What is securities fraud?

Duke Law Journal

Volumn 61, Issue 3, 2011, Pages 511-581

  Buell, Samuel W ^a  

^a DUKE UNIVERSITY   (United States)

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EID: 84455207372     PISSN: 00127086     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (272)

1. E.g., Francesco Guerrera & Henny Sender, Goldman Sachs Splash, FIN. TIMES, Apr. 17, 2010, at 1.
2. Louise Story & Gretchen Morgenson, S.E.C. Accuses Goldman of Fraud in Housing Deal, N.Y. TIMES, Apr. 17, 2010, at A1.
3. Gregory Zuckerman, Susanne Craig & Serena Ng, U.S. Charges Goldman Sachs with Fraud, WALL ST. J., Apr. 17, 2010, at A1.
4. Complaint at 7-11, SEC v. Goldman Sachs & Co., No. 10-CV-3229 (S.D.N.Y. Apr. 16, 2010).
5. See, e.g., Editorial, After Goldman, N.Y. TIMES, Apr. 22, 2010, at A28 (characterizing Goldman's conduct as gambling on the market).
6. Paul Krugman, Op-Ed., Looters in Loafers, N.Y. TIMES, Apr. 19, 2010, at A23 ("[N]ow the S.E.C. is charging that Goldman created and marketed securities that were deliberately designed to fail, so that an important client could make money off that failure. That's what I would call looting.")
7. John Carney, Goldman Sachs Girds for Battle with the SEC over Fraud Case, CNBC.COM (May 26, 2010, 4:00 PM ET), http://www.cnbc.com/id/37362236/Goldman_Sachs_Girds_for_Battle_With_the_SEC_Over_Fraud_Case ("A sticking point for Goldman is the SEC's fraud allegations. The company is unwilling to agree to any settlement that would have the appearance of affirming that Goldman committed fraud, a person familiar with the matter says. However, Goldman might be willing to settle a case alleging that Goldman was only negligent in omitting a material fact in marketing the deal, the person said.")
8. Abigail Field, Deconstructing Goldman Sachs's Fraud Defense, DAILY FIN. (Apr. 19, 2010, 1:45 PM), http://www.dailyfinance.com/story/investing/deconstructing-goldman-sachss-fraud-defense/19444284 (evaluating the merits of the SEC's complaint and Goldman's defense).
9. Tom Granahan, In Defense of Goldman Sachs, FOX BUS. (Apr. 21, 2010), http://www.foxbusiness.com/markets/2010/04/21/defense-goldman-sachs (questioning whether Goldman's sale of assets should really be labeled fraudulent solely because a third party believed the assets were weak).
10. See generally MICHAEL LEWIS, THE BIG SHORT: INSIDE THE DOOMSDAY MACHINE 6-10, 14-15 (2010) ("All these subprime lending companies were growing so rapidly, and using such goofy accounting, that they could mask the fact that they had no real earnings, just illusory, accounting-driven, ones.")
11. Debate about the nature of Goldman's responsibility for the cataclysm that stemmed from the mortgage-related securities market rages on
12. See, e.g., WILLIAM D. COHAN, MONEY AND POWER: HOW GOLDMAN SACHS CAME TO RULE THE WORLD 1-24 (2011) ("There is little doubt that Goldman's dual decisions to establish 'the big short' and then to write down the value of its mortgage portfolio exacerbated the misery at other firms.")
13. Louis Story & Gretchen Morgenson, S.E.C. Case Stands Out Because It Stands Alone, N.Y. TIMES, May 31, 2011, at A1 ("How Mr. Tourre alone came to be the face of mortgage-securities fraud has raised questions among former prosecutors and Congressional officials about how aggressive and thorough the government's investigations have been into Wall Street's role in the mortgage crisis.")
14. Matt Taibbi, The People v. Goldman Sachs, ROLLING STONE, May 26, 2011, at 41 ("[T]he mountain of evidence collected against Goldman by... investigators-details of gross, baldfaced fraud delivered up in such quantities as to almost serve as a kind of sarcastic challenge to the curiously impassive Justice Department-stands as the most important symbol of Wall Street's aristocratic impunity and prosecutorial immunity produced since the crash of 2008.")
