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United States Government Accountability Office: 
Washington, DC 20548: 


July 21, 2011: 

The Honorable Tim Johnson:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate: 

The Honorable Spencer Bachus:
The Honorable Barney Frank:
Ranking Member:
Committee on Financial Services:
House of Representatives: 

Subject: Securities Fraud Liability of Secondary Actors: 

Since the 1930s, publicly traded companies that commit fraud in the 
issuance or sale of their securities have been liable to private 
investors under the U.S. securities laws, as well as subject to 
government enforcement of these laws. Entities commonly referred to as 
"secondary actors"--such as banks, brokers, accountants, and lawyers, 
who play important but generally lesser roles in securities 
transactions[Footnote 1]--may also be liable to investors and to the 
government for certain securities law violations, but as of 1994, such 
entities are liable only to the government, not to investors, for 
substantially assisting--or "aiding and abetting"--securities fraud 
under section 10(b) of the Securities Exchange Act of 1934 (1934 Act). 
[Footnote 2] Before 1994, courts had interpreted section 10(b), as 
implemented by the Securities and Exchange Commission's (the SEC) Rule 
10b-5,[Footnote 3] as implicitly authorizing investors to file aiding 
and abetting lawsuits even though the 1934 Act did not expressly 
authorize it.[Footnote 4] The courts found that Congress had created 
an "implied private cause of action" under section 10(b). In the 
landmark 1994 decision Central Bank of Denver, N.A. v. First 
Interstate Bank of Denver, N.A.,[Footnote 5] however, the U.S. Supreme 
Court clarified that section 10(b) and Rule 10b-5 do not create an 
implied private cause of action for aiding and abetting, a 
determination the Court reaffirmed in its 2008 decision in Stoneridge 
Investment Partners, LLC v. Scientific-Atlanta, Inc[Footnote 6] and 
its 2011 decision in Janus Capital Group, Inc. v. First Derivative 
Traders.[Footnote 7] Congress took action in the wake of Central Bank 
as well; in 1995, it enacted the Private Securities Litigation Reform 
Act,[Footnote 8] giving the SEC express authority to seek enforcement 
against aiders and abettors of securities fraud, but imposing 
additional procedural restrictions on the filing of private securities 
fraud class action lawsuits--one of the primary vehicles by which 
investors seek redress. 

Although the Supreme Court's decisions in Central Bank, Stoneridge, 
Janus, and other recent cases have established the contours of 
liability under section 10(b) as the statute is currently written, 
debate continues over what the appropriate scope of liability should 
be. As the Supreme Court noted in Central Bank, "[t]he issue ... is 
not whether imposing private civil liability on aiders and abettors is 
good policy but whether aiding and abetting is covered by the 
statute."[Footnote 9] In response, legislation has been introduced to 
amend the 1934 Act, most recently in 2010, to establish an express 
private right of action for aiding and abetting violations of the 
federal securities laws.[Footnote 10] Proponents of the legislation 
have argued that creating such private liability could have a number 
of potentially positive implications for investors, the U.S. capital 
markets, and public companies, while opponents have argued that 
creating such liability could have the opposite effect. 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- 
Frank Act or the Act)[Footnote 11] requires GAO to analyze the impact 
of creating a private right of action for aiding and abetting 
securities law violations, including describing the factual and legal 
background against which creation of such authority would be 
considered. This analysis responds to that mandate.[Footnote 12] 

We conducted our work from August 2010 through July 2011 in accordance 
with GAO's quality assurance framework relevant to our objectives. The 
framework requires that we plan and perform the engagement to obtain 
sufficient, appropriate evidence and legal support to meet our stated 
objectives. We believe that the information we obtained and the 
analysis we conducted provide a reasonable basis for any findings and 
judgments in this product. A more detailed description of our scope 
and methodology is included in Enclosure I. 


Following the stock market crash of 1929 and the ensuing Great 
Depression, Congress enacted two statutes that established the 
fundamental securities regulatory framework in place today. The 
Securities Act of 1933 (1933 Act) regulates public offerings of 
securities, while the Securities Exchange Act of 1934 (1934 Act) 
regulates trading in securities after they have been issued.[Footnote 
13] These laws require companies that issue securities to disclose 
specific information both before the security is first issued and 
periodically thereafter, to enable investors to make informed 
investment decisions. 

The securities laws also include a number of remedies for investors 
who are injured by violations of the laws. The most prominent of these 
is section 10(b) of the 1934 Act, implemented by SEC Rule 10b-5, 
[Footnote 14] which prohibits material misrepresentations or omissions 
and fraudulent conduct and provides a general anti-fraud remedy for 
purchasers and sellers of securities.[Footnote 15] Starting in the 
1940s, federal courts determined that even though section 10(b) did 
not expressly authorize private investors and sellers to sue under 
section 10(b) and Rule 10b-5, there was an "implied private cause of 
action" to do so based on what the courts found to be congressional 
intent to ensure maximum enforcement. Using this implied cause of 
action, investors sued both the parties who carried out the fraud--
using a theory of primary liability--and those who assisted, or aided 
and abetted, the fraud--using a theory of secondary liability. Service 
providers that customarily assist companies with securities 
transactions were included in this category of secondary liability and 
became known as "secondary actors." Secondary actors can include 
accountants, attorneys, underwriters, credit rating agencies, 
securities analysts, and others. Some of these secondary actors have 
been characterized as "gatekeepers" because they allegedly serve as 
intermediaries between investors and issuers of securities and verify 
or certify the accuracy of corporate disclosure or have the ability to 
use their special status to influence the behavior of companies and 
thus prevent wrongdoing. At least some of these alleged gatekeepers 
vigorously disagree that they serve, or should serve, such a function. 

In order to bring a successful case for securities fraud, a private 
party must prove six basic elements. These elements have been 
developed by the courts over the years, and some aspects have been 
affected by the requirements of the Private Securities Litigation 
Reform Act of 1995 (PSLRA).[Footnote 16] The elements are: (1) a 
material misrepresentation or omission; (2) fraudulent conduct "in 
connection with" the purchase or sale of a security; (3) a wrongful 
state of mind, known as "scienter," when making the misrepresentation 
or omission; (4) reliance upon the fraudulent conduct; (5) measurable 
monetary damages; and (6) a causal connection between the 
misrepresentation or omission and the economic loss. Each of these 
elements has been extensively interpreted by the courts, and because 
these elements are not defined by statute, court decisions continue to 
shape how they are applied. 

The ability of investors to sue for aiding and abetting securities 
fraud (as distinct from a direct suit for securities fraud) changed in 
1994. In Central Bank, the Supreme Court clarified that section 10(b) 
does not establish a private cause of action for aiding and abetting. 
Relying on the language of the statute, the Court found that Congress 
had not, expressly or even by implication, created a private cause of 
action for aiding and abetting. The Court reasoned that the requisite 
securities fraud element of investor reliance is not present where a 
party aids or abets a fraud, because the aider and abettor's conduct 
is not known to, and thus cannot be relied upon by, investors. The 
Court emphasized, however, that while there is no private cause of 
action for aiding and abetting, secondary actors may still be 
primarily liable for securities fraud if they themselves commit all of 
the elements listed above. 

Lawsuits alleging securities fraud are often brought as class actions. 
Class actions are well-suited to securities litigation because they 
enable a number of shareholders to combine claims that they could not 
afford to litigate individually. In PSLRA, Congress targeted what it 
identified as abuses in class action securities fraud litigation by 
imposing additional procedural restrictions on the filing of such 
lawsuits, designed to help weed out weaker cases at an earlier stage 
in the proceedings.[Footnote 17] Two particularly important PSLRA 
reforms for Rule 10b-5 actions are a heightened requirement for 
alleging the scienter element and the codification of the element of 
loss causation. The Supreme Court has decided cases involving both of 
these reforms. PSLRA also gave the SEC specific authority to pursue 
cases against aiders and abettors of securities fraud. 

After the Supreme Court struck down aiding and abetting liability in 
Central Bank, courts continued to address the question of primary 
liability for secondary actors. In 2008, the Supreme Court reaffirmed 
its Central Bank decision in Stoneridge. The Court determined in 
Stoneridge that secondary actors--in this case customers and 
suppliers--who were part of a "scheme to defraud" were not primarily 
liable under Rule 10b-5 because investors had not relied on their 
fraudulent conduct. As it had in Central Bank, the Supreme Court again 
emphasized the requisite element of investor reliance in ruling that 
the secondary actors were not liable to investors. The Court ruled 
that it was not sufficient that an entity participate in a scheme to 
defraud; rather, the investor must show he actually relied on the 
secondary actor's conduct or participation. Since Stoneridge, courts 
have addressed whether secondary actors may be held liable for 
substantial participation in the preparation of fraudulent statements, 
or whether the statements must actually be attributed to the secondary 
actor for liability to arise. In June 2011, the Supreme Court ruled in 
the Janus case that an investment adviser cannot be held liable for 
mere participation in the drafting and dissemination of false and 
misleading prospectuses issued by its client; the Court found that the 
client, not the adviser, "made" the fraudulent statement, and thus the 
adviser was not liable.[Footnote 18] It remains to be seen how the 
lower courts will implement this latest Supreme Court decision. 

Arguments for and against creating a private right of action for 
aiding and abetting relate to concerns frequently expressed about 
class action securities litigation: whether it successfully and 
efficiently deters securities fraud and whether it adequately and 
fairly compensates investors who are the victims of fraud. Proponents 
of creating a private right of action argue that it is necessary to 
compensate investors and effectively would deter securities fraud. 
Opponents maintain that the current system of enforcement by the 
government already adequately compensates investors and deters fraud. 
Opponents also argue that creating a private right of action would 
expand the number of class action securities lawsuits, thus harming 
the competitiveness of the U.S. securities markets. In response, 
proponents argue that the reforms enacted in PSLRA are sufficient to 
guard against non-meritorious litigation. 


Part I. Overview Of Section 10(B) And Rule 10b-5 Anti-Fraud Provisions 
And Elements Of A Private Cause Of Action For Securities Fraud: 

A. History of the Private 10b-5 Cause of Action through the Mid-1990s: 

In the wake of the 1929 stock market crash and the ensuing Great 
Depression, Congress enacted two statutes that established the 
fundamental federal securities regulatory framework in place today. 
The 1933 Act regulates public offerings of securities, while the 1934 
Act regulates trading in securities after they have been issued. 
[Footnote 19] As the Supreme Court has explained, together, these acts 
"embrace a fundamental purpose ... to substitute a philosophy of full 
disclosure for the philosophy of caveat emptor."[Footnote 20] Both 
statutes require disclosure of certain types of information and 
prohibit fraudulent or deceptive practices in particular circumstances. 

In addition, the 1934 Act contains a broad anti-fraud prohibition, 
section 10(b). Under section 10(b), it is: 

"unlawful for any person, directly or indirectly, by the use of any 
means or instrumentality of interstate commerce ... [to] use or 
employ, in connection with the purchase or sale of any security ... 
any manipulative or deceptive device or contrivance in contravention 
of such rules and regulations as the [SEC] may prescribe as necessary 
or appropriate in the public interest or for the protection of 
investors."[Footnote 21] 

To implement section 10(b), in 1942, the SEC promulgated Rule 10b-5, 
which has become a critical component of the overall securities 
regulatory scheme. Rule 10b-5 prohibits the direct or indirect use of 
any means of interstate commerce to engage in certain wrongful conduct 
in connection with the purchase or sale of any security. Specifically, 
Rule 10b-5 makes it unlawful, among other things: 

"(a) To employ any device, scheme, or artifice to defraud, 

(b) To make any untrue statement of a material fact or to omit to 
state a material fact necessary in order to make the statements made, 
in the light of the circumstances under which they were made, not 
misleading, or: 

(c) To engage in any act, practice, or course of business which 
operates or would operate as a fraud or deceit upon any 
person."[Footnote 22] 

B. Proving Securities Fraud under Rule 10b-5: 

As detailed below, to be successful in a 10b-5 private cause of action 
for primary liability for securities fraud, a plaintiff must allege, 
and ultimately prove, six elements:[Footnote 23] (1) material 
misrepresentation or omission; (2) nexus to the purchase or sale of a 
security; (3) scienter; (4) reliance; (5) economic loss; and (6) loss 
causation. If any element is not proven, the plaintiff will not 
recover damages. These elements also have been influenced by 
legislative changes enacted in 1995 in PSLRA but because they are not 
specifically defined by statute, court decisions continue to shape 
their interpretation.[Footnote 24] Rule 10b-5 cases against secondary 
actors usually involve an allegation of a material misrepresentation 
where a corporation issues a materially misleading statement to the 
public or has failed to disclose information or remained silent about 
a matter about which it has a duty to disclose. 

Six Elements of a 10b-5 Private Cause of Action: 

1. Material misrepresentation or omission. The defendant must have 
committed fraud or deceit, generally as a material misrepresentation 
or omission.[Footnote 25] A "material" misrepresentation or omission 
is one that affects a reasonable investor's purchase decision. 
[Footnote 26] Courts have held that Rule 10b-5 does not itself impose 
a duty to disclose, meaning that nondisclosure without an independent 
duty will not establish a Rule 10b-5 violation.[Footnote 27] However, 
if a company makes a statement, there may be a further duty to correct 
or update the information that was disseminated.[Footnote 28] 
Additionally, a company can be held liable for statements considered 
to be half-truths--statements that are literally themselves true, but 
omit some other material fact that would be necessary to make the 
statement as a whole not misleading.[Footnote 29] 

2. Nexus. The defendant's fraudulent conduct must meet the "nexus" 
requirement, meaning that the conduct must have been "in connection 
with the purchase or sale" of a security in interstate 
commerce.[Footnote 30] The Supreme Court in Blue Chip Stamps held that 
under the language of section 10(b)--making it "unlawful for any 
person" to "use or employ, in connection with the purchase or sale of 
any security ..., any manipulative or deceptive device or contrivance 
in contravention of such rules and regulations as the [SEC] may 
prescribe as necessary or appropriate in the public interest or for 
the protection of investors"[Footnote 31]--only those who actually 
purchased or sold securities have an implied private right of action 
under Rule 10b-5, not those who decided not to purchase or sell a 
security based on fraudulent conduct.[Footnote 32] This part of the 
nexus element is known as the purchaser/seller requirement. 

