In 1994, the US Supreme Court in the Central Bank case ruled that Section 10(b) of the Securities and Exchange Act of 1934 (Exchange Act) did not provide for a private right of action against those who aid and abet another's violation of the securities laws. For a time, this decision ensured that "secondary actors" would not be subject to civil liability under Section 10(b) for any misrepresentations or omissions contained in those materials. Secondary actors include:

Eventually, however, the SEC and private claimants proffered creative new theories designed to circumvent the Central Bank's limit on liability. Chief among these new theories was "scheme liability." Under this theory, claimants would recast a misrepresentation or omission (for which only the actual speaker could be held liable) as a "scheme" to make a misrepresentation or omission. Claimants would then allege that anyone who played any role in the scheme could be held liable as a primary violator of Section 10(b).

After much debate in the lower courts about the viability of this approach, the Supreme Court took up the issue in Stoneridge Investment Partners, LLC v Scientific-Atlanta, Inc., 552 U.S. 148 (2008) (Stoneridge). There, the Court rejected scheme liability, holding that to allow it would permit a finding of liability in a circumstance where claimants did not rely directly on anything the defendant said or did. Because direct reliance is an essential element of a Section 10(b) claim, liability could not follow in those circumstances.

Although many assumed that the Court's decision in Stoneridge would end the debate regarding the liability of secondary actors under Section 10(b), the SEC and the claimants' bar have now launched another offensive to dramatically expand the scope of liability by circumventing the bright-line rule announced in Stoneridge.

Unfortunately for defendants, these efforts have initially met with some success.

In In re HealthSouth Corporation Securities Litigation (257 F.R.D. 260 (N.D. Ala. 2009)), a district court ruled that holders of a company's common stock could assert Section 10(b) claims against UBS, which acted as underwriter of a Rule 144A offering of HealthSouth bonds, even though the bonds were only offered to qualified institutional investors (QIBs).

In the case, UBS argued, among other things, that:

The Court rejected the UBS's arguments, holding that the underwriter made false representations to the market about the issuer's financial condition: because its name appeared on the cover of the offering materials, UBS was lending its "good name" to the offering. The Court found that UBS made a "statement" to the effect that "these bonds are good enough for [us], so they must be good enough for you."

In addition, the Court ruled that the underwriter could be held primarily liable because its activities (including the dissemination of the private offering materials) indirectly affected the market for the company's common stock (among other reasons, the QIBs that were offered the bonds were also "significant participants" in the market for the company's common stock).

Somewhat similarly, in SEC v Tambone (550 F.3d 106 (1st Cir. 2009)), a federal appellate court decided that employees of an underwriter could be held primarily liable for misrepresentations made in prospectuses even though they were neither drafted by the underwriter's employees nor attributed to them.

In that case, the SEC as the claimant argued that because the defendants had a duty to confirm the accuracy of the prospectuses, they could be held primarily liable because they both:

Although the court did not address the SEC's "adoption" theory, it did embrace its "implied statement" theory, holding that an underwriter's role and duties are such that it can be viewed as having made "an implied statement without actually uttering the words in question" and that the underwriter's employees' conduct was therefore actionable under Section 10(b).

The appellate court has since agreed to re-hear the case en banc in mid-October and has vacated the above decision.

In In re Mutual Funds Investment Litigation (566 F.3d 111 (4th Cir. 2009)), the Fourth Circuit adopted a standard that, like Tambone, cast a wide net for liability under Section 10(b).

There, the claimants sought to hold an investment advisor, among other defendants, primarily liable for misstatements in mutual fund prospectuses that were not publicly attributed to them.

According to the claimants, the defendants should be held responsible for these misstatements because, as a "practical matter," it was obvious that they "run" the funds and consequently, the public would likely attribute the misstatements to defendants.

The Court agreed. It explained that at the pleading stage, a claimant need only allege facts from which a court "could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to defendant."

Although the courts in these cases accepted the SEC's and claimants' expansive reading of Section 10(b), the district court in In re Refco, Inc. Securities Litigation (609 F. Supp. 2d 304) refused to do so.

In that case, the Court was asked to decide whether a law firm could be held primarily liable for misstatements made in offering materials when the firm was mentioned only as counsel for the issuer and none of the allegedly false statements made in the documents were attributed to it. The Court correctly held that the firm could not, explaining that "[t]o rise to the level of a primary violation . . . the misrepresentation must be attributed to the specific actor at the time of public dissemination."

The claimants have appealed this decision to the Second Circuit and, in connection with that appeal, the SEC has submitted an amicus brief urging the Court to adopt a slightly modified version of the previously-rejected "scheme" theory of liability.

In particular, the SEC asserts that liability under Section 10(b) should not be limited to those to whom a statement is explicitly attributed. Rather, civil liability should extend to anyone who "created" the statement at issue. According to the SEC, a statement is "created" by a person "if the statement is written or spoken by him, or if he provides the false or misleading information that another person then puts into the statement, or if he allows the statement to be attributed to him."

The current debate over the limits prescribed by Stoneridge may prompt the Supreme Court or Congress to address the issue. Indeed, Senator Arlen Specter has recently introduced a bill, S. 1551, entitled the 'Liability for Aiding and Abetting Securities Violations Act of 2009,' which would expand civil liability under Section 10(b) to cover "any person that knowingly or recklessly provides substantial assistance to another person" who commits securities fraud.

Until that bill passes or the Supreme Court weighs in, "secondary actors," including lawyers, accountants and financial institutions, should expect continued efforts by the SEC and claimants to blur the distinction between primary liability and aiding and abetting.

