Rule 10b-5
Report of the Task Force on Statute of Limitations for Implied Actions
Committee on Federal Regulation of Securities, 41(2): 645–66 (Feb. 1986)
This Report contains a comprehensive compilation and analysis of the caselaw regarding the application of statutes of limitation to implied actions. It calls for legislative enactment of a uniform statute of limitations to eliminate the confusion, uncertainties, and anomalies in this area.
Insider Trading Under Rule 10b-5: The Theoretical Bases for Liability
Willis W. Hagen II, 44(1): 13–41 (Nov. 1988)
After briefly discussing the development of insider trading law, this Article analyzes the fiduciary duty theory, the concept of a temporary insider, and the misappropriation theory. It examines two, diametrically opposed positions that the law could take under section 10(b) and rule 10b-5: (i) to impose liability whenever anyone intentionally uses misappropriated, nonpublic information to purchase or sell securities, or (ii) to impose liability only when an insider breaches a fiduciary duty in acquiring material nonpublic information that is used in connection with the purchase or sale of securities.
The Limits of the Fraud on the Market Doctrine
William J. Carney, 44(4): 1259–92 (Aug. 1989)
This Article explores the economic reasoning that underlines the fraud-on-the-market doctrine for open and developed markets. It first reviews the rules governing rule 10b-5 decisions and the economic theory used in formulating evidentiary presumptions. Next, it examines the behavior of participants in impersonal markets, and then it examines the market process in open and developed secondary trading markets. It concludes with an analysis of the economic forces operating with respect to new issues and the integrity of an offering.
After Reves v. Ernst & Young, When Are Certificates of Deposit "Notes" Subject to Rule 10b-5 of the Securities Exchange Act?
Randall W. Quinn, 46(1): 173–88 (Nov. 1990)
In Reves v. Ernst &Young, 494 U.S. 56 (1990), the Supreme Court for the first time addressed the meaning of the phrase "any note" in the definition of security in the Exchange Act. This Article examines the status of certificates of deposit under the Exchange Act after Reves, focusing on two issues that the decision left open: the scope of the exclusion created by Marine Bank v. Weaver, 455 U.S. 551 (1982) for instruments issued by federally regulated and insured banks and the interpretation of the Exchange Act's exclusion for notes having a maturity of not exceeding nine months.
Loss of State Claims as a Basis for Rule 10b-5 and 14a-9 Actions: The Impact of Virginia Bankshares
Scott E. Jordan, 49(1): 295–325 (Nov. 1993)
In Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977), the Supreme Court implied in a footnote that, if, during the course of a freeze-out merger, management omitted to state a fact that would have provided a basis for a state law remedy, such omission could possibly serve as the basis for a federal securities action under rule 10b-5 of the Exchange Act. Some appellate courts interpreted Santa Fe to allow federal securities actions to be premised solely on the loss of state law claims caused by management's misleading statements. Commentators have argued that interpreting Santa Fe to allow such actions is contrary to the pronouncement in the text of the opinion. Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991), turns the tide. Virginia Bankshares indicates that the Supreme Court would be unwilling to allow shareholders to bring federal securities actions based upon the loss of a state law claim. This Article provides guidance to securities law practitioners and offers a solution to the courts in light of Virginia Bankshares .
How Accurate are Estimates of Aggregate Damages in Securities Fraud Cases?
Kenneth R. Cone and James E. Laurence, 49(2): 505–26 (Feb. 1994)
The parties in rule 10b-5 securities class actions frequently use computer simulations of stock trading to estimate aggregate damages. Despite the fact that these models often generate damage estimates amounting to hundreds of millions of dollars, they have never been publicly tested against actual class claims. This Article tests the models against claims data from two securities cases and concludes that the models substantially overestimate actual claims.
The Implications of Central Bank
Joel Seligman, 49(4): 1429–49 (Aug. 1994)
This Article addresses seriatim: (i) the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), (ii) the implications of that decision, and (iii) what should be the appropriate liability standard in derivative claims.
Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A .—The Beginning of an End, Or Will Less Lead to More?
Lisa Klein Wager and John E. Failla, 49(4): 1451–66 (Aug. 1994)
This Article explores the implications of Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), from a practitioner's vantage point. In particular, it identifies the most likely areas of future litigation related to alternative theories of liability that may be asserted against parties who traditionally have been charged with aiding and abetting securities fraud. The authors question whether the demise of aiding and abetting liability will, as a practical matter, lessen the likelihood that professionals and other "outsiders" will be sued.
Central Bank of Denver v. SEC
Simon M. Lorne, 49(4): 1467–78 (Aug. 1994)
The author, General Counsel of the SEC, presents a hypothetical future opinion of the Supreme Court. The opinion demonstrates that the Court's recent decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), cannot properly be read as precluding the possibility that the SEC may still bring enforcement actions seeking injunctive or other civil relief against those who aid or abet violations of section 10(b) and rule 10b-5.
The Future of Aiding and Abetting and Rule 10b-5 After Central Bank of Denver
David S. Ruder, 49(4): 1479–87 (Aug. 1994)
This Article urges Congress to amend section 10(b) of the Exchange Act—which is highly unlikely to happen—to provide aider and abettor liability and suggests that Congress may be faced with the need to deal with a Supreme Court majority that will be limiting the law of securities fraud under rule 10b-5.