3. Scienter. The defendant must have "scienter." That is, the 
defendant must have performed the conduct at issue with a wrongful 
state of mind. The plaintiff must prove that the defendant intended 
"to deceive, manipulate, or defraud."[Footnote 33] To meet this 
standard of "mental fault," a plaintiff must allege and prove more 
than negligence, i.e., more than a failure to exercise the standard of 
care that a reasonable person would exercise under the circumstances. 
Rather, Rule 10b-5 liability requires the defendant to have acted 
knowingly or recklessly. Under the "knowing" standard, the defendant 
either knew or consciously disregarded the fact that the results of 
his conduct were reasonably certain to occur. Under the "reckless" 
standard, the defendant must have made a statement with a deliberate 
disregard of a known risk of misleading investors that is either known 
to the speaker or so obvious the speaker must have known of it. 
[Footnote 34] Although many federal appellate courts have found that 
reckless behavior satisfies the scienter requirement in Rule 10b-5 
cases, courts have differed on the degree of recklessness required. 
[Footnote 35] 

4. Reliance. The plaintiff must have relied upon the defendant's 
fraudulent conduct when entering into the transaction at issue. In 
other words, the defendant's fraudulent misrepresentation or omission 
must have affected the plaintiff's decision to purchase or otherwise 
enter into the transaction. In certain circumstances, the plaintiff 
can qualify for a rebuttable presumption of reliance, which reverses 
the burden and requires the defendant to disprove this presumption. 
The first circumstance in which a plaintiff is entitled to a 
rebuttable presumption of reliance is where the defendant had a duty 
to disclose to the plaintiff and made a material omission.[Footnote 
36] In a face-to-face transaction between seller and purchaser during 
which the defendant seller failed to state material facts, the 
plaintiff's reliance can be presumed from the materiality of the 
omissions. That is, if the facts omitted would have been important 
(i.e., material) to an individual's decision to purchase, reliance by 
the plaintiff on the defendant's omission can be presumed. The second 
rebuttable presumption circumstance involves the fraud-on-the-market 
doctrine, where proof of actual reliance is not necessary in a class 
action against public companies.[Footnote 37] The fraud-on-the-market 
presumption applies if the information at issue is material, the 
market is sufficiently active, and the misinformation was disseminated 
publicly.[Footnote 38] Essentially, reliance is presumed when the 
statements at issue become public and the public information is 
reflected in the market price of the publicly traded security. By 
assuming an accurate share price, the shareholders "relied" on the 
misstatement, so it is not necessary to prove actual, individual 

5. Economic loss. The plaintiff must have suffered measurable monetary 
damages for which he seeks recovery. As with the common law tort of 
fraud, such damages must constitute an actual economic loss, and not 
merely nominal or trivial damages. This element also requires the 
plaintiff to have already suffered the economic loss; he cannot merely 
expect a loss in the future. 

6. Loss causation. There must be a causal connection between the 
defendant's material misrepresentation or omission and the plaintiff's 
economic loss. That is, the plaintiff's loss must not only be related 
to the defendant's fraudulent misrepresentation or omission, but 
actually caused by it.[Footnote 39] 

In the 1940s, lower level federal courts first interpreted section 
10(b) and Rule 10b-5 as creating an implied private right of action by 
purchasers and sellers of securities injured by securities 
fraud.[Footnote 40] Over the decades, federal appellate courts and 
eventually the U.S. Supreme Court agreed, interpreting the statute 
broadly and flexibly in light of its remedial purpose and well- 
developed common law fraud principles.[Footnote 41] While a private 
cause of action under Rule 10b-5 still exists today, its breadth has 
been narrowed substantially in the last two decades by the Supreme 
Court's clarification in the 1994 Central Bank case that Congress did 
not intend to create a private cause of action for aiding and abetting 
under section 10(b).[Footnote 42] Additionally, while the law 
governing the private right of action under section 10(b) was shaped 
solely by court decisions for decades, in 1995, Congress recognized 
the implied private right of action (for primary violations) but 
imposed new procedural requirements for private primary liability 
securities fraud class actions.[Footnote 43] 

Part II. The Roles Of Secondary Actors In Securities: 


A number of "primary" and "secondary" parties are typically involved 
in securities transactions both during the issuance process and after 
the public offering is complete. First and foremost is the securities 
issuer, which must comply with specific statutory and regulatory 
requirements to disclose information and inform investors. The issuer 
and its executives may commit securities fraud by failing to comply 
with those requirements by making deceptive statements or through 
participating in fraudulent schemes. Other entities may then assist or 
cooperate with the issuer. Commentators have asserted that at least 
some of these secondary actors are "gatekeepers"[Footnote 44] who 
serve as intermediaries between issuers and investors, but some of the 
secondary actors disagree that they serve this role.[Footnote 45] In 
some cases, the intermediary is responsible for determining the 
accuracy of a company's statements about itself, or about a 
transaction, as well as for assessing the merits of an offering or 
other transaction. The gatekeeper may assure the accuracy of corporate 
disclosures in connection with securities offerings, thus addressing 
the problem of information asymmetry between issuers and investors. 
[Footnote 46] For example, a credit rating agency assesses a company's 
ability to repay long-term debts; an accountant audits a company's 
financial statements; and a securities analyst measures a company's 
prospects in the marketplace. In some cases the gatekeeper's role is 
legally mandated. Some commentators have argued that a gatekeeper may 
be able to deter corporate clients from engaging in fraudulent 
practices by influencing the behavior of the client.[Footnote 47] 
Finally, in some cases, plaintiffs may allege that commercial partners 
of issuers are involved in fraudulent transactions. 

A. Accountants: 

Public accountants perform a broad range of accounting, auditing, tax, 
and consulting activities for their clients.[Footnote 48] The practice 
of accounting is regulated by the applicable board of accountancy of 
each state, the District of Columbia, or U.S. territory in which an 
accountant practices, as well as the rules and codes of conduct of 
professional associations to which the accountant belongs, such as the 
American Institute of Certified Public Accountants (AICPA).[Footnote 
49] In that regard, each regulatory jurisdiction defines what 
constitutes "public accounting" and who qualifies as a "certified 
public accountant" or "CPA" under their regulatory 
authorities.[Footnote 50] Subject to applicable requirements of each 
licensing jurisdiction, public accountants may provide services as 
individuals or firms to clients, including public companies, or to 
their employers, if they are employed in-house by a public company. 
[Footnote 51] In this regard, public accountants can serve public 
companies as part of management (i.e., as employees), as contracted 
consultants (i.e., as vendors of professional services), or as 
independent certified public accounting service providers. 

Certified public accountants can serve as external auditors of public 
companies. Federal securities laws require that public companies have 
the financial statements that they prepare upon initial registration 
and annually thereafter audited by a certified public accountant. To 
obtain an audit, the audit committee of the public company's board of 
directors engages an external auditor from among the independent 
public accountants who are registered with and regulated by the Public 
Company Accounting Oversight Board (PCAOB).[Footnote 52] The audit 
must be conducted in accordance with the auditing standards 
promulgated by PCAOB,[Footnote 53] which require auditors to plan and 
perform the audit to obtain reasonable assurance of whether the 
financial statements are free of material misstatement (whether caused 
by error or fraud) and, for public companies with market 
capitalization in excess of $75 million, whether effective internal 
control over financial reporting was maintained as of the balance 
sheet date in all material respects.[Footnote 54] The objective of the 
financial statement audit[Footnote 55] is for the external auditor to 
reach an opinion on the fairness in which the financial statements of 
the company present, in all material respects, the financial position, 
results of operations, and cash flows in conformity with generally 
accepted accounting principles. In connection with the financial 
statement audit, the PCAOB auditing standards require auditors to 
review information reported outside the financial statements and 
consider whether such information or the manner in which it is 
presented is materially inconsistent with the audited information in 
the financial statements. External auditors may also perform work 
related to other public company financial reports, such as compiling 
financial reports and reviewing quarterly financial statements and 
other reports for the public company, subject to the applicable 
accounting standards. 

B. Attorneys: 

Attorneys play important roles in securities transactions. These can 
include assisting corporate clients with various types of securities 
transactions, such as private placements, public offerings of 
securities, and other corporate transactions. Attorneys also are often 
involved in preparing disclosure documents, advising on disclosure 
issues, and representing clients in formal proceedings. Attorneys also 
may represent securities professionals, such as underwriters and 
broker-dealers in connection with raising capital for corporate 
clients. In addition, attorneys may give advice concerning the 
application of the law to specific transactions and on periodic 
reports to shareholders and the SEC or public statements made by 
corporate executives. 

In many cases, attorneys may provide written legal opinions to advise 
corporate clients on the best method of carrying out transactions. 
They may also provide opinions to issuers in connection with 
securities registration or the validity of a securities issuance. In 
some cases, attorneys for the issuer or other parties associated with 
a public offering may provide opinions to assure the parties that 
certain legal conditions necessary to the closing of the offering have 
been met.[Footnote 56] Counsel generally reviews the veracity and 
completeness of registration materials and attempts to ensure that a 
thorough investigation of the issuer is made.[Footnote 57] 

C. Investment Banks: 

Investment bank activities may include merger and acquisition 
services, underwriting, asset management and other securities services 
as well as trading and principal investments. They may act as trading 
counterparties to other companies or provide financing as commercial 
lenders. [Footnote 58] In addition, investment banks may provide 
advisory services to other companies in connection with structuring 
transactions. As noted below, securities analysts may be employed by 
or otherwise affiliated with investment banks. As underwriters, 
investment banks assist companies that are registering their 
securities offerings under the 1933 Act with sales of their 
securities. The underwriter acts as an intermediary between the issuer 
and the investor and assists with pricing the offering and structuring 
financing. Most commonly, the company will enter into a negotiated 
underwriting agreement with an investment banker or group of 
investment bankers. The underwriter and the issuer prepare the 
registration statement. The underwriters usually are broker-dealers 
who are members of the Financial Industry Regulatory Authority 
(FINRA), the self-regulatory organization that oversees broker-
dealers, and the underwriting agreements are subject to the rules that 
FINRA publishes. FINRA also sets standards for and reviews 
underwriters' compensation.[Footnote 59] 

The most common underwriting arrangement is the firm-commitment 
underwriting in which the issuer sells the allotment of shares 
outright to a group of securities firms.[Footnote 60] The securities 
firms are represented by managers, managing underwriters or principal 
underwriters, who sign the agreement and then contact other broker- 
dealers to become members of the underwriting group and act as 
wholesalers of the securities. Underwriters undertake a substantial 
factual investigation of the issuer to ensure that all disclosures are 

D. Credit Rating Agencies: 

The 1934 Act defines a credit rating as an assessment of the 
creditworthiness of an obligor as an entity or with respect to 
specific securities or money market instruments.[Footnote 61] In the 
past few decades, credit ratings have assumed increasing importance in 
the financial markets, in large part due to their use in law and 
regulation. In 1975, the SEC first used the term National Recognized 
Statistical Rating Organization (NRSRO) to describe those rating 
agencies whose ratings could be relied upon to determine capital 
charges for different types of debt securities broker-dealers held. 
[Footnote 62] Since then, the SEC has used the NRSRO designation in a 
number of regulations. Issuers seek credit ratings for a number of 
reasons, such as to improve the marketability or pricing of their 
financial obligations, or to satisfy investors, lenders, or 
counterparties. Institutional investors, such as mutual funds, pension 
funds, and insurance companies are among the largest owners of debt 
securities in the United States and are substantial users of credit 
ratings. Retail participation in the debt markets generally takes 
place indirectly through these fiduciaries. Institutional investors 
may use credit ratings as one of several inputs to their own internal 
credit assessments and investment analysis. Broker-dealers that make 
recommendations and sell securities to their clients also use ratings. 
[Footnote 63] 

Academic literature suggests that credit ratings affect financial 
markets both by providing information to investors and other market 
participants and by their use in regulations. Studies find that 
obtaining a credit rating generally increases a firm's access to 
capital markets and that firms with credit ratings have capital 
structures different from those of firms without them. Some studies 
suggest that firms adjust their capital structure to achieve a 
particular credit rating. One explanation of these relationships is 
that credit rating agencies have access to private information about 
the issuers and issues they rate, and the ratings they assign 
incorporate this information. Thus, ratings are a mechanism for 
communicating this otherwise unavailable information to market 
participants. The appropriate role of credit rating agencies has 
become increasingly controversial in the wake of the recent financial 
crisis. The performance of the three largest NRSROs in rating subprime 
residential mortgage-backed securities and related securities raised 
questions about the accuracy of their ratings generally, the integrity 
of the ratings process, and investor reliance on NRSRO ratings for 
investment decisions.[Footnote 64] The Dodd-Frank Act made a number of 
changes affecting rating agencies, as discussed in Part V below. 

E. Securities Analysts: 

Securities analysts, through their research and stock recommendations, 
play an important role in providing investors with information that 
may affect investment decisions. Analysts typically research the 
current and prospective financial condition of certain publicly traded 
companies and make recommendations about investing in those companies' 
securities based on their research. This research is likely to include 
all publicly available information about the company and its 
businesses, including financial statements; research on the company, 
industry, product or sector; and public statements by and interviews 
with executives of the company and its customers and suppliers. The 
analysis and opinions are generally presented on a relative basis and 
compare companies' performance with a sector or industry. To develop 
judgments about the future prospects of the company and its 
securities, analysts may evaluate the company's expected earnings, 
revenue, and cash flow; operating and financial strengths and 
weaknesses; long-term viability; and dividend potential. They also may 
assess the sensitivity of their projections to cyclical factors and 
various types of risks, including market and credit risk. Information 
in analyst reports has been cited as valuable to the investing public 
because an investor might rely on the recommendations and analysis as 
helping to foster accurate pricing of securities.[Footnote 65] 

Analysts perform their research for different types of investors, 
including brokerage firm customers. Sell-side analysts (who perform 
research for affiliated investment banks and produce widely- 
disseminated reports about companies and advice to buy, sell or hold 
securities) are subject to oversight by securities self-regulatory 
organizations and the SEC.[Footnote 66]Buy-side analysts (who perform 
research for institutional investors, such as mutual funds) produce 
private reports for their employers who may purchase securities for 
their own account or for client accounts. In contrast, independent 
analysts may provide research without any relationship to the firms 
that they cover. 

Part III. Significant Legislative And Court Developments Affecting 
Secondary Actor Liability For Securities Fraud: 

A. Central Bank Decision (1994): 

Prior to 1994, federal courts held that there was an implied private 
right of action under Rule 10b-5 against not only primary actors, but 
also aiders and abettors. Lawsuits for aiding and abetting securities 
fraud generally could be brought by private parties in federal courts, 
as well as by the SEC in civil actions in federal court or in an 
administrative proceeding. The elements to be proved in a private 
aiding and abetting theory of liability were: (1) the existence of a 
primary violation of section 10(b) by another person; (2) some level 
of knowledge by the aiding and abetting defendant of the primary 
violation (such as recklessness); and (3) substantial assistance by 
the aiding and abetting defendant in committing the primary violation. 
[Footnote 67] 

In 1994, the Supreme Court in Central Bank of Denver held that 
although primary actors could be held liable for securities fraud in 
private lawsuits, the language of the 1934 Act did not expressly or 
implicitly authorize private investors to sue those secondary actors 
alleged to have aided and abetted securities fraud.[Footnote 68] In 
Central Bank, a municipal authority issued bonds to finance public 
improvements at a development, and the bonds were secured by liens on 
the property.[Footnote 69] The bond covenants required that the land 
be worth at least 160 percent of the bonds' outstanding principal and 
interest.[Footnote 70] Central Bank of Denver, the indenture trustee, 
had concerns that the property's actual value was less than the 
required 160 percent and considered obtaining an independent property 
appraisal.[Footnote 71] After discussions with the municipal 
authority, however, Central Bank decided to postpone the appraisal; 
the authority then became insolvent, and bondholders sued Central 
Bank, alleging that the bank recklessly aided and abetted the 
authority's fraud.[Footnote 72] 

The Supreme Court found Central Bank not liable under section 10(b). 
The Bank had not committed any primary violation, and the statute did 
not, the Court ruled, expressly or even by implication, include a 
private right of action for aiding and abetting. The Court reasoned 
that the scope of section 10(b) prohibits only the actual making of a 
material misstatement (or omission) and does not reach aiding and 
abetting such a violation. The Court noted that because Congress did 
not include an express private cause of action for aiding and abetting 
anywhere in the federal securities laws, it cannot logically be 
inferred that Congress would have implied such a cause of action under 
section 10(b). Additionally, the Court concluded that when Congress 
wished to provide aiding and abetting liability, it did so expressly, 
for example, in connection with the general criminal aiding and 
abetting statute.[Footnote 73] According to the Court, Congress's 
failure to mention aiding and abetting in section 10(b) indicates that 
such liability was not intended. 

