#13091 - Enforcement Of The Securities Laws - Securities Regulations (Duke Cox)

Private causes of action supplement the SEC’s enforcement efforts and thus assure greater compliance with the securities laws

A significant portion of the private litigation under the securities laws occurs through class action procedures

Private Securities Litigation Reform Act (PSLRA) §21D of the ’34 Act

1. Appointment of a lead plaintiff

   1. Provides a rebuttable presumption that the member of the purported class with the largest financial stake in the relief sought is the “most adequate plaintiff”

   2. Notice must be given to all members of the purported class action so they may request to be the lead plaintiff

   3. A person can serve as a lead plaintiff in up to five securities class actions during any three-year period

2. Among the tasks of the lead plaintiff is to select and retain counsel to represent the class

   1. Before the suit gets filed, lead plaintiff negotiates a fee contract reduces windfall for lawyers

3. An obvious object of the lead plaintiff provision is to harness the institutional investor’s self-interest to guide the direction of the class action

   1. Because party with the largest financial stake is likely to be an institutional investor

4. PSLRA bars discovery until after the defendant’s motion to dismiss

   1. Bar to discovery until all pre-trial motions are over with

      1. Don’t have the ability to flesh out your pleadings with discovery

5. Pleading requirement: facts alleged must create a “strong inference” of knowledge or recklessness

   1. As a result, cases are dismissed far more often

   2. Must allege that guy actually knew or had reckless disregard

Rule 11 (FRCP) = sanctions for frivolous shit

1. At the end of trial, the court must determine (under PSLRA) in its own discretion whether any of the lawyers are deserving of sanctions

   1. Regardless whether the people have made rule 11 motions

      1. This shapes the conduct of litigation

Securities Litigation Uniform Standards Act (SLUSA)

1. Confers on the federal courts the exclusive jurisdiction over most securities class actions

   1. Covered security: if the security is listed on an exchange, or a market the SEC identifies as an exchange

   2. Covered class action: suit with more than 50 persons

Aiders, Abettors, and Primary Violators

1. Central bank: antifraud provision prohibits only the making of a material misstatement (or omission) or the commission of a manipulative act.

   1. Aiders and abettors not liable under Section 10(b) and Rule 10b-5

2. Janus: primary participant liability reaches those with “ultimate authority over the statement including its content and whether and how to communicate it

3. EA §20(e): expressly authorizes SEC (but not private) enforcement actions for aiding and abetting

   1. Knowingly or recklessly

      1. Refers to the knowledge requirement of misstatement

   2. In order for a defendant to be liable as an aider and abettor, the SEC must prove:

      1. The existence of a securities law violation by the primary (as opposed to the aiding and abetting) party

      2. Knowledge of this violation on the part of the aider and abettor

      3. Substantial assistance by the aider and abettor in the achievement of the primary violation

         1. Substantial assistance: that he in some sort associated himself with the venture, that he participated in it as in something that he wished to bring about, and that he sought by his action to make it succeed

   3. There is a sliding scale between the three elements

      1. For example, a high degree of knowledge may lessen the SEC’s burden in proving substantial assistance, just as a high degree of substantial assistance may lessen the SEC’s burden in proving scienter

   4. The SEC is not required to plead or prove that an aider and abettor proximately caused the primary securities law violation

4. EA §10A: when the auditor discovers an illegal ac, it has an obligation to determine whether that act will have a material impact on the company’s financial statements. If such an impact is likely, the auditor not only must bring the matter to the attention of the appropriate level of management, but also must bring it to the attention of the client’s audit committee or board of directors.

