PRIMARY LIABILITY UNDER RULE 10b-5
Primary liability in a Section 10(b)-5(b) false statement case was defined by the Supreme Court in terms of control and authority over the statement in Janus capital Group, Inc. v. First derivative Traders, 131 S.Ct. 2296 (2011). Closely parsing the word “make” in the rule the Court held that “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” Janus however did not consider the question of liability under subsections (a) and (c) of the rule.
The question of primary liability is of critical importance in private damage actions where there is no liability for aiding and abetting. It is also significant in SEC enforcement actions in certain instances. See, e.g., SEC v. Daifotis, No. 3:11-c-00137 (N.D. CA.)(here). In Hawaii Ironworkers Annuity Trust Fund v. Cole, Case No. 3:10CV371 (N.D.Oh. Decided Sept. 7, 20911) the court considered the question of primary liability under each subsection of the rule.
Cole arose out of the bankruptcy of Dana Corporation. Prior to seeking bankruptcy protection a widespread financial fraud took place at the company orchestrated by its former CEO and CFO. Senior officials at the company repeatedly made false statements regarding the financial condition of the company. Ultimately the fraud was exposed, a restatement filed and the company collapsed.
The four defendants were officers of the company who worked in the operating divisions. According to the amended complaint, Dana’s former CEO and CFO and top management set a 6% profit margin for the company which was not based on forecasts or performance. The operating divisions were essentially required to prepare results showing the specified profit margin. The defendants, in accord with the directives of senior management, participated in the preparation of results ultimately furnished to investors which falsely specified the performance of the company.
Prior to the decision in Janus the court denied a motion to dismiss, concluding that the four defendants could be held primarily. The court held that “[t]he complaint here alleges more than mere incidental and insignificant help in creating the false bright picture that others presented to the public. According to the complaint the defendants sketched out and helped fill in the picture during the entire period it was on display.”
The court reversed this decision in part following Janus. The court began by concluding that Janus applies to corporate insiders such as the defendants. While the defendants in that case were legally separate entities, there is noting in the decision which confines it to such a fact pattern. The holding of the case focus on the language of the rule which applies equally to all defendants.
At the same time however the key question under Janus is who is the ultimate authority as to the making of the statement. The four defendants here clearly were not that authority according to the pending complaint. Rather, they acted in response to the mandatory directives of senior officers. Accordingly, the court reversed its earlier ruling as to Rule 10b-5(2).
While subsection (b) of the rule focuses on the maker of a false statement, subsections (a) and (c) of Rule 10b-5 are concerned with deceptive conduct. Such conduct can be a basis for primary liability as the Court made clear in Stoneridge Inv. Partners, LLC v. Scientific-Atlanta Inc., 552 U.S. 148 (2008). While a plaintiff must establish reliance to sustain such a claim, neither Stoneridge nor Janus require attribution of the conduct to the specific individual as a predicate for such liability. Here the defendants clearly engaged in manipulative conduct according to the allegations of the pending complaint. Accordingly, the court declined to reconsider that portion of its earlier ruling which held that under subsections (a) and (c) of the rule the four defendants can be held primarily liable.
Program: ABA Seminar: Is the DOJ and SEC War On Insider Trading Rewriting the Rules? ABA program, live in New York City, webcast nationally. Friday September 23, 2011 from 12 – 1:30 p.m. at Dorsey & Whitney, 51 West 52 St. New York, New York 10019.
Co-Chairs: Thomas O. Gorman, Dorsey & Whitney LLP and Frank C. Razzano, Pepper Hamilton LLP.
Panelists: Christopher L. Garcia, Chief, Securities and Commodities fraud Task Force, Assistant U.S. Attorney, Southern District of New York; Daniel Hawke, Chief, Market Abuse Unit, Securities and Exchange Commission; Stuart Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association; Tammy Eisenberg, Chief Compliance Officer, General Counsel and Senior Vice President, DIAM U.S.A., Inc.
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