15. Goldman's reported revenues for 2010 were $39.16 billion. Press Release, Goldman Sachs Grp., Inc., Goldman Sachs Reports Earnings per Common Share of $13.18 for 2010, at 1 (Jan. 19, 2011), available at http://www2.goldmansachs.com/media-relations/press-releases/current/pdfs/2010-q4-earnings.pdf.
16. Samuel W. Buell, Potentially Perverse Effects of Corporate Civil Liability, in PROSECUTORS IN THE BOARDROOM: USING CRIMINAL LAW TO REGULATE CORPORATE CONDUCT 87, 89 (Anthony S. Barkow & Rachel E. Barkow eds., 2011). I will not repeat here my complaints about the deficit of this process.
17. Consent of Defendant Goldman, Sachs & Co. at 1-2, SEC v. Goldman Sachs & Co., No. 10-CV-3229 (S.D.N.Y. July 14, 2010) (stating, "[w]ithout admitting or denying the allegations of the complaint,"that Goldman "regret[ted]"making incomplete disclosures in its marketing materials).
18. Sewell Chan & Louise Story, Goldman Pays $550 Million To Settle Fraud Case, N.Y. TIMES, July 15, 2010, at A1.
19. Press Release, SEC, Goldman Sachs To Pay Record $550 Million To Settle SEC Charges Related to Subprime Market CDO (July 15, 2010), available at http://www.sec.gov/news/press/2010/2010-123.htm.
20. See infra text accompanying notes 120-41. Though it is not a securities fraud case, the Department of Justice's (DOJ's) pending civil case under the False Claims Act, 31 U.S.C. §§ 3729-3733 (2006), against Deutsche Bank related to the collapse of the mortgage market-an enforcement action that likewise fetched substantial headlines-raises the same concerns. The complaint is full of allegations that Deutsche Bank repeatedly lied about what it was doing in the mortgage market, but the legal theories are based on claims of negligence and gross negligence. Complaint at 1, 40-47, United States v. Deutsche Bank AG, No. 11 Civ. 2976 (S.D.N.Y. May 8, 2011).
21. See infra text accompanying notes 154-74
22. See infra text accompanying notes 117-19
23. Compare, e.g., United States v. Diggs, 613 F.2d 988, 997 (D.C. Cir. 1979) (stating that "proof of fraudulent intent is critical"in criminal prosecutions for mail fraud), with, e.g., RESTATEMENT (SECOND) OF CONTRACTS § 164 (1981) (providing that misstatement-inducing assent voids a contract if it is either fraudulent or material).
24. See Securities Exchange Act of 1934 §§ 21B, 32, 15 U.S.C. §§ 78u-2, 78ff (2006) (setting forth the civil and criminal penalties for SEC violations); Dearlove v. SEC, 573 F.3d 801, 837 (D.C. Cir. 2009) (holding that an accountant's unreasonable conduct during an audit of financial statements warranted debarment from SEC practice).
25. See, e.g., Chem. Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir. 1984) (Friendly, J.) (identifying the purpose of securities regulation as preventing deception and trickery).
26. Recent Press Releases, SEC, http://www.sec.gov/news/press.shtml (last modified Nov. 10, 2011) (announcing various prosecutions brought by the SEC against people who had gained an unfair advantage in the market through deception or insider knowledge).
27. See Joseph Raz, Responsibility and the Negligence Standard 15-16 (Columbia Law Sch. Pub. Law & Legal Theory Working Paper Grp., Paper No. 09-207, 2009), available at http://ssrn.com/abstract=1436022 (arguing that efficiency cannot be measured without first settling normative questions).
28. See, e.g., Lynn Bai, James D. Cox & Randall S. Thomas, Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms, 158 U. PA. L. REV. 1877, 1912-14 (2010) (studying the effects of class action settlements on the operating efficiency of firms).
