LIABILITY IN SECURITIES FRAUD DAMAGE ACTIONS: Part VI – The Lines Are Not So Bright When Applied to Complex Business Transactions

In tracing the road which will eventually lead to the Supreme Court’s decision in Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc. next term and will define the scope of liability under Section 10(b), we have reviewed the three tests used by the Circuit Courts to differentiate between primary and secondary actors in securities fraud suits. In theory, there are clear dividing lines between the “substantial participation” test, the “bright line” test and “scheme” liability. District Courts have struggled to apply these theories to complex business transactions however, revealing that the lines between these tests are not always so clear.

In jurisdictions following the “bright line” test, for example, the courts have not always required that the defendant actually make the statement. Consider the result in In re Vivendi Universal, S.A. Sec. Litig., No. 02 CIV 5571, 2003 U.S. Dist LEXIS 19431 (S.D.N.Y. Nov. 3, 2003). There, the court declined to dismiss claims against a CFO where statements were made by the company. Similarly, in In re Lernout & Hauspie, 230 F. Supp. 2d 166 (D. Mass. 2002), the Court permitted a claim to go forward against the outside auditors on the theory that it could be inferred that the auditor made the statements. These holdings seem somewhat at odds with the focus of the “bright line” test. Indeed, in some senses the rulings begin to resemble something one might expect under the substantial participation test. At the same time, the Ninth Circuit is not the only court to adopt scheme liability. Consider for example, two cases from the Southern District of New York where the bright line test is the rule of choice from the Second Circuit. In In re Global Crossing, 313 F. Supp. 2d 189 (S.D.N.Y. 2003), the Court permitted a securities fraud claim to proceed against an outside auditor based on a scheme liability theory. There, the Court ruled that the auditors could be held liable based on allegations that they masterminded the scheme. However, the Court noted that the auditors could not be held liable for specific misrepresentations of others involved in the scheme.