Second Circuit Rejects Extending Private Rule 10b-5 Liability to Attorneys Who "Created" the Fraud

In Pacific Investment Management Co. v. Mayer Brown (2d Cir. Apr. 27, 2010)(Download MayerBrownopinion), the Second Circuit affirms the district court's dismissal of investors' complaint against the law firm Mayer Brown and its partner Joseph Collins for their role in the securities fraud committed by Refco Inc.  The Court holds that a secondary actor (defined as parties who are not employed by the issuer whose securities are the subject of allegations of fraud) can be held liable in private Rule 10b-5 damages actions only for false statements attributed to the secondary actor at the time of dissemination.  Absent attribution, plaintiffs cannot establish that they relied on the defendants' own false statements, and the secondary actors' participation in the creation of the false statements amounts to, at best, aiding and abetting securities fraud.  The Court rejects the plaintiff's argument (supported in an SEC amicus brief) in favor of a creator standard as inconsistent with Supreme Court precedent (Central Bank, Stoneridge) and the Second Circuit's "bright line" test adopted in Wright v. Ernst & Young (2d Cir. 1998), which held that an outside accountant could not be held liable for public statements not attributed to it.

The Court acknowledges the confusion in the Circuit created by Wright and its later decision in In re Scholastic Corp. Securities Litigation (2d Cir. 2001), where it held that a corporate officer could be liable for misrepresentations made by the corporation, even though none of the statements was specifically attributable to him.  That opinion did not cite Wright and led to confusion about whether Wright's attribution standard was relaxed.  However, in 2007, the Second Circuit applied the attribution standard again in a case involving an outside accounting firm in Lattanzio v. Deloitte & Touche.  While emphasizing the Wright attribution standard and rejecting the creator standard, the Second Circuit does not entirely clear up the confusion.  While its definition of secondary actors to exclude the issuer's employees would logically point to reconciling Wright/Lattanzio and Scholastic on this basis, the Court explicitly declines to do so:  "because this appeal does not involve claims against corporate insiders, we intimate no view on whether attribution is required for such claims or whether Scholastic can be meaningfully distinguished from Wright and Lattanzio."

The Court also affirms the district court in rejecting plaintiffs' alternative argument based on "scheme liability" because Stoneridge foreclosed this theory.  The Court does acknowledge that after Stoneridge it is "somewhat unclear" how the deceptive conduct of a secondary actor could be communicated to the public and yet remain "deceptive," but it nevertheless finds it clear after Stoneridge that the "mere fact that the ultimate result of a secondary actor's deceptive course of conduct is communicated to the public through a company's financial statements is insufficient to show reliance on the secondary actor's own deceptive conduct."

After Stoneridge, some have argued that the Supreme Court's opinion should not be read as foreclosing the "scheme liability" theory where the secondary actors play a role that is more closely connected to the securities or capital-raising process, such as those professionals who advise securities issuers, in contrast to the suppliers named as defendants in Stoneridge.  I always thought that argument to be wishful thinking, and at least in the Second Circuit, it will not fly.