PRECEDENT, PREDICTABILITY, AND JUDICIAL PREROGATIVE: CENTRAL BANK OF DENVER, N.A. v. FIRST INTERSTATE BANK OF DENVER, NA. AND JACK K.

PRECEDENT, PREDICTABILITY, AND JUDICIAL PREROGATIVE: CENTRAL BANK OF DENVER, N.A. v. FIRST INTERSTATE BANK OF DENVER, NA. AND JACK K. NABER INTRODUCTION Among the less celebrated landmarks of President Franklin D. Roosevelt's New Deal Era of Legislation, the 73rd Congress enacted the Securities Act of 1933 ("1933 Act") and the Securities Exchange Act of 1934 ("1934 Act").' Both were enacted in response to the collapse of the United States' financial markets, following the stock market crash of 1929, and to address reports of serious abuse in the securities industry. 2 Primarily, the 1933 Act regulates the initial distribution of securities and the 1934 Act regulates post-distribution trading. 3 Section 10(b) of the 1934 Act contains general anti-fraud provisions. 4 Pursuant to this statutory section, the Securities and Exchange Commission adopted Rule 10b-5 in 1942 which also prohibits fraudulent acts in connection with the sale of securities. 5 1. THE AMERICAN PEOPLE: CREATING A NATION AND A SOCIETY 793-801 (Gary B. Nash et al. eds., 1986) (listing the most recognized New Deal programs); Securities Exchange Act of 1933, 15 U.S.C. 77a-77bbbb (1989); Securities Exchange Act of 1934, 15 U.S.C. 88 78a-7811 (1989). 2. Central Bank of Denver, N.A. v. First Interstate Bank of Denver N.A., 114 S. Ct. 1439, 1445 (1994). 3. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 752 (1975). 4. See 15 U.S.C. 78j (1989). Section 10(b) provides in relevant part: 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 Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Id. 5. Central Bank of Denver, 114 S. Ct. at 1445; see 17 C.F.R. 240.10b-5 (1994). Rule 10b-5 provides: 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, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were, not misleading or (c) To engage in any act, practice, or course of business which operates or would

420 CREIGHTON LAW REVIEW [Vol. 28 While the text of section 10(b) clearly addresses fraudulent acts, courts continue to define both the scope of conduct prohibited by section 10(b) and Rule 10b-5 and the remedies available to private plaintiffs. 6 In Superintendent of Insurance of New York v. Bankers Life & Casualty Co.,7 the United States Supreme Court recognized the existence of an implied private right of action for primary violations of fraud and misrepresentation under section 10(b) of the 1934 Act. 8 More recently, in Herman & MacLean v. Huddleston, 9 the Supreme Court confirmed the existence of this implied right of action by stating that "a private right of action under [section] 10(b) of the 1934 Act and Rule 10b-5 has been consistently recognized for more than 35 years. The existence of this implied remedy is simply beyond peradventure." 10 However, the Court had never addressed whether section 10(b) affords a private right of action for alleged aiding and abetting violations.11 In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. ("Central Bank of Denver") 12 the Court on its own motion took the opportunity to decide the issue of whether section 10(b) and Rule 10b-5 afford a private plaintiff a cause of action against those who allegedly were aiding and abetting others in the commission of a fraudulent act. 13 The Court concluded that the anti-fraud provisions of section 10(b) of the 1934 Act do not create such a private right of action.14 This Note will first review the Court's decision in Central Bank of Denver.' 5 Next, this Note will examine how courts have defined the scope of section 10(b) and Rule 10b-5.1 6 This Note will then argue that the Court failed in Central Bank of Denver to properly consider a operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. 240.10b-5 (1994). 6. See infra notes 99-205 and accompanying text. 7. 404 U.S. 6 (1971). 8. Superintendent of Ins. of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6, 10 (1971). 9. 459 U.S. 375 (1983). 10. Herman & MacLean v. Huddleston, 459 U.S. 375, 380 (1983). 11. Central Bank of Denver, 114 S. Ct. at 1443. See Herman, 459 U.S. at 379 n.5 (reserving the issue of whether section 10(b) affords a private right of action for aiding and abetting); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 191-92 n.7 (1976) (reserving the issue of whether section 10(b) affords a private right of action for aiding and abetting). 12. 114 S. Ct. 1439 (1994). 13. See Central Bank of Denver, 114 S.Ct. at 1444; Arthur F. Mathews & W. Hardy Callcott, Securities Issues Confound Court Observers, CoNN. L. TRIB., Aug 1, 1994, at 16. 14. Central Bank of Denver, 114 S. Ct. at 1455. 15. See infra notes 20-99 and accompanying text. 16. See infra notes 100-229 and accompanying text.

1995] AIDING AND ABETTING SECURITIES FRAUD 421 long history of judicial interpretations of section 10(b) and Rule 10b- 5.17 This Note will then discuss the importance of the Court's holding. 1 8 This Note concludes that the role the Court assumed for itself in Central Bank of Denver is a disturbing one, with implications that may extend beyond the case itself. 19 FACTS AND HOLDING In 1986, the Colorado Springs-Stetson Hills Public Building Authority ("Authority") issued $15 million in bonds to finance public improvements at Stetson Hills, a planned community in Colorado Springs, Colorado. 20 The bonds were secured by landowner assessment liens covering approximately 250 acres. 2 1 In June of 1988, the Authority issued an additional $11 million in bonds. 22 This new bond issue was similarly secured by landowner assessment liens and covered approximately 272 acres. 23 The indenture trustee for the two bond issues was Central Bank of Denver, N.A. ("Central Bank"). 24 Pursuant to the bond covenants, the land subject to the land owner assessment liens was required to be worth 160% or more of the bonds' outstanding principal and interest. 25 In addition, AmWest Development, the developer of Stetson Hills, was required to give Central Bank an annual report showing that the land was worth at least 160% of the bonds' outstanding principal and interest. 26 In January of 1988, AmWest supplied Central Bank with a current appraisal that showed the land value in 1988 remained virtually unchanged from the reported land value in the 1986 appraisal. 27 Soon thereafter, the senior underwriter for the 1986 bond issue wrote to Central Bank expressing concern that the land value might not actually be meeting the 160% test due to a decline in property values in Colorado Springs. 28 As a result, Central Bank directed its in-house appraiser to look over the 1988 appraisal. 2 9 The in-house appraiser reported 17. See infra notes 230-66 and accompanying text. 18. See infra notes 267-77 and accompanying text. 19. See infra notes 278-79 and accompanying text. 20. First Interstate Bank of Denver, N.A. v. Pring, 969 F.2d 891, 893 (10th Cir. 1992), cert. granted in part sub noma., Central Bank of Denver v. First Interstate Bank of Denver, 113 S. Ct. 2927 (1993), rev'd, Central Bank of Denver, 114 S. Ct. at 1439 (1994). 21. Pring, 969 F.2d at 893. 22. Id. 23. Id. 24. Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 114 S. Ct. 1439, 1443 (1994). 25. Id. 26. Id. 27. Id. 28. Pring, 969 F.2d. at 894. 29. Id.