SEC v. Central Bank: A Draft Opinion for the Court's Conference
Edward C. Brewer, III and John L. Latham, 50(1): 19–46 (Nov. 1994)
In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), the Supreme Court held that section 10(b) of the Exchange Act does not create aiding and abetting liability. That decision involved private parties suing under the section 10(b) implied right of action. After Central Bank, the SEC has dismissed most of its aiding and abetting claims and requested that Congress amend section 10(b) but is pursuing a small number of test cases in which it maintains that the decision does not apply to its enforcement actions under the existing statute. Simon M. Lorne, General Counsel of the SEC, presented a hypothetical opinion to that effect in Central Bank of Denver v. SEC, 49 BUS. LAW. 1467 (1994), and three other symposium Articles commented on the questions and problems raised by the Central Bank decision. The authors, who are counsel of record to an individual aiding and abetting defendant in a test case in the Eleventh Circuit and the Northern District of Georgia, present a contrary hypothetical opinion explaining why, after Central Bank, the SEC may not pursue aiding and abetting claims under the existing section 10(b).
SEC Rule 10b-5 and Its New Statute of Limitations: The Circuits Defy the Supreme Court
Lewis D. Lowenfels and Alan R. Bromberg, 51(2): 309–34 (Feb. 1996)
In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson , 501 U.S. 350 (1991), the Supreme Court ruled that an implied private action under SEC rule 10b-5 must be commenced within one year after discovery of the facts constituting the violation and within three years after such violation. Does the one-year period commence when the victim of the alleged fraud becomes aware of facts that would lead a reasonable person to investigate whether he might have a claim (inquiry notice) or is the commencement of the one- year period delayed until the plaintiff becomes aware that he is in fact a victim of fraud (actual notice)? The Supreme Court opts for "actual notice"; the federal circuit courts require "inquiry notice." This Article examines this conflict between the Supreme Court and the circuit courts, analyzes the facts of the leading cases, and explores the arguments for and against "inquiry" and "actual" notice, respectively.
How to Stop Arguing About 10b-5 Opinions in Exempt Offerings
Robert F. Quaintance, Jr., 51(3): 703–19 (May 1996)
This Article proposes guidelines for use by practitioners and financial intermediaries in determining the need for "10b-5 opinions" (also known as negative assurance letters) in exempt securities offerings. The Article explores the case law (including Gustafson v. Alloyd Co ., 513 U.S. 561 (1995)), statutes, legislative history, and ethical considerations relevant to 10b-5 opinions and concludes generally that 10b-5 opinions can and should be obtained in "public-style" exempt offerings, in which the relationship of the issuer, the intermediary, and the investors, the nature of the disclosure document, and the extent of the due diligence investigation resemble those present in a registered public offering but that 10b-5 opinions need not be obtained in the traditional private placement, in which the intermediary plays a lesser role and the disclosure documents and the intermediary's due diligence investigation are more abbreviated.
Effect on 10b-5 Damages of the 1995 Private Securities Litigation Reform Act: A Forward-Looking Assessment
Jonathan C. Dickey and Marcia K. Mayer, 51(4): 1203–19 (Aug. 1996)
This Article considers how section 21D of the Private Securities Litigation Reform Act of 1995 is likely to affect damage assessments in securities class actions and other rule 10b-5 cases. Graphs are used to illustrate how this new "bounce-back" rule will reduce or even eliminate damages in cases where a stock suffers only a short-term price decline. This theoretical presentation is supplemented with analyses of investor losses and plaintiffs' claims in shareholder class actions that settled from 1991 to 1994. The empirical evidence suggests that, except perhaps in bull markets, the law will have at most a modest impact on damages in the vast majority of cases.
A New Standard for Aiders and Abettors Under the Private Securities Litigation Reform Act of 1995
Lewis D. Lowenfels and Alan R. Bromberg, 52(1): 1–12 (Nov. 1996)
Generally speaking, during the past twenty years, the elements to be proved to establish an action for aiding and abetting securities violations by private parties or by the SEC have been same: (i) a primary violation by another person; (ii) some degree of the defendant's knowledge of the primary violation, recklessness, or other scienter; and (iii) substantial assistance by the defendant. The Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), eliminated damage actions brought by private parties for aiding and abetting securities violations. The Private Securities Litigation Reform Act of 1995 unequivocally reaffirmed the SEC's authority to maintain civil enforcement actions in court against aiders and abettors. The central thesis of this Article is that the Reform Act (i) will require the second element of aiding and abetting to scale upward to a "knowing" or full scienter requirement, eliminating the constructive knowledge in the form of recklessness and "should have known," which had previously sufficed in some cases; and (ii) will require the third element of aiding and abetting to scale upward to require the SEC to prove that the actions and/or inactions of the alleged aider and abettor were a substantial proximate causal factor of the primary violation and loss, eliminating the "but for" causation which had previously sufficed in some SEC cases.
Secondary Liability Under Rule 10b-5: Still Alive and Well After Central Bank?
Gareth T. Evans and Daniel S. Floyd, 52(1): 13–34 (Nov. 1996)
Although in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), the Supreme Court held that there is no aiding and abetting liability in a private action under rule 10b-5, the Court recognized that secondary actors are still subject to liability for primary violations. Since Central Bank, numerous lower courts have struggled with the issue of when the conduct of secondary actors (such as accountants, underwriters, and lawyers) gives rise to primary as opposed to aiding and abetting liability. Some courts have imposed primary liability on secondary actors for assisting in the preparation of statements that are alleged to contain misrepresentations or omissions. Other courts have held that the same conduct is merely aiding and abetting. This Article analyzes the approaches courts have taken to the scope of primary liability following Central Bank and discusses whether they are consistent with the Supreme Court's reasoning.
