Summary: The Evolution of the Supreme Court’s Rule 10b-5 Jurisprudence:

Protecting Fraud at the Expense of Investors

This article traces the evolution of Supreme Court jurisprudence over the past forty years through the prism of Rule 10b-5. It uses four “trilogies” to develop this evolution. At the start of the 1970s, the liberal trend characterized by the Warren Court still prevailed. An implied private cause of action was still in favor and litigators were viewed as private attorneys general, enforcing the securities laws to further the policy of protecting investors.

The expansion of Rule 10b-5 was slowed and more judicial discipline injected by the Burger Court in the mid-1970s. A trilogy of well-reasoned conservative decisions put Rule 10b-5 jurisprudence in a proper perspective: plaintiffs needed to be buyers or sellers to have standing, scienter was required to distinguish the implied cause of action from the express remedies in the securities acts, and deception was the touchstone for an action predicated upon a statute giving the SEC the authority to prohibit only manipulative or deception conduct.

The Rehnquist Court in the 1980s began a reactionary trend. A trilogy of cases involving insider trading introduced common law fiduciary duty to constrain the securities laws, and began to use outcome determinative analysis to curtail enforcement, leading to the rash of insider trading in the 1980s.

The final trilogy began with the Rehnquist Court and ended with the Roberts Court. Conservative jurisprudence has now been abandoned and the Court uses one ill-reasoned decision to awkwardly justify an even more ill-reasoned decision. Central Bank, in eliminating aiding and abetting liability, was the epitome of judicial activism. The Court decided an issue not raised by the parties, it rejected the unanimous position of all the judicial circuit courts, and it failed to recognize the difference between negligence and recklessness – ignoring the fact that aiding and abetting liability traditionally had not been applicable to negligence actions.

In the Stoneridge and Janus Capital cases, the Court strained to contort these cases as being controlled by Central Bank, even though they involved direct participation in the fraud, rather than aiding and abetting liability. It then articulated an absurd interpretation of the word “make” in Janus Capital to exculpate the person who not only drafted the document but also controlled the “facts” in the document that made it misleading.

The Conclusion asserts that, since the 1980’s, the Supreme Court, confronting activity that it acknowledged as fraudulent, has engaged in tortuous, outcome-deterministic reasoning to create, in effect, safe harbors for fraudulent activity. To reverse the Court’s ill-advised emasculation of liability for collateral participants, Congress needs to extend aiding and abetting liability to private litigation. By reversing Central Bank, it will also take down Stoneridge and Janus Capital.

Professor Charles W. Murdock