CREIGHTON LAW REVIEW [Vol. 28 that the Amwest appraisal seemed overly optimistic in light of the real estate market at the time and, therefore, suggested that Central Bank hire an outside appraiser to review the 1988 appraisal. 30 However, after discussing the 1988 appraisal several times with AmWest, Central Bank agreed to wait to do the independent review until the end of the year, which was six months after the June of 1988 closing on the bond issue. 31 The Authority defaulted on the 1988 bonds before the independent review could be completed. 32 First Interstate Bank of Denver and Jack Naber ("bondholders"), purchasers of $2.1 million dollars of the 1988 bonds, sued the Authority, the underwriters, an AmWest director, and Central Bank alleging violations of section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"). 33 The bondholders alleged that Central Bank violated section 10(b) by aiding and abetting the other defendants in the fraud. 34 Central Bank argued that it did not have any conscious intent to aid the primary violation, and did not provide substantial assistance to the primary violation. 35 Thus, Central Bank moved for summary judgment. 36 The United States District Court for the District of Colorado granted Central Bank's motion for summary judgment. 37 The district court held that the bondholders had not raised a genuine issue as to scienter; the state of mind required for both aiding and abetting violations and primary violations. 38 Furthermore, the district court found that the bondholders had failed to establish that Central Bank had a duty to disclose. 39 The district court held that in order to impose aider and abettor liability, the bankholders had to show both recklessness and a corresponding duty to disclose. 40 The bondholders appealed the district court's decision. 41 The United States Court of Appeals for the Tenth Circuit agreed with the district court, finding that Central Bank owed no duty to disclose to the bondholders. 42 However, the court explained that this was not the decisive issue in assessing Central Bank's liability. 43 In- 30. Central Bank of Denver, 114 S. Ct. at 1443. 31. Pring, 969 F.2d. at 895. 32. Central Bank of Denver, 114 S. Ct. at 1443. 33. Id. 34. Id. 35. Pring, 969 F.2d. at 900. 36. Id. 37. Central Bank of Denver, 114 S. Ct. at 1443. 38. Pring, 969 F.2d. at 900; Brief for Respondents at 9, Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 114 S. Ct. 1439(1994) (No. 92-854). 39. Pring, 969 F.2d at 900. 40. Id. 41. Id. at 891. 42. Id. at 900. 43. Id. at 901.

1995] AIDING AND ABETTING SECURITIES FRAUD 423 stead, the court reasoned that if the bondholders were able to prove the elements necessary to impose aider and abettor liability, Central Bank would not be immune from liability. 4 4 The court held that in an aiding and abetting claim based on assistance by action, scienter is satisfied by recklessness alone. 45 As such, the* court explained that the real issue as to the aiding and abetting claim was whether Central Bank was reckless when it delayed the independent review in light of the strong indication that the 160% test was not being met. 4 6 Thus, the court held that the district court's decision to grant Central Bank summary judgment was inappropriate. 4 7 Consequently, the Tenth Circuit reversed the district court's grant of summary judgment. 48 Central Bank then filed a writ of certiorari with the United States Supreme Court and the Supreme Court granted Central Bank's petition. 4 9 In so doing, the Court requested the parties to brief an issue that neither had raised: whether section 10(b) of the 1934 Act and Rule 10b-5 promulgated thereunder created an implied private right of action for aiding and abetting allegations. 50 The Court explained that it had granted certiorari in order to end the "continuing confusion" over the scope of section 10(b) and whether it includes a private right of action for aiding and abetting. 5 1 In examining whether an implied private right of action existed for aiding and abetting under section 10(b), the Court focused primarily on two aspects: (1) the text of section 10(b), first alone and then in comparison to other statutes; and (2) the weaknesses in the Security and Exchange Commissions' ("SEC") and bondholder's arguments made in favor of implying a private right of action for aiding and abetting claims. 5 2 44. Id. 45. Id. at 903. 46. Id. at 903-4. 47. Id. at 904. 48. Id. at 905. 49. Central. Bank of Denver v. First Interstate Bank of Denver, 113 S. Ct. 2927 (1993) (granting certiorari in part). In granting certiorari, the Supreme Court limited the parties to the issues of whether recklessness satisfied the scienter requirement, and whether section 10(b) of the 1934 Act and Rule lob-5 created a private right of action for aiding and abetting. Id. 50. Central Bank of Denver, 113 S. Ct. at 2927; Matthew J. Barrett, Does SEC Rule 10b-5 Provide an Implied Private Right of Action for Aiding and Abetting Securities Fraud?, A.B.A. PREVIEW OF U.S. SuP. CT. CASES, (Nov. 29, 1993); David 0. Stewart, Limited Exposure: Decision Ends Liability for Aiding and Abetting' on Security Deals, 80 A.B.A. J. 42 (July 1994); Arthur F. Mathews & W. Hardy Callcott, Securities Issues Confound Court Observers, CONN. L. TRIB., Aug 1, 1994, at 16. 51. 114 S. Ct. at 1444. 52. Central Bank of Denver, 114 S. Ct. at 1445-55; see Lawrence S. Robbins, High Court Sends Mixed Messages, N.Y. L.J., July 11, 1994, at 51.