Liabilities of Lawyers and Accountants Under Rule 10b-5
Lewis D. Lowenfels and Alan R. Bromberg, 53(4): 1157–80 (Aug. 1998)
Following the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A ., 511 U.S. 164 (1994), abolishing aiding and abetting liability in private actions, accountants and lawyers remain potentially liable to nonclients under rule 10b-5 on grounds of primary liability in connection with their clients' securities fraud. The recent decisions with respect to both accountants and lawyers involve alleged misrepresentations or nondisclosures in the communications of the respective professionals or their clients with investors. Predictability, particularly in the cases involving accountants, is difficult because many of the decisions are irreconcilable and give little certainty. The cases involving lawyers are somewhat less irreconcilable but as yet cannot be said to have formed a clear, coherent pattern. In summary, the "certainty and predictability" that the Supreme Court had hoped to achieve in Central Bank have not yet been realized with respect to the liabilities of either accountants or lawyers to nonclients under rule 10b-5.
U.S. Securities Fraud Across the Border: Unpredictable Jurisdiction
Lewis D. Lowenfels and Alan R. Bromberg, 55(3): 975–1021 (May 2000)
We live in an increasingly global financial community. In recent years, transactions involving securities often extend across national borders. Under these circumstances, parties who view themselves as defrauded in connection with securities transactions that are predominantly extraterritorial in nature, but have some connection to the United States, often attempt to seek redress in U.S. courts under the broad antifraud provisions of section 10(b) of the Exchange Act and rule 10b-5 promulgated thereunder. Parties seeking such redress must first establish subject matter jurisdiction under the Exchange Act. This Article addresses the essential question, which is to what extent and under what factual circumstances the federal securities laws and particularly the antifraud provisions of section 10(b) and rule 10b-5 will be applied to securities transactions that are predominantly extraterritorial in nature but have some connection to the United States. Unfortunately, Congress has not provided clear, specific guidelines with respect to these issues. Therefore, it has been left to the federal courts to attempt to develop some parameters in this area. This Article explores both the meager statutory guidelines and the much more extensive case law which delineate these parameters.
The Neglected Relationship of Materiality and Recklessness in Actions Under Rule 10b-5
Allan Horwich, 55(3): 1023–38 (May 2000)
The concept of "materiality" under the federal securities laws has received much attention from the courts and the SEC, yet it has become increasingly murky. Judgments about what is and what is not material for purposes of the disclosure requirements under SEC rules and the antifraud provisions of the federal securities laws are often very difficult. At the same time, errors in making those judgments can result in civil liability. Litigants seldom contend that, and courts seldom address whether, a defendant's judgment about whether a fact was material is germane in assessing liability, particularly under rule 10b- 5. This Article suggests that the determination of liability under rule 10b-5, particularly where the defendant is alleged to have acted recklessly (rather than with a specific intent to defraud), should take into account whether the defendant was reckless in failing to appreciate the materiality of the fact that was omitted or misrepresented. In other words, a determination of whether a defendant acted with scienter encompasses an evaluation of whether the defendant was reckless in not recognizing that the omitted or misrepresented fact was material.
Individual Civil Liability Under the Federal Securities Laws for Misstatements in Corporate SEC Filings
Christian J. Mixter, 56(3): 967 (May 2001)
Last fall, amid the sound and fury of the "pleading standards" debate under the Private Securities Litigation Reform Act (PSLRA), the Ninth Circuit quietly reaffirmed the basic principle that a CEO who, acting knowingly or recklessly, signs a materially false or misleading corporate SEC filing may not escape liability under Section 10(b) and Rule 10b-5 by arguing that he was a bystander to the preparation of that filing. This Article discusses the background and the implications of the Ninth Circuit's ruling with respect to both primary and "control person" liability for signers of corporate annual and periodic reports; the current state of the law on liability for secondary actors in false statements cases after Central Bank; the so-called group pleading or group publication doctrine; and the many additional statutes and rules that the SEC may use against corporate officials whose companies file false or misleading disclosures with the Commission.
Don't Call Me a Securities Law Groupie: The Rise and Possible Demise of the "Group Pleading" Protocol in 10b-5 Cases
William O. Fisher, 56(3): 991 (May 2001)
The group pleading protocol permits securities law plaintiffs to name individuals as defendants in 10b-5 lawsuits without specifically alleging their participation in preparing the statements on which plaintiffs sue. This Article traces the development of this protocol in the Ninth and Second Circuits, focusing on which defendants are within the "group" and what kinds of corporate communications are "group- published." The Article then proceeds to discuss abuse of the protocol by decisions viewing it as a rule of substantive law rather than a pleading shortcut, and cases improperly applying the protocol to scienter pleading. The article concludes with sections addressing: (i) the effect of Central Bank and primary liability law on group pleading; (ii) whether group pleading survives the Private Securities Litigation Reform Act; and (iii) how much common sense lies behind the factual assumptions on which the protocol is based.
The Boundaries of the "In Connection With" Requirement of Rule 10b-5: Should Advertising Be Actionable as Securities Fraud?
