The 10b-5 Daily

There is a district court split over whether secondary actors who did not prepare or substantially participate in preparing corporate financial misstatements can still be held liable for them under Rule 10b-5 as scheme participants. Last week, the U.S. Court of Appeals for the Eighth Circuit weighed in on the issue and flatly rejected this theory of liability.

In In re Charter Communications, Inc. Sec. Litig., 2006 WL 925354 (8th Cir. April 11, 2006), the court addressed allegations that the vendor defendants entered into sham transactions with Charter knowing that the company “intended to account for them improperly and that analysts would rely on the inflated revenues and operating cash flow in making stock recommendations.” The plaintiffs argued (relying primarily on a district court decision in the Parmalat case) that the vendors violated Rule 10b-5(a) and (c) by participating in a fraudulent scheme or course of business.

The court found, however, that “any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission, or who does not directly engage in manipulative securities trading practices, is at most guilty of aiding and abetting and cannot be held liable under Sec. 10(b) or any subpart of Rule 10b-5.” Since the plaintiffs did not allege that the vendor defendants made or approved Charter’s financial misrepresentations, the claims against them were properly dismissed.

Holding: Dismissal affirmed.

Quote of note: “To impose liability for securities fraud on one party to an arm’s length business transaction in goods or services other than securities because that party knew or should have known that the other party would use the transaction to mislead investors in its stock would introduce potentially far-reaching duties and uncertainties for those engaged in day-to-day business dealings. Decisions of this magnitude should be made by Congress.”

The respondents’ brief in the Kircher case before the U.S. Supreme Court is now available online. The docket reveals that an amicus brief in support of Kircher has been filed by four law professors. Putnam Funds, in turn, is supported by amicus briefs from the Washington Legal Foundation, the Securities Industry Association and the Bond Market Association, and the U.S. Chamber of Commerce. Oral argument is scheduled for April 24.