CREIGHTON LAW REVIEW [Vol. 28 In discussing the first aspect, the Court stated that the text of the 1934 Act controlled its decision. 53 The Court cited earlier decisions in which it used the statutory text to determine the scope of conduct prohibited by section 10(b). 5 4 The Court noted that it had similarly relied on the statutory text in interpreting other sections of the 1934 Act and the Securities Act of 1933. 55 As such, the Court stated that the text of section 10(b) does not include terms such as "aiding" and "abetting," which "bodes ill for respondents." 56 In focusing on the plain language of section 10(b), the Court also rejected the SEC's argument that the phrase "directly or indirectly" contained in section 10(b) includes aiders and abettors. 7 The Court explained that the SEC's argument was flawed because aiding and abetting liability extends to a larger group than those who engage in the activity "indirectly." 58 The Court stated that the term "indirectly" refers to people who are participating in the fraudulent activity, albeit "indirectly." 5 9 Moreover, the Court reasoned that "indirectly" does not include those persons who do not engage in the activity at all and only aid and abet the persons who are perpetrating the fraud. 60 The Court next focused on other statutes that explicitly mention the terms "aid" and "abet" as evidence that "Congress [knows] how to impose aiding and abetting liability when it [chooses] to do so." 61 The Court stated that "if... Congress intended to impose aiding and abetting liability, we presume it would have used the words 'aid' and 'abet' in the statutory text." 62 Again, the Court noted that the "text of the 1934 Act does not itself reach those who aid and abet a [section] 10(b) violation." 63 In discussing the second aspect of its holding, the Court responded to the SEC's and the bondholder's arguments which sug- 53. Id. at 1446. 54. Id. at 1446-47. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 (1976) (examining the statute to decide that negligent acts could not violate 10(b)); Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 470 (1977) (considering the statutory language in determining that 10(b) did not cover breaches "of fiduciary duty by majority against a minority shareholders without any charge of misrepresentation or lack of disclosure"); Chiarella v. United States, 445 U.S. 222,232 (1980) (holding that unless a trader has an independent duty to disclose, 10(b) is not violated when a person trades securities without disclosing inside information). 55. Central Bank of Denver, 114 S. Ct. at 1447 (citing Pinter v. Dahl, 486 U.S. 622 (1988)) (relying heavily on the text of 12(1) of the 1934 Act in interpreting the scope). 56. Central Bank of Denver, 114 S. Ct. at 1447. 57. Id. 58. Id. at 1447-48. 59. Id. at 1447. 60. Id. 61. Id. at 1448. 62. Id. 63. Id.

1995] AIDING AND ABETTING SECURITIES FRAUD 425 gested that section 10(b) does afford an implied private cause of action for aiding and abetting liability. 64 The Court first discussed the argument that Congress intended to include in section 10(b) aiding and abetting liability. 6 5 The SEC and the bondholders argued that at the time Congress enacted section 10(b), aiding and abetting liability was "well established in both civil and criminal actions." 66 Thus, the SEC maintained that it is logical to assume that Congress meant to include within the scope of section 10(b) the firmly established theory of aiding and abetting liability. 67 The Court rejected the SEC's and bondholders' argument by tracing Congress' actions in civil aiding and abetting statutes, concluding that Congress has addressed aiding and abetting liability for each statute individually. 68 The Court stated that this congressional intent argument suggested one of three conclusions. 69 First, the Court noted that it might suggest that all federal statutes implicitly include aiding and abetting liability. 70 In analyzing this possibility, the Court concluded that there was no evidence of congressional intent to extend such broad liability coverage to federal civil statutes. 71 Second, the Court stated that the congressional intent argument might suggest that Congress created aiding and abetting liability only in section 10(b). 72 The Court rejected this theory by concluding that "nothing in the text or history of [section] 10(b) even implies that aiding and abetting was covered by the statutory prohibition on manipulative and deceptive conduct." 73 Third, the Court noted that the congressional intent argument might suggest that the 73rd Congress had intended all of the express causes of action within the 1934 Act to also create aiding and abetting liability. 74 However, the Court found no evidence that Congress had such an intent. 75 The Court further noted that Congress expressly imposed some forms of secondary liability, and thus deliberately chose 64. Id. at 1450. 65. Id. 66. Id. (citing Brief for Amicus Curiae in Support of Respondents at 10, Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 114 S. Ct. 1439 (1994) (92-854). 67. Central Bank of Denver, 114 S. Ct. at 1450 (citing Brief Amicus Curiae in support of Respondents at 11 (92-854)). 68. Central Bank of Denver, 114 S. Ct. at 1450-52. 69. Id. at 1451. 70. Id. 71. Id. The Court also stated that there was no precedent for such an expansion of federal law. Id. 72. Central Bank of Denver, 114 S. Ct. at 1451. 73. Id. 74. Id. 75. Id.