Francesca Muratori, 56(3): 1057 (May 2001)
The content of advertising has traditionally been the domain of consumers and the companies enticing them to make purchases, often stretching the truth in the process. Consumers, long familiar with those techniques, understand that ads are not the province of hard facts. Those relationships may be poised to undergo change in the wake of the Second Circuit's holding in In re Carter-Wallace Securities Litigation . Issuer liability to stockholders who claim a trading decision was based on allegedly misleading advertising expands the boundaries of the "in connection with" element of Rule 10b-5 and imposes uncertainty on the conduct of business.
Rule 10b-5's "In Connection With": A Nexus for Securities Fraud
Lewis D. Lowenfels and Alan R. Bromberg, 57(1): 1 (Nov. 2001)
The precise meaning of the crucial words "fraud in connection with the purchase or sale of any security" as used in section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder has never been completely clear. Courts have not pinned down with any specificity the meaning of the requirement that fraud occur in connection with the purchase or sale of a security. In this article the authors analyze this requirement from a number of different vantage points in a number of different factual settings. There is a clear dichotomy in the case law. On one side is a broad judicial interpretation of the "in connection with" phrase, and this broad view is clearly the predominant line of authority. On the other side is a narrower, more circumscribed, judicial interpretation of this phrase which, although by no measure predominant, does manage to retain a certain stubborn vigor and vitality. The ultimate test is a nexus: how close must the fraud be to the purchase or sale of a security to invoke the coverage of Rule 10b-5?
Understanding Dura
Merritt B. Fox, 60(4): 1547—1576 (August 2005)
This article evaluates the issues remaining open after the recent Supreme Court decision in Dura Pharmaceuticals, Inc. v. Broudo, concerning causation in Rule 10b—5 fraud—on—the—market actions. Analytically, for a positive misstatement to cause an investor to suffer a loss, (1) the misstatement must inflate the market price of a security, (2) the investor must purchase the security at the inflated price, and (3) the investor must not resell the security sufficiently quickly that the price at the time of sale is still inflated. The lower courts have been left the task of designing a comprehensive set of rules concerning what the plaintiff must plead and prove, and the acceptable forms of evidence, concerning each of these critical elements. Dura simply narrowly holds that a plaintiff cannot establish causation merely by pleading and proving that the misstatement inflated price.
One important matter on which the Court expresses no opinion is whether loss causation can ever be established where the price at the time suit is brought (or, if earlier, the time of sale) is higher than the purchase price. The article concludes that a blanket rule against actions where the price has increased would be inappropriate because there are situations where the price has increased but each of the three critical elements can still be reasonably easily and definitively established. Where one or more of these elements cannot be reasonably easily and definitively established, however, a price increase is a negative piece of evidence and under some specified circumstances a bright line rule barring actions might be appropriate.
The other important matter on which the Court expresses no opinion is whether the plaintiff must plead and prove a price drop immediately following the unambiguous public announcement of the truth. Again, the Article concludes that a blanket rule requiring such a showing is inappropriate. Other ways of demonstrating that the misstatement inflated price are sufficiently reliable that they should be allowed under at least some circumstances. The absence of a price drop after the announcement, however, makes it less clear when the inflation dissipated, which is relevant to whether the plaintiff bought at an inflated price and did not sell at one. Some plaintiffs can show these other elements reasonably easily and definitively in other ways, for example plaintiffs who purchase the security immediately after the misstatement is made and still hold it at the time of the public announcement of its falsity. For ones who cannot, it may be appropriate to ban actions where there is no post announcement price drop. This problem is less critical for class actions because at least minimum losses to the class as a whole can be established without concern as to when the inflation dissipated.
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Cross–Border Tender Offers and Other Business Combination Transactions and the U.S. Federal Securities Laws: An Overview
Jeffrey W. Rubin, John M. Basnage, and William J. Curtin, III, 61(3):1071—1134 (May 2006)
In structuring cross–border tender offers and other business combination transactions, parties must consider carefully the potential application of U.S. federal securities laws and regulations to their transaction. By understanding the extent to which a proposed transaction will be subject to the provisions of U.S. federal securities laws and regulations, parties may be able to structure their transaction in a manner that avoids the imposition of unanticipated or burdensome disclosure and procedural requirements and also may be able to minimize potential conflicts between U.S. laws and regulations and foreign legal or market requirements. This article provides a broad overview of U.S. federal securities laws and regulations applicable to cross–border tender offers and other business combination transactions, including a detailed discussion of Regulations 14D and 14E under the Securities Exchange Act and the principal accommodations afforded to foreign private issuers thereunder.
Independent Directors as Securities Monitors
Hillary A. Sale, 61(4):1375-1412 (August 2006)
This paper considers the role of independent directors of public companies as securities monitors. Rather than engaging in the debate about whether independent directors are good or bad, important or unimportant, the paper takes their existence and basic governance role as a given, focusing instead on what recent statements from Securities and Exchange Commission officials indicating an increased focus on independent directors and their role in preventing securities fraud. The paper notes that the SEC believes that independent directors are on the board to act, at least in part, as securities monitors. This securities monitor role is another aspect of the information-forcing-substance disclosure model that the SEC has used to achieve improved corporate governance. Although directors face heightened risk when they draft or sign disclosure documents, they also have an ongoing responsibility to be informed of developments within the company, ensure good processes for accurate disclosures, and make reasonable efforts to assure that disclosures are adequate. Independent directors with expertise should be involved in reviewing and, sometimes, drafting statements. All directors, however, should be fully aware of the company's press releases, public statements, and communications with security holders and sufficiently engaged and active to question and correct inadequate disclosures. In addition to defining the role of independent directors as securities monitors, the article reviews the liability independent directors might face under private causes of action and contrasts it with the SEC's enforcement powers and remedies. The article describes some of the SEC's prior statements that emphasize the role of independent directors as securities monitors and the importance of their providing both guidance and check and balance.
