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Abandonment of the private right of action for aiding and abetting securities fraud/staff report on private securities litigation : hearing before the Subcommittee on Securities of the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred Third Congress, second session, online

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Online LibraryUnited States. Congress. Senate. Committee on BankAbandonment of the private right of action for aiding and abetting securities fraud/staff report on private securities litigation : hearing before the Subcommittee on Securities of the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred Third Congress, second session, → online text (page 1 of 41)
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S. Hrg. 103-759

ABANDONMENT OF THE PRIVATE RIGHT OF AC-
TION FOR AIDING AND ABEHING SECURITIES
FKAUD/STAfF REPORT ON PRIVATE SECURITIES
UTIGATION __^^__^_

Y 4. B 22/3: S. HRG. 103-759

fibandonnent of the Private Right of... ^^-^

SUBCOMMITTEE ON SECURITIES

OF THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED THIRD CONGRESS

SECOND SESSION

ON

THE RECENT SECURITIES LAW DECISIONS BY THE U.S. SUPREME
COURT, CENTRAL BANK OF DENVER VS. FIRST INTERSTATE BANK OF
DENVER. IN A 5-4 DECISION, THE COURT WIPED OUT PRIVATE LI-
ABILITY FOR THOSE WHO "AID AND ABET" SECURITIES FRAUD



STAFF REPORT ON PRIVATE SECURITIES LITIGATION



MAY 12, 1994



Printed for the use of the Committee on Banking, Housing, and Urban Affairs




r'~,<^



U.S. GOVERNMENT PRINTING OFFICE
83-610 CC WASHINGTON : 1994

For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-045972-9



\^



S. Hrg. 103-759

ABANDONMENT OF THE PRWATE RIGHT OF AC-
TION FOR AIDING AND ABEHING SECURITIES
FRAUD/STAFF REPORT ON PRIVATE SECURITIES
UTIGATION _^__^_^

Y 4. B 22/3: S. HRG. 103-759

Hbandonnent of the Private Right of... ^ ^^

SUBCOMMITTEE ON SECURITIES

OF THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED THIRD CONGRESS

SECOND SESSION

ON

THE RECENT SECURITIES LAW DECISIONS BY THE U.S. SUPREME
COURT, CENTRAL BANK OF DENVER VS. FIRST INTERSTATE BANK OF
DENVER. IN A 5-4 DECISION, THE COURT WIPED OUT PRIVATE LI-
ABILITY FOR THOSE WHO "AID AND ABET" SECURITIES FRAUD



STAFF REPORT ON PRIVATE SECURITIES LITIGATION



MAY 12, 1994



FVinted for the use of the Committee on Banking, Housing, and Urban Affairs



y-v: 1




U.S. GOVERNMENT PRINTING OFFICE
83-610 CC WASHINGTON : 1994

For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-045972-9



COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

DONALD W. RIEGLE, Jr., Michigan, Chairman

PAUL S. SARBANES, Maryland ALFONSE M. D'AMATO, New York

CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas

JIM SASSER, Tennessee CHRISTOPHER S. BOND, Missouri

RICHARD C. SHELBY, Alabama CON'NIE MACK, Florida

JOHN F. KERRY, Massachusetts LAUCH FAIRCLOTH, North Carolina

RICHARD H. BRYAN, Nevada ROBERT F. BENNETT, Utah

BARBARA BOXER, California WILLIAM V. ROTH, Jr., Delaware

BEN NIGHTHORSE CAMPBELL, Colorado PETE V. DOMENICI, New Mexico

CAROL MOSELEY-BRAUN, Illinois

PATTY MURRAY, Washington

Steven B. Harris, Stafjf Director and Chief Counsel

Howard A. Menell, Republican Sta/T Director

Edward M. Mai^n, Editor



Subcommittee on Securities

CHRISTOPHER J. DODD, Connecticut, Chairman

JIM SASSER, Tennessee PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama WILLIAM V. ROTH, JR., Delaware

RICHARD H. BRYAN, Nevada CHRISTOPHER S. BOND, Missouri

CAROL MOSELEY-BRAUN, Illinois LAUCH FAIRCLOTH, North Carolina

PATTY MURRy\Y, Washington PETE V. DOMENICI, New Mexico

COLTRTNEY WARD, Staf/ Director and Chief Counsel

George R. Kjiamer, Special Counsel

SHEIIJ\ P. Duffy, Legislative AssLttant

Wayne A. ABERNATIFY, Republican Economist

Laura SIMONE Unger, Republican Counsel

Ira PaULL, Republican Counsel

(II)