426 CREIGHTON LAW REVIEW [Vol. 28 where secondary liability should be included. 76 As such, the Court stated that courts should not alter congressional meaning. 77 Another argument made by the bondholders was that the lack of congressional action indicated that Congress agreed with the manner in which courts had interpreted section 10(b). 78 The Court disagreed and asserted that congressional inaction does not signify congressional approval. 79 The Court also explored the SEC's public policy arguments which reasoned that section 10(b) should include an aiding and abetting cause of action. 80 The Court explained that generally the judicial interpretation of section 10(b) cannot be based on public policy reasons. 81 Additionally, the Court noted that there existed public policy reasons to not afford a private right of action for aiding and abetting under Rule 10b-5. 82 The SEC's final argument in favor of an implied private right of action for aiding and abetting claims under section 10(b) was that the Court should rely on section 2 of Title 18 of the United States Code, a general aiding and abetting statute applicable to all criminal offenses. 83 In rejecting the SEC's argument, the Court stated that "while it is true that an aider and abettor of a criminal violation of any provision of the 1934 Act, including [section] 10(b), violates 18 U.S.C. [section] 2, it does not follow that a private civil aiding and abetting cause of action must also exist." 8 4 76. Id. at 1451-52. 77. Id. at 1452. 78. Id. 79. Id. at 1452-53. (quoting Patterson v. McLean Credit Union, 491 U.S. 164, 175 n.1 (1989) (citations omitted) (stating that "[i]t does not follow... that Congress' failure to overturn a statutory precedent is reason for this Court to adhere to it"); Helvering v. Hallock, 309 U.S. 106, 121 (1940) (stating, "we walk on quicksand when we try to find in the absence of corrective legislation a controlling legal principle")). 80. Central Bank of Denver, 114 S. Ct. at 1453. 81. Id. 82. Id. at 1454. The Court stated that "the rules for determining aiding and abetting liability are unclear," and that leads to "little predictive value" for people who service participants in the securities business; new companies may find it hard to obtain advice from professionals in the business because the professionals fear the company will not survive, and the professionals will then be held liable; and the increased cost from litigation in this area may be passed on to the company's investors. Id. 83. Central Bank of Denver, 114 S. Ct. at 1454-55. The SEC raised this issue only in its oral argument. Id. Section 2 of Title 18 of the United States Code provides in full: (a) whoever commits an offense against the United States or aids, abets, counsels, commands, induces, or procures its commission, is punishable as a principal (b) whoever willfully causes an act to be done which if directly performed by him or another would be an offense against the United States, is punishable as a principal. 18 U.S.C. 2 18 U.S.C. 2 (1989). 84. Central Bank of Denver, 114 S. Ct. at 1455.

1995] AIDING AND ABETTING SECURITIES FRAUD 427 The Court held that there is no private cause of action to impose aiding and abetting liability under section 10(b). 85 Therefore, because the bondholders never alleged that Central Bank was "manipulative or deceptive... within the meaning of section 10(b)," but rather alleged Central Bank aided and abetted in the fraud, the Court concluded that Central Bank may not be held liable. 8 6 Justice John Paul Stevens dissented for two primary reasons. 8 7 First, Justice Stevens disagreed with the Court's lack of attention to the history of aider and abettor liability. 8 8 Second, Justice Stevens explained that the Court's reasoning further jeopardizes "established forms of secondary liability not expressly addressed in the securities laws." 89 Justice Stevens first focused on the history of aider and abettor liability. 90 Justice Stevens argued that the Court devoted little attention to the long history of aider and abettor liability under section 10(b) and Rule 10b-5. 91 Justice Stevens noted that "in hundreds of judicial and administrative proceedings in every circuit court in the federal system, the courts and the SEC have concluded that aiders and abettors are subject to liability under [S]ection 10(b) and Rule lob-5." 9 2 Justice Stevens explained that this history of past decisions is important for two reasons. 93 First, Justice Stevens noted that the judges making the decisions near the time section 10(b) was enacted were more familiar with the times and therefore better understood the legislative intent behind the enactment. 94 Second, Justice Stevens explained that because there is a long history of judicial holdings that recognize a private right of action for aiding and abetting liability, Congress should be the only one to change this "settled" interpretation. 95 Justice Stevens next argued that the Court's decision would have a broad negative impact by jeopardizing other forms of secondary liability not expressly mentioned in the securities laws. 96 Justice Stevens explained that the Court's approach to aiding and abetting 85. Id. 86. Id. 87. Id. at 1456 (Stevens, J., dissenting). Justice Harry A. Blackmun, Justice David H. Souter, and Justice Ruth Bader Ginsburg joined in Justice Stevens' dissent. Id. 88. Central Bank of Denver, 114 S. Ct. at 1456 (Stevens, J., dissenting). 89. Id. 90. Id. 91. Id. 92. Id. (citing to 5B A. Jacobs, Litigation and Practicing Under Rule 10b-5 40.02 (rev. ed. 1993)). 93. Id. at 1457-58 (Stevens, J., dissenting). 94. Id. at 1465 (Stevens, J., dissenting). 95. Id. at 1458 (Stevens, J., dissenting). 96. Id. at 1460 (Stevens, J., dissenting).

CREIGHTON LAW REVIEW [Vol. 28 liability "at the very least casts serious doubt, both for private and SEC actions, on other forms of secondary liability that, like the aiding and abetting theory, have long been recognized by the SEC and the courts but are not expressly spelled out in the securities statutes." 97 Justice Stevens concluded by recognizing the proposition that legislation should properly be left to Congress and that the Court should hesitate before acknowledging private rights of action without direction from Congress. 9 " However, Justice Stevens warned that the Court should exercise caution when disregarding rights of action that have been judicially acknowledged for decades. 99 BACKGROUND In 1934, Congress enacted the Securities Exchange Act ("1934 Act") to regulate the post-distribution trading of securities. 100 Section 10(b) is the general anti-fraud provision of the 1934 Act. 101 Section 10(b) prohibits the use "in connection with the purchase or sale of any security... [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." 10 2 In 1942, the Securities and Exchange Commission ("SEC") promulgated Rule 10b-5 pursuant to the authority given it by section 10(b). 10 3 Rule 10b-5 prohibits any person from "employ[ing] any device, scheme, or artifice to defraud," or "mak[ing] any untrue statement.., or omit[ting] to state a material fact" or "engag[ing] in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security." 10 4 Neither the section nor the Rule contain an express private right of action for violations.' 05 In 1971, the United States Supreme Court first concluded that an implied private right of action against primary violators existed under section 10(b) and Rule 10b-5.1 0 6 Since that time, the Supreme Court has continued to address what are the neces- 97. Id. at 1460 (Stevens, J., dissenting). 98. Id. 99. Id. 100. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 752 (1975). 101. David O.Stewart, Limited Exposure: Decision Ends Liability for Aiding and Abetting' on Security Deals, 80 A.B.A. J. 42 (July 1994). 102. 15 U.S.C. 78j (1989). 103. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195 (1976). 104. 17 C.F.R. 240.10b-5 (1994). 105. Matthew J. Barrett, Does SEC Rule 10b-5 Provide an Implied Private Right of Action for Aiding and Abetting Securities Fraud?, A.B.A. PREVIEW OF U.S. SuP. CT. CASES (Nov. 29,1993). 106. Superintendent of Ins. of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6 (1971).