Internal Investigations and the Defense of Corporations in the Sarbanes-Oxley Era
Robert S. Bennett, Alan Kriegel, Carl S. Rauh, and Charles F. Walker, 62(1): 55–88 (Nov. 2006)
Internal investigations long have been an integral part of the successful defense of corporations against charges of misconduct, as well as an important board and management tool for assessing questionable practices. With the heightened standards of conduct and increased exposure created by Sarbanes-Oxley, this essential instrument for safeguarding corporate interests has become even more crucial in identifying and managing risk in the enforcement arena. This article examines from a practitioner's standpoint when and how internal investigations should be conducted in order to protect the corporation in criminal, civil and administrative proceedings. Particular attention is paid to the issues created by a concurrent government investigation and in dealing with employees and former employees in the course of an investigation. The article also addresses the role of the Audit Committee under Sarbanes-Oxley, and the important issue of reporting the findings of the investigation to appropriate corporate officials. The subject of self-reporting by the Company to enforcement authorities is considered as well. In this context, the article explores the SEC's position on crediting self-reporting and cooperation as set forth in the Seaboard report; Department of Justice policy as embodied in the Thompson Memorandum; and the impact of the Federal Sentencing Guidelines for Organizations.
The Origin, Application, Validity, and Potential Misuse of Rule 10b5-1
Allan Horwich, 62(3): 913–954 (May 2007)
The SEC adopted Rule 10b5-1 to define what it means to trade securities "on the basis of" material nonpublic information. This was to address decisions and commentary that found no insider trading violation of Rule 10b-5 where the defendant did not "use" inside information in deciding to trade, even if one "possessed" the information when the decision was made. Rule 10b5-1 specifies exclusive affirmative defenses for one charged with trading on the basis of material nonpublic information, the essence of which are that there is no violation if the trade was made pursuant to a pre-arranged plan, even if the seller or buyer later became aware of the information before the trade was made. There is, however, a substantial argument that the SEC exceeded its powers in adopting exclusive criteria for what it means to trade "on the basis of" material nonpublic information, rather than creating a safe harbor. Non-use of inside information in deciding to trade remains a defense even if the trade was not made pursuant to a Rule 10b5-1 plan. Although the SEC abandoned a proposal to require detailed disclosure of some Rule 10b5-1 plans, other SEC rules require disclosure of a plan in some circumstances, although compliance may be deficient. Irrespective of mandated disclosure, there are reasons both for and against voluntary disclosure of a Rule 10b5-1 plan. Some have suggested that Rule 10b5-1 is being misused in that executives establish such plans, know when a trade will occur under the plan and then, in order to maximize their profits when the trade is made, delay or accelerate disclosure of corporate news that would affect the stock price. In most situations, any such timing of corporate disclosure would not violate the securities laws.
When Should Investor Reliance Be Presumed in Securities Class Actions?
Roberta S. Karmel, 63(1): 25–54 (November 2007)
Reasonable or justifiable reliance is one of the elements of a claim by a private party under section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"). Section 18 of the Exchange Act has an even stricter reliance requirement, but proof of reliance is not required for a claim under section 11 of the Securities Act of 1933. This Article will discuss the basis for these discrepancies and inquire into whether traditional interpretations of the reliance requirement need to be re–examined. There are at least two possible reasons for such a re–examination at this time. First, the reliance requirement is frequently presumed in securities class actions based on the efficient capital market hypothesis ("ECMH"), but the ECMH has come to be seriously questioned in the academic literature. Second, high–powered decision makers in several recent reports have asserted that U.S. capital markets are becoming less competitive than overseas markets due, in part, to the high level of civil liability under the federal securities laws. These decision makers recommend that the uncertainties as to the elements of liability under Rule 10b–5 be resolved. Once such element is reliance because the issue of reliance in the certification of class actions has become an actively litigated area and the decisions in these cases are often crucial to the outcome of the litigation.
This Article argues that in developing the law of civil liability under Rule 10b–5, the courts should be guided by the doctrine that public companies impliedly represent that the statements they make in U.S. Securities and Exchange Commission ("SEC") filings and other required public utterances are truthful, and accordingly, they should be liable when materially false or misleading statements are made that cause damage to investors, whether or not investors can prove they read and relied upon such statements in purchasing or selling securities. Nevertheless, a plaintiff should be required to prove that such presumed reliance was reasonable. Such a theory of constructive reliance could be achieved through a reinterpretation of section 18 of the Exchange Act, through presumptions concerning reliance in Rule 10b–5 cases, or through legislation or possibly rule making by the SEC.