CONTENTS



THURSDAY, MAY 12, 1994

Page

Opening statement of Senator Dodd 1

Opening statements, comments, or prepared statements of:

Senator Gramm 3

Senator Domenici 5

Senator Riegle 10

WITNESSES

Howard Metzenbaum, U.S. Senator from the State of Ohio 7

Arthur Levitt, Chairman, Securities and Exchange Commission; accompanied

by: Simone Lome, Esquire, General Counsel, SEC 13

Prepared statement 46

I. The Central Bank of Denver decision 47

IL Potential effect on the SEC's enforcement program 48

in. Effect on private securities actions 50

rV. Conclusion 52

Response to written questions of Senator Domenici 80

Donald C. Langevoort, Lee S. and Charles A. Speir Professor of Law, Vander-

bilt Law School 21

Prepared statement 52

The probable impact on private rights of action 52

The probable impact of SEC enforcement 54

The policy question 55

Response to written questions of Senator Domenici 86

Mark J. GrilTin, director, Securities Division, Utah Department of Commerce,

on behalf of North American Securities Administration Association 22

Prepared statement 56

Overview and executive summary 56

Private actions and aiding and abetting liability under the securities

laws 57

The Supreme Court's decision in Central Bank 60

Conclusion 61

Response to written questions of Senator Domenici 89

Stuart J. Kaswell, senior vice president and general counsel, Securities Indus-
try Association 24

Prepared statement 64

Summary 64

Introduction 64

Discussion 65

Conclusion 69

Response to written questions of Senator Domenici 96

Harvey J. Goldschmid, Dwight Professor of Law, Columbia University School

of Law 25

Prepared statement 69

Policy considerations 70

Two possible mitigating open issues 71

Recommendations 72

Response to written questions of Senator Domenici 101



(III)



VI

Page

Eugene I. Goldman, partner, McDermott, Will & Emery 28

Prepared statement 73

The Central Bank decision applies to SEC actions 73

It is not essential at this time to provide the SEC with express

authority to bring aiding and abetting claims 74

Legislation authorizing aiding and abetting 74

If Congress considers a legislative response 74

Response to written questions of Senator Domenici 104

David S. Ruder, Northwestern University School of Law, Former Chairman

of the Securities and Exchange Commission 30

Prepared statement 75

Introduction 75

Analysis 75

Conclusion 78

Response to written questions of Senator Domenici 107

Additional Material Supplied for the Record

Affordable Housing Disposition Program Bimonthly Report, January/February

1994 109

Various newspaper articles relating to low-income housing and the homeless . 113

Fried, Frank, Harris, Shriver & Jacobson, letter dated May 12, 1994 to
Senator Dodd requesting views on Central Bank of Denver from Harvey

L.Pitt 126

The University of Michigan Law School, letter to Senator Riegle dated April

22, 1994 from Professor Joel Seligman 151

Staff Report on Private Securities Litigation 166



ABANDONMENT OF THE PRIVATE RIGHT OF
ACTION FOR AIDING AND ABETTING SECU-
RITIES FRAUD/STAFF REPORT ON PRIVATE
SECURITIES LITIGATION



THURSDAY, MAY 12, 1994

U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,

Subcommittee on Securities,

Washington, DC.

The Subcommittee met in room 538, of the Dirksen Senate Office
Building at 2:40 p.m., Senator Christopher J. Dodd (Chairman of
the Subcommittee) presiding.

OPENING STATEMENT OF SENATOR CHRISTOPHER J. DODD

Senator DoDD. The Committee will come to order.

Welcome everyone here to our hearing this afternoon. We are
here to examine one of the more significant recent Securities law
decisions by the U.S. Supreme Court, Central Bank of Denver vs.
First Interstate Bank of Denver. In that rather sweeping 5 to 4 de-
cision, the Court wiped out private liability for those who, "aid and
abet securities fraud." While aider and abettor liability may sound
like a dry and arcane point of law to many, it is not.

As our witnesses will tell us this afternoon, aiding and abetting
is the common law legal doctrine that provides liability for those
who do not directly violate the law but who provide assistance to
the unlawful acts of others.

In my view, aiding and abetting liability has been critically im-
portant in deterring individuals from assisting possible fraudulent
acts by others. Until the Supreme Court changed the landscape a
few weeks ago, aiding and abetting liability was an important tool
in ensuring honesty and high professional standards by individual
professionals who facilitate access to the securities markets.