1995] AIDING AND ABETTING SECURITIES FRAUD 429 sary elements of a Rule 10b-5 action. 10 7 The Court has also attempted to determine the scope of conduct prohibited by section 10(b). 08 s Despite the Court's efforts to adequately define the scope of section 10(b) and Rule 10b-5, the Court had never addressed whether or not section 10(b) or Rule 10b-5 extends liability to secondary violators.' 0 9 However, the Court did reserve this issue in two earlier decisions: Ernst & Ernst v. Hochfelder 1 0 and Herman & MacLean v. Huddleston. 111 In Ernst, the Supreme Court "applied a strict approach to the securities statutes in defining the scope of conduct prohibited by section 10(b)." 112 In 1942, the plaintiffs began investing in a fraudulent securities scheme executed by First Securities' president, Leston B. Nay. 113 Nay convinced the plaintiffs to put money in "escrow" accounts by telling them that their investment would result in high rates of return." 4 However, Nay never put the money into any kind of accounts. 1 5 Instead, he used the money for his own purposes. 116 The 107. 421 U.S. 723 (1975). In Blue Chip Stamps, the United States Supreme Court began to interpret the scope of Rule 10b-5 more restrictively. Roberta S. Karmel, Implications of the 'Central Bank of Denver' Case N.Y. L.J., June 16, 1994, at 3. The Court held that for every Rule 10b-5 case, the plaintiff must be a seller or buyer of securities. Blue Chip Stamps, 421 U.S. 723. In so holding, the Court focused primarily on Congressional intent and public policy considerations. Id. at 737. In Blue Chip Stamps, the Court expressed its disapproval of implied claims: We believe that the concern expressed for the danger of vexatious litigation which could result from a widely expanded class of plaintiffs under Rule 10b-5 is founded on something more substantial than the common complaint of the many defendants who prefer avoiding lawsuits entirely to either settling them or trying them. Id. at 740. 108. Chiarella v. United States, 445 U.S. 222, 224 (1980); Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 464-65 (1977). In Santa Fe, the Supreme Court relied on the statutory language of 10(b) in interpreting the statute, and the Court concluded that the language of 10(b) did not cover breaches of fiduciary duty by corporate directors. Santa Fe, 430 U.S. at 476. Instead, the Court explained that this type of action was covered by state corporate law in that federal securities laws were designed primarily to prevent manipulation in the stock markets. Karmel, N.Y. L.J. at 3; Santa Fe, 430 U.S. at 478-80; The Court further concluded that 10(b) prohibits making "a material misstatement.., or the commission of a manipulative act." Central Bank of Denver, 114 S. Ct. at 1448 (citing Santa Fe, 430 U.S. at 473). In Chiarella, the Supreme Court dealt with a Rule 10b-5 action against a printer who used inside information when trading securities. Chiarella, 445 U.S. at 224. The Court held in Chiarella that silence, without a duty to inform will not be an actionable fraud. Id. at 235. 109. Barrett, A.B.A. PREVIEW OF U.S. SuP. CT. CASES. 110. 425 U.S. 185, 191-92 n.7 (1976). 111. 459 U.S. 375, 379 n.5 (1983). 112. Norman B. Arnoff & Susan B. Jacobs, The 'Central Bank of Denver of Denver' Impact, N.Y. L.J., June 14, 1994, at 3. 113. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 189 (1976). Nay also owned 92% of First Securities' stock. Id. 114. Ernst & Ernst, 425 U.S. at 189. 115. Id. 116. Id.

CREIGHTON LAW REVIEW [Vol. 28 plaintiffs continued to give Nay money until the fraud was discovered, some twenty-six years later. 117 After discovering the fraud, the plaintiffs immediately filed an action in the United States District Court for the Northern District of Illinois. 118 The plaintiffs alleged that the accounting firm of Ernst & Ernst had aided and abetted in the fraud by negligently auditing First Securities, and therefore violated section 10(b) of the 1934 Act and Rule 10b-5.11 9 The district court dismissed the action by granting Ernst & Ernst's motion for summary judgment. 120 The district court concluded that there was no issue of material fact regarding Ernst & Ernst's performance of its audits. 121 The plaintiffs appealed the district court's decision. 122 The United States Court of Appeals for the Seventh Circuit reversed the district court's decision. 123 The court concluded that if one breaches a duty to disclose and inquire, and the fraud would have been detected but for the breach of that duty, the breaching party is liable for aiding and abetting in violation of Rule 10b-5.124 The court held that there were issues of material fact as to whether Ernst & Ernst's failure to discover an irregular procedure by Nay constituted a breach of its duty. 125 The United States Supreme Court granted certiorari. 126 The issue before the Supreme Court was whether, in the absence of scienter, a private cause of action for civil damages was available under section 10(b) and Rule 10b-5.1 27 The Court first explained the general purpose of the 1934 Act. 128 Next, the Court determined that the appropriate starting point to resolve the question of the elements of a section 10(b) cause of action is the specific language of the section itself.1 29 In addressing the SEC's and the plaintiffs' argument that nothing in the 117. Id. The fraud was discovered in 1968 when Nay left a suicide note exposing the fraud. Id. 118. Ernst & Ernst, 425 U.S. at 189-90. 119. Id. at 189-90. 120. Id. at 191. 121. Id. This was compared to generally accepted auditing standards. Id. 122. Ernst & Ernst, 425 U.S. at 191. 123. Id. Hochfelder v. Ernst & Ernst, 503 F.2d 1100, 1119 (7th Cir. 1974), cert. granted, 421 U.S. 909 (1975), rev'd, Ernst & Ernst, 425 U.S. at 185 (1976). 124. Hochfelder, 503 F.2d at 1104; Ernst & Ernst, 425 U.S. at 191. 125. Hochfelder, 503 F.2d at 1111. Nay directed that no one could open mail that came to him at work if it was addressed to him or to his attention. Ernst & Ernst, 425 U.S. at 190. This was an irregular procedure, and could have prevented an effective audit. Id. The plaintiffs alleged that this is what Ernst & Ernst should have discovered and asked about. Id. 126. Ernst & Ernst v. Hochfelder, 421 U.S. 909 (1975) (granting certiorari). 127. Ernst & Ernst, 425 U.S. at 193. 128. Id. at 194-97. 129. Id. at 197.

