In a decision sharply critical of lawyers on both sides of a civil suit alleging lawyer misconduct, the 9th U.S. Circuit Court of Appeals held that attorneys and law firms could not use state law to avoid civil liability under 10(b) of the federal Securities Exchange Act of 1934 for alleged fraudulent misrepresentations in the sale of securities.
Joining four other circuits, the court held on Oct. 27 that attorneys could be held liable for violations of § 10(b) even if they made misrepresentations to third parties adverse to their clients — and even if state law shielded lawyers from liability. Thompson v. Paul, No. 06-15515.
Pamela Thompson served as chief financial officer of YP.Net, a publicly traded company now known as LiveDeal Inc., subject to the federal Securities Exchange Act. Alleging questionable accounting and auditing practices at the firm and its alleged refusal to make proper disclosures to the Securities and Exchange Commission (SEC), Thompson resigned and forwarded her resignation letter to the SEC.
YP sued Thompson, and she countersued the company. Eventually, Thompson and the company reached a settlement under which Thompson received a substantial amount of YP common stock. However, three days after the settlement, YP’s chief executive officer, Angelo Tullo, was indicted on multiple counts of fraud, conspiracy and other charges. YP’s stock plummeted in value.
Alleging that lawyers from Lewis and Roca, the Phoenix law firm representing YP and Tullo, knew of the criminal investigation of Tullo, but lied to Thompson, telling her there was no investigation, Thompson and her four children sued the firm, the partners involved in the alleged fraud and their wives. She argued that, by fraudulently misrepresenting that there was no criminal investigation, the lawyers violated § 10(b), which forbids deceptive practices in securities sales.
The U.S. District Court for the District of Arizona dismissed Thompson’s claim, holding that, under Arizona law, “[a]n attorney’s duty to a non-client arises only if the non-client is an ‘intended beneficiary’ of the attorney’s services.” The court added that, pursuant to the Arizona Supreme Court’s decision in Lewis v. Swenson, 617 P.2d 69 (Ariz. 1980), an adverse party was not an intended beneficiary of the opposing counsel’s services.
Thompson appealed to the 9th Circuit, which reversed the lower court and held that the lawyers could be held liable under 10(b). The court also found reason to criticize just about every attorney involved in the case.
“We pause to say that the district court was not well served by the attorneys who appeared before it,” the 9th Circuit said. It specifically admonished the law firm’s counsel for making a “frivolous” argument, and, in reversing the district court, put the blame for the lower court’s erroneous holding squarely on the lawyers.
“[I]t is apparent to us that by erroneously framing the question of attorney liability under Section 10(b) as one basically controlled by state law and then failing to cite the federal cases on point, the parties invited the district court to engage in its state law analysis,” the 9th Circuit said.
The court noted that the stock settlement with Thompson was a “sale” of a securities under 10(b), and joined the 3d, 5th, 6th and 7th circuits in holding that lawyers were liable under 10(b) regardless of contrary state law, even if the third parties were not their clients.
“An attorney who undertakes to make representations to prospective purchasers of securities is under an obligation, imposed by Section 10(b), to tell the truth about those securities,” the court said, adding, “That he or she may have an attorney-client relationship with the seller of the securities is irrelevant under Section 10(b).”
K. Stewart Evans Jr., a senior partner in the Washington office of Philadelphia-based Pepper Hamilton, has defended § 10(b) securities fraud claims. He said that the 9th Circuit was correct in reversing the district court.