Over several decades, courts in virtually every circuit in the
United States have applied aiding and abetting liability in cases
under the Federal Securities laws. In addition, the Securities and
Exchange Commission has long used aiding and abetting liability
as part of its arsenal of legal remedies.

I think the essence of the Supreme Court's decision was captured
in one sentence of that opinion, and let me quote it:

To be sure, aiding and abetting a wrongdoer ought to be actionable in certain in-
stances. The issue however is not whether imposing private liability on aiders and
abettors is good policy but whether aiding and abetting liability is covered by the
statute.

(1)



That one quotation succinctly explains, in my view, why we're
here today. Five Justices looked at the language of the statute and
decided to set aside policy consequences and, frankly, decades of
precedent in lower courts, because aiding and abetting liability was
not explicitly spelled out in that statute.

This afternoon, we're going to explore the implications of the
Central Bank decision. We're going to look at how that case might
affect the efforts of the SEC to ensure that accountants, lawyers,
and other professional gatekeepers do not facilitate fraudulent acts
by their clients.

We will also consider the possible consequences of the case for
defrauded investors seeking to recover their losses from account-
ants and attorneys. In assessing the decision's impact and begin-
ning to consider the potential legislative responses, I believe it is
very important to remember that aiding and abetting liability in
this area has evolved out of case law with no direction whatsoever
from the Legislative Branch, the Congress of the United States.

There are some differences in the courts on what the elements
of liability are and how they should be applied. Some of the wit-
nesses here today have great concerns about the scope and clarity
of aiding and abetting liability as it evolved in the lower courts,
prior to the Bank of Denver decision.

Lawyers, accountants, and other professionals should not get off
the hook, in my view, when they assist their clients in committing
fraud. However, I want to make sure that the law gives clear guid-
ance on what is right and what is wrong. It is our responsibility,
in my view, in the legislative branch to do so.

Chairman Arthur Levitt says in his statement today and I quote:

The Central Bank decision illustrates why it is important to address abuses in
the system through legislation, rather than to rely solely on the courts.

I couldn't agree more.

The Supreme Court has laid down a gauntlet for Congress. The
tone and substance of the Central Bank decision leave no doubt
about that. Some may suggest that Congress could respond to this
challenge in a very limited way by simply adding the words "aiding
and abetting" into the statute and shipping the matter back into
the courts. In my view, if we just act reflexively, I'm confident that
we will all be back here again in a few years, if not less, discussing
a new, troubling Supreme Court decision on the same subject.

It's clear to me that there's a pattern here. Two years ago. Con-
gress found itself trying to address the Lampf case in which the
Supreme Court cut back the statute of limitations for fraud actions
to 3 years.

We passed a very narrow bill and that overturned the Court's de-
cision only retroactively. The Court is now considering whether
that bill was constitutional, and may very well throw the issue
back in our laps.

We are dealing with a Court that is not inclined to interpret any-
thing that we do in this area in a broad manner. Even Justice Ste-
vens' dissent in Central Bank indicated that he would take a very
narrow interpretation of any new legislation in this area.

In my view, we need to respond to the Supreme Court's decision
promptly and I emphasize promptly. But we must also craft a bill
that will not lend itself to a new round of dismemberment by the



Supreme Court. We should take the opportunity to try and flush
out the elements of aiding and abetting liability. We need to con-
sider what to do about other related questions that may reach the
Supreme Court, such as the scope for other types of secondary li-
ability.

I also believe that we cannot pretend that this issue exists in a
vacuum. It is clear that the Supreme Court's analysis in Central
Bank and other securities cases has been strongly swayed by a con-
cern about the potential for abuses of the private securities litiga-
tion system.

If Congress remains mute on key issues concerning the function
of private liability under the securities laws, the consequence will
be to continue defaulting to the Court on the nature of the private
remedy under Section 10(b) that, in my view, is not a responsible
approach and it is not the outcome that I certainly want to see.

Having said that, I will look forward this afternoon to the testi-
mony of our witnesses and the comments of my colleagues, as we
review this critically important decision.

Let me turn to my colleagues from Texas and from New Mexico,
and Howard, we'll then turn to you for your opening comments.

OPENING STATEMENT OF SENATOR PHIL GRAMM

Senator Gramm. Mr. Chairman, I want to thank you for holding
this hearing.

Senator Domenici and I, at 3 o'clock, are going to have to go over
to the Senate floor and debate the budget. Then we will both be
back.

I believe, Mr. Chairman, that we have seldom held a hearing on
a more important subject than the one we are considering today.

Lawsuits have two effects. One is the intended effect, and that
is that they give people the ability to use our system of justice to
recover losses that they have incurred due to the fraudulent acts
of others.