29. Stephen J. Choi, Karen K. Nelson & A.C. Pritchard, The Screening Effect of the Private Securities Litigation Reform Act, 6 J. EMPIRICAL LEGAL STUD. 35, 35-37 (2009) (considering whether the Private Securities Litigation Reform Act (PSLRA) of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified as amended in scattered sections of 15 and 18 U.S.C.), successfully screens frivolous claims).
30. John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation, 106 COLUM. L. REV. 1534, 1538 (2006) (arguing that to deter securities fraud most effectively, significant financial damages should be imposed on the culpable actors, not, for example, on innocent shareholders).
31. Amanda M. Rose, The Multienforcer Approach to Securities Fraud Deterrence: A Critical Analysis, 158 U. PA. L. REV. 2173, 2176 (2010) (suggesting that the power to enforce the securities fraud provisions be consolidated in the SEC).
32. Of course, only systemically speaking were "little guys"victimized in the Goldman case. In the transaction itself, the allegedly defrauded buyer was no little guy.
33. Even relatively informed participants in the public discussion can display tendencies in this direction
34. See, e.g., Andrew Ross Sorkin, Pulling Back the Curtain on Inquiries, N.Y. TIMES, Dec. 7, 2010, at B1 (speculating on why the Obama Justice Department has pursued small fraudsters in large numbers but has left the leaders of large firms largely unmolested in recent criminal inquiries, but failing to consider the possibility that prosecutors may lack sufficient evidence of criminal guilt to prove such cases).
35. For a taste of the large dollop of which I speak, one need only peruse the online comments posted in response to a column such as Sorkin's
36. See Readers' Comments: Pulling Back the Curtain on Fraud Inquiries, N.Y. TIMES, http://community.nytimes.com/comments/dealbook.nytimes.com/2010/12/06/pulling-back-the-curtainon-fraud-inquiries/?sort=oldest (last visited Nov. 9, 2011).
37. Another such source is Charles Ferguson's Oscar-winning film, INSIDE JOB (Sony Pictures Classics 2010)
38. See Jodi L. Short & Michael W. Toffel, Making Self-Regulation More Than Merely Symbolic: The Critical Role of the Legal Environment, 55 ADMIN. SCI. Q. 361, 361 (2010) ("We find that organizations are more likely to follow through on their commitments to self-regulate when they (and their competitors) are subject to heavy regulatory surveillance and when they adopt self-regulation in the absence of an explicit threat of sanctions.")
39. See, e.g., SEC v. Zandford, 535 U.S. 813, 819 (2002) ("Among Congress' objectives in passing the Act was 'to insure honest securities markets and thereby promote investor confidence' after the market crash of 1929."(quoting United States v. O'Hagan, 521 U.S. 642, 658 (1997))).
40. 17 C.F.R. § 240.10b-5 (2011).
41. See Samuel W. Buell, Novel Criminal Fraud, 81 N.Y.U. L. REV. 1971, 1972 (2006) ("Instability in the law of fraud is structural.") Many judicial formulations of this idea exist, and they can be found going back several centuries. A perhaps extreme, but not atypical, version is the following: "Fraud is kaleidoscopic, infinite. Fraud being infinite and taking on protean form at will, were courts to cramp themselves by defining it with a hard and fast definition, their jurisdiction would be cunningly circumvented at once by new schemes beyond the definition."Stonemets v. Head, 154 S.W. 108, 114 (Mo. 1913).
42. See Jonathan M. Karpoff, D. Scott Lee & Gerald S. Martin, The Legal Penalties for Financial Misrepresentation 8 (May 2, 2007) (unpublished manuscript), available at http://ssrn.com/abstract=933333 ("When criminal fraud or intent is suspected, the SEC can refer the matter to the DOJ for parallel criminal prosecution. Criminal penalties include fines and various forms of probation or incarceration....")
43. Regrettably, there being six of them, graphic representation of these axes is beyond my competence
44. Fraud can be committed through a true statement that is misleading because it omits additional facts that are necessary to make those facts that are uttered not misleading (fraud by partial omission). RESTATEMENT (SECOND) OF TORTS § 529 (1976). Fraud can be committed by silence (fraud by complete omission or by nondisclosure).