The Court in Central Bank also placed a heavy emphasis on reliance as 
a requirement for a 10b-5 action, a requirement that is by definition 
absent in aiding and abetting actions. The Court saw reliance as 
essential to any Rule 10b-5 action and could not allow the plaintiff 
to recover in a situation where the plaintiff did not directly rely on 
any fraudulent statements or omissions by the defendant.[Footnote 74] 
The plaintiff therefore could not recover damages because the 
defendant's conduct did not satisfy all the elements of primary 
liability in a private Rule 10b-5 action and could not recover under 
an aiding and abetting theory as such a theory was not provided by 
section 10(b). 

Finally, the Court acknowledged various policy arguments for and 
against recognition of a private cause of action for aiding and 
abetting, but rejected the assertion that the cause of action under 
Rule 10b-5 should extend to aiders and abettors simply because it 
would ensure achievement of the statute's objectives. "The SEC [in a 
friend of the court brief] points to various policy arguments in 
support of the 10b-5 aiding and abetting cause of action," the Court 
noted.[Footnote 75] However, "policy considerations cannot override 
our interpretation of the text and structure of the Act ... The point 
here ... is that it is far from clear that Congress in 1934 would have 
decided that the statutory purposes would be furthered by the 
imposition of private aider and abettor liability."[Footnote 76] The 
Court also cited policy-based reasons for eliminating a cause of 
action for aiding and abetting, including large sums expended by 
secondary actors even before trial and the generally vexatious nature 
of Rule 10b-5 class action litigation.[Footnote 77] 

B. Private Securities Litigation Reform Act (1995): 

Following Central Bank, Congress addressed some concerns about class 
action securities litigation by enacting the Private Securities 
Litigation Reform Act of 1995.[Footnote 78] PSLRA amended the 
securities laws by creating new procedural requirements for 
instituting private actions, including Rule 10b-5 actions. PSLRA is 
intended to address concerns that Congress had about securities class 
action litigation by discouraging frivolous litigation.[Footnote 79] A 
class action is a litigation procedure that allows a representative of 
a group of persons to sue on behalf of that group when the litigated 
issues are of common interest to a number of persons. Class actions 
enable members of a class, i.e., shareholders, to sue even though they 
are geographically dispersed, and class action lawsuits enable members 
of the class to combine claims that they could not afford to litigate 
individually. Securities fraud actions typically are brought to 
benefit all shareholders who purchased stock during a class period in 
which misrepresentations about the stock have been made but not 

With PSLRA, Congress targeted what it identified as abuses in class 
action securities fraud litigation.[Footnote 80] In particular, 
Congress was concerned that plaintiffs' attorneys pursued cases that 
were intended to generate large fees and settlements without regard to 
the best interests of shareholders and corporations. The PSLRA 
amendments include: 

(1) Imposing additional requirements concerning whom a court can 
appoint as class representative in claims under both the 1933 and the 
1934 Acts, with a presumption in favor of the class member with the 
largest financial interest in the relief sought by the class.[Footnote 
81] This reform was intended to increase the likelihood that 
institutional investors would serve as class representatives and 
replace the traditional approach of selecting the first plaintiff to 
file as the class representative.[Footnote 82] 

(2) Limiting attorney's fees in securities class actions to a 
reasonable percentage of any damages paid to the class.[Footnote 83] 

(3) Restricting the use of pre-trial discovery by barring discovery 
until after a resolution of a motion to dismiss.[Footnote 84] 

(4) Instituting a system of proportionate liability, as opposed to 
joint and several liability, for defendants in private actions that 
did not knowingly violate Rule 10b-5. Defendants who acted knowingly 
would be subject to joint and several liability.[Footnote 85] 

(5) Providing a so-called safe harbor for forward-looking statements. 
If the predicted results do not materialize, liability cannot be based 
on a predictive statement if the statement is identified as such and 
accompanied by meaningful cautionary language.[Footnote 86] 

PSLRA is directed primarily at concerns about class action litigation 
and raises the standards for certain elements that must be alleged in 
order to maintain an action to recover for securities fraud.[Footnote 
87] In filing a complaint in a Rule 10b-5 case, the plaintiff must 
allege each of the six required elements, discussed above, and if the 
plaintiff fails to adequately allege any one of the elements, the 
claim is subject to dismissal by the court. As discussed below, PSLRA 
addressed three aspects of the elements of a Rule 10b-5 fraud action: 
the standard for describing the statements alleged to have been 
misleading, the standard for what must be alleged about the 
defendant's mental state, and the standard for proving loss causation. 
PSLRA's heightened pleading requirements are designed to enable courts 
to screen out cases that lack merit at an early stage in the 
proceedings, thus saving defendants the expense of defending these 

1. Heightened Pleading Standards: 

All private Rule 10b-5 actions are subject to PSLRA's heightened 
pleading standards that require plaintiffs to specifically assert 
"each statement alleged to have been misleading [and] the reason or 
reasons why the statement is misleading."[Footnote 88] To meet this 
standard, the complaint must generally include facts that show exactly 
why the statements were misleading, including facts about the "time, 
place, and content of the alleged misrepresentations."[Footnote 89] 
The court then determines whether the complaint sufficiently states a 
cause of action by examining the specific factual content of the 
allegations made with respect to each essential element of the action. 
If a plaintiff fails to meet the heightened complaint standards for 
alleging this element, PSLRA requires the court to dismiss the case 
upon the defendant's motion to dismiss.[Footnote 90] 

2. Scienter: 

PSLRA created a heightened requirement in connection with scienter, 
the third element of the Rule 10b-5 cause of action noted previously. 
Under PSLRA, the complaint must "state with particularity facts giving 
rise to a strong inference" that the defendant acted with scienter. 
[Footnote 91] This means that the complaint must support an inference 
that the defendants acted with scienter, "a mental state embracing 
intent to deceive, manipulate or defraud."[Footnote 92] PSLRA does 
not, however, define what constitutes "a strong inference." 

In a significant recent decision, the U.S. Supreme Court in Tellabs, 
Inc. v. Makor Issues & Rights, Ltd. addressed how to treat competing 
inferences in determining whether a complaint establishes a strong 
inference of scienter. The Court held that the fraud claims will 
survive dismissal and be decided at trial only if a reasonable person 
would find that the inference of scienter is "more than merely 
plausible or reasonable--it must be cogent and at least as compelling 
as any opposing inference of nonfraudulent conduct."[Footnote 93] This 
standard requires that the lower courts, when considering a private 
complaint in a securities fraud action, must consider the complaint in 
its entirety and take into account plausible opposing inferences. 
First, the court must consider everything in the complaint, including 
documents incorporated by reference, to determine "whether all of the 
facts alleged, taken collectively, give rise to a strong inference of 
scienter, [and] not whether any individual allegation, scrutinized in 
isolation, meets that standard."[Footnote 94] Second, the court must 
engage in a comparative analysis, considering not just the inferences 
asserted by the plaintiff but all the competing inferences put forth 
by the defendant that could be drawn rationally from the alleged 
facts.[Footnote 95] At trial, the plaintiff must then prove scienter 
by a preponderance of the evidence, i.e., the plaintiff must establish 
that it is "more likely than not" that the defendant acted with 
scienter. The Court in Tellabs did not determine whether recklessness 
was sufficient to prove scienter or whether the plaintiff must show 
intent to deceive, manipulate, or defraud.[Footnote 96] 

3. Loss Causation: 

PSLRA codified the element of loss causation by requiring the 
plaintiff to prove that the defendant's act or omission (i.e., 
material misrepresentation or omission) actually caused the economic 
loss for which the plaintiff is seeking damages.[Footnote 97] In many 
Rule 10b-5 class action lawsuits, the plaintiffs' economic loss 
relates to a significant drop in stock price. Therefore, the loss 
causation element requires the plaintiffs to allege and prove that, 
for example, they bought the stock at a price that was artificially 
inflated as a result of the defendant's misstatement or omission. 
[Footnote 98] This means that the plaintiffs must allege and prove 
that there is a strong relationship between the defendant's conduct 
and the plaintiffs' subsequent loss. 

The Supreme Court in 2005 in Dura Pharmaceuticals v. Broudo 
interpreted the loss causation requirement.[Footnote 99] In that case, 
shareholders alleged that Dura Pharmaceuticals (Dura) made fraudulent 
statements about its belief of future Food and Drug Administration 
approval of a new medical device. The shareholders claimed that they 
suffered economic loss, because this misrepresentation caused an 
artificial elevation in Dura's share price and after the statement was 
disclosed as fraudulent, the share price fell. The plaintiffs argued 
that their damages were based on overpayment at the time of purchase. 
Looking to the language of PSLRA and principles of common law tort 
actions for deceit and misrepresentation, the Supreme Court found that 
to satisfy the loss causation requirement, it is not sufficient to 
state that the price was inflated by the fraud, but the plaintiff must 
go further to show economic loss. The temporary drop in share price 
following the disclosure of the fraudulent statement, according to the 
Court, was not inevitably caused by the fraud. The fraudulent 
statement may have contributed to the price drop, but many other 
factors, including changed economic circumstances and new industry-
specific or firm-specific facts, also may have contributed to or 
caused the drop in share price. According to the Court, it is not 
sufficient for the fraudulent statement to "touch upon" or relate to 
the economic loss; instead, the statement actually must cause the 
loss.[Footnote 100] The Court determined that the plaintiff's 
complaint was legally insufficient and remanded the case to be decided 
by the lower court under the Court's interpretation of the loss 
causation requirement. 

The requirements for successfully alleging loss causation continue to 
be litigated. The Supreme Court in Dura did not determine the 
appropriate pleading standard for loss causation. Courts of appeal 
have differed on whether the heightened pleading standard set forth in 
rule 9(b) of the Federal Rules of Civil Procedure or the 
"plausibility" standard under rule 8(a)(2) should apply.[Footnote 101] 
Additionally, the Supreme Court recently determined in the case of 
Erica P. John Fund, Inc. v. Halliburton Co. that securities fraud 
plaintiffs need not prove loss causation order to obtain class 
certification.[Footnote 102] 

C. Securities Litigation Uniform Standards Act (1998) and Class Action 
Fairness Act (2005): 

After PSLRA was enacted, some plaintiffs tried to avoid its higher 
standards for federal court lawsuits by suing in state court. Congress 
reacted to this trend by passing the Securities Litigation Uniform 
Standards Act of 1998 (SLUSA).[Footnote 103] SLUSA provides that 
certain class actions with more than fifty class members involving 
state securities laws and class actions based on common law fraud are 
preempted and cannot be filed.[Footnote 104] SLUSA generally applies 
to class actions involving publicly traded securities.[Footnote 105] 
Immediately after the passage of SLUSA in 1998, there was some 
disagreement as to how far the law went in displacing class actions 
for securities fraud under state law. Some believed that SLUSA only 
applied to those initiating a lawsuit who met the purchaser/seller 
requirement from Blue Chip Stamps, discussed above. Others read SLUSA 
more broadly as not containing that specific limitation. The Supreme 
Court addressed the issue in 2006, holding that the more broad reading 
was appropriate and that it is not necessary for the purchaser/seller 
requirement to be met in order for a securities fraud action to be 
preempted by SLUSA.[Footnote 106] The Court found this reading of 
SLUSA to be more consistent with Congress's goal of creating uniform 
procedural standards in PSLRA for bringing securities fraud lawsuits. 
If only a narrow subset of private securities fraud class actions were 
preempted by SLUSA, plaintiffs could circumvent the procedural 
requirements put in place in PSLRA by filing class actions outside 
that narrow subset in state court or in federal court under state law. 
In essence, the Court found that the distinction between 
purchasers/sellers and holders is irrelevant for the purposes of SLUSA 
preemption, and that class actions brought by either type of party 
cannot be brought under state law or in state court because they are 
preempted.[Footnote 107] 

Additionally, Congress enacted the 2005 Class Action Fairness Act 
(CAFA).[Footnote 108] CAFA confers original federal jurisdiction over 
any class action with at least 100 claimants, minimal diversity, 
[Footnote 109] and an aggregate amount in controversy of at least $5 
million. Commentators have noted that SLUSA and CAFA result in state 
securities class actions being restricted to claims that involve 
corporate governance or merger and acquisition transactions that are 
based on the law where the defendant was incorporated, smaller class 
actions, and perhaps class actions based solely on 1933 Act claims. 
[Footnote 110] 

D. Primary Liability for Secondary Actors under Rule 10b-5 after 
Central Bank: 

Recent court cases have addressed the extent to which secondary 
actors' actions may make them primarily liable under Rule 10b-5. Prior 
to Central Bank, courts had not often distinguished between secondary 
actor conduct that was subject to primary liability and conduct that 
amounted only to aiding and abetting. After Central Bank, plaintiffs 
brought actions based on secondary actors' involvement in fraudulent 
transactions or participation in making fraudulent statements. The 
Supreme Court has recently decided two cases on the scope of liability 
for secondary actors under Rule 10b-5. 

1. Stoneridge case addresses scheme liability and reliance: 

After Central Bank, instead of alleging that defendants made a 
fraudulent statement, plaintiffs in some rule 10b-5 cases alleged that 
the secondary actors were part of a "scheme to defraud." The concept 
of scheme liability is premised on subsections (a) and (c) of Rule 10b-
5, which respectively make it unlawful to "employ any device, scheme, 
or artifice to defraud" and prohibit "any act, practice, or course of 
business which operates ... as a fraud or deceit ... in connection 
with the purchase or sale of any security."[Footnote 111] Under this 
theory, active participation in a scheme to defraud would be 
sufficient to create liability in a Rule 10b-5 action for securities 
fraud. Appellate courts varied in their support of such a concept of 
scheme liability, with some circuits finding scheme liability 
sufficient for secondary actors to be liable in a 10b-5 action. 
[Footnote 112] 

In 2008, the Supreme Court addressed the issue of scheme liability in 
Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. 
[Footnote 113] In that case, plaintiffs alleged that Charter 
Communications, Inc. (Charter), the company being sued for primary 
liability for securities fraud, entered into sham transactions with 
two vendors.[Footnote 114] The vendors allegedly were aware of the 
fraudulent transactions, which Charter used to inflate its operating 
revenues and cash flow in financial statements presented to its 
investors.[Footnote 115] Investors sued the two vendors, among others, 
alleging that they participated in a "scheme to defraud" with Charter 
and should therefore be held liable under 10b-5, regardless of the 
fact that they made no public statement of their own.[Footnote 116] 

The Court held that it is not sufficient for the defendant to have 
merely participated in a scheme to defraud, but that the plaintiff 
actually must have relied on the defendant's participation or conduct 
for liability to attach. Because the vendors neither had a duty to 
Charter's investors nor made a statement on which the investors 
relied, the vendors were not liable. The Court reasoned that to allow 
scheme liability where no reliance exists would create a way for 
plaintiffs to bring suit for conduct that would otherwise be 
considered aiding and abetting, because the conduct did not meet the 
necessary elements for primary liability. And because Congress chose 
not to overturn Central Bank by creating a private aiding and abetting 
cause of action for securities fraud when enacting PSLRA, the Court 
concluded that there still was no private aiding and abetting action 
under Rule 10b-5.[Footnote 117] 

2.Janus case addresses scope of Rule 10b-5 prohibition of fraudulent 

Most recently, in Janus Capital Group, Inc. v. First Derivative 
Traders,[Footnote 118] the Supreme Court has addressed what must be 
shown to establish liability under Rule 10b-5(b), which prohibits 
"making any untrue statement of a material fact" in connection with 
the purchase or sale of securities.[Footnote 119] Janus involved an 
investment adviser that provided advice and administration services to 
a group of mutual funds that issued prospectuses containing false 
statements. In a 5-4 decision, the Court found that the investment 
adviser did not "make" the statement contained in the prospectuses 
because it did not have "ultimate authority over the statement, 
including its content and whether and how to communicate it."[Footnote 
120] The Court noted that without control, one who prepares a 
statement cannot "make" a statement in its own right. Although the 
Court recognized that there was a close relationship between the 
investment adviser and the mutual funds, it found that the investment 
adviser was not the maker of statements by its client mutual fund. The 
Court observed that "any reapportionment of liability in the 
securities industry in light of the close relationship between 
investment advisers and mutual funds is properly the responsibility of 
Congress and not the courts."[Footnote 121] 

The dissent disagreed with the majority's analysis of Rule 10b-5, 
concluding that certain secondary actors, such as management companies 
and individual company officers, might "make" statements contained in 
a firm's prospectus. The dissent pointed out that each of the fund's 
officers was an employee of the investment adviser and that those 
employees both carried out the fund's daily activities and implemented 
its long term strategies.[Footnote 122] The dissent went on to 
conclude that the specific close relationships alleged among the 
investment adviser, the fund and prospectus statements warranted the 
conclusion that the investment adviser "made" the statement. 

