Testing the Limits of Primary Violations Under Section 10(b)

It is plain to us that the complaint alleged [Mr.] Romano to be a primary violator. [Mr.] Romano “participated in the fraudulent scheme,” First Jersey Secs., 101 F.3d at 1471, i.e., the manipulation of USE’s stock, by effecting the very buy and sell orders that artificially manipulated USE’s stock price upward. Indeed, if the trader who executes manipulative buy and sell orders is not a primary violator, it is difficult to imagine who would [be] liable. Id. at 112.

The court explained that “[Mr.] Romano is a primary violator despite the fact that someone else directed the market manipulation scheme.” Id. (emphasis supplied). Thus, under U.S. Environmental, one need not be the “architect” of a fraudulent scheme in order to be held liable as a primary violator.

In analyzing U.S. Environmental, Koeltl found significant the court’s endorsement of First Jersey’s “participation” standard, “although it did not provide any bounds to that test because the defendant actually executed the trades that were alleged to be manipulative,” and left unclear what level of participation is sufficient to establish primary liability.

Koeltl also analyzed the standard used to determine primary liability in private actions during the same period, including Wright v. Ernst & Young, 152 F.3d 169, 176 (2d Cir. 1998), and Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997), in both of which the 2nd Circuit rejected a substantial participation standard and found “secondary actors [could not] be held primarily liable under §10(b) for mere knowledge and assistance in the fraud.” Indeed, in Shapiro, a 10b-(5)b case, the court held that “a defendant must actually make a false or misleading statement in order to be held liable under §10(b). Anything short of such conduct is merely aiding and abetting, and no matter how substantial that aid may be, it is not enough to trigger liability under §10(b).” This standard is in accord with the Supreme Court’s Stoneridge decision holding that a private plaintiff must plead and prove that the defrauded party (in Stoneridge, the public) actually relied upon the deceptive act of the defendant. Koeltl believed that the Wright standard used in private actions “undercut” the “participation” standard used in SEC actions. At least one court has stated that First Jersey was “effectively overruled by the 2nd Circuit’s decisions in Shapiro [and] Wright.” Ravens v. Republic N.Y. Corp., 2002 U.S. Dist. LEXIS 12162, at *39 (E.D. Pa. April 24, 2002). Another way to analyze these cases is that the court has simply applied a somewhat different standard to primary liability in SEC cases, or in deceptive acts cases, or in both.

In any event, the differing approaches has left 2nd Circuit authority in flux. Ultimately, Koeltl applied the “participation” standard and found the complaint adequately pleaded defendants’ primary liability.