45. W. PAGE KEETON, DAN B. DOBBS, ROBERT E. KEETON & DAVID G. OWEN, PROSSER AND KEETON ON THE LAW OF TORTS § 106, at 736-37 (5th ed. 1984).
46. Or fraud can be committed by action rather than by utterance or representation (fraud by conduct). RESTATEMENT (SECOND) OF TORTS § 525 cmt. b.
47. I will not deal here with two other avenues for conceiving of fraud. The first avenue would be to explore fraud as a social construct by studying public opinion about fraud through survey and interview work, perhaps coupled with an examination of discourse about fraud in the popular media.
48. For examples of this approach, see Paul H. Robinson, Michael T. Cahill & Daniel M. Bartels, Competing Theories of Blackmail: An Empirical Research Critique of Criminal Law Theory, 89 TEX. L. REV. 291, 313-22 (2010).
49. Paul H. Robinson & John M. Darley, Objectivist Versus Subjectivist Views of Criminality: A Study in the Role of Social Science in Criminal Law Theory, 18 OXFORD J. LEGAL STUD. 409, 417-21 (1998).
50. Paul H. Robinson & John M. Darley, Testing Competing Theories of Justification, 76 N.C. L. REV. 1095, 1108-15 (1998).
51. To get a sense of the debate about this methodology, see Donald Braman, Dan M. Kahan & David Hoffman, Reply, A Core of Agreement, 77 U. CHI. L. REV. 1655, 1655-60 (2010).
52. Donald Braman, Dan M. Kahan & David A. Hoffman, Some Realism About Punishment Naturalism, 77 U. CHI. L. REV. 1531, 1532-38 (2010).
53. Paul H. Robinson, Owen D. Jones & Robert Kurzban, Response, Realism, Punishment, and Reform, 77 U. CHI. L. REV. 1611, 1611-15 (2010).
54. The second avenue would be to describe fraud in terms of outcomes produced by actors in the legal system and the incentives that operate on those legal actors
55. William J. Stuntz, The Pathological Politics of Criminal Law, 100 MICH. L. REV. 505, 506-11, 517-19, 546-49 (2001).
56. For example, fraud might turn out to be large financial losses caused by persons who lack sufficient power in the political economy to convince legislators and enforcers to steer sanctions away from them
57. See Vikramaditya S. Khanna, Corporate Crime Legislation: A Political Economy Analysis, 82 WASH. U. L.Q. 95, 97-98 (2004) ("Overall, my analysis suggests that most of the important players, including many corporations and management, have reasons to support some corporate crime legislation. This is because it helps to avoid or mitigate legislative and judicial alternatives-such as new forms of corporate civil liability and managerial criminal liability-that would be even more costly to corporate interests."(emphasis omitted)).
58. Or, in a perhaps contradictory finding, fraud might be defined so as to allow sanctions against those individuals whose punishment would yield the greatest career benefits for enforcers
59. See, e.g., Edward L. Glaeser, Daniel P. Kessler & Anne Morrison Piehl, What Do Prosecutors Maximize? An Analysis of the Federalization of Drug Crimes, 2 AM. L. & ECON. REV. 259, 261 (2000) (noting that prosecutors might prosecute high-profile individuals to further their own careers).
60. Daniel C. Richman & William J. Stuntz, Al Capone's Revenge: An Essay on the Political Economy of Pretextual Prosecution, 105 COLUM. L. REV. 583, 607 n.78 (2005) ("There is some evidence that federal prosecutors do pursue such career goals in their case selection decisions.")
61. Public fraud has been a subject of intense controversy in other areas of federal fraud regulation. See, e.g., McNally v. United States, 483 U.S. 350, 352-61 (1987) (reversing a mail fraud conviction because the statute did not proscribe defrauding the public of its right to an honest government); United States v. Weyhrauch, 548 F.3d 1237, 1239 (9th Cir. 2008) (holding that the federal honest-services mail fraud statute does not require that the conduct at issue also violate an applicable state law), vacated, 130 S. Ct. 2971 (2010); United States v. Margiotta, 688 F.2d 108, 113 (2d Cir. 1982) (affirming the conviction of a political leader for mail fraud predicated upon a breach of fiduciary duty to the community, although the political leader had held no official public office).