This Article will discuss the common law action for deceit, its inapplicability to issuer fraud in modern securities markets, and the defects of section 18 of the Exchange Act as a substitute for the common law. The development of Rule 10b–5 actions as an alternative cause of action and the requirements for reliance in Rule 10b–5 cases will also be covered. This Article then will discuss the ECMH, the theories of its supporters and detractors, as well as its use by the SEC in formulating securities disclosure policy. Finally, a revisionist view will be presented of how the fraud–on–the–market doctrine should be used in connection with proof of reliance in securities litigation.
The Loss Causation Requirement for Rule 10b–5 Causes of Action: The Implications of Dura Pharmaceuticals, Inc. v. Broudo
Allen Ferrell and Atanu Saha, 63(1): 163–186 (November 2007)
In order to have recoverable damages in a Rule 10b–5 action, plaintiffs must establish loss causation, i.e., that the actionable misconduct was the cause of economic losses to the plaintiffs. The requirement of loss causation has come to the fore as a result of the U.S. Supreme Court's landmark decision in Dura Pharmaceuticals, Inc. v. Broudo. We address in this Article a number of loss causation issues in light of Dura, including the proper use of event studies to establish recoverable damages, the requirement that there be a corrective disclosure, what types of disclosure should count as a corrective disclosure, post–corrective disclosure stock price movements, the distinction between the class period and the damage period, collateral damage caused by a corrective disclosure, and forward–casting estimates of recoverable damages.
Applying Stoneridge to Restrict Secondary Actor Liability Under Rule 10b-5
Todd G. Cosenza, 64(1): 59-78 (November 2008)
Although the U.S. Supreme Court's decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., was widely viewed as a sweeping rebuke of the application of "scheme" liability to secondary actors, the Court's decision also raised some questions regarding the precise scope of secondary actor liability under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. There is an obvious tension between the Court's holding that the secondary actors in Stoneridge could not be held liable because their "deceptive acts, which were not disclosed to the investing public, [were] too remote to satisfy the element of reliance" and its pronouncement that "[c]onduct itself can be deceptive" and could therefore satisfy a Rule 10b-5 claim. In particular, the question of what type of conduct satisfies the element of reliance in a claim against a secondary actor who assists in the drafting of a company's public disclosures remains open to interpretation.
This Article first discusses the general standards of section 10(b) liability and the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. The next part of the Article compares the judicial standards of secondary actor liability under Rule 10b-5(b)—the bright line, substantial participation, and creator standards—that emerged in the post- Central Bank era. It then discusses Stoneridge and the Court's recent rejection of secondary actor "scheme" liability under Rule 10b-5(a) and (c). Finally, it reviews recent applications of Stoneridge and analyzes the implications of these decisions going forward.
Negative Assurance in Securities Offerings (2008 Revision)
Report of the Subcommittee on Securities Law Opinions, Committee on Federal Regulation of Securities, ABA Section of Business Law, 64(2): 395-410 (February 2009)
Disclosure Obligations Under the Federal Securities Laws in Government Investigations
David M. Stuart and David A. Wilson, 64(4): 973-998 (August 2009)
With the prevalence of government investigations into corporate conduct, public companies frequently face decisions about whether, when, how, and where to disclose to investors the existence of such investigations and the facts learned in the course of, or as a result of, those investigations. While the federal securities laws (and the rules and regulations promulgated thereunder) require disclosure of specific events that may arise during an investigation, neither those laws nor the courts that have interpreted them provide clear guidance for many of the disclosure decisions that must be made over the course of an investigation. As a result, counsel must carefully analyze numerous facts and circumstances, understand the company's previous disclosures, make "materiality" assessments, and determine whether to make disclosure in a current report or wait until the next periodic filing. This Article seeks to present, through an analysis of precedent disclosures, caselaw, rules, and practical ramifications, the considerations counsel must take into account in evaluating disclosure decisions in the context of an investigation. These considerations can help counsel avoid having a disclosure decision worsen the already difficult circumstances posed by the investigation itself.
Reforming the Regulation of Broker-Dealers and Investment Advisers
Arthur B. Laby, 65(2): 395–440 (February 2010)
A key component of financial regulatory reform is harmonizing the law governing broker-dealers and investment advisers. Historically, brokers charged commissions and were regulated under the Securities Exchange Act of 1934. Advisers charged asset-based fees and were subject to the Investment Advisers Act of 1940, which contains a special exclusion for brokers. In recent years, brokers have changed their compensation structure and many now market themselves as advisers, raising questions about whether they should be treated as such. The Obama Administration's 2009 white paper on regulatory reform and draft legislation call for a fiduciary duty to be imposed on brokers that provide advice. This Article explores the debate over regulating brokers and advisers, and makes four key claims. First, changes in brokers' compensation and marketing methods vitiate application of the broker-dealer exclusion and should subject brokers to the Advisers Act. Second, changes in the nature of brokerage, spurred by changes in technology, make the broker-dealer exclusion unsustainable and Congress should repeal it. The third claim is that imposing fiduciary duties on brokers is incompatible with their historical roles as dealers and underwriters. To resolve this tension, this Article suggests a compromise that enhances brokers' duties but does not hobble their ability to perform their traditional functions. Finally, regulating brokers as advisers would overburden the U.S. Securities and Exchange Commission. This Article offers alternatives to alleviate the strain.
Closing Time: You Don’t Have to Go Home, But You Can’t Stay Here
Richard D. Bernstein, James C. Dugan, and Lindsay M. Addison, 67(4): 957 - 976 (August 2012)
In a significant trend, U.S. courts are increasingly rejecting cases involving foreign plaintiffs or foreign conduct. This trend was accelerated by the U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd., which established that U.S. securities laws cannot be applied extraterritorially. Lower courts have extended the presumption against extraterritoriality to other federal and state statutes.