Part IV. Additional Legal Avenues For Pursuing Secondary Actors And 
Compensating Investors: 

Since the Supreme Court issued its Central Bank decision in 1994, 
there has been no aiding and abetting liability for secondary actors 
in private securities fraud cases litigated under Rule 10b-5. However, 
in certain circumstances, aiders and abettors of securities fraud may 
be subject to liability under other provisions of state or federal 
securities laws. The SEC and Department of Justice (DOJ) both have 
express statutory authority to impose sanctions on persons who aid and 
abet securities fraud. Other provisions of the federal securities laws 
also may give investors the right to bring suit against parties who 
have defrauded them, including secondary actors. Although SLUSA 
generally requires that class actions be brought in federal court, in 
certain circumstances, large institutional investors can bring non- 
class action suits (or small class action suits below the threshold 
triggering SLUSA) against aiders and abettors in state court where the 
heightened PSLRA standards do not apply. Finally, the SEC is 
authorized to distribute money penalties that it collects to injured 
investors under the Fair Funds provision of the Sarbanes-Oxley Act; 
this provides an alternative method of compensating investors. 

A. Federal Government Enforcement: 

In PSLRA, Congress expressly authorized the SEC to pursue persons who 
knowingly provide substantial assistance to primary violators of the 
securities laws.[Footnote 123] The Dodd-Frank Act amended the pleading 
standard in the 1934 Act from "knowingly" to "knowingly or 
recklessly." The lower pleading standard may enable the SEC to more 
easily bring cases for aiding and abetting securities fraud. The SEC 
can bring civil actions against secondary actors in administrative 
proceedings or court actions. The possible resolutions in these 
actions include, among other remedies, injunctions, disgorgement 
orders, civil penalties, and orders barring or suspending individuals 
from serving as officers or directors of securities issuers or 
participating in the securities industry.[Footnote 124] Even if an 
investigation by the SEC does not result in an enforcement action, the 
SEC can publicize the results of its investigations.[Footnote 125] 

The SEC has used its authority to enforce the securities laws against 
aiders and abettors. Before the Stoneridge class action lawsuit was 
filed, the SEC had recovered around $45 million in disgorgement and 
civil penalties from the two secondary actors that the SEC found to 
have aided and abetted the violations by Charter Communications. 
[Footnote 126] Similarly, the SEC has pursued secondary actors 
involved in other enforcement or civil actions. 

DOJ has authority to impose criminal sanctions to enforce the federal 
securities laws, including aiding and abetting securities fraud. 
[Footnote 127] The SEC may refer violations to DOJ to determine if 
criminal sanctions are appropriate, and the U.S. Attorney's Office 
decides independently when a violation warrants a criminal 
prosecution. Any person convicted of violating the 1934 Act is subject 
to a maximum fine of $5 million ($25 million for corporations) and a 
maximum of 20 years imprisonment. In many instances, DOJ has conducted 
investigations and brought criminal prosecutions in the same cases 
pursued by the SEC. In 2010 there were 12 U.S. federal securities 
class action law suits that had DOJ involvement. Additionally, DOJ 
pursued secondary actors that aided and abetted fraud in the Enron and 
AOL Time Warner cases. Furthermore, it obtained fines against 
individual officers of Charter Communications, who were accused of 
conspiracy and aiding and abetting the alleged fraud at issue in 
Stoneridge.[Footnote 128] 

The Sarbanes-Oxley Act gives the SEC authority to distribute civil 
money penalties for federal securities law violations to investors who 
have been harmed by those violations.[Footnote 129] Prior to enactment 
of Sarbanes-Oxley, the SEC could seek disgorgement of defendants' 
profits both in federal court and in administrative proceedings, and 
disgorged funds could be distributed to investors. The SEC describes 
disgorgement as forcing defendants "to give up the amount by which 
they were unjustly enriched."[Footnote 130] Sarbanes-Oxley provides 
the SEC with authority to combine any civil penalty with the 
disgorgement amount in a Fair Fund to compensate victims of the 
violation. In a recent report, we recently found that from 2002 
through February 2010, $9.5 billion in disgorgements had been ordered, 
of which $9.1 billion had been collected and $6.9 billion had been 
distributed to investors.[Footnote 131] We also found that the SEC was 
taking steps to better capture, report, and manage the programmatic 
and financial impact of the collections and distribution process, but 
it was too early for us to determine the impact and ultimate success 
of the SEC's efforts at improving the program. Before the enactment of 
the Dodd-Frank Act, penalties were only distributed to investors if 
there were a disgorgement order against the defendant. The Dodd-Frank 
Act enables the SEC to distribute penalties in cases where there is no 
disgorgement, providing the SEC with greater flexibility to compensate 
injured investors.[Footnote 132] 

B. Other Private Causes of Action: 

In some circumstances, secondary actors can be subject to liability 
under other provisions of the federal securities laws. Both the 1933 
Act and the 1934 Act provide investors with a right to bring a private 
suit against market participants who have defrauded them. The 1933 Act 
provides private rights of action to investors injured by violations 
of the registration and disclosure requirements in the following 

* Section 11 of the 1933 Act provides an express private right of 
action for damages for material misrepresentations or omissions in a 
registration statement for an offering of new securities. Section 11 
applies to issuers, signatories, directors of the issuer, and 
underwriters. Section 11 also provides for the liability of an expert, 
including accountants, engineers, and appraisers, or any person who 
consents to be named as having prepared or certified any portion of 
the registration statement.[Footnote 133] In general, "materiality" 
refers to those facts that a reasonable investor would consider 
significant in making an investment decision.[Footnote 134] Defendants 
in a section 11 claim can avoid liability by showing that they 
conducted a reasonable investigation with regard to the registration 
statement.[Footnote 135] However, this defense does not apply to 

* Section 12 of the 1933 Act provides remedies to investors who 
purchase securities that were sold in violation of the Act's 
registration requirements or by means of a false or misleading 
communication. Section 12(a)(1) provides that anyone who offers or 
sells a security in violation of the registration requirements is 
liable in a civil action to the person purchasing the security. 
[Footnote 136] Damages are limited to the return of the purchase price 
of the security with interest upon return of the security.[Footnote 
137] Section 12(a)(2) creates an express private remedy for material 
oral and written misstatements or omissions in connection with the 
sale or offer of a security.[Footnote 138] Under section 12(a)(2), the 
seller or offerer of the security is liable to the purchaser of the 
security. Like section 11, section 12(a)(2) provides for a "due 
diligence" defense that permits a defendant who exercised reasonable 
care but did not know of the untruth or omission. 

The 1934 Act also provides private remedies for fraud and 
manipulation, including remedies for violations of a prohibition on 
manipulative practices,[Footnote 139] and a private right of action 
for investors who have been injured due to reliance on a material 
misstatement or omission of fact in connection with a document 
required to be filed with the SEC under the 1934 Act.[Footnote 140] 

C. Controlling Person Liability: 

The 1933 and the 1934 Acts impose liability not only on the person who 
actually commits a securities law violation, but also on the entity or 
individual who controls the violator. Section 20(a) of the 1934 Act 
provides that "[e]very person who, directly or indirectly, controls 
any person liable under any provision of this chapter or of any rule 
or regulation thereunder shall also be liable jointly and severally 
with and to the same extent as such controlled person."[Footnote 141] 
However, no liability exists if "the controlling person acted in good 
faith and did not directly or indirectly induce the acts constituting 
the violation or cause of action."[Footnote 142] Section 15 of the 
1933 Act imposes similar liability, but is limited to violations of 
sections 11 or 12 of the Act.[Footnote 143] Although the provisions 
are not identical, they have been interpreted and applied similarly. 
[Footnote 144] 

Although section 20(a) does not define the term "control," the SEC has 
promulgated a rule defining "control" as "the possession, direct or 
indirect, of the power to direct or cause the direction of the 
management and policies of a person, whether through the ownership of 
voting securities, by contract, or otherwise."[Footnote 145] However, 
the determination of whether control exists depends on the particular 
factual circumstances of each case. 

Section 929P(c) of the Dodd-Frank Act clarified that the SEC can 
maintain an enforcement action for control person liability under 
section 20(a); this provision resolved a conflict among the U.S. 
Courts of Appeals over this issue.[Footnote 146] 

D. State Law Liability: 

In addition to the various remedies available against secondary actors 
under federal law, many states' "blue sky laws" impose express private 
liability for secondary actors.[Footnote 147] Many state statutes 
extend liability not only to control persons but also to other actors 
who participate or materially aid in the fraudulent securities 
transaction.[Footnote 148] The conduct required for secondary 
liability varies from state to state, as states' definitions of 
"participate" and "materially aid" differ, but many states have some 
type of private cause of action for aiding and abetting securities 
fraud. However, since enactment of SLUSA, state secondary liability 
causes of action generally may only be brought by individuals or 
classes of 50 plaintiffs or fewer.[Footnote 149] Plaintiffs that are 
members of large class actions are therefore generally unable to 
utilize state blue sky laws to hold secondary actors liable for aiding 
and abetting securities fraud. 

Part V. Current Standards For Secondary Liability In Light Of Recent 

As discussed above, while secondary actors are not liable to private 
plaintiffs for aiding and abetting securities fraud, they may be 
liable for primary violations of Rule 10b-5. This scope of this 
liability has been shaped by the Supreme Court's decisions in Central 
Bank, Stoneridge, and Janus, as well as by PSLRA's procedural and 
substantive revisions applicable to securities fraud lawsuits. 
Additionally, secondary actors are subject to liability under other 
provisions of 1933 and 1934 Acts, including those that prohibit 
misrepresentations in registration statements filed for publicly 
traded securities or in connection with manipulative practices. 

A. Liability of Attorneys: 

Liability of attorneys to investors has been based on the attorneys' 
formal legal opinions as well as their direct contacts with investors. 
For example, when an attorney makes a materially false or misleading 
statement as part of an opinion intended to be used by a third-party 
investor, the attorney may be held primarily liable under Rule 10b-5. 
Additionally, attorneys will be treated as professionals for purposes 
of section 11 of the 1933 Act when providing expert opinions.[Footnote 
150] Attorneys who write tax opinions have a duty to make inquiry into 
all relevant facts, to be satisfied that the material facts are 
accurately and completely described in the offering materials, and to 
assure that any representations about future activities are clearly 
identified, reasonable, and complete.[Footnote 151] One federal 
appeals court has ruled that a knowingly or recklessly false tax 
opinion letter, which the attorneys expressly consented could be 
distributed to investors, could give rise to primary liability under 
Rule 10b-5.[Footnote 152] Another federal appeals court has ruled that 
recklessly false tax opinion letters could be the basis for primary 
Rule 10b-5 liability. Although the opinion letters contained 
disclaimers (that they were based only on facts provided by the 
client), the court held that the attorney might nonetheless be liable 
where the law firm knew or had reason to know that the factual 
description of the transaction provided by the client was materially 
inaccurate.[Footnote 153] In a recent case, AFFCO Investments 2001 
L.L.C. v. Proskauer Rose, L.L.P., the defendant law firm worked behind 
the scenes to prepare model opinions supporting the validity of a tax 
shelter.[Footnote 154] The plaintiffs participated in the tax shelter 
based, in part, on the promises of opinions from unnamed law firms. 
After their investment, the plaintiffs received the favorable tax 
opinions from the defendant. Citing Stoneridge, the Fifth Circuit 
Court of Appeals ruled that without direct attribution to the law firm 
of its role in the tax scheme, reliance on its participation could not 
be shown.[Footnote 155] 

In contrast, when a client makes a misrepresentation to investors, 
courts have held that the attorneys drafting the documents for the 
client cannot be held liable for the misrepresentations. In Schatz v. 
Rosenberg, the attorney preparing closing documents for the client's 
sale of a control block of stock could not be held liable under Rule 
10b-5 although the attorney knew that representations in the documents 
that were relied on by purchasers were false.[Footnote 156] The 
federal appeals court in that case found that the attorney could not 
be held liable for failing to disclose information about a client to a 
third party, absent some fiduciary or confidential relationship to the 
third party.[Footnote 157] Another federal appeals court held that in 
cases in which a law firm assists in drafting materially false 
offering documents, but itself does not make any false statement, the 
firm cannot be held primarily liable under Rule 10b-5 for the false 
statements made by its clients.[Footnote 158] The court also 
determined that the law firm was not primarily liable for any material 
omissions, because Rule 10b-5 proscribes failure to state material 
facts only when the defendant has a duty to disclose. The court found 
that the law firm did not have such a duty. In another federal appeals 
case, the PIMCO case, attorneys allegedly reviewed and revised 
portions of an issuer's offering documents that they knew contained 
false statements.[Footnote 159] The Second Circuit held in PIMCO that 
secondary actors can be held liable in a private Rule 10b-5 action 
only for those statements attributable to them.[Footnote 160] In the 
recent Janus case, the Supreme Court determined that attribution is 
normally required for liability.[Footnote 161] 

However, when an attorney makes representations directly to 
prospective purchasers of securities, the attorney is under an 
obligation to tell the truth about those securities and may be held 
liable under Rule 10b-5 if those representations are materially 
misleading. In Rubin v. Schottenstein, Zox & Dunn, the Sixth Circuit 
found that when an attorney elects to speak with prospective 
investors, "he assumes a duty to provide complete and non-misleading 
information with respect to the subjects on which he undertakes to 
speak" and "he assumed a duty to speak fully and truthfully on those 
subjects."[Footnote 162] 

B. Liability of Investment Banks: 

Investment banks may be primarily liable in private Rule 10b-5 actions 
for fraud in connection with the purchase or sale of securities if all 
the requirements for liability are met. In litigation involving the 
now-insolvent Enron Corporation, investors sued investment banks and 
law firms that were alleged to have helped Enron report financial 
results fraudulently.[Footnote 163] The defendants were alleged to 
have engaged in a series of transactions with Enron that enabled it to 
temporarily take liabilities off its books and to book revenue from 
transactions. Although the Federal District Court for the Southern 
District of Texas denied the defendants' motion to dismiss and allowed 
the case to proceed,[Footnote 164] the Fifth Circuit reversed[Footnote 
165] and found that the investors failed to state a claim for primary 
violations against the lender. The Fifth Circuit found that because 
the bank's conduct was not conduct on which an efficient market could 
be presumed to rely, the fraud-on-the-market presumption did not 
apply. The court also ruled that the lack of any duty running from the 
banks to investors prevented the investors from relying on the 
Affiliated Ute presumption of reliance to allow the class action to go 
forward. The Supreme Court declined to review this appellate decision. 
[Footnote 166] Other scheme liability cases involved investment banks 
that provided services to the company. The district court in In Re 
Parmalat Sec. Litigation cited Stoneridge in determining that 
investors could not have relied on the deceptive disclosures made by 
the defendant.[Footnote 167] As discussed below, investment banks are 
often named as defendants in litigation against securities analysts 
affiliated with the bank. 