62. Abraham S. Goldstein, Conspiracy To Defraud the United States, 68 YALE L.J. 405, 417 (1959) ("A detailed examination of the cases dealing with [the federal crime of conspiracy's requirement that a defendant] 'defraud the United States' will reveal that.... [t]he phrase has no fixed meaning. Instead, it has acquired a series of meanings-some supplanting prior ones, others existing concurrently."(quoting Act of Mar. 2, 1867, ch. 169, § 30, 14 Stat. 471, 484)).
63. The question of what kinds of offender objectives and victim interests mark out the boundary of fraud is implicated in the recent controversy over the federal honestservices fraud statute, 18 U.S.C. § 1346 (2006). See Skilling v. United States, 130 S. Ct. 2896, 2931-34 (2010) (holding that the honest-services statute is limited to bribery and kickbacks).
64. Samuel W. Buell, The Court's Fraud Dud, 6 DUKE J. CONST. L. & PUB. POL'Y 31, 31-33 (2010) (discussing the Supreme Court's failure to conceptually develop its fraud jurisprudence in three mail fraud cases from the October 2009 Term).
65. Others have criticized the state of the law establishing the mental states required to impose liability for securities fraud
66. See generally Norwood P. Beveridge, Is Mens Rea Required for a Criminal Violation of the Federal Securities Laws?, 52 BUS. LAW. 35 (1996).
67. Elaine E. Bucklo, The Supreme Court Attempts To Define Scienter Under Rule 10b-5: Ernst & Ernst v. Hochfelder, 29 STAN. L. REV. 213 (1977).
68. James D. Cox, Ernst & Ernst v. Hochfelder: A Critique and an Evaluation of Its Impact upon the Scheme of the Federal Securities Laws, 28 HASTINGS L.J. 569 (1977).
69. Louis Haimoff, Holmes Looks at Hochfelder and 10b-5, 32 BUS. LAW. 147 (1976).
70. Kevin R. Johnson, Liability for Reckless Misrepresentations and Omissions Under Section 10(b) of the Securities Exchange Act of 1934, 59 U. CIN. L. REV. 667 (1991).
71. William H. Kuehnle, On Scienter, Knowledge, and Recklessness Under the Federal Securities Laws, 34 HOUS. L. REV. 121 (1997).
72. Paul S. Milich, Securities Fraud Under Section 10(b) and Rule 10b-5: Scienter, Recklessness, and the Good Faith Defense, 11 J. CORP. L. 179 (1986).
73. Margaret V. Sachs, Harmonizing Civil and Criminal Enforcement of Federal Regulatory Statutes: The Case of the Securities Exchange Act of 1934, 2001 U. ILL. L. REV. 1025.
74. Michael L. Seigel, Bringing Coherence to Mens Rea Analysis for Securities-Related Offenses, 2006 WIS. L. REV. 1563.
75. John L. Ruppert, Note, The Supreme Court's Trimming of the Section 10(b) Tree: The Cultivation of a New Securities Law Perspective, 3 J. CORP. L. 112 (1977).
76. None of these works has developed a comprehensive analysis of the concepts of fraud and securities fraud as routes to rethinking and reforming the doctrine across the fields of criminal, regulatory, and private civil liability
77. STUART P. GREEN, LYING, CHEATING, AND STEALING: A MORAL THEORY OF WHITE-COLLAR CRIME 76-79 (2006).
78. James Edwin Mahon, The Definition of Lying and Deception, STAN. ENCYCLOPEDIA OF PHIL. (Feb. 21, 2008), http://plato.stanford.edu/entries/lying-definition.
79. See also John Morris, Can Computers Ever Lie?, 14 PHIL. F. 389, 390 (1976) ("When we say that someone tells a lie, we mean at least this: that he asserts something, claiming (implicitly or explicitly) that it is true, and thereby pledging his own faith in its truth; that, in fact, he believes that it is untrue; and finally that he hopes that his listener will be deceived by what he says, and believe that it is true.")
