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Second Circuit Limits “Secondary Actor” Securities Claims

By Jeffrey B. Tracy, Litigation News Associate Editor – July 1, 2010

The U.S. Court of Appeals for the Second Circuit has issued an opinion giving attorneys and law firms significant protections from claims that they are liable as “secondary actors” for false statements they allegedly created for use in their client’s public offering documents.

In Pacific Investment Management Co. LLC v. Mayer Brown LLP [PDF], the plaintiffs brought a securities fraud suit against an attorney and law firm as “secondary actors” under Rule 10b-5 of the Securities and Exchange Act of 1934.

The plaintiffs alleged that the attorney and law firm participated in a scheme to defraud investors and drafted portions of their client’s public offering documents that contained false and misleading information. The statements at issue were not attributed to the attorney or the law firm.

The U.S. District Court for the Southern District of New York dismissed the plaintiffs’ action, holding that none of the statements were attributed to the attorney or firm, thus barring recovery under Rule 10b-5. Further, the district court held that the plaintiffs’ “scheme liability” claim had been foreclosed by the Supreme Court’s earlier decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. [PDF].

The Second Circuit’s Decision
On appeal, the plaintiffs, joined by the Securities and Exchange Commission (SEC), advocated a “creator standard” that would hold secondary actors, like outside counsel, liable for creating false statements that investors rely on. The Second Circuit rejected the “creator standard,” noting that it would lead to “uncertainty regarding the scope of Rule 10b-5 liability and potentially deter beneficial conduct.”

Rather than the “creator standard,” the court adopted an “attribution requirement,” holding that a secondary actor can only be held liable in private actions under Rule 10b-5 if the false statements are “attributed to the secondary-actor defendant at the time of dissemination.”

Contrary to the “creator standard,” the court stated, the “attribution requirement makes clear—to secondary actors and investors alike—that those who sign or otherwise allow a statement to be attributed to them expose themselves to liability.”

In applying the attribution requirement, the court affirmed the district court’s decision, noting that no statements in the offering documents were attributed to either the attorney or the law firm when they were disseminated. Further, the court held that the mere mention of a law firm in offering documents could not be considered an “articulated statement” by that law firm adopting its client’s statements as its own.

The court also affirmed the dismissal of the plaintiffs’ “scheme liability” claim, noting that Stoneridge foreclosed liability where a plaintiff alleged that the secondary actor’s supporting role made them part of a “scheme” to defraud investors.

Future Implications for Litigators
Howard S. Suskin, Chicago, cochair of the Class Actions and Derivative Suits Subcommittee of the ABA Section of Litigation’s Securities Litigation Committee , believes it is likely that the Supreme Court will act on Pacific. “It is noteworthy that the SEC strongly opposes the test articulated in Pacific,” says Suskin.

“There are also a number of cases that do not articulate the same test as Pacific did. Because of that, the Supreme Court, despite addressing a similar issue two years ago in Stoneridge, could take up the issue,” says Suskin.

Suskin also believes that Pacific will directly impact attorneys and law firms in the securities arena. “Lawyers, law firms, and professionals in general, must be more mindful of statements being attributed to them,” says Suskin.

“More than ever, professionals in a variety of fields, but especially attorneys and firms, are taking additional steps to clear and vet statements to better protect themselves and the firm,” he says.

The Pacific decision makes clear that “to bring a 10b-5 action, the statement must be attributed expressly to the attorney or firm and that even if the firm or attorney is identified as counsel in the offering documents, this will not be enough,” says Carla R. Walworth, New York, cochair of the Class Actions and Derivative Suits Subcommittee of the Section’s Securities Litigation Committee.

“This gives attorneys and firms clear guidance on what conduct gives rise to liability and also provides a degree of certainty to the investor about what statements to rely on,” says Walworth.

According to Walworth, “the certainty this decision provides about limits to liability for misrepresentations encourages market participation.”

Walworth believes that this decision also will have a ripple effect through the securities market.

“First, the decision specifically reserves the question of whether corporate insiders can be held liable, by virtue of their position with the company even in the absence of explicit attribution,” says Walworth.

“Second, before the Pacific decision even came out, we saw the House of Representatives move to amend specific sections of the Securities Exchange Act of 1934 to create a more liberal ‘substantial assistance’ standard, rather than the ‘explicitly attributed’ standard adopted under Pacific,” says Walworth.

“While the legislation has not yet passed out of Committee, the mood in Congress in reaction to Stoneridge and Pacific is to provide more avenues for investors to recover for securities fraud.”

Keywords: Litigation, Second Circuit, securities fraud, secondary actor securities claims

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