Investment banks also serve as underwriters in connection with the 
issuance of securities. Section 2(a) of the 1933 Act defines an 
underwriter as "any person who has purchased from an issuer with a 
view to, or offers or sells for an issuer in connection with, the 
distribution of any security, or participates or has a direct or 
indirect participation under such undertaking."[Footnote 168] 
Underwriters may be held liable under sections 11 and 12(a)(2) of the 
1933 Act. Section 11 imposes liability on underwriters "in case any 
part of the registration statement, when such part became effective, 
contained an untrue statement of material fact or omitted to state a 
material fact required to be stated therein or necessary to make the 
statements therein not misleading."[Footnote 169] Section 12(a)(2) 
imposes liability on "any person who offers or sells a security ... by 
means of a prospectus or oral communication, which includes an untrue 
statement of material fact or omits to state a material fact necessary 
in order to make the statements ... not misleading." 

Under both sections 11 and 12, an underwriter may absolve itself of 
liability by establishing an affirmative "due diligence" defense. This 
defense may be invoked if the underwriter proves it undertook a 
"reasonable investigation" to determine that the statements in the 
registration statement were true or exercised "reasonable care" in 
determining whether statements in registration statement were true. 
[Footnote 170] An underwriter is not liable for any part of the 
registration statement that is made "on the authority of an expert" if 
the underwriter shows that it "had not reasonable ground to believe 
and did not believe" that there were material misstatements or 
omissions in that part of the registration statement.[Footnote 171] 

A recent First Circuit decision, SEC v. Tambone, held that an 
underwriter who has a duty to investigate the nature and circumstances 
of an offering does not make an implied representation to investors 
that statements in the prospectus are truthful for purposes of primary 
Rule 10b-5 liability.[Footnote 172] In Tambone, the prospectus was 
alleged to contain statements that the underwriter knew to be false. 

C. Liability of Accountants: 

Independent public accountants can be subject to primary liability if 
their audit reports, which are included in public reports of the 
public company, or other public statements (or omissions) otherwise 
meet the elements of primary liability.[Footnote 173] According to 
AICPA officials with whom we spoke, a significant percentage of 
private civil actions naming public company auditors are for 
allegations of liability under Rule 10b-5 for false or misleading 
statements reflected in auditor reports. One important aspect of Rule 
10b-5 cases against public accountants is the requirement to plead and 
prove that the independent auditor acted with scienter. Many courts 
have held that alleged violations of applicable auditing and 
accounting standards by the external auditor are not sufficient, by 
themselves, to establish scienter. For example, courts have held that 
negligent performance of an audit, including failure to design an 
audit that would have resulted in reviewing a fraudulent transaction 
or failure to review certain transactions to such a degree that 
company manipulation of the transaction would have been detected, does 
not meet the requirement to prove intent to defraud or recklessness. 
[Footnote 174] Also, as discussed above, section 11 of the 1933 Act 
expressly subjects external auditors to civil liability for false or 
misleading statements they make in connection with their audits of 
public company registration statements. To the extent that external 
auditors do not engage in conduct that subjects them to primary 
liability--in other words, issuing audit opinions or other statements 
to investors--they are not subject to a private cause of action for 
secondary liability under the federal securities laws. However, 
accountants also are subject to the tort or statutory civil liability 
laws of the state, District of Columbia, or U.S. territory in which 
the conduct giving rise to liability may have occurred. The sources 
and standards for liability to investors and others under these laws 
vary by jurisdiction. 

D. Liability of Credit Rating Agencies: 

Several amendments enacted as part of the Dodd-Frank Act increase the 
potential liability of credit rating agencies in securities fraud 
actions. First, prior to the enactment of the Dodd-Frank Act, SEC Rule 
436(g) provided that a security rating assigned to a class of debt 
securities or a class of preferred stock by an NRSRO is not a part of 
the registration statement prepared by an expert under section 11 of 
the 1933 Act. The Dodd-Frank Act supersedes the regulation so that 
NRSROs may be exposed to liability as experts under section 11 of the 
1933 Act for material misstatements and omissions with respect to the 
ratings.[Footnote 175] Second, the Dodd-Frank Act also specifically 
provides that the enforcement and penalty provisions of the 1934 Act 
"apply to statements made by a credit rating agency in the same manner 
and to the same extent as such provisions apply to statements made by 
a registered public accounting firm or a securities analyst under the 
securities laws."[Footnote 176] Third, the law modifies the requisite 
"state of mind" for private securities fraud actions for money damages 
against a credit rating agency. An investor or other plaintiff may now 
satisfy pleading standards by stating facts giving rise to a strong 
inference that the credit rating agency knowingly or recklessly failed 
to conduct a reasonable investigation of the rated security or the 
credit rating agency failed to obtain reasonable verification of such 
factual elements from a competent party independent of the issuer. 
[Footnote 177] Fourth, the Dodd-Frank Act clarifies that ratings are 
not forward-looking statements for purposes of the PSLRA safe harbor. 
[Footnote 178] Fifth, the Dodd-Frank Act also increases the SEC's 
enforcement authority in connection with NRSROs.[Footnote 179] 
Finally, the Dodd-Frank Act requires every federal agency to review 
existing regulations that require the use of an assessment of the 
credit-worthiness of a security or money-market instrument and modify 
the regulations to remove any reference or the requirement of reliance 
on credit ratings and substitute with an appropriate standard of 
credit-worthiness.[Footnote 180] 

Some federal courts have determined that rating agencies have First 
Amendment protection and are liable only for "actual malice" in making 
their ratings.[Footnote 181] Under this standard, the rating agencies 
would be liable only if they knew their statements were false or the 
statements were made with reckless disregard of the truth. In 
Compuware Corporation v. Moody's Investors Services,[Footnote 182] the 
Sixth Circuit determined that in a breach of contract claim, the 
actual malice standard applied to credit ratings published by Moody's. 
In Abu Dhabi Commercial Bank v. Morgan Stanley & Co., Inc. the Federal 
District Court for the Southern District of New York determined that 
First Amendment protections may not apply when ratings information is 
made available only to a small group of investors rather than to the 
general public.[Footnote 183] The court determined that because the 
ratings were distributed to a small number of investors, they were not 
"matters of public concern" and thus may not be protected by the First 

E. Liability of Securities Analysts: 

Securities analysts may be subject to primary liability if publication 
of their research reports meets the test for primary liability. 
Investors have brought lawsuits against securities analysts and 
investment banks alleging that securities analyst reports were false 
and misleading and intended to artificially inflate the value of 
securities. As indicated above, sell-side analysts may be affiliated 
with or employed by investment banks or other financial firms that 
have clients for whom they provide services. These clients may be the 
same companies that securities analysts are researching and about 
which they write reports. The analyst may face a conflict of interest 
if the investment bank client will be benefited by positive coverage 
in his research report. FINRA and the New York Stock Exchange (NYSE) 
have promulgated rules on analyst recommendations, including increased 
supervision and restrictions on activities designed to prevent 
potential conflicts of interests.[Footnote 184] The FINRA and NYSE 
rules are designed to help insure analyst independence. The First 
Circuit has found that even though a securities analyst may have a 
conflict of interest, the plaintiff in a securities fraud case must 
show that particular statements in the recommendation were false and 
misleading when made in order to establish liability.[Footnote 185] 

Courts have also focused on loss causation and reliance in Rule 10b-5 
cases involving securities analysts and investment banks. In a case 
where investors in companies that Merrill Lynch's research analysts 
covered alleged that the opinions were materially misleading and 
violated section 10(b), the Second Circuit determined that the 
plaintiffs did not sufficiently plead that the alleged 
misrepresentations and omissions caused the claimed losses.[Footnote 
186] In Fogarazzo v. Lehman Brothers, Inc. the plaintiffs alleged that 
Lehman Brothers, Morgan Stanley and Goldman Sachs issued fraudulently 
optimistic research reports that artificially inflated the stock price 
of a company. The Federal District Court for the Southern District of 
New York determined that for class certification purposes, the 
plaintiffs had adequately pled loss causation by showing that the 
element of loss causation may be proven class-wide., which can be 
shown by proposing a suitable methodology.[Footnote 187] In addition, 
some courts have determined that the fraud-on-the-market presumption 
of reliance can apply to lawsuits against securities analysts without 
a specific finding that the analysts' misrepresentations actually 
affected the price of the securities traded in the open 
market.[Footnote 188] Commentators have differed over whether a 
lawsuit against a securities analyst under section 10(b) is likely to 
be successful.[Footnote 189] 

Part VI. Proposals And Potential Implications Of Creating A Private 
Cause Of Action For Aiding And Abetting Securities Fraud: 

Legislation recently has been introduced in the U.S. Senate and House 
of Representatives, in 2009 and 2010, respectively, to create a 
private right of action to permit investors to pursue claims against 
secondary actors for aiding and abetting securities fraud.[Footnote 
190] Both bills proposed to amend section 20(e) of the 1934 Act 
[Footnote 191] to include an express private right of action for 
aiding and abetting a violation of the securities laws. The bills 
would make individuals and firms that knowingly or recklessly provide 
substantial assistance to primary actors in a securities fraud liable 
to investors. 

Proponents and opponents have made various policy arguments to support 
or oppose creating a private right of action for aiding and abetting 
securities fraud. Because enacting a private cause of action for 
aiding and abetting could expand the volume of securities class action 
lawsuits, many of these arguments reflect policy concerns that have 
been expressed about class action securities litigation generally. 
These concerns include whether these lawsuits effectively and 
efficiently deter securities fraud, whether they appropriately 
compensate injured investors and how they impact the capital markets 
and the economy. 

Proponents of creating such an action have included attorneys that 
represent investors; public retirement funds, including the California 
State Teachers' Retirement System, New York State Common Retirement 
Fund, and Pennsylvania State Employees' Retirement System; the North 
American Securities Administrators Association; investor and consumer 
advocacy groups, including AARP, the National Association of 
Shareholder and Consumer Attorneys, and the Consumer Federation of 
America; former SEC commissioners; and law professors.[Footnote 192] 
Opponents of creating such an action have included industry and 
business associations, such as the American Institute of Certified 
Public Accountants, U.S. Chamber of Commerce, Business Roundtable, and 
Securities Industry and Financial Markets Association; securities 
firms; U.S. securities exchanges, including the New York Stock 
Exchange and Nasdaq; former SEC commissioners; and law professors. A 
summary of key policy arguments made for and against creating a 
private right of action for aiding and abetting securities fraud and 
expanding liability in connection with securities fraud class actions 
is set forth below. 

A. Deterring Fraud: 

Deterrence is often cited as a primary goal of enforcement of 
securities laws. A number of parties are involved in the enforcement 
of Rule 10b-5, including the SEC, the Department of Justice, private 
investors in class action litigation, and state officials that bring 
enforcement actions. Proponents of creating a private right of action 
for aiding and abetting securities fraud argue that such action is a 
necessary supplement to SEC enforcement and provides an additional 
deterrent to fraud. SEC enforcement actions serve as one of the 
primary tools for deterring fraud by secondary actors. In light of the 
financial scandals that have occurred over the past decade that were 
aided by secondary actors, proponents question whether SEC alone can 
adequately deter securities fraud. They note that the SEC and Congress 
repeatedly have recognized that SEC enforcement is not sufficient to 
deter wrongdoers and compensate investors. In that regard, proponents 
contend that private aiding and abetting liability would serve a 
critical deterrent function. They also note that private enforcement 
is not subject to government budgeting constraints and is 
entrepreneurially motivated, enabling private plaintiffs and their 
attorneys to vigorously pursue secondary participants. Moreover, they 
argue that the prospect of a large recovery and, hence, large 
attorney's fees are necessary to attract the attention of the creative 
entrepreneurial attorney. 

Proponents also argue that allowing injured investors to seek recourse 
from secondary actors that may serve as "gatekeepers" would not only 
better deter them from aiding and abetting fraud but also better 
motivate them to be diligent gatekeepers. Gatekeepers have been cited 
as including accountants, securities analysts, credit rating agencies, 
and underwriters.[Footnote 193] These secondary actors assist publicly 
held companies with their securities transactions and related 
disclosures--for example, by verifying or certifying the accuracy of 
financial and other information. In some cases, publicly traded 
companies cannot complete their securities transactions without the 
approval of such secondary actors. As a result, these secondary actors 
can provide a check on securities fraud to the benefit of investors. 
Proponents contend that the current legal regime that excludes aiding 
and abetting liability improperly shields secondary actors from 
private liability and, thus, does not sufficiently deter them from 
aiding and abetting fraud or encourage them to be more diligent 
gatekeepers. According to proponents, deterring secondary actors that 
serve as gatekeepers from engaging in fraud can be easier than 
deterring the primary violators, because they do not stand to reap the 
same gain as the primary violators. One commentator has also advocated 
a modified strict liability regime for gatekeepers.[Footnote 194] 

Opponents respond that a private right of action for aiding and 
abetting is unnecessary for deterrence of securities fraud, because 
public enforcement under the current regulatory structure is adequate. 
First, the SEC employs a broad range of statutory and administrative 
tools to combat fraud involving aiders and abettors and that authority 
has been expanded by the Dodd-Frank Act.[Footnote 195] According to 
opponents, the SEC has used this authority vigorously, in large part 
to pursue individual wrongdoers. They note that SEC enforcement 
actions, more so than private lawsuits, have a significant stigma that 
can cause reputational damage. Second, DOJ has broad statutory powers 
to pursue secondary actors who assist others in committing securities 
fraud.[Footnote 196] Opponents note that the threat of a criminal 
indictment is a serious deterrent, because even an indictment, and 
certainly a conviction, could amount to a professional death sentence. 
They further note that the SEC and DOJ have the expert judgment to 
decide when to prosecute alleged aiders and abettors of securities 
fraud, and these agencies, unlike private attorneys, do not have a 
profit motive that can bias their decisions. 

Third, opponents cite the authority of the PCAOB to promulgate 
auditing standards and bring enforcement actions against accounting 
firms and individual auditors. Finally, opponents note that laws in 
several states provide penalties that potentially help to deter 
secondary actors from aiding and abetting securities fraud. These 
include state "blue sky" laws that permit attorneys general and state 
regulators to seek fines and obtain restitution from,[Footnote 197] 
and impose criminal sanctions against,[Footnote 198] anyone who aids 
and abets state securities law violations. 