80. See James Edwin Mahon, A Definition of Deceiving, 21 INT'L J. APPLIED PHIL. 181, 181 (2007) ("Whether or not an act of lying has occurred does not depend on whether or not a particular effect-for example, the belief that what the liar says is true-has been produced in another....")
81. See Roderick M. Chisholm & Thomas D. Feehan, The Intent To Deceive, 74 J. PHIL. 143, 146-48, 159 (1977) (distinguishing between lying, which is "the endeavor to add to someone's stock of false beliefs,"and bad faith, which is "the endeavor to subtract from someone's stock of true beliefs").
82. E.g., Richard A. Posner, Utilitarianism, Economics, and Legal Theory, 8 J. LEGAL STUD. 103, 137-38 (1979).
83. See John C.P. Goldberg, The Constitutional Status of Tort Law: Due Process and the Right to a Law for the Redress of Wrongs, 115 YALE L.J. 524, 530 (2005) ("[N]otwithstanding the dominant tendency among modern scholars to treat tort law as an instrument for attaining public goals such as loss-spreading or efficient precaution-taking, it is still best understood as a law of redress.")
84. John C.P. Goldberg & Benjamin C. Zipursky, Torts as Wrongs, 88 TEX. L. REV. 917, 918 (2010) (asserting that tort law is focused on "wrongs and recourse"rather than on the allocation of accident costs).
85. Note that a view in the style of Account B need not entail limiting fraud law to civil remedies. Criminal liability, unlike under federal fraud law, could require proof of harm to a victim. Or criminal liability could attach upon proof of a conspiracy or an attempt or scheme to impose certain types of loss or gain.
86. See John C.P. Goldberg, Anthony J. Sebok & Benjamin C. Zipursky, The Place of Reliance in Fraud, 48 ARIZ. L. REV. 1001, 1011 (2006) ("[T]he core of the legal wrong that has historically been labeled 'fraud' or 'deceit' is the wrong of interfering with a particular interest of the victim, namely her interest in making certain kinds of choices in certain settings free from certain forms of misinformation.")
87. See, e.g., Quail Hill, LLC v. Cnty. of Richland, 692 S.E.2d 499, 508 (S.C. 2010) (stating the elements of the common-law tort of negligent misrepresentation as "(1) the defendant made a false representation to the plaintiff; (2) the defendant had a pecuniary interest in making the statement; (3) the defendant owed a duty of care to see that he communicated truthful information to the plaintiff; (4) the defendant breached that duty by failing to exercise due care; (5) the plaintiff justifiably relied on the representation; and (6) the plaintiff suffered a pecuniary loss as the proximate result of his reliance on the representation"); see also RESTATEMENT (SECOND) OF CONTRACTS §§ 159, 162 (1981) (distinguishing misrepresentation from fraud by requiring intention for fraud but not for misrepresentation).
88. See, e.g., Nielsen v. Adams, 388 N.W.2d 840, 846 (Neb. 1986) ("The fact that the defendant deceives, itself, establishes scienter even though the defendant may have been unaware of the deception. Therefore, to the extent that we have, in previous cases, included 'intent to deceive' as a necessary element of a cause of action for fraudulent misrepresentation or deceit, we specifically now reject that view...."); Kincaid v. SouthTrust Bank, 221 S.W.3d 32, 39-40 (Tenn. Ct. App. 2006) ("Constructive fraud is essentially fraud without the element of intent. Neither actual dishonesty of purpose nor intent to deceive is an essential element of constructive fraud."(citation omitted)).
89. See also Leon Green, Deceit, 16 VA. L. REV. 749, 750-58 (1930) (discussing how the American common law of torts has accommodated theories ranging from "actual fraud,"which requires the intention to deceive, to "innocent misrepresentation,"which merely causes loss).