I think there is a total and absolute commitment to the principle
that the functioning of our justice system must give people the ca-
pacity to go into court and recover costs that have been imposed
on them by improper actions that other people have knowingly un-
dertaken.

Unfortunately, lawsuits have an unintended effect. That effect is
that they change the way people do business. They change market
behavior, they drive up costs, they disrupt the process of accumu-
lating and creating wealth and generating jobs.

We have seen, in the securities area, the proliferation of lawsuits
that have driven up the cost of operating in the equity markets,
that have made it increasingly difficult and expensive for small-
and medium-sized businesses to give professional assistance. We
have seen, I believe, a very substantial market impact. That has
occurred, in part, because of the very low thresholds for bringing
suit that have existed because of various judgments that have been
made by the lower courts. I believe aiding and abetting is a perfect
example of that.

I want to review, very briefly, Mr. Chairman, what the decision
by the Supreme Court did and what it did not do, not in legal
terms, because I am not a lawyer, but in just simple, plain old



street English. The Court continued its basic established position
that if you defraud somebody, you are liable. It continued its posi-
tion that if somebody knowingly participated in the defrauding act,
they are liable.

But what the Court also said was that you can't simply, sue
someone because someone provided professional services, but they
were not involved in the fraud, for aiding and abetting, because the
statute does not provide for that liability.

The Court did not remove your ability to sue an accountant, a
lawyer, or a securities dealer for malpractice. That right of action
still exists. The Court didn't eliminate the ability to sue for fraud.
They left open the actions that exist in our common law and in the
established principles that we follow in terms of people protecting
their rights and recovering damages in civil suits.

The Supreme Court, in my opinion, very wisely decided to re-
move a liability standard that had not been written by Congress
but that, over the years, had been written by judges who wanted
to be lawmakers without the inconvenience of having to run for
public office.

The Court noted that the aiding and abetting standard might en-
courage "vexatious" litigation "requiring secondary actors to expend
large sums even for pretrial defense and the negotiation of settle-
ments. . . . This uncertainty," the Court said, "and excessive litiga-
tion can have ripple effects. For example, newer and smaller com-
panies may find it difficult to obtain advice from professionals. . . .
In addition, the increased costs incurred by professionals because
of the litigation and settlement costs may be passed on to their cli-
ent companies, and in turn incurred by the company's investors,
the intended beneficiaries of the statute."

Finally, Mr. Chairman, I think it is very instructive to look at
these aiding and abetting cases. They are frequently cases that are
filed against people that have deep pockets. They end up being set-
tled in large numbers out of court, where defendants look at the
cost of litigating and the cost of paying someone off who is basically
engaging in piracy. These defendants frequently decide that it is
cheaper to pay tribute than it is to seek justice in a judicial system
that is very expensive.

Now I entered this hearing, Mr. Chairman, I hope with an open
mind. I do not enter it with an empty mind on this subject.

If somebody's going to try to overturn this Supreme Court deci-
sion, they're going to be getting up mighty early in the morning.
They're going to be making a very strong case because, quite frank-
ly, I believe this Supreme Court decision is a decision moving us
in the right direction.

I think millions of American jobs in the future depend on this
issue. I believe that there is a very heavy burden of proof on people
who say that we ought to be making it easier to sue people who
had no knowledge of the fraud, people who were merely providing
professional service, particularly when we already have the ability
to sue for fraud, to sue for malpractice.

So I think the Court has made an important decision. I think
they have done it for exactly the right reasons. And while I'm cer-
tainly going to listen to people who are testifying, they're going to



have to have a very, very strong argument to move me on this sub-
ject. I feel strongly about this issue.

This is a big, big issue in terms of the American economy. Our
capital market is a very important part of the success of our econ-
omy, and one of the reasons that, despite the most absurd actions
by Grovernment, the economy continues to perform.

When we hamper the ability of the capital markets to work, we
stick a knife in the heart of the American economy. I'm very leery
about knowingly allowing that to happen.

Senator DoDD. Thank you very much.

Senator Domenici.

OPENING STATEMENT OF SENATOR PETE V. DOMENICI

Senator Domenici. Mr. Chairman, I'm not going to have much
time because it falls to me to open this debate on the floor.

Mr. Chairman, I've been saying for quite some time, and I'm very
pleased that to some significant degree, you have joined with me,
or I with you, that Section 10(b) is not working as it should.

And frankly, the Supreme Court said the same thing in the
Central Bank of Denver case. In a sense, implied cause of action
under 10(b) is a court created creature rule and every element has
been developed by the courts.