Opponents also question the ability of private securities class 
actions to deter fraud, citing research showing that resolution of 
class actions does not depend on the merits of the case, but are based 
on the settlement value to the defendant and the fact that defendants 
view settlement as a cost of doing business. They also cite the fact 
that companies and insurers, not individual wrongdoers, pay 
settlements. Thus, the cost of settlements is ultimately borne by the 
corporation's shareholders, not those that committed the fraud. 
Opponents of creating a private right of action for aiding and 
abetting securities fraud argue that such a right would lead to an 
increase in non-meritorious lawsuits and, in turn, an increase in 
litigation risk. Opponents note that creating the right of action 
would expand the range of parties and transactions that could give 
rise to a private lawsuit to include ordinary commercial transactions 
and customers, vendors, and others with no direct connection to the 
securities markets: 

Although PSLRA heightened the pleading requirements applicable to 
securities fraud claims, opponents note that getting non-meritorious 
complaints dismissed is still costly and difficult. Opponents maintain 
that a lawsuit under an aiding and abetting theory of liability would 
often be inherently fact intensive. Thus, according to opponents, 
there would be factual disputes in nearly every case, making it 
difficult for innocent parties to succeed on a motion to dismiss. Once 
a claim survives a motion to dismiss, the case is almost always 
settled regardless of the merits of the case. According to opponents, 
even if a case lacks merit, defendants may seek to settle for cost-
benefit reasons, such as avoiding the high costs of discovery and 
litigation or the risks of massive damages. That is, the settlement 
value to defendants can turn more on the expected costs of their 
defense and less on the merits of the claim. Opponents maintain that 
going to trial is a risk that secondary actors are often unwilling to 
take, no matter how non-meritorious the case. This is in part because 
of the potential for these actors to be found jointly and severally 
liable if they knowingly participate in the fraud, putting them at 
risk of paying damages out of proportion to their involvement in the 
fraud.[Footnote 199] 

B. Compensating Investors: 

Proponents of creating a private right of action for aiding and 
abetting argue that such action would help to compensate investors who 
have been harmed through securities fraud. Proponents disagree with 
the criticism that class action lawsuits do not effectively compensate 
investors because current shareholders who do not benefit from the 
increase in stock price effectively compensate those who bought at 
fraud-related prices during the class period.[Footnote 200] They note 
that this criticism does not apply to litigation against secondary 
actors because recoveries from secondary actors do not come from the 
corporation. They note that publicly traded companies that have 
committed securities fraud have become distressed or insolvent in some 
cases, leaving secondary actors who assisted issuers in the fraud as 
the only sources from which injured investors can recover their 
losses. According to proponents, such an outcome is more common for 
new companies but also has included other companies. Proponents also 
note that the argument that higher costs discourage firms from listing 
on U.S. securities exchanges does not apply directly where secondary 
liability is involved. 

Proponents further note that in contrast to securities fraud cases 
that result in recoveries from issuers, recoveries from secondary 
actors provide unique compensation to investors, because the current 
shareholders of the issuers do not bear the cost of the recoveries. 
According to proponents, if investors were allowed to bring lawsuits 
against only issuers (and their directors and officers), they would 
not be able to recover much of their losses and, as a result, public 
confidence in the markets would suffer. Proponents maintain that 
private securities class actions currently represent the principal 
means by which financial penalties are imposed in cases of securities 
fraud and manipulation. Specifically, proponents contend that the 
SEC's disgorgement and civil money penalty authorities, although 
enhanced by Sarbanes-Oxley, are limited and generally can be used to 
recover only a fraction of the losses suffered by investors in large-
scale securities frauds. As an example, they note that the SEC 
recovered $440 million from aiders and abettors in the Enron fraud, 
while investors recovered $7.3 billion in private suits.[Footnote 201] 
They further argue that the SEC, with its limited resources, cannot 
bring actions in every one or even most of the securities fraud cases 
that have proliferated in recent years. 

Opponents to creating private aiding and abetting liability argue that 
such action would not effectively or efficiently serve the goal of 
compensating injured investors. First, they note that damages 
resulting from securities fraud lawsuits historically have provided 
limited compensation to investors: such lawsuits, on average, have 
settled for a small percentage of losses alleged by investors, with a 
large proportion of total settlement value going toward attorney 
fees.[Footnote 202] Second, opponents maintain that aiding and 
abetting liability would not increase the amount of money to which 
injured investors would be entitled; rather, it would increase only 
the number of actors who would be responsible for paying the judgment. 
Thus, according to opponents, investors would benefit only if the 
primary actor becomes insolvent or otherwise unable to pay a judgment. 

Opponents note that when a securities fraud case involving securities 
traded in the secondary market is settled, a company's present 
shareholders, in effect, largely pay the company's past shareholders. 
According to opponents, investors with a diversified stock portfolio 
generally will receive settlement payments in some cases and make 
settlement payments in other cases but will be worse off in the end 
because of legal fees.[Footnote 203] They argue that this circularity 
of payments renders class actions an illogical method of compensation. 
Moreover, according to opponents, the cost of settling and defending 
securities class action is passed to shareholders through higher 
directors and officers' insurance premiums. Finally, opponents contend 
that a private right of action for aiding and abetting is unnecessary 
for compensation purposes because of the government's ability to 
compensate injured investors without the legal costs associated with 
private litigation. For example, they note that Sarbanes-Oxley 
directed the SEC to create a Fair Fund program to collect and return 
money that it recovers through disgorgement and civil penalties to 
injured investors. Similarly, DOJ is able to return ill-gotten gains 
directly to injured investors through restitution and forfeiture. 

C. Effect on Investors and the Economy: 

Proponents of creating a private right of action for aiding and 
abetting securities fraud argue that such an action would not result 
in a significant increase in non-meritorious lawsuits. They note that 
PSLRA's reforms provide secondary actors with safeguards from non- 
meritorious lawsuits.[Footnote 204] The heightened pleading standard 
is seen as a key safeguard as it is designed to make it more difficult 
for plaintiffs to allege securities fraud without specific evidence of 
misconduct. Even if a private aiding and abetting cause of action were 
created, proponents argue that PSLRA's pleading standard would enable 
defendants to succeed on a motion to dismiss when one is warranted. 
Proponents note that the pre-trial dismissal rate for securities class 
actions has nearly doubled since PSLRA, but settlement sizes have 
increased--reflecting, in their view, a higher proportion of 
meritorious litigation.[Footnote 205] 

Proponents further note that such trends have prompted securities 
experts to surmise that PSLRA's reforms may be preventing meritorious 
claims from being filed.[Footnote 206] They point out that Congress 
has limited the use of class action lawsuits for securities fraud to 
federal courts instead of state courts. In 1998, Congress enacted 
SLUSA to address the concern that securities fraud lawsuits had 
shifted from federal to state courts as a means of circumventing 
PSLRA. Additionally, proponents note that a private right of action 
for aiding and abetting existed for decades before Central Bank and 
the passage of PSLRA, and secondary actors at that time did not 
experience a high volume of non-meritorious lawsuits. Finally, 
proponents say that such a private right of action would protect the 
integrity and enhance the competitiveness of U.S. financial markets 
because it would promote transparency and good corporate governance. 

According to opponents, creating a private right of action for aiding 
and abetting would exacerbate the impediment that class action 
lawsuits pose to economic growth in the United States. Opponents note 
that the risk of securities fraud litigation already has caused some 
foreign companies to choose not to do business with U.S. companies to 
avoid a higher litigation risk. Alternatively, business partners could 
take steps to mitigate such risk, such as by insuring themselves 
against the risk or charging companies higher prices for their 
services. However, opponents note that any such approach would 
increase the cost of doing business with a publicly held company and, 
in turn, the cost of being a publicly held company. Opponents also 
contend that the higher costs imposed on U.S. publicly traded 
companies because of securities fraud litigation risk would discourage 
U.S. and foreign firms from listing or remaining listed on U.S. 
securities exchanges or raising capital in the United States. 
Opponents maintain that the U.S. capital markets are losing their 
competitiveness with foreign markets, in part evidenced by their lower 
growth rate and creation of fewer new companies relative to foreign 
markets.[Footnote 207] 

D. Possible Measures That Might Mitigate Potential Negative Effects: 

At least one legal expert has suggested that if Congress were to 
create private aiding and abetting liability, it could mitigate the 
potential adverse effects of such actions by placing a ceiling on 
liability for secondary actor defendants. This would be particularly 
appropriate for secondary actors such as accountants or other 
professionals.[Footnote 208] This expert noted that a liability 
ceiling could be beneficial, in part because gatekeepers can be 
deterred more easily, given that they stand to make only a small 
portion of the gain from fraud that a primary actor expects and the 
failure of a gatekeeper could be as disruptive to the capital markets 
when gatekeeper services are highly concentrated. The expert further 
noted that a ceiling on damages would not only permit gatekeepers that 
currently cannot obtain liability insurance to obtain such coverage, 
thus averting their potential collapse, but also protect gatekeepers 
from feeling pressure to settle by the threat of potential 
astronomical damages if found liable at trial. 

According to this expert, the goal of the liability ceiling would be 
to devise a penalty that is sufficient to deter aiding and abetting by 
secondary actors but not so large as to threaten their insolvency. 
Because some secondary actors are publicly held companies and some are 
not, a variety of measures should be used to set the amount of the 
ceiling: for example, market capitalization or net worth for public 
companies, and revenues or income for private ones. A ceiling may be 
necessary so that companies are not subject to unlimited liability. In 
brief, the expert proposed that the ceiling be set at $2 million for a 
natural person and $50 million for a public corporation, noting that 
the real impact of a ceiling is to induce the parties to settle for an 
amount below the ceiling. 

Another legal expert opposed to creating private aiding and abetting 
liability has suggested limiting the damages available in Rule 10b-5 
fraud-on-the-market cases to focus on deterrence rather than 
compensation.[Footnote 209] This expert noted that instead of making 
defendants liable for all losses resulting from fraud, defendants 
should be forced to disgorge their gains (or expected gains, for those 
who fail in their scheme) from the fraud. According to this expert, in 
most fraud-on-the-market cases, the corporation does not benefit from 
the fraud but rather is the victim of the fraud, such as when an 
executive is awarded an undeserved bonus by creating the appearance of 
meeting the target stock price. This expert noted that under a 
disgorgement rule, the proper remedy would be for the executive to 
return the bonus earned from the fraud to the corporation. According 
to this expert, if Congress were to adopt a disgorgement measure of 
damages for Rule 10b-5 class actions, plaintiffs' lawyers would have 
to settle with executives instead of corporations or secondary 
defendants. Under this approach, secondary actors complicit in a 
corporation's fraud would be forced to give up their fees (or some 
multiple thereof) earned during the fraud period. Other proposals 
suggested by legal experts in connection with aiding and abetting 
liability to private investors involve how liability is imposed. Under 
current law, proportionate liability (liability based on the 
percentage of responsibility) generally applies where the defendant 
does not act knowingly. If the person knowingly violates the 
securities laws, liability can be joint and several (each defendant 
potentially can bear the total damages). These legal experts propose 
creating aiding and abetting liability but limiting potential 
liability to proportionate liability for secondary actors shown to 
have actual knowledge of the wrongdoing or who demonstrate intent to 


Legislation and court decisions over the past two decades have 
dramatically altered the scope of private securities fraud liability 
for secondary actors, as well as the requirements for litigating all 
types of private securities fraud class actions. Debate continues over 
whether a private cause of action for aiding and abetting securities 
fraud should be created, centering on whether this would enhance 
deterrence of securities fraud, promote equitable compensation of 
injured investors, and affect the U.S. economy and corporate 

We are sending copies of this analysis to interested congressional 
committees and to the Chairman of the Securities and Exchange 
Commission and the Attorney General. In addition, this analysis will 
be available at no charge on GAO's website at [hyperlink,]. 

If you or your staff have questions about this analysis, please 
contact Susan D. Sawtelle at (202) 512-6417 or 
Contact points for our Offices of Congressional Relations and Public 
Affairs are: Ralph Dawn, Managing Director, Congressional Relations, 
(202) 512-4400 or; and Chuck Young, Managing Director, 
Public Affairs, at (202) 512-4800 or The following 
persons made key contributions to this analysis: Orice Williams Brown, 
Managing Director, Financial Institutions and Markets; Assistant 
General Counsel Rachel M. DeMarcus; Assistant Directors Richard S. 
Tsuhara and Francis L. Dymond; Patrick S. Dynes; Lauren S. Fassler; 
Nina Horowitz; Daniel S. Kaneshiro; Marc W. Molino; and Patricia A. 

Signed by: 

Susan D. Sawtelle: 
Managing Associate General Counsel: 

[End of section] 

Enclosure I: 

Scope and Methodology of this Analysis: 

To conduct this analysis, we reviewed the securities laws and 
regulations that provide for a right of action for private plaintiffs 
for violations of the securities laws. We focused on the evolution of 
the implied private right of action under section 10(b) of the 1934 
Act and SEC Rule 10b-5 against persons who commit fraud in connection 
with the purchase or sale of securities. We also reviewed sources that 
discuss the roles of various financial market participants such as 
public companies, investment banks, accountants, lawyers, and vendors. 
We reviewed relevant federal legislation including the Private 
Securities Litigation Reform Act of 1995 (PSLRA), the Securities 
Litigation Uniform Standards Act of 1998 (SLUSA), the Sarbanes-Oxley 
Act of 2002, and the Dodd-Frank Wall Street Reform and Consumer 
Protection Act. We reviewed key Supreme Court decisions, including the 
Central Bank decision in 1994, the Stoneridge decision in 2008, and 
the Janus decision in 2011, concerning the types of claims that can be 
brought against secondary actors under section 10(b) of the 1934 Act, 
as well as other relevant federal court decisions. We reviewed the 
briefs filed with the Supreme Court by the parties and other 
interested entities in the Central Bank and Stoneridge cases and 
interviewed a number of these entities. We also reviewed relevant law 
review articles and court decisions on the scope of the implied 
private right of action under section 10(b). Further, we reviewed key 
court decisions and articles interpreting PSLRA and SLUSA since their 
enactment in the mid-1990s. Finally, we interviewed representatives 
from a broad range of organizations to obtain their input and 
perspectives on the potential implications of authorizing a private 
right of action for aiding and abetting, including the Securities and 
Exchange Commission; the Department of Justice; consumer, corporate, 
accounting, and securities associations; and companies and individuals 
that participated in the Central Bank and Stoneridge litigation. We 
provided a copy of the draft report to the Department of Justice and 
the Securities and Exchange Commission for review and comment. The 
Securities and Exchange Commission provided technical comments that we 
incorporated as appropriate; the Department of Justice did not provide 

[End of section] 


[1] In general, "secondary actors" are persons charged with "secondary 
liability" because they do not directly commit violations of the anti- 
fraud provisions but instead are alleged to provide substantial 
assistance to fraudulent conduct. Because transactions subject to the 
federal securities laws are often complex and involve multiple 
entities, it can be difficult to determine, at the time a violation 
occurs, who should be subject to primary versus secondary liability. 
In this report, we use the term "secondary actor" to refer to parties 
providing services to, or involved in transactions with, corporate 

[2] 15 U.S.C.  78j(b). 

[3] 17 C.F.R.  240.10b-5. 

[4] See, e.g., Brennan v. Midwestern United Life Ins. Co., 259 F. 
Supp. 673 (N.D. Ind. 1966). 

[5] 511 U.S. 164 (1994). 

[6] 552 U.S. 148 (2008). 

[7] 131 S. Ct. 2296 (2011). 

