Aiding and Abetting under Rule 10b-5: Time for a Change?

Should lawyers and others continue to get a free pass on aiding and abetting the commission of securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and the SEC's Rule 10b-5? Two of our esteemed law academy colleagues testified on this issue a few weeks ago before the U.S. Senate Subcommittee on Crime and Drugs of the United States Senate Committee on the Judiciary. The bill at issue was the "The Liability for Aiding and Abetting Securities Violations Act of 2009," Senate Bill 1551, introduced by Senator Arlen Specter. In essence, the bill would permit private actions to be brought against those providing substantial assistance to a securities fraud or other violation of the securities laws. Professor Jack Coffee (Columbia) supports the bill, but believes there should be a cap on liability. He states that:

the time has come for legislative re-examination of the immunity given secondary participants; a balance needs to be struck. As I suggest below, this balance is best struck by restoring private aiding and abetting liability, but with a ceiling on damages.

In his testimony, Professor Coffee contends that pleading requirements for scienter would make it difficult for plaintiffs to bring frivolous litigation against aiders and abettors that survives a motion to dismiss.

Professor Adam Pritchard (Michigan) opposes the bill as a significant threat to free enterprise. He notes the pressure on issuers to settle out securities fraud cases and argues that "[g]iving the plaintiffs’ bar aiding‐and‐abetting authority would offer class action lawyers one more weapon with which to shake down settlements." He also indicates that the bill has the capacity to transform lawyers and other professionals into "quasi‐fraud police."

Who is right? One? Both? Neither?

On the one hand, it does not seem right (at some level) to let fraud facilitators "walk." On the other hand, because the securities class action process and the elements of a Rule 10b-5 claim most often propel securities fraud actions toward settlement (even if the case is weak), plaintiffs have incentives to seek new deep pockets (aiders and abettors drawn from the ranks of lawyers, accountants, and investment bankers, among others) from which to extract settlement payments. Professor Pritchard suggests an alternative to the bill that he has posited elsewhere: force wrongdoers to disgorge any ill-gotten gains.

Accountants, lawyers, and investment bankers who are complicit in the corporation’s fraud should be forced to give up their fees (or some multiple thereof) earned during the fraud period. Canada uses a version of this remedy in its recently adopted securities class action legislation. Under that legislation, the liability cap for experts is $1 million or the revenue that the expert and its affiliates have earned from the issuer and its affiliates during the 12‐month period immediately preceding the day on which the misrepresentation or the failure to make timely disclosure occurred. Those limits are inapplicable if the fraud is done knowingly.

I find this an interesting proposition worth further thought.

I respect the scholarship of Professors Coffee and Pritchard. The testimony of each on this matter does not disappoint; I commend it to your reading.