The Dodd-Frank Wall Street Reform and Consumer Protection Act’s stated purpose is
[t]o promote the financial stability of the United States by improving accountability and transparency in the financial system, to end 'too big to fail,' to protect the American taxpayer by ending bailouts, [and] to protect consumers from abusive financial services practices . . .
Whether or not the Act can achieve these stated purposes, and exactly how it will be implemented, remains to be seen. Over the past year, more than 170 rules have been proposed by the various regulatory agencies responsible for implementing the Dodd-Frank Act and close to two dozen have been finalized. Yet the regulatory implementation of the Act has been slow, and the SEC missed many of the rule-making deadlines in mid-July of this year.
Constrained by their budget and needing time to review the flood of comments the agency has received for each of its proposed rules, the regulators needed time to finalize the rules required by the Act. Over the next several months, many of those rules will be finalized, others will be proposed and more than 200 provisions of the Act will take effect. However, over the course of the past year, Dodd-Frank has impacted many areas of law, including securities litigation and enforcement.
Aiding and Abetting
Although the SEC has long had the ability to bring aiding and abetting claims under the Securities and Exchange Act of 1934, Dodd-Frank authorizes it to bring such claims under the Securities Act of 1933, the Investment Company Act and the Investment Advisers Act. Section 929O of the Act also lowers the state of mind necessary to satisfy a claim for aiding and abetting.
Previously, an aider or abetting was required to act “knowingly,” but the Act lowers the standard to “recklessly.” The lowered standard increases the likelihood of success for SEC aiding and abetting actions. As Dodd-Frank expressly authorizes such claims under additional statutes, the scope of the SEC’s ability also will broaden. This puts third parties that provide services to issuers, such as accounting firms, consultants and law firms, at increased risk of facing regulatory actions.
To date, however, the SEC has not been active in pursuing aiding and abetting claims under the new provisions of Dodd-Frank likely because of issues with the retroactive application of the statute. For example, in the Northern District of California, a judge dismissed the SEC’s claims for aiding and abetting violations of Sections 13 and 34 of the Investment Company Act, holding that Dodd-Frank’s provisions cannot be applied retroactively. The court noted that Dodd-Frank did not include any express directive to apply the statute retroactively and any such application would impair defendants’ rights, increase liability and impose new duties. Thus, the impact of the SEC’s increased abilities remains to be seen.
Historically, there has been no private right of action under Section 10(b) of the Securities and Exchange Act against aiders and abettors. The U.S. Supreme Court held in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. that the implied private right of action under Section 10(b) for securities fraud does not extend to aiders and abettors.
In its most recent term, the Supreme Court affirmed and extended this doctrine by ruling in Janus Capital Group, Inc. v. First Derivative Traders that only an entity that has “ultimate authority” over an allegedly false statement can be held liable in a private action brought under Rule 10b-5. The Supreme Court’s ruling effectively blocks the plaintiffs’ bar from bringing private aiding-and-abetting lawsuits over misleading prospectuses against the people and firms that may have prepared the statements but did not have ultimate authority over them.
Though Dodd-Frank contemplates allowing private aiding and abetting claims in the future by requiring the Comptroller General to conduct a study on the impact of allowing such private rights of action, one wonders whether Congress will be able to further amend the Act to allow for such private claims in light of the Supreme Court’s recent decision in Janus.
Section 929P(b) of Dodd-Frank also expands the extraterritorial jurisdiction of the antifraud provisions of the federal securities laws. The Act amends the antifraud provisions of the Securities Act, the Exchange Act and the Investment Advisers Act to confer U.S. courts with jurisdiction over an action or proceeding brought by the SEC or the U.S. involving:
conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors;
or conduct occurring outside of the United States that has a foreseeable substantial effect within the United States.
Section 929P(b) effectively overrides the Supreme Court’s decision in Morrison v. National Australia Bank Ltd.,U.S, as it applies to the SEC. Morrison held that Section 10(b) of the Exchange Act and SEC Rule 10b-5 prohibited fraud only in connection with the purchase or sale of a security listed on an American stock exchange and the purchase or sale of any other security in the United States. The decision rejected the so-called “conduct/effect” test, which permitted foreign investors to file Section 10(b) actions if the alleged wrongful conduct either occurred in the United States or had a substantial effect in the United States or upon U.S. citizens. Dodd-Frank expressly grants the SEC authority to bring actions based on the “conduct/effect” standard.
While the Act increases the extraterritorial reach of regulators, Dodd-Frank does not authorize a private right of action under such a standard. Thus, the impact of Morrison on private securities actions continues. So far, the ruling has had a significant impact in private securities litigations as well as private and government RICO and criminal matters. As a result of Morrison, defendants have been able eliminate several claims and groups of plaintiffs from lawsuits, thus inducing favorable settlements. For example, in In re: Infineon Technologies AG Securities Litigation, within months after U.S. District Court for the Northern District of California dismissed claims from Infineon shareholders who had purchased ordinary shares outside of the United States, the company reached a $6.2 million settlement with investors. According to a settlement motion, “substantial changes in the law regarding the claims of foreign investors” resulted in the parties reaching a deal.
Additionally, Morrison has been a critical component of court decisions analyzing the reach of SEC enforcement proceedings. In SEC v. Tourre, for instance, the SEC brought claims under the Exchange Act and the Securities Act against Goldman Sach’s former vice president, Fabrice Tourre, for his role in structuring the ABACUS 2007-AC1 CDO that he marketed and sold to investors. Judge Barbara Jones of the Southern District of New York dismissed the SEC claims premised on sales that actually occurred abroad based on Morrison. The court also held that Morrison applies to claims arising under the Securities Act as well, but that the analysis was different. Where the SEC based its claims on completed sales, for example, they were dismissed for the same reasons that the 10b-5 claims failed—the complaint did not recite any sales actually accomplished in the United States. However, because the Securities Act contemplates liability based on fraudulent offers, the SEC’s claims based on allegations that Tourre “offered ABACUS notes to IKB and solicited ABN’s participation” in it survived.
Dodd-Frank added procedural and substantive provisions that impact securities litigation and enforcement, and give the SEC additional tools to enforce the securities laws. The significant changes in bringing and proving aiding and abetting violations, the expanded extra-territorial jurisdiction of the SEC, and the power of the SEC to impose monetary penalties in cease and desist proceedings, are just some of the many changes included in the Act. With additional rules and studies forthcoming, uncertainty continues to exist with respect to the final structure, application and effect of the regulations that are required by the Act. Undoubtedly, Dodd-Frank will continue to change the landscape of securities litigation and enforcement for years to come.