We're aware of the fact that many of the contentions of this
Court with reference to aiding and abetting in terms of vexatious
litigation, in terms of settlements being rampant rather than trials
because of the nature of the litigation, we're aware of that on a
much broader front than this case applies to. This permits us to
have another set of very interesting hearings that would permit us
to explore just what is going on in our courts.

Frankly, whether you agree or disagree with the decision in
Central Bank of Denver it isn't easy to say what the law was prior
to the decision. Even Senator Metzenbaum, whom I will not get a
chance to hear, but I will read your testimony, I think he might
think it's pretty easy to fix this, just return it with some language
to where it apparently was before.

I submit that's not very easy at all, because as you now look at
that, in order to define secondary liability, clearly we have to have
a clear definition of the primary violation. And that too is rather
fuzzy. The case law is inconsistent. Predictive statement cases are
but one example of this inconsistency. To reverse the Central Bank
of Denver decision we need to resolve what the appropriate stand-
ard of care should be.

Should the standard be knowing conduct, reckless conduct, or
merely negligent conduct? Should it make a difference if the person
being sued is an aider or abettor who owed a fiduciary duty to the
plaintiffs? What is the appropriate burden of proof? What are the
appropriate pleading requirements? The Second and Seventh Cir-
cuits have set out rules; other circuits have lesser requirements.

Should there be rights of contribution? And if so, should it be pro
rata, or pro tanto basis when settling and non-settling defendants
are involved? There's a split in the circuits on this issue too. Should
there be proportionate liability under certain circumstances? And if
so, what are they? It may be that focusing solely on aiding and
abetting liability is only half the fix.



What is the law in view of Central Bank for conspiracy claims
under 10(b)? The dissenting Justices stated that they thought that
the majority decision abolished conspiracy claims. They also raised
questions about the standard for holding employers vicariously lia-
ble for the acts of their employees.

There are many unanswered questions. I knew many of these
questions existed when I introduced by first job reform bill. I con-
centrated on one aspect which I had become convinced of, that
there were far too many lawsuits filed, that many of them had no
real merit, but most of them settled regardless of the merits.

That they were having a big ripple effect, to borrow the Supreme
Court's words, for the ripple effect of using litigation to set stand-
ards of behavior is certainly not one that is conducive to orderliness
and a real sense of certainty about what we expect of people, com-
panies, markets, et cetera.

Mr. Chairman, this is a very fortuitous hearing, as I see it, be-
cause we were ready to proceed with a broader based bill, and per-
haps some, who thought we could wait, in fact, some might have
thought we could wait forever on the Dodd-Domenici bill. I've heard
that said before.

I think waiting and delay on Dodd-Domenici is no longer a wise
option. Obviously, if we're going to take a real look at this decision.
That's not going to be done without a comprehensive examination
of and strong movement on the Dodd-Domenici bill to clarify sig-
nificant aspects of securities class action litigation above and be-
yond the Denver Bank case.

Thank you very much.

Senator Dodd. Thank you very much for those comments. Sen-
ator Domenici. I think you properly pointed out the disparity that
does exist in several jurisdictions with regard to the standards and
there's also the conspiracy elements that were addressed in part by
this decision, so the aiding and abetting question is an important
one. The standard is an important question and other issues have
been raised.

The mere insertion of that language in the statute, in my view,
is not enough. We've got to do a more comprehensive job if we're
going to do our job thoughtfully and responsibly as we look at this
particular question.

So I thank you immensely for your help and backing in other
matters.

We're now pleased to welcome our colleague who has, over the
years, paid very close attention to these issues. He's certainly no
newcomer to them.

Let me just say what I've said on the floor of the Senate. Wheth-
er people agree or disagree with Howard Metzenbaum, you will be
missed in this institution because you watch these issues so care-
fully and you pay so much attention to them.

I hope to see you again before this Committee before the fall
comes. But if, for whatever reason, it's not the case, I'm pleased
and honored that you're here.

Senator Mktzknbaum. Thank you very much, Mr. Chairman.

I put my finger up to my good friend, Pete.

Senator Domknici. Could I say something about the Senator?

Senator Dodd. Absolutely.



Senator DOMENICI. I don't think very many people know that, at
one point, this distinguished Senator was a policeman on the floor



Online LibraryUnited States. Congress. Senate. Committee on BankAbandonment of the private right of action for aiding and abetting securities fraud/staff report on private securities litigation : hearing before the Subcommittee on Securities of the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred Third Congress, second session, → online text (page 1 of 41)