On 15 September 2009, the US Bankruptcy Court for the Southern District of New York, in the Lehman Brothers chapter 11 cases, held that Metavante Corporation (Metavante), counterparty to Lehman Brothers Special Financing Inc. (LBSF) under an unterminated interest rate swap agreement (Swap Agreement), could not rely on the safe harbour provisions in the Bankruptcy Code to excuse its failure to perform its obligations under the Swap Agreement.

Further, the Court held that Metavante, by failing to exercise its rights to terminate the Swap Agreement, had waived those rights and the swap agreement was therefore to be regarded as a "garden variety executory contract."

LBSF and Metavante entered into the Swap Agreement on 4 December 2007, under the terms of a standard 1992 ISDA Master Agreement.

Under the Swap Agreement:

Lehman Brothers Holdings Inc. (LBHI) was the credit support provider for LBSF's obligations under the Swap Agreement.

As of May 2009, Metavante owed LBSF approximately US$6,640,138, representing net payments for the November 2008, February 2009 and May 2009 payment dates, as well as default interest in excess of US$300,000 on that amount.

Metavante refused to pay these amounts to LBSF, relying on Section 2(a)(iii) of the Swap Agreement. This provides that the obligation to make payments under the Swap Agreement is subject to the condition precedent that no event of default has occurred and is continuing.

Metavante argued that LBHI's bankruptcy filing had made LBSF an "ineffective counterparty," an essential item of value that Metavante had bargained for, and Metavante could not, therefore, be compelled to make its payment obligations under the Swap Agreement.

LBSF and LBHI argued that the Swap Agreement was an executory contract, as material performance (specifically payment obligations) remained due by both LBSF and Metavante. Therefore, Metavante was precluded from relying on Section 2(a)(iii) of the Swap Agreement, as this section amounted to an ipso facto clause. Ipso facto clauses are provisions in executory contracts and unexpired leases that automatically terminate the contract, modify a contractual right, or permit the other contracting party to do so, in the event of a bankruptcy. Such clauses are unenforceable against a chapter 11 debtor under section 365(e)(1) of the Bankruptcy Code.

LBHI and LBSF also pointed to section 365(a) of the Bankruptcy Code, which provides at the relevant part that a debtor in possession, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.

The debtors cited case law to support the proposition that while a debtor determines whether to assume or reject an executory contract, the counterparty to such contract must continue to perform its obligations under the contract.

LBSF and LBHI noted that the Bankruptcy Code contains "safe harbour provisions" that carve out an exception to the general rule that ipso facto clauses are void by permitting qualifying non-debtor counterparties to derivative contracts to exercise certain limited contractual rights in the case of a chapter 11 filing. LBHI and LBSF argued, however, that the safe harbour provisions are available to a counterparty only to the "narrow extent" that such counterparty seeks to liquidate, terminate, or accelerate its contracts with the chapter 11 filer, or offset or net out its positions under the derivative contract.

The Bankruptcy Court agreed that Metavante's refusal to perform its obligations under the Swap Agreement was not protected by the Bankruptcy Code's safe harbour provisions. The only rights of a swap counterparty that fell under the safe harbour were to "offset or net out any termination values or payment amounts arising under or in connection with the termination, liquidation or acceleration of one or more swap agreements."

Metavante had not attempted to liquidate, terminate or accelerate the Swap Agreement, or to offset or net out its position as a result of the events of default caused by the filing of bankruptcy petitions by LBHI and LBSF. Metavante had simply withheld performance, relying on the condition precedent language in Section 2(a)(iii) of the Swap Agreement.

This conduct, which the Bankruptcy Court described as "riding the market for the period of one year, while taking no action whatsoever," was "simply unacceptable and contrary to the spirit [of the safe harbour provisions] of the Bankruptcy Code."

The Bankruptcy Court pointed to the legislative history of the safe harbour provisions that indicate that the rationale for the enactment of these provisions was that "the immediate termination for default and the netting provisions are critical aspects of swap transactions and are necessary for the protection of all parties in light of the potential for rapid changes in the financial markets."

The Bankruptcy Court also relied on a decision in In re Enron Corp. that held that a counterparty's action under the safe harbour provisions must be made fairly contemporaneously with the bankruptcy filing, otherwise the contract will be rendered just another ordinary executory contract. The Bankruptcy Court found that Metavante's window to act promptly under the safe harbour provisions has passed, and that its failure to terminate the Swap Agreement by the date of the ruling constituted a waiver of that right.

The Bankruptcy Court held further that LBSF was entitled to continued receipt of the payments under the Swap Agreement and that Metavante's failure to make such payments constituted an attempt to control property of the debtors' estates, in violation of the automatic stay imposed by section 362 of the Bankruptcy Code.

Therfore, the Bankruptcy Court entered an Order directing Metavante to perform under the Swap Agreement until such time as LBSF and LBHI determine whether to assume or reject the agreement.

On 25 September 2009, Metavante filed a motion to amend the Order to provide clarification with regard to the debtors' future obligation to Metavante pending the debtors' decision to assume or reject the Swap Agreement.

Specifically, Metavante seeks, among other things:

Clarification of the assurances that the debtors will be required to provide if Metavante becomes a net payee under the transaction.

That the Bankruptcy Court order that the payments due from Metavante under the Swap Agreement be paid into an interest-bearing escrow account pending the debtors' decision to assume or reject the Swap Agreement.

The hearing on Metavante's motion is set for 18 November 2009 at 10:00 prevailing Eastern Time.