1995] AIDING AND ABETTING SECURITIES FRAUD 431 language of section 10(b) limits it to only knowing or intentional practices, the Court stated that the text addresses intentional misconduct, and that because the text is controlling, "further inquiry may be unnecessary." 130 Nevertheless, the Court turned to the legislative history of. the 1934 Act in order to determine whether the history of the Act gave the SEC and the plaintiffs' argument validity. 131 The Court found no evidence in the legislative history that Congress intended section 10(b) to prohibit conduct that did not involve scienter.1 32 The SEC and the plaintiffs also argued that other sections of the 1934 Act suggested that civil liability may be imposed for negligent conduct.1 33 The Court rejected this argument by concluding that the structures of both the 1934 Act and the Securities Act of 1933 ("1933 Act") do not support this argument. 134 The Court determined that from this argument it would follow that causes of action covered by other sections of the Acts could be brought under section 10(b). 135 Accordingly, the Court reasoned that such a result would "nullify the effectiveness of the carefully drawn procedural restrictions on these express actions." 136 The Court stated that without support in the legislative history, it could not reach such a result.' 3 7 The final argument addressed by the Court was that Rule 10b-5 contains language that alone encompasses negligent behavior.' 38 However,* the Court rejected this argument by explaining that Rule 10b-5 was written expressly under the authority of section 10(b). 139 As such, the "scope [of Rule 10b-5] cannot exceed the power granted the Commission by Congress under [section] 10(b)." 140 The Court held that a private cause of action for damages will not lie under section 10(b) and Rule 10b-5 in the absence of an allegation of scienter. 141 The Court further concluded that because the plaintiffs specifically disclaimed that Ernst & Ernst engaged in any intentional 130. Id. at 201. 131. Id. 132. Id. at 201-06. 133. Id. at 206-07. 134. Id. at 207. 135. Id. at 210. The Court specifically referred to 11, 12(2), and 15. Id. 136. Ernst & Ernst, 425 U.S. at 210.. 137. Id. at 211. 138. Id. at 212. The SEC and Hochfelder pointed only to subsection (b) and (c) for this proposition. Id. 139. Ernst & Ernst, 425 U.S. at 212-13. 140. Id. at 214. 141. Id. at 193.

CREIGHTON LAW REVIEW [Vol. 28 misconduct there was no reason to remand the action.1 42 Thus, the Court reversed the Seventh Circuit's decision. 143 Justice Harry A. Blackmun dissented. 144 Justice Blackmun argued that the Court's narrow interpretation of section 10(b) limits the chance of recovery for the victim of a fraudulent transaction. 145 Justice Blackmun further emphasized the importance of the auditor's role in ensuring full disclosure and noted that the Court's decision prevented any exploration of whether Ernst & Ernst had violated Rule 10b-5 by failing to question Nay and disclose its findings to the plaintiffs. 146 The Court did not consider whether section 10(b) and Rule 10b-5 impose civil liability for aiding and abetting. 147 The Court stated that "[i]n view of our holding that an intent to deceive, manipulate, or defraud is required for civil liability under [section] 10(b) and Rule 10b- 5, we need not consider whether civil liability for aiding and abetting is appropriate under the section and the Rule, nor the elements necessary to establish such a cause of action." 148 In Herman & MacLean v. Huddleston, 149 the Court again, as in Ernst, reserved the issue of whether section 10(b) includes a private right of action for aider and abettor liability.1 5 0 In Herman, the plaintiffs purchased securities from Texas International Speedway ("TIS"), a company which subsequently went bankrupt. '51 The plaintiffs filed a class action suit in the United States District Court for the Southern District of Texas against most of the participants in the securities offering, including the accounting firm of Herman & MacLean. 152 The plaintiffs alleged that Herman & MacLean violated section 10(b) and Rule 10b-5 by engaging in a fraudulent scheme to conceal or misrepresent material facts regarding TIS's financial situation.' 5 3 Herman & MacLean had issued an opinion concerning the financial statements and balance sheet of TIS. 154 The jury found that the plaintiffs had proved their case by a preponderance of the evidence and that the de- 142. Id. at 215. 143. Id. 144. Id. (Blackmun, J., dissenting). Justice William J. Brennan joined the dissent. Id. 145. Ernst & Ernst, 425 U.S. at 215-16 (Blackmun, J., dissenting). 146. Id. at 218 (Blackmun, J., dissenting). 147. Id. at 191-92 n.7. 148. Id. 149. 459 U.S. 375 (1983). 150. Herman & MacLean v. Huddleston, 459 U.S. 375, 379 n.5 (1983). 151. Id. at 377-78. 152. Id. at 378. In January of 1973, the case was moved to the United States District Court for the Northern District of Texas. Id. at 378 n. 1. 153. Herman & MacLean, 459 U.S. at 378. 154. Id.