   1. If the corporation/audit committee doesn’t do anything, then the auditor must resign and report to the SEC noisy withdrawal

Control person and respondeat superior liability

1. SA §15: control person liability

   1. Control person of someone liable under §§11 or 12

   2. The control person avoids liability if it is established that the controlling person had no knowledge of or reasonable grounds to believe in the existence of the facts upon which the liability of the control person is alleged to exist

2. EA §20(a): control person liability

   1. Control person of someone liable under 10b-5

   2. Liability arises unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action

      1. Good faith factors:

         1. Whether the controlling person derives direct financial gain from the activity of the controlled person

         2. The extent to which the controlled person is tempted to act unlawfully because of the controlling person’s policies. E.g. compensations system

         3. The extent to which statutory or regulatory law or the defendant’s own policies require supervision

         4. The relationship between the plaintiff and the controlling person; and

         5. The demonstration of some public policy need to impose such a requirement.

3. What does it mean to be a control person?

   1. 2-prong test for determining control person liability:

      1. The control person needs to have actually exercised general control over the operations of the wrongdoer

      2. The control person must have had the power or ability – even if not exercised – to control the specific transaction or activity that is alleged to give rise to liability

4. Attorneys and accountants are not control persons solely because of their ability to persuade and counsel the primary violator

5. By and large, most circuits view the control person provisions as designed to expand respondeat superior liability, not to limit it, so that there is no frustration of legislative intent if respondeat superior liability is imposed even beyond the scope of the control person provisions

   1. Most courts invoke the traditional “master-servant” approach of respondeat superior liability under which the employer (or other principal) is vicariously liable so long as the employee’s or agent’s violation was committed within the scope of employment

      1. The employee must act within the scope of his actual authority

      2. Once the action is established to fall within the scope of employment, issues of good faith or noninducement by the employer become completely irrelevant

Rescission Remedy

1. §29(b) private parties may rescind contracts that were made or performed in violation of other substantive provisions

   1. If the contract itself involves such a violation, it shall be void

   2. Elements

      1. The contract involved a prohibited transaction

      2. He is in contractual privity

      3. Is the class of person that the securities acts were designed to protect.

Equitable bars, indemnity, and contribution

1. Estoppel is available to bar the plaintiff’s recovery of damages; laches applies only to actions seeking equitable relief

   1. Four elements must be present to establish the defense of estoppel: (1) the party to be estopped must know the facts; (2) he must intend that his conduct shall be acted on or must so act that the party asserting the estoppel has a right to believe it is so intended; (3) the latter must be ignorant of the true facts; and (4) he must rely on the former’s conduct to his injury

2. Waiver generally refers to the voluntary or intentional relinquishment of a known right

   1. EA §29(a): renders void any condition, stipulation, or provision binding any person to waive compliance with the provisions or regulations of the Act

      1. Anti-waiver provision

3. Literally, in pair delicto means “of equal fault” and when successfully invoked bars the plaintiff’s recovery at law because the court concludes the plaintiff and the defendant had the mutual intent to violate the securities laws. In considering whether the plaintiff should be so barred, the courts consider the comparative fault of the plaintiff and the defendant, barring suit only when the plaintiff’s culpability, particularly knowledge, rises to a level equal to that of the defendant

4. Indemnification involves shifting the burden of paying the damage award from one person who has paid the judgment to another

   1. With rare exception, indemnification is not permitted in securities laws cases

      1. Indemnification is always denied to those who have violated the securities laws

5. Contribution refers to the right of a joint tortfeasor to obtain an equitable shares of the damage award among those liable for the violation

   1. Contribution is granted under the securities laws, even to those who intentionally violated the securities laws

6. So we can have a provision for contribution based on relative benefits, which may act very similarly to indemnification (i.e. if relative benefits are defined as profit from the transaction, and if one side receives very little profit)

7. PSLRA

   1. Assume two defendants in a security action

      1. Settlement reached with one of the defendants for $1 million

      2. Case goes to trial and jury returns verdict of $3 million

         1. What else does the jury then have to do?

            1. The jury must then look at the culpable participants and assign to each their culpability (under PSLRA)

   2. PSLRA

      1. Fault is proportionate

      2. When it gets to contribution,...