[8] Pub. L. No. 104-67, 109 Stat. 737 (1995) (codified as amended in 
scattered sections of titles 15 & 18 of the U.S. Code). 

[9] 511 U.S. at 177. 

[10] See, e.g., H.R. 5042, 111th Cong. (2010). 

[11] Pub. L. No. 111-203, 124 Stat. 1376 (2010) (codified in scattered 
sections of titles 12 & 15 of the U.S. Code). 

[12] Specifically, section 929Z of the Act directs GAO to study the 
impact of authorizing a private right of action against any person who 
aids or abets another in violation of the securities laws, and 
identifies areas to be included in the study if practicable. This 
analysis addresses all of those areas. Part I of the analysis provides 
an overview of the general anti-fraud prohibitions of section 10(b) 
and Rule 10b-5 and identifies the elements that private investors must 
show to prove a case for securities fraud. Part II discusses the roles 
that secondary actors, including accountants, attorneys, and 
underwriters, play in securities transactions. Part III reviews 
significant legislative and case law developments over the past two 
decades affecting secondary actors' liability for securities fraud. 
Part IV discusses other legal avenues for pursuing secondary actors 
and compensating investors. Part V sets out current standards for 
secondary actor liability in light of these developments. Finally, 
Part VI identifies recent proposals to create a private cause of 
action for aiding and abetting securities fraud, describes arguments 
that have been advanced in favor of and against such proposals, and 
discusses steps that have been identified, if such a right were 
created, to mitigate potential concerns that have been raised with 
creating such liability. 

[13] Securities Act of 1933, 48 Stat. 74 (1933) (codified as amended 
at 15 U.S.C.  77a et seq.); Securities Exchange Act of 1934, 48 
Stat. 881 (1934) (codified as amended at 15 U.S.C.  78a et seq.). 

[14] 17 C.F.R.  240.10b-5. 

[15] Section 10(b) of the 1934 Act makes it unlawful "to use or employ 
[by the use of any means or instrumentality of interstate commerce], 
in connection with the purchase or sale of any security ... any 
manipulative or deceptive device or contrivance in contravention of 
such rules and regulations as the Commission may prescribe as 
necessary or appropriate in the public interest or for the protection 
of investors." 15 U.S.C.  78j(b). 

[16] Pub. L. No. 104-67, 109 Stat. 737 (1995) (codified as amended in 
scattered sections of titles 15 & 18 of the U.S. Code). 

[17] H.R. Rep. No. 104-369, at 31-32, 37-41 (1995) (Conf. Rep.). 

[18] 131 S. Ct. 2296 (2011). 

[19] Securities Act of 1933, 48 Stat. 74 (1933) (codified as amended 
at 15 U.S.C.  77a et seq.); Securities Exchange Act of 1934, 48 
Stat. 881 (1934) (codified as amended at 15 U.S.C.  78a et seq.). 

[20] Central Bank of Denver, 511 U.S. at 171 (quoting Affiliated Ute 
Citizens of Utah v. United States, 406 U.S. 128, 151 (1972)). 

[21] 15 U.S.C.  78j(b). 

[22] 17 C.F.R.  240.10b-5. 

[23] In private civil litigation filed in federal court, the person 
bringing the lawsuit (the plaintiff) generally must plead (lay out in 
the initial complaint) just "enough facts to state a claim to relief 
that is plausible on its face." Bell Atlantic v. Twombly, 550 U.S. 
544, 570 (2007). The Federal Rules of Civil Procedure provide special 
standards for fraud cases. The plaintiff's complaint must allege "with 
particularity" specific facts showing each of the elements of fraud. 
Fed. R. Civ. P. 9(b). Additionally, the PSLRA enhanced pleading 
requirements for private securities cases; if the plaintiff's 
complaint fails to allege the necessary facts with particularity, the 
court can dismiss the case. If the complaint is sufficient, then, as 
in all civil suits, the plaintiff must prove each of the elements of 
his claim by a preponderance of the evidence at trial, or, if the 
facts are not in dispute, in motions filed with the court. 

[24] See, e.g., Janus Capital Group, Inc. v. First Derivative Traders, 
131 S. Ct. 2296 (2011); Stoneridge Investment Partners, LLC v. 
Scientific-Atlanta, Inc., 552 U.S. 148 (2008). 

[25] 17 C.F.R.  240.10b-5. 

[26] Basic Inc. v. Levinson, 485 U.S. 224, 240 (1988). In a recent 
case, Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011), 
the Supreme Court addressed how a plaintiff would plead the 
materiality of adverse events associated with a pharmaceutical 
company's products. 

[27] Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1321-22 
(citing Basic Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988)). 

[28] Thomas Lee Hazen, Treatise on the Law of Securities Regulation,  
12.17 (West Group 2005). 

[29] See, e.g., Donald C. Langevoort, Half-truths: Protecting Mistaken 
Inferences by Investors and Others, 52 Stan. L. Rev. 87, 88 (1999). 

[30] Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 768 (1975) 
(citing 17 C.F.R.  240.10b-5). 

[31] 15 U.S.C.  78j(b). 

[32] Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 746-47 

[33] Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976). 

[34] Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th 
Cir. 1977). The Seventh Circuit states that "reckless conduct may be 
defined as a highly unreasonable omission, involving not merely 
simple, or even inexcusable negligence, but an extreme departure from 
the standards of ordinary care, and which presents a danger of 
misleading buyers or sellers that is either known to the defendant or 
is so obvious that the actor must have been aware of it." Id. (citing 
Franke v. Midwestern Okla. Dev. Auth., 428 F.Supp. 719 (W.D. Okla. 

[35] See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 
319 n.3 (2007). The Supreme Court has not yet determined whether 
reckless conduct is sufficient to satisfy the scienter requirement. 

[36] Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 
152-53 (1972). 

[37] Basic, Inc. v. Levinson, 485 U.S. 224, 246-47 (1988). In 1968, 
the Second Circuit Court of Appeals laid the groundwork for the fraud-
on-the-market doctrine by determining that privity was not a 
requirement for Rule 10b-5 liability. Thus, parties other than the 
issuer could be held liable. SEC v. Texas Gulf Sulphur, 401 F.2d 833 
(2d Cir. 1968) (en banc), cert. denied, 404 U.S. 1005(1971). 

[38] Id. 

[39] See 15 U.S.C.  78u-4(b)(4); see also Dura Pharmaceuticals, Inc. 
v. Broudo, 544 U.S. 336, 338 (2005). 

[40] See, e.g., Kardon v. National Gypsum Co., 69 F. Supp. 512, 514 
(E.D. Pa. 1946). An implied private cause of action exists where 
Congress did not include an explicit private right of action in a law, 
but courts read a provision to mean that Congress intended there to be 
a remedy in order to ensure the provision is enforced. 

[41] Superintendent of Ins. of N.Y. v. Bankers Life & Casualty Co., 
404 U.S. 6, 13, n.9 (1971). 

[42] 511 U.S. 164 (1994). 

[43] Private Securities Litigation Reform Act, Pub. L. No. 104-67, 109 
Stat. 737 (1995) (codified as amended in scattered sections of titles 
15 & 18 of the U.S. Code). 

[44] See, e.g., John C. Coffee, Jr., Gatekeepers: The Professions and 
Corporate Governance (Oxford Univ. Press 2006). 

[45] See Report of the New York City Bar Association Task Force on the 
Lawyer's Role in Corporate Governance--November 2006, 62 Bus. Law. 427 

[46] See John C. Coffee, Jr., Gatekeeper Failure and Reform: The 
Challenge of Fashioning Relevant Reforms, 84 B.U. L. Rev. 301, 308-09 

[47] Reiner H. Kraakman, Corporate Liability Strategies and the Costs 
of Legal Controls, 93 Yale L. J. 857, 888-96 (1984). 

[48] Bureau of Labor Statistics, Occupational Outlook Handbook, 2010-
11 Edition: Accountants and Auditors (2010), available at [hyperlink,]; see also AICPA, FAQs--Become a 
CPA, [hyperlink,] 
(last visited July 19, 2011). 

[49] AICPA, Code of Professional Conduct (2010), available at 

[50] For example, the Code of Virginia defines "the practice of public 
accounting" as "the giving of an assurance" other than under certain 
circumstances, Va. Code Ann.  54.1-4400, and it generally prohibits 
the practice of public accounting or the use of the title "Certified 
Public Accountant" unless licensed by the Virginia Board of 
Accountancy, Va. Code Ann.  54.1-4414. 

[51] According to AICPA, all 55 public accounting licensing 
jurisdictions require prospective public accountants to pass the 
Uniform CPA Examination as a condition of licensure. The AICPA is 
responsible for content development and scoring of the CPA Exam. See 
AICPA, Examination Overview, [hyperlink,]
(last visited July 19, 2011). 

[52] PCAOB was established by the Sarbanes-Oxley Act of 2002 to 
oversee the audit of public companies subject to the securities laws, 
and related matters, in order to protect the interests of investors 
and further the public interest in the preparation of informative, 
accurate, and independent audit reports for companies whose securities 
are sold to, and held by and for, public investors. 15 U.S.C.  7211. 
PCAOB Rule 2100 requires each domestic or foreign firm to register 
with PCAOB if it prepares or issues any audit report with respect to 
an issuer or plays a substantial role in the preparation or issuance 
of such audit reports. Registered public accountants are subject to 
periodic inspection by PCAOB and investigation and disciplinary action 
by PCAOB for noncompliance with the Sarbanes-Oxley Act, the rules of 
PCAOB and the SEC, and other laws, rules, and professional auditing 
standards governing the audits of public companies, brokers, and 
dealers. PCAOB Rules 4000, 5000. 

[53] PCAOB, Standards, available at [hyperlink,]. 

[54] See also SEC Regulation S-X, Art. 2, 17 C.F.R.  210.2-02. 

[55] See PCAOB, Statement on Auditing Standards No. 1, AU  110.01. 

[56] Ass'n of the Bar of the City of N.Y., Report of the Special 
Committee on Lawyers' Role in Securities Transactions, 32 Bus. Law. 
1879, 1884-86 (1977). 

[57] The rules and ethical considerations of the Model Rules of 
Professional Conduct and the Model Code of Professional Responsibility 
of the American Bar Association address the duties of attorneys in a 
range of contexts. The Model Rules and/or Model Codes are adopted in 
some form by most individual states, and depending on the details of a 
particular state's rules, would apply to attorney conduct in the 
context of securities-related transactions. For example, attorneys 
have an obligation to be properly prepared, accept only those matters 
they are competent to handle, and, in rendering opinions and 
disclosure advice, diligently represent their clients. On the other 
hand, if a client's conduct is criminal in nature, counsel must not 
assist or advise the client in furthering such conduct. 

[58] See Robert J. Rhee, The Decline of Investment Banking: 
Preliminary Thoughts on the Evolution of the Industry 1996-2008, 5 J. 
Bus. & Tech. L. 75 (2010). 

[59] See FINRA Rule 5100, Securities Offerings, Underwriting and 
Compensation. The purpose of the review is to assure that the 
compensation is fair and reasonable. 

[60] Other types of negotiated underwriting agreements include strict 
underwriting and best efforts underwriting. The strict underwriter 
guarantees to purchase the unsold portion of the allotment. Best 
efforts underwriting does not put the underwriter at risk if investors 
do not purchase the shares being offered to the public. 

[61] 15 U.S.C.  78c(a)(60). 

[62] See 17 C.F.R.  240.15c3-1. 

[63] See GAO, Securities and Exchange Commission: Action Needed to 
Improve Rating Agency Registration Program and Performance-Related 
Disclosures, [hyperlink,] 

[64] See SEC Office of Compliance Inspections and Examinations, 
Division of Trading and Markets and Office of Economic Analysis, 
Summary Report of Issues Identified in the Commission Staff's 
Examinations of Select Credit Rating Agencies (2008). 

[65] See, e.g., Mark A. Chen & Robert Marquez, Regulating Securities 
Analysts 23 (Working Paper, 2003), available at [hyperlink,]. 

[66] See, e.g., SEC Regulation Analyst Certification; NASD Rule 2711; 
NYSE Rule 472. Sell-side analysts are subject to rules requiring them 
to disclose conflicts of interest and prohibiting certain conduct that 
would result in a conflict of interest. 

[67] First Interstate Bank of Denver, N.A. v. Pring, 969 F.2d 891, 898 
(10th Cir. 1992), rev'd sub nom. Central Bank of Denver, N.A. v. First 
Interstate Bank of Denver, N.A., 511 U.S. 164 (1994). 

[68] 511 U.S. 164, 191 (1994). 

[69] Id. at 167. 

[70] Id. 

[71] Id. at 167-68. 

[72] Id. at 168. 

[73] See 18 U.S.C.  2. 

[74] 511 U.S. at 180. 

[75] Id. at 188. 

[76] Id. at 188-90. 

[77] Id. at 189. 

[78] Pub. L. No. 104-67, 109 Stat. 737 (1995). 

[79] H.R. Rep. No. 104-369, at 31, 32-36, 42-47 (1995) (Conf. Rep.). 

[80] Id. 

[81] 15 U.S.C.  77z-1(a)(3)(B), 78u-4(a)(3)(B). 

[82] H.R. Rep. No. 104-369, at 32-35 (1995) (Conf. Rep.). 

[83] 15 U.S.C.  78u-4(a)(6). 

[84] Id.  78u-4(b)(3)(B). 

[85] Id.  78u-4(f). If defendants are found jointly and severally 
liable under Rule 10b-5, the entire damage award generally can be 
collected from one or more of the defendants. Where proportionate 
liability applies, defendants are liable for only their proportionate 
share of the damages. 

[86] Id.  78u-5(c). 

[87] H.R. Rep. No. 104-369, at 41 (1995) (Conf. Rep.). 

[88] 15 U.S.C.  78u-4(b)(1). 

[89] See In re Credit Suisse First Boston Corp., 431 F.3d 36, 46 (1st 
Cir. 2005) (quoting Greebel v. FTP Software, Inc., 194 F.3d 185, 193 
(1st Cir. 1999)). 

[90] 15 U.S.C.  78u-4(b)(3)(A). 

[91] Id.  78u-4(b)(2). 

[92] Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 
(quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-94, n.12 

[93] Id. at 314. 

[94] Id. at 310. 

[95] Id. at 314. 

[96] In Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 
(2011), the Court applied the Tellabs standard to find that the 
defendant acted with the required level of scienter. 

[97] 15 U.S.C.  78u-4(b)(4). 

[98] See H.R. Rep. No. 104-369, at 41 (1995) (Conf. Rep.). 

[99] 544 U.S. 336 (2005). 

[100] Id. at 343 (emphasis in original). 

[101] Fed. R. Civ. P. 8(a)(2) requires that a plaintiff submit "a 
short and plain statement of the claim showing that the pleader is 
entitled to relief"; Fed. R. Civ. P. 9(b) requires that a plaintiff 
"state with particularity the circumstances constituting fraud." See 
Gregory A. Markel & Martin L. Seidel, Lower Courts Divided on Standard 
For Pleading Loss Causation Post-'Dura', 245 N.Y. L.J. 61 (2011). 

[102] 131 S. Ct. 2179 (2011). In order for a class action to proceed, 
the court must find that "the questions of law and fact common to 
class members predominate over any questions affecting only individual 
members, and that a class action is superior to other available 
methods for fairly and efficiently adjudicating the controversy." Fed. 
R. Civ. P. 23(b)(3). The Fifth Circuit U.S. Court of Appeals had found 
that the plaintiff had to prove the separate element of loss causation 
in order to trigger Basic's presumption of reliance. The Supreme Court 
determined that this requirement was not justified by the Basic case. 