SEC Enforcement Actions and Issuer Litigation in the Context of a "Short Attack"
Charles F. Walker and Colin D. Forbes; 68(3): 687-738 (July 2013)
Issuers faced with a short attack—short selling of the issuer’s stock combined with the spread of negative rumors—may contemplate defensive strategies such as litigation and contacting government regulators, in addition to the investor and public relations efforts that are typically utilized in the wake of negative media coverage. Precedent calls for caution in these circumstances, as the record shows that the results of such strategies are mixed, with the SEC often turning its investigative focus to the issuer, and with costly litigation frequently resulting in compromise. This article begins with a discussion of the recent history of regulatory and legislative efforts to address concerns around short attacks and “naked” short selling. It then turns to a discussion of the SEC enforcement cases and private litigation relating to short attacks, and concludes that the SEC has appropriately brought enforcement cases only in clear-cut instances of fraud, while policing the margins through enforcement of the technical requirements of Regulation SHO. The article shows that the SEC enforcement record in this area, and the proof issues generally attendant to these cases, present important considerations for issuers who perceive themselves under siege in a short attack.
Damages and Reliance Under Section 10(b) of the Exchange Act
Joseph A. Grundfest; 69(2): 307-392 (February 2014)
A textualist interpretation of the implied private right of action under section 10(b) of the Exchange Act concludes that the right to recover money damages in an aftermarket fraud can be no broader than the express right of recovery under section 18(a) of the Exchange Act. The Act’s original legislative history and recent Supreme Court doctrine are consistent with this conclusion, as is the Act’s subsequent legislative history. Section 18(a), however, requires that plaintiffs affirmatively demonstrate actual “eyeball or eardrum” reliance as a precondition to recovery and does not permit a rebuttable presumption of reliance. Accordingly, if the Exchange Act is to be interpreted as a “harmonious whole,” with the scope of recovery under the implied section 10(b) private right being no greater than the recovery available under the most analogous express remedy, section 18(a), then section 10(b) plaintiffs must either demonstrate actual reliance as a precondition to recovery of damages, or the U.S. Supreme Court should revisit Basic, as suggested by four Justices in Amgen, and overturn Basic’s rebuttable presumption of reliance. A textualist approach thus provides a rationale for either distinguishing or reversing Basic that avoids the complex debate over the validity of the efficient market hypothesis, an academic dispute that the Court is not optimally situated to referee.
Halliburton II: It All Depends on What Defendants Need to Show to Establish No Impact on Price
Merritt B. Fox; 70(2): 437-464 (Spring 2015)
Rule 10b-5 private damages actions cannot proceed on a class basis unless the plaintiffs are entitled to the fraud-on-the-market presumption of reliance. In Halliburton II, the Supreme Court provides defendants with an opportunity, before class certification, to rebut the fraud-on-the market presumption through evidence that the misstatement had no effect on the issuer’s share price. It left unspecified, however, the standard by which the sufficiency of this evidence should be judged.
This Article explores the two most plausible approaches to setting this standard. One approach would be to impose the same statistical burden on defendants seeking to show there was no price effect as is currently imposed on plaintiffs to show that there was a price effect when the plaintiffs later need to demonstrate loss causation. The other approach would be to decide that defendants can rebut the presumption of reliance simply by persuading the court that the plaintiffs will not be able meet their statistical burden. If the courts choose the first approach, Halliburton II is unlikely to have much effect on the cases that are brought or on their resolution by settlement or adjudication. If they choose the second approach, the decision’s effect will be more substantial. The Article concludes with a brief discussion of some of the considerations that should be relevant to courts in their choice between the two approaches.
The Legality of Opportunistically Timing Public Company Disclosures in the Context of SEC Rule 10b5-1
Allan Horwich, 71(4): 1113-1150 (Fall 2016)
Commentators have discovered that executives who engage in securities transactions purportedly under the shield of a Rule 10b5-1 Plan, so that their trades do not constitute unlawful insider trading, achieve abnormal returns. There is speculation that these returns may be achieved by influencing the timing of corporate disclosures, so that, for example, bad news is withheld at the corporate level until after a Plan sale occurs.
This Article concludes that so long as this delay in disclosure does not violate an SEC mandated disclosure requirement, Rule 10b-5 is not violated, and the SEC could not expand Rule 10b-5 to reach disclosure timing of this type. The Article also addresses the application of the common law to disclosure timing. The use of corporate information to time corporate disclosure for a personal benefit, to achieve a more favorable outcome in personal securities trading pursuant to a Plan, may be a breach of duty under the corporate common law of some states, including Delaware, applying established principles of the common law of insider trading. It is unlikely, if not impossible, however, that state regulatory authorities could or would pursue such conduct.
If remedial action is needed to discourage, and effectively preclude, disclosure timing, it should be in the nature of SEC mandated disclosures of information regarding Rule 10b5-1 Plans, something the SEC proposed more than ten years ago and then abandoned without explanation, and the exclusion of those who engage in disclosure timing from the benefits of Rule 10b5-1 by amending that rule itself.