1995] AIDING AND ABETTING SECURITIES FRAUD 433 fendants had acted with scienter. 155 Thus, the district court held that "Herman & MacLean and others had violated [section] 10(b) and Rule 10b-5 by making fraudulent misrepresentations in the TIS registration statement." 15 6 Herman & MacLean appealed the district court's decision. 15 7 The United States Court of Appeals for the Fifth Circuit held that a cause of action, even when it may be actionable under a section of the 1933 Act, may be brought under section 10(b) of the 1934 Act. 158 However, the court noted that the appropriate standard for determining an action under section 10(b) was by "clear and convincing" evidence. 159 The court disagreed with the district court's instruction to the jury that the appropriate standard of proof was a preponderance of evidence. 160 The court reversed and remanded to the district court. 161 The United States Supreme Court granted certiorari to address whether an implied right of action under section 10(b) includes conduct that is subject to express civil liability under the 1933 Act and to decide the proper standard of proof for actions brought under section 10(b). 16 2 The Supreme Court held that the facts leading to express civil liability pursuant to the federal securities laws could properly create the foundation for a section 10(b) action. 16 3 The Court concluded that there was no logical reason to excuse liability under section 10(b) for fraud simply because the conduct may also be actionable under another section of the securities laws. 16 4 The Court also held that the appropriate standard of proof in section 10(b) actions is a preponderance of the evidence. 16 5 The Court reasoned that this is the standard generally used in civil actions and it "allows both parties to 'share the risk of error in roughly equal fashion.' "166 Although the Court reserved discussion of whether section 10(b) and Rule 10b-5 include a private cause of action for aiding and abetting liability, the lower federal courts have addressed the scope of sec- 155. Id. at 378-79. 156. Id. at 379. 157. Huddleston v. Herman & MacLean, 640 F.2d 534, 545 (5th Cir. 1981), cert. granted, 456 U.S. 914 (1982), aff'd in part, rev'd in part, 459 U.S. 375 (1983). 158. Huddleston, 640 F.2d at 543. 159. Id. at 545-46; Herman & MacLean, 459 U.S. at 379. 160. Huddleston, 640 F.2d at 545-46. 161. Id. at 560. 162. Huddleston v. Herman & MacLean, 456 U.S. 914 (1982) (granting certiorari); Herman, 459 U.S. at 379. 163. Herman, 459 U.S. at 379-80. 164. Id. at 382-83. 165. Id. at 390. 166. Id. (quoting Addington v. Texas, 441 U.S. 418, 423 (1979)).

CREIGHTON LAW REVIEW [Vol. 28 tion 10(b) and Rule 10b-5 to determine whether the scope encompasses a private cause of action against aiders and abettors.1 67 In 1946, with Kardon v. National Gypsum Co., 168 the lower courts began to explore the scope of section 10(b) and Rule 10b-5.1 69 In Kardon, the Kardons, alleged that the defendant, National Gypsum Company, conspired through misrepresentations to induce them to sell their stock in other corporations for a much lower price than its true value. 170 National moved to dismiss, claiming that the Kardons failed to state a valid cause of action. 171 The United States District Court for the Eastern District of Pennsylvania held that civil suits brought by private persons as a result of section 10(b) and Rule 10b-5 violations were permitted and therefore denied National's motion to dismiss. 172 Since Kardon, the lower federal courts have considered whether the implied private right of action includes claims of aiding and abetting. 173 Brennan v. Midwestern United Life Insurance Co. 174 is considered to be the leading case concerning aider and abettor liability.1 7 5 Decided in 1969, Brennan, was the first case in which a court analyzed aiding and abetting liability under section 10(b) in detail. 176 In Brennan, the United States Court of Appeals for the Seventh Circuit held that there is an implied private right of action included for aiding and abetting in securities fraud in violation of section 10(b) of the 1934 Act. 177 In Brennan, the plaintiffs purchased almost three million dollars worth of stock from Dobich Securities Corporation ("Dobich"), a brokerage firm.' 78 However, Dobich used the money from the stock 167. Herman, 459 U.S. at 379 n.5. See Cleary v. Perfectune, Inc., 700 F.2d 774, 777 (1st Cir. 1983); Kerbs v. Fall River Indus., Inc., 502 F.2d 731, 740 (10th Cir. 1974); Landy v. FDIC, 486 F.2d 139, 162-63 (3d Cir. 1973) cert. denied, 416 U.S. 960 (1974). 168. 69 F. Supp. 512 (E.D. Pa. 1946). 169. Kardon v. National Gypsum Co., 69 F. Supp. 512 (E.D. Pa. 1946); Barrett, A.B.A. PREVIEW OF U.S. SuP. CT. CASES. 170. Kardon, 69 F. Supp. at 512. 171. Id. 172. Id. at 514. 173. See Cleary v. Perfectune, Inc., 700 F.2d 774, 777 (1st Cir. 1983); Kerbs v. Fall River Indus., Inc., 502 F.2d 731, 740 (10th Cir. 1974); Landy v. FDIC, 486 F.2d 139, 162-63 (3d Cir. 1973) cert. denied, 416 U.S. 960 (1974). 174. 417 F.2d. 147 (7th Cir. 1969), cert. denied, 397 U.S. 989 (1970). 175. See Brennan v. Midwestern United Life Ins. Co., 417 F.2d. 147, 153-155 (7th Cir. 1969), cert. denied, 397 U.S. 989 (1970); Roberta S. Karmel, Implications of the 'Central Bank of Denver of Denver' Case N.Y. L.J., June 16, 1994, at 3. 176. Brief for Respondents at 27 n.20, Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 114 S. Ct. 1439 (1994) (92-854). 177. Brennan, 417 F.2d. at 153-55. 178. Brennan v. Midwestern United Life Ins. Co., 259 F. Supp 673, 675 (N.D. Ind. 1966).

