Scheme Liability: Why Should Plaintiffs Be Able to Sue Under Subsection (b) of Rule 10b-5, But Not Subsection (a)?

Abstract

The Supreme Court is presently considering the Stoneridge case which raises the question of whether private investors who are victimized by schemes to defraud that violate subsection (a) of Rule 10b-5 may sue? It is undisputed that plaintiffs may sue under subsection (b) of Rule 10b-5 if they are defrauded by misrepresentations and omissions in connection with the purchase or sale of securities. Why can they not sue under subsection (a) of the same rule? In this paper, I continue a debate with scheme liability opponent Joseph Grundfest. Professor Grundfest constructs an arc of history argument which claims that the implied to sue under §10(b) was frozen in time in 1975 when Cort v. Ash heightened the standard for judicial implication of private rights to sue. Therefore, he claims, plaintiffs claiming under subsection (b) of Rule 10b-5 enjoy a squatter's right to sue, but to recognize scheme liability would be to improperly extend this implied of action. Professor Grundfest's argument rests on two false premises, either of which is fatal to his position. First, he assumes that the to sue for fraudulent schemes in violation of 10b-5(a) did not exist in 1975 when, in fact, it was very well established in numerous cases. Second, he assumes that the §10(b) implied to sue is frozen in time as of 1975 when, in fact, the Supreme Court has at least twice expressly stated that it is not so frozen, and the conditions specified for extending the private to sue are precisely met in the case of scheme liability. In response to Professor Grundfest, I also argue that the to sue under §10(b), while not originally intended by Congress, now carries such a stamp of Congressional approval that it makes no sense to continue to treat it as if it were purely a judicial invention. I also show that the common law of fraud that informed Congress's enactment of §10(b) broadly recognized scheme liability in 1934 and indisputably would have imposed liability upon parties who acted as did the defendants in Stoneridge. This is critically relevant, for the Supreme Court has held that where the language of §10(b) does not answer a question regarding interpretation of the private to sue, the proper way to proceed is to determine what a 1934 Congress would have intended had §10(b) included an express private to sue.