Who Is A Primary Violator?

In Central Bank, the U.S. Supreme Court held that private action under Rule 10b-5 can only be brought against persons who are primary violators and not against those who aid and abet a primary violator. How to tell the difference between a primary violator and an aider and abettor, however, has been the subject of much debate.

The SEC has filed an amicus brief in the Homestore securities litigation currently pending before the U.S. Court of Appeals for the Ninth Circuit that urges the court to adopt a broad test for determining who is a “primary violator.” The lower court dismissed the claims against three companies – AOL Time Warner, Cendant, and L90 (as well as a few of their executives) – that were Homestore’s business partners in transactions whose alleged purpose was to inflate Homestore’s revenues. The lower court reasoned that these business partners could not be primary violators because they did not have a special relationship with Homestore (e.g., accountant or attorney).

The plaintiffs appealed these dismissals. In support of the plaintiffs, the SEC argues that Central Bank did not create a “special relationship” test for a primary violator and that engaging in a transaction whose purpose was to create a false appearance of revenues constitutes a deceptive act that can support primary liability.

Quote of note: “The Commission urges the following test for determining when a person’s conduct as part of a scheme to defraud constitutes a primary violation: Any person who directly or indirectly engages in a manipulative or deceptive act as part of a scheme to defraud can be a primary violator of Section 10(b) and Rule 10b-5; any person who provides assistance to other participants in a scheme but does not himself engage in a manipulative or deceptive act can only be an aider and abettor.”