[103] Pub. L. No. 105-353, 112 Stat. 3227 (1998). 

[104] 15 U.S.C.  78bb(f)(5)(B). 

[105] Id.  78bb(f)(5)(E). 

[106] Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 
71, 88-89 (2006). 

[107] Id. 

[108] Pub. L. No. 109-2, 119 Stat. 4 (2005) (codified in scattered 
sections of title 28 of the U.S. Code). 

[109] The diversity requirement is satisfied if "any member of a class 
of plaintiffs is a citizen of a State different from any defendant." 
28 U.S.C.  1332(d)(2). 

[110] See, e.g., Jennifer J. Johnson, Securities Class Actions in 
State Court, U. Cin. L. Rev. (forthcoming), available at [hyperlink,]. 

[111] 17 C.F.R.  240.10b-5. 

[112] See, e.g., Simpson v. AOL Time Warner, Inc., 452 F.3d 1040 (9th 
Cir. 2006). 

[113] 552 U.S. 148 (2008). 

[114] Id. at 153. 

[115] Id. at 155. 

[116] Id. 

[117] Id. at 167. As noted below, however, the SEC successfully 
enforced against the vendors. 

[118] 131 S. Ct. 2296 (2011). 

[119] 17 C.F.R.  240.10b-5(b) (emphasis added). 

[120] 131 S. Ct. at 2302. 

[121] Id. at 2304. 

[122] Id. at 2306. 

[123] Pub. L. No. 104-67, 929O, 109 Stat. 737 (1995). 

[124] 15 U.S.C.  78u (Investigations and Actions by SEC); 15 U.S.C.  
78u-1 (Civil Penalties for Insider Trading); 15 U.S.C.  78u-2 (Civil 
Remedies in Administrative Proceedings); 15 U.S.C.  78u-3 (Cease-and- 
Desist Proceedings); 15 U.S.C.  78 (Penalties for Willful 
Violations); 15 U.S.C. 78u(d)(1) (Injunctions); 15 U.S.C.  78u(d)(2) 
(Barring service as officer or director). 

[125] 15 U.S.C.  78u(a). 

[126] See SEC v. Scientific-Atlanta, Inc., SEC Litig. Release No. 
19,735 (June 22, 2006); In re Motorola, Inc., Exchange Act Release No. 
55,737 (May 8, 2007). 

[127] The principal tool for criminal enforcement of the securities 
laws is 18 U.S.C.  2(a), which states that "whoever commits an 
offense against the United States or aids, abets, counsels, commands, 
induces or procures the commission, is punishable as a principal." 
Offenses include violations of the criminal provisions of the 
securities laws. 15 U.S.C.  78ff(a). 

[128] See Judgment, United States v. Barford, No. 4:03CR00434 (E.D. 
Mo. Apr. 22, 2005); Judgment, United States v. Smith, No. 4:03CR434 
(E.D. Mo. Apr. 22, 2005); Judgment, United States v. Kalkwarf, No. 
4:03CR434 (E.D. Mo. Apr. 22, 2005); Judgment, United States v. McCall, 
No. 4:03CR00434 (E.D. Mo. Apr. 22, 2005). 

[129] Pub. L. No. 107-204, 116 Stat. 745 (2002); 15 U.S.C.  7246. 

[130] SEC, Report Pursuant to Section 308(c) of the Sarbanes-Oxley Act 
of 2002 at 3 (2003). 

[131] GAO, Securities and Exchange Commission: Information on Fair 
Fund Collections and Distributions, [hyperlink,] (2010). 

[132] 15 U.S.C.  7246(a). 

[133] Id.  77k(a)(4). 

[134] 17 C.F.R.  230.405. 

[135] 15 U.S.C.  77k(b)(3)(B). 

[136] Id.  77l(a)(1). 

[137] Id.  77l (a). 

[138] The Supreme Court has held that section 12(a)(2) applies only to 
public offerings. Gustafson v. Alloyd Co., 513 U.S. 561 (1995). 

[139] 15 U.S.C.  78i. 

[140] Id.  78r(a). 

[141] Id.  78t(a). 

[142] Id. 

[143] Id.  77o. 

[144] The two standards may differ concerning whether knowledge of the 
misstatements is required. Hazen, supra note 28,  7.12, at 344. 

[145] 17 C.F.R.  230.405. 

[146] 15 U.S.C.  78t(a). 

[147] Securities Litigation Uniform Standards Act of 1997: Hearing on 
S. 1260 Before the Subcomm. on Securities, S. Comm. on Banking, 
Housing, and Urban Affairs, 105th Cong. 47 (1997) (prepared statement 
of Arthur Levitt, Jr., Chairman & Isaac C. Hunt, Jr., Commissioner, 
U.S. Securities and Exchange Commission) (stating that according to 
the SEC, 49 of 50 states authorize private rights of action for aiding 
and abetting violations of state securities laws). 

[148] Jennifer J. Johnson, Secondary Liability for Securities Fraud: 
Gatekeepers in State Court, Del. J. Corp. L. (forthcoming) (citing 
Unif. Sec. Act  410(b) (1956) (amended 1958); Unif. Sec. Act  509(b) 
(2002)), available at [hyperlink,]. 

[149] 15 U.S.C.  78bb(f)(5)(B)(ii). 

[150] In re Am. Cont'l Corp./Lincoln Sav. & Loan Sec. Litig., 794 
F.Supp. 1424, 1453 (D. Ariz. 1992). 

[151] ABA Comm. on Ethics & Prof'l Responsibility, Formal Op. 346 
(1982) (discussing tax law opinions in tax shelter investment 
offerings). Formal Opinions supplement the Model Rules and Code by 
providing guidelines in certain areas. 

[152] Ackerman v. Schwartz, 947 F.2d 841, 848-49 (7th Cir. 1991). 

[153] Kline v. First W. Gov't Sec., Inc., 24 F.3d 480, 485-86 (3d Cir. 

[154] 625 F.3d 185 (5th Cir. 2010). 

[155] Id. at 192-195. 

[156] 943 F.2d 485, 492-93 (4th Cir. 1991). 

[157] Id. 

[158] Ziemba v. Cascade Int'l, Inc. 256 F. 3d 1194, 1205-07 (11th Cir. 

[159] Pacific Inv. Mgmt. Co. v. Mayer Brown LLP, 603 F.3d 144, 149-50 
(2d Cir. 2010). 

[160] Id. at 157-58. 

[161] 131 S. Ct. 2296 (2011). 

[162] 143 F.3d 263, 268 (6th Cir. 1998). See also Thompson v. Paul, 
547 F.3d 1055, 1062 (9th Cir. 2008). 

[163] Donald C. Langevoort, Reading Stoneridge Carefully: A Duty-Based 
Approach to Reliance and Third-Party Liability Under Rule 10b-5, 158 
U. Pa. L. Rev. 2125 (2010). 

[164] In re Enron Corp. Sec., Derivative & ERISA Litig., 529 F. Supp. 
2d 644 (S.D. Tex. 2006). 

[165] Regents of the Univ. of Cal. v. Credit Suisse First Boston 
(USA), Inc., 482 F.3d 372 (5th Cir. 2007). 

[166] Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA) 
Inc., 482 F.3d 372 (5th Cir. 2007), cert. denied, Regents of the Univ. 
of Cal. v. Merrill Lynch, Pierce Fenner & Smith, Inc, 552 U.S. 1170 

[167] In re Parmalat Secs Litig., 570 F. Supp. 2d 521, 524 (S.D.N.Y. 

[168] 15 U.S.C.  77b(a)(11). 

[169] Id.  77k(a)(5). 

[170] The SEC has promulgated Rule 176 to identify certain 
circumstances bearing on the reasonableness of the investigation and 
the determination of what constitutes reasonable ground for belief. 17 
C.F.R.  230.176. 

[171] 15 U.S.C.  77k(b)(3)(C). 

[172] SEC v. Tambone, 597 F.3d 436, 447-448 (1st Cir. 2010). 

[173] See McGann v. Ernst & Young, 102 F.3d 390 (9th Cir. 1996), and 
cases cited therein. Compare with Wright v. Ernst & Young, 152 F.3d 
169 (2d Cir. 1998), cert. denied, 525 U.S. 1104 (1999) (auditor's 
alleged review and tacit approval of company press release does not 
result in primary liability where auditor did not make a public 
statement about it). See Central Bank, 511 U.S. at 191 ("Any person or 
entity, including a lawyer, accountant, or bank, who employs a 
manipulative device or makes a material misstatement (or omission) on 
which a purchaser or seller of securities relies may be liable as a 
primary violator under 10b-5, assuming all of the requirements for 
primary liability under Rule 10b-5 are met.") (emphasis in original). 

[174] See, e.g., In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th 
Cir. 1994), cert. denied, 516 U.S. 868 (1995); In re Software 
Toolworks Inc. Sec. Litig., 50 F.3d 615 (9th Cir. 1994). 

[175] 15 U.S.C.  78m note. 

[176] Id.  78o-7(m)(1). 

[177] Id.  78u-4(b)(2). 

[178] Id.  78o-7(m)(1). 

[179] Id.  78o-7(d)(1), 78o-7(d)(2). 

[180] 15 U.S.C.  78o-7 note. 

[181] This standard originated in New York Times v. Sullivan, 376 U.S. 
254, 279-80 (1964), where the Supreme Court held that the First 
Amendment protects a public official for a defamatory falsehood 
relating to his official conduct unless he proves the statement is 
made with knowledge that it is false or with reckless disregard of the 
whether it was false. 

[182] 499 F.3d 520, 530 (6th Cir. 2007). 

[183] 651 F. Supp. 2d 155, 175-176 (S.D.N.Y. 2009). 

[184] FINRA Rule 2711; NYSE Rule 472. In addition, SEC Regulation AC 
requires that a research report disseminated by a broker or dealer 
include certifications by the research analyst that the views 
expressed in the report accurately reflect the analyst's personal 
views. 17 C.F.R.  242.500. 

[185] See In re Credit Suisse First Boston Corp., 431 F.3d 36, 53-54 
(1st Cir. 2005) ("[T]he fact that an organization is ethically 
challenged does not impugn every action that it takes. In a securities 
fraud case, the plaintiffs still must carry the burden, imposed by the 
PSLRA, of pleading facts sufficient to show that the particular 
statements sued upon were false and misleading when made."). 

[186] Lentell v. Merrill Lynch & Co., Inc, 396 F.3d 161, 172-174 cert. 
denied, 126 S. Ct. 421. The plaintiffs did not allege facts that would 
establish that the analyst's misstatements and omissions concealed the 
risk that materialized and played some part in diminishing the market 
value of the securities. 

[187] 263 F.R.D. 90, 106-107 (S.D.N.Y. 2009). 

[188] See In re Salomon Analyst Metromedia Litig., 544 F. 3d 474, 480- 
483 (2d Cir. 2008); In re Healthsouth Securites Litigation, 257 F.R.D. 
260 (N.D. Alabama 2009) 

[189] See John C. Coffee, Jr., Security Analyst Litigation, N.Y. L.J. 
at 5 (2001); Elizabeth A. Nowicki, A Response to Professor Coffee: 
Analyst Liability Under Section 10(b) of the Securities Exchange Act 
of 1934, 72 U. Cin. L. Rev. 1305 (2004). 

[190] See H.R. 5042, 111th Cong. (2010); S. 1551, 111th Cong. (2009). 

[191] 15 U.S.C.  78t. 

[192] Some of these entities have not expressly supported creating a 
private right of action for aiding and abetting. 

[193] See, e.g., John C. Coffee, Jr., Gatekeeper Failure and Reform: 
The Challenge of Fashioning Relevant Reforms, 84 B.U. L. Rev. 301 

[194] Frank Partnoy, Barbarians at the Gatekeepers? A Proposal for a 
Modified Strict Liability Regime, 79 Wash. U. L. Q. 491 (2001). 

[195] Dodd-Frank lowered the scienter standard that the SEC must show 
to prove aiding and abetting violations from knowledge to recklessness 
and made civil penalties available in enforcement actions. 

[196] The U.S. Code criminalizes aiding and abetting violations of the 
securities laws and mail and wire fraud and conspiracy to violate 
those laws. 18 U.S.C.  2, 371. 

[197] See, e.g., Del. Code Ann. tit. 6,  7325; Cal. Corp. Code  
25403(b), 25530-25536; State v. McLeod, 12 Misc. 3d 1157(A), 2006 WL 
1374014, at *11 (N.Y.S. 2006) (citing N.Y. Gen. Bus. Law Art. 23-A  
352(1), 352-c(2) (the Martin Act)). 

[198] See, e.g., Del. Code Ann. tit. 6,  7325; Cal. Corp. Code  
25540-25542; 815 Ill. Comp. Stat.  5/14. 

[199] As noted above, under the PSLRA, joint and several liability 
applies only when the conduct of the defendant is knowing. 15 U.S.C.  

[200] See, e.g., Jill E. Fisch, The Continuing Evolution of Securities 
Class Actions Symposium: Confronting the Circularity Problem in 
Private Securities Litigation, 2009 Wis. L. Rev. 333 (2009). 

[201] The class action claim was based on a scheme theory of liability 
that was subsequently overturned, and other secondary actors who had 
not settled escaped liability when the class action was decertified. 
Opponents also note that damages were estimated at $40 billion. 

[22] For the federal securities class action cases that settled during 
1996-2010, NERA Economic Consulting found that attorneys' fees 
declined as a percentage of settlement value as the settlement values 
rose. For settlements less than $100 million, the median attorneys' 
fees as a percent of settlement value ranged from around 28 percent to 
33 percent. For settlements between $100 and $500 million, the median 
attorneys' fees fell to around 23 percent. For settlements above $500 
million, the median declined to around 9 percent. 

[203] See John C. Coffee, Jr., Reforming the Securities Class Action: 
An Essay on Deterrence and Its Implementation, 106 Colum. L. Rev. 1534 

[204] For a summary of PSLRA's reforms and analyses of their 
effectiveness, see Stephen J. Choi & Robert B. Thompson, Securities 
Litigation and Its Lawyers: Changes during the First Decade after the 
PSLRA, 106 Colum. L. Rev. 1489 (2006). 

[205] See, e.g., Todd Foster, Ronald I. Miller, & Stephanie Plancich, 
Recent Trends in Shareholder Class Action Litigation: Filings Plummet, 
Settlements Soar (2007). 

[206] See, e.g., Stephen J. Choi, Karen K. Nelson, & A.C. Pritchard, 
The Screening Effect of the Private Securities Litigation Reform Act, 
35-68 (U. of Mich. L. & Econ., Olin Working Paper No. 07-008, 2007). 

[207] See, e.g., McKinsey & Company, Sustaining New York's and the 
U.S.'s Global Financial Services Leadership (2006) (report 
commissioned by Mayor Michael R. Bloomberg & Senator Charles E. 
Schumer); Committee on Capital Markets Regulation, Interim Report 

[208] John C. Coffee, Jr., Testimony Before the Subcommittee on Crime 
and Drugs of the Committee on the Judiciary of the U.S. Senate, Sep. 
17, 2009. 

[209] Adam C. Pritchard, Testimony before the Subcommittee on Crime 
and Drugs of the Committee on the Judiciary of the U.S. Senate, Sep. 
17, 2009. 

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