90. RESTATEMENT (SECOND) OF TORTS § 525 (1976)
91. Prosser lists the elements of "the tort cause of action in deceit"as (1) a false representation; (2) knowledge or belief in the falsity of the representation (or lack of sufficient information to make the representation) (known as "scienter"); (3) intention to induce the plaintiff to act or to refrain from acting in reliance on the representation; (4) justifiable reliance; and (5) damage
92. If one understands, as I think one should, that the intention to induce someone to act on a false representation is the same thing as the intention to deceive, then Prosser is defining the tort of deceit as core fraud
93. RESTATEMENT (SECOND) OF TORTS § 552
94. Professor Donald Langevoort states that a speaker's awareness of falsity is all that is required for securities fraud because the speaker's motive is not-and should not be-relevant to the question of scienter
95. Donald C. Langevoort, Reflections on Scienter (and the Securities Fraud Case Against Martha Stewart That Never Happened), 10 LEWIS & CLARK L. REV. 1, 5-10 (2006).
96. Langevoort seems to overlook how the question of purpose or goal falls in the space between an actor's mere awareness and her motive or reason for acting. The purpose of deception can serve many potential motives. The distinction is between matters within the actor's near sight and those out on her horizon.
97. See, e.g., Game On Ventures, Inc. v. Gen. RV Ctr., Inc., 587 F. Supp. 2d 831, 838 (E.D. Mich. 2008) ("[C]ontrary to fraudulent misrepresentation and silent fraud, a plaintiff asserting an innocent misrepresentation claim need not prove that the defendant intended to deceive the plaintiff into relying on the false or misleading representation."(citation omitted)); W. Side Fed. Sav. & Loan Ass'n of N.Y.C. v. Hirschfeld, 476 N.Y.S.2d 292, 295 (App. Div. 1984) ("If we subtract from fraud the element of scienter the remainder constitutes the tort of innocent misrepresentation."(citation omitted)).
98. Cf. United States v. Svoboda, 347 F.3d 471, 478-79 (2d Cir. 2003) (clarifying the distinction in the crime of conspiracy between the element of knowledge of the existence and the goals of the conspiracy, for which the theory of willful blindness is relevant, and the element of intent to advance conspiracy toward its goals, for which such a theory is not permissible).
99. See, e.g., In re Ikon Office Solutions, Inc., 277 F.3d 658, 667 (3d Cir. 2002) (stating that, in an action for securities fraud, knowledge, or even recklessness, can establish the required "exacting threshold of scienter"with respect to the intent to deceive).
100. Holmes begins his discussion of fraud by saying that the actor must intend to deceive-in his formulation, intend "that the other should believe and act upon"a misrepresentation
101. OLIVER WENDELL HOLMES, JR., THE COMMON LAW 90 (Am. Bar Ass'n Publ'g 2009) (1881).
102. But then, in a nearly impenetrable passage, Holmes dispenses with mental state, concluding that the whole matter really reduces to "an external standard of conduct"under which a statement that, objectively evaluated, would tend to mislead is, in fact, a statement made with the intent to deceive
103. Holmes concedes that the tort of fraud is thus "more extensive than the sphere of actual moral fraud"because, "starting from the moral ground, it works out an external standard of what would be fraudulent in the average prudent member of the community, and requires every member at his peril to avoid that."
104. Holmes appears to have been working with a conception of fraud similar to the one described in Account B in Part I.C.1.
105. Derry v. Peek, (1889) 14 App. Cas. 337 (H.L.) (appeal taken from Eng.) (U.K.).
106. See, e.g., Sandberg v. Va. Bankshares, Inc., 979 F.2d 332, 346 & n.13 (4th Cir. 1992) (referencing Derry for the proposition that "conscious disregard of whether a statement is true satisf[ies] the scienter requirement"), vacated, No. 91-1873(L), 1993 WL 524680 (4th Cir. Apr. 7, 1993); United Trade Assocs. Ltd. v. Dickens & Matson (USA) Ltd., 848 F. Supp. 751, 761 (E.D. Mich. 1994) (citing Derry for the proposition that a reckless misrepresentation is sufficient to prove fraud); Conn. Nat'l Bank v. Giacomi, 10 Conn. L. Rptr. 66, 78 (Super. Ct. 1993) ("[A] statement recklessly made is one not honestly made.")