SEC Cybersecurity Guidelines: Insights into the Utility Risk Factor Disclosures for Investors
Edward A. Morse, Vasant Raval, and John R. Wingender, Jr., 73(1): 1-34 (Winter 2017/2018)
In October 2011, the SEC issued new guidelines for disclosure of cybersecurity risks. Some firms responded to these guidelines by issuing new risk factor disclosures. This article examines the guidelines and cybersecurity disclosures in the context of existing laws governing securities regulation. It then examines empirical results from firm disclosures following the new guidelines. Evidence shows a relatively small proportion of firms chose to modify their risk factor disclosures, with most firms choosing not to disclose any specific cybersecurity risk. Moreover, disclosing firms generally experienced significant negative stock market price effects on account of making new disclosures. Rather than viewing disclosure as a positive signal of management attentiveness, investors apparently viewed it as a cautionary sign.
A Call for the SEC to Adopt More Safe Harbors that Limit the Reach of Rule 10b-5
Allan Horwich; 74(1) 53-90 (Winter 2018/2019)
The SEC has often adopted regulations that describe conduct that is deemed not to violate the law or that effectively exclude specified conduct from the scope of particular provisions of the securities laws, such as the prohibition on deception imposed by SEC Rule 10b-5. This article examines the nature of and rationales for the provisions that have narrowed the reach of that rule, and proposes that this approach be applied more broadly, further reducing the exposure of issuers of securities and other persons to claims under Rule 10b-5 without impairing the SEC’s enforcement of the securities laws. This will reduce uncertainty regarding the scope of Rule 10b-5, including in the arena of private damage claims, directing the focus to misrepresentations and half-truths. Several specific proposals are made here. The intention is to focus attention on the utility of the safe harbor approach in today’s litigation landscape and generate discussion that might lead to broader application of this concept.
The Myth of Morrison: Securities Fraud Litigation Against Foreign Issuers
Robert Bartlett, Matthew D. Cain, Jill E. Fisch, and Steven Davidoff Solomon; 74(4) 967-1014 (Fall 2019)
Using a sample of 388 securities fraud lawsuits filed between 2002 and 2017 against foreign issuers, we examine the effect of the Supreme Court’s decision in Morrison v. National Australia Bank Ltd. We find that the description of Morrison as a steamroller, substantially ending litigation against foreign issuers, is a myth. Instead, we find that Morrison did not significantly change the type of litigation brought against foreign issuers, which, both before and after this case, focused on foreign issuers with a U.S. listing and substantial U.S. trading volume. Although dismissal rates rose post- Morrison, we find no evidence that this was related to the decision. Settlement amounts and attorneys’ fees remained unchanged post-Morrison. We use these findings to theorize that Morrison was primarily a preemptive decision about standing that firmly delineated the exposure of foreign issuers to U.S. liability in response to the Vivendi case, which sought to expand the scope of liability for foreign issuers whose shares traded primarily in non-U.S. venues. When Morrison is placed in its true context, it is justified as a decision in line with administrative and court actions that have historically aligned firms’ U.S. liability to be proportional to their U.S. presence. Although Morrison had this defining effect, it did not change the litigation environment for foreign issuers, which was the oft-cited import of the decision. More generally, our analysis of Morrison also underscores how the decision has been mistakenly characterized as a case primarily about extraterritoriality rather than standing.
State Section 11 Litigation in the Post-Cyan Environment (Despite Sciabacucchi)
Michael Klausner, Jason Hegland, Carin LeVine, and Jessica Shin; 75(2): 1769-1790 (Spring 2020)
In Cyan, Inc. v. Beaver County Employees Retirement Fund, the U.S. Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) preserved state courts’ jurisdiction to adjudicate cases brought under the Securities Act of 1933, with defendants having no right to remove a case to federal court. The result of this decision has been a dramatic increase in section 11 cases litigated in state court, often with a parallel case brought in federal court against the same defendants based on the same alleged misstatements.
Loss Causation and the Materialization of Risk Doctrine in Securities Fraud Class Actions
Richard A. Booth; 75(2): 1791-1814 (Spring 2020)
In the context of a claim for securities fraud under SEC Rule 10b-5, most federal circuit courts have ruled or recognized that loss causation can be proven by an event that demonstrates an earlier statement by a defendant company to be false. In other words, corrective disclosure need not take the form of speech. Rather, a statement can be shown to be false by the materialization of a risk that was concealed by the company, and investors can be compensated for any losses they suffer as a result. Although this doctrine is well established, its ultimate effect is to overcompensate investors, thus encouraging excessive securities litigation and chilling voluntary disclosure.
The Evolution and 2020 Status of Cooperation in SEC Enforcement Investigations
Dixie L. Johnson, Carmen J. Lawrence, and Jamie Stinson 75(4): 2427-2466 (Fall 2020)
When facing potential enforcement action from the Securities and Exchange Commission (“SEC”), companies often seek to mitigate the consequences by cooperating with the SEC in one or more of the following ways: self-policing, self-reporting, remediation, and cooperation. While a 2001 SEC report of investigation known as the Seaboard Report provides a roadmap for what steps to take in order to earn cooperation credit and describes generally the potential benefits to be received, no such report or guidance exists that details exactly what tangible benefits a company will receive in return for the earned credit and how it will be determined. In addition, outside of narrow exceptions where the SEC engages in self-reporting initiatives, companies looking for publicly available guidance on how best to cooperate face a lack of consistency in the SEC’s settlement documentation describing cooperation factors and what benefits may be earned.