2001)

 

I. INTRODUCTION

. . . Plaintiffs, shareholders of Cascade International, Inc., ("Cascade"), brought this securities class action against Cascade officers and directors, including Victor Incendy, Cascade's President and CEO; Bernard H. Levy, Cascade's independent auditor; Coopers & Lybrand ("C&L"), an accounting firm; Gunster, Yoakley, & Stewart, P.A. ("GY&S"), a law firm; and others, alleging, inter alia, violations of Section 10(b) of the Securities Exchange Act of 1934,[71]  and Rule 10b-5,[72] promulgated thereunder.

In an Order dated December 16, 1993, the district court granted several defendants' motions to dismiss, including such motion filed by GY&S.[73]  The district court denied C&L's motion to dismiss, except with respect to Plaintiffs' claims of negligent misrepresentation and common law fraud.[74]  Plaintiffs filed a motion for entry of final judgment pursuant to Fed. R. Civ. Proc. 54(b) as to GY&S and other defendants. This motion was denied.

In 1994, C&L filed a motion to reconsider the district court's ruling on C&L's motion to dismiss in light of Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,[75]  in which the Supreme Court held that a private plaintiff may not maintain an aiding and abetting suit under ¤ 10(b). In an Order dated June 27, 1995, the district court granted C&L's motion to reconsider and dismissed Plaintiffs' ¤ 10(b) claim against C&L in light of Central Bank.[76]  The district court also denied Plaintiffs' motion for leave to amend their complaint.[77]