1995] AIDING AND ABETTING SECURITIES FRAUD 435 purchases for working capital and "other improper purposes." 17 9 Dobich, without ever delivering the stock to the plaintiffs, went bankrupt.1 8 0 One of the corporations of which Dobich sold shares of stock in was Midwestern United Life Insurance Company ("Midwestern"). 18 1 The plaintiffs filed a class action suit in the United States District Court for the Northern District of Indiana against Midwestern, alleging that Midwestern had aided, abetted, and assisted in the alleged fraudulent activity of Dobich by failing to report the improper activities.' 8 2 Midwestern conceded that the plaintiffs' allegations against Dobich were sufficient to state a cause of action.1 8 3 However, Midwestern contended that the plaintiffs failed to state a cause of action against it because an aider and abettor is not liable in a civil action under section 10(b) and Rule 10b-5.1 8 4 Midwestern argued that one cannot be liable for aiding and abetting without an affirmative action or a breach of an affirmative duty.' 85 Midwestern also argued that the plaintiffs failed to establish that they relied on any actions Midwestern had taken.' 8 6 The district court held that section 10(b) did imply a private right of action for aiding and abetting violations.1 8 7 The court relied on section 876(b) of the Restatement of Torts in reaching its conclusion. 188 Section 876(b) provides that a person will be held liable for harm that results from the conduct of another if that person "knows that the other's conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other." 1 9 The court contended that the Restatement principles "best fulfill the purposes of the Securities Exchange Act." 190 The court also held that one can be liable as an aider and abettor without an affirmative action. 19 1 In reaching this conclusion, the court stated that: [D]uties are often found to arise in the face of special relationships, and there are circumstances under which a person or corporation may give the requisite assistance or encourage- 179. Id. 180. Id. 181. Id. Midwestern served as its own transfer agent. Id. 182. Brennan, 259 F. Supp. at 675. 183. Id. at 676. 184. Id. 185. Id. at 681. 186. Id. at 682. 187. Id. at 685. 188. Id. at 680. 189. RESTATEMENT (SECOND) OF TORTS 876(b) (1977). 190. Brennan, 259 F. Supp. at 680. 191. Id. at 682.

436 CREIGHTON LAW REVIEW [Vol. 28 ment to a wrongdoer so as to constitute an aiding and abetting by merely failing to take action. 192 Thus, the district court denied Midwestern's motion to dismiss the action for failure to state a claim. 193 Following the court's denial of Midwestern's motion to dismiss, the district court tried the case in 1968.194 The district court held that Midwestern had aided and abetted in Dobich's primary violation of section 10(b), by its silence, inaction, and affirmative conduct. 195 Midwestern appealed the decision of the district court. 196 The Seventh Circuit, in affirming the district court's decision held that a secondary defendant may be liable for giving active and knowing assistance to a third party who is engaged in fraudulent activities that violate the securities laws. 197 The court further determined that liability may be imposed on an aider and abettor for inaction combined with affirmative acts by the defendant. 198 Since Brennan, all eleven of the United States Courts of Appeals to address this issue have held that a private action to impose aiding and abetting liability does exist under the federal securities laws. 199 For example, in Kerbs v. Fall River Industry, 200 the United States Court of Appeals for the Tenth Circuit held that a person can be held 192. Id. at 681-82 (citations omitted). 193. Id. at 685. 194. Brennan v. Midwestern United Life Ins. Co., 286 F. Supp. 702 (N.D. Ind. 1968), aff'd, 417 F.2d at 147 (7th Cir. 1969); cert.denied, 397 U.S. 989 (1970). 195. Brennan, 417 F.2d at 148. 196. Id. at 147-49. 197. Id. at 153-55. 198. Id. at 155. 199. Cleary v. Perfectune, Inc., 700 F.2d 774, 777 (1st Cir. 1983); IIT v. Cornfeld, 619 F.2d 909, 922 (2d Cir. 1980); Rolf v. Blyth, Eastman Dillon & Co.,Inc., 570 F.2d 38, 47-48 (2d Cir. 1978), cert. denied, 439 U.S. 1039 (1978); Hirsch v. du Pont, 553 F.d 750, 759 (2d Cir. 1977); Healey v. Catalyst Recovery of Pa., Inc., 616 F.2d 641, 651 (3d Cir. 1980); Monsen v. Consolidated Dressed Beef Co., Inc., 579 F.2d 793, 799 (3d Cir. 1978), cert. denied sub norn; First Pennsylvania Bank, N.A. v. Monsen, 439 U.S. 930 (1978); Gould v. American-Hawaiian S. S. Co., 535 F. 2d. 761, 779 (3d Cir. 1976); Landy v. FDIC, 486 F.2d 139, 162-63 (3d Cir. 1973), cert. denied, 416 U.S. 960 (1974); Schatz v. Rosenberg, 943 F.2d 485, 495 (4th Cir. 1991), cert. denied sub nom., Schatz v. Weinberg & Green, 112 S. Ct. 1475 (1992); Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94-95 (5th Cir. 1975); SEC v. Washington County Util. Dist., 676 F.d 218, 227 (6th Cir. 1982); SEC v. Coffey, 493 F.2d 1304, 1316 (6th Cir. 1974), cert. denied, 420 U.S. 908 (1975); Hochfelder v. Midwest Stock Exch., 503 F.2d 364-74 (7th Cir. 1974), cert. denied, 419 U.S. 875 (1974); Stokes v. Lokken, 644 F.2d 779, 782-83 (8th Cir. 1981); Strong v. France, 474 F.2d 747, 752 (9th Cir. 1973); Kerbs v. Fall River Indus., Inc., 502 F.2d 731, 740 (10th Cir. 1974); Woods v. Barnett Bank of Ft. Lauderdale, 765 F.2d 1004, 1011 (11th Cir. 1985). The District of Columbia has not considered the question in private actions but has found aiding and abetting liability in actions brought by the SEC See SEC v. Falstaff Brewing Corp., 629 F.2d 62, 72 (D.C. Cir. 1980), cert. denied, Kalmanovitz v. SEC, 449 U.S. 1012 (1980). 200. 502 F.2d 731 (10th Cir. 1974).