107. Derry, 14 App. Cas. at 374 (Lord Herschell L.J.).
108. LACK'S LAW DICTIONARY (9th ed. 2009) first defines scienter as "[a] degree of knowledge that makes a person legally responsible for the consequences of his or her act or omission; the fact of an act's having been done knowingly, esp. as a ground for civil damages or criminal punishment."
109. See also 7 LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATION 3411 (3d rev. ed. 2003) (defining scienter in the common-law action for deceit as knowledge of the falsity of one's representation).
110. An alternative definition of scienter is "[a] mental state consisting in an intent to deceive, manipulate, or defraud."
111. See infra text accompanying notes 147-71
112. MODEL PENAL CODE § 2.02(2)(c) (1962).
113. See James A. Henderson, Jr. & Aaron D. Twerski, Intent and Recklessness in Tort: The Practical Craft of Restating Law, 54 VAND. L. REV. 1133, 1144 (2001) ("[F]or recklessness to be present, the actor must not only know that the risk is great and easily avoidable, but she also must subjectively entertain callous indifference to the plight of would-be victims.")
114. See United States v. Shortman, 91 F.3d 80, 81 (9th Cir. 1996) ("Gross negligence is defined as wanton or reckless disregard for human life."(citations omitted) (quoting United States v. Keith, 605 F.2d 462, 463 (9th Cir. 1979)) (internal quotation marks omitted)); Bd. of Cnty. Comm'rs v. Liberty Grp., 965 F.2d 879, 884 (10th Cir. 1992) ("[T]he line between gross negligence and recklessness is a fine one at best. '[T]here is often no clear distinction at all between [recklessness] and 'gross' negligence, and the two have tended to merge and take on the same meaning.'"(second and third alterations in original) (quoting KEETON ET AL., supra note 25, § 34, at 214)); St. Onge v. Detroit & Mackinac Ry. Co., 321 N.W.2d 865, 867 (Mich. Ct. App. 1982) ("The term 'gross negligence'-when it is used to describe an extreme departure from the ordinary standard of care-has essentially the same meaning as the term 'recklessness.'"); RESTATEMENT (SECOND) OF TORTS § 500 (1964) (defining "reckless disregard of safety"as "knowing or having reason to know of facts which would lead a reasonable man to realize, not only that his conduct creates an unreasonable risk of physical harm to another, but also that such risk is substantially greater than that which is necessary to make his conduct negligent").
115. Though I do not think it necessary here, one could drill deeper into the concept of recklessness. Professor Kim Ferzan argues for consideration of a third form of recklessness that she calls "opaque recklessness."
116. Kimberly Kessler Ferzan, Opaque Recklessness, 91 J. CRIM. L. & CRIMINOLOGY 597, 598-99 (2001).
117. According to Professor Ferzan, an actor is exercising opaque recklessness when she considers the riskiness of her behavior in some general sense (for example, it is dangerous to drive too fast) but does not consider the specific risk for which she may be liable (for example, if I drive too fast, I may strike and kill that pedestrian possibly crossing a block down the road)
118. Professor Ken Simons argues that there are three aspects or types of recklessness: (1) "cognitive"recklessness, involving awareness of risk (a "belief state"); (2) reckless indifference, involving "callousness"toward risk (a "desire state"); and (3) recklessness in the gross negligence sense (a conduct standard, not a mental state)
119. Kenneth W. Simons, Rethinking Mental States, 72 B.U. L. REV. 463, 465 (1992).
120. A more ambitious version of this argument has been mounted by Professor Larry Alexander, who argues that recklessness should be viewed as equivalent to intent and knowledge for the general purposes of the criminal law because, properly defined, recklessness involves the same "basic moral vice of insufficient concern for the interests of others."
121. Larry Alexander, Insufficient Concern: A Unified Conception of Criminal Culpability, 88 CALIF. L. REV. 931, 931 (2000).
122. See Derry v. Peek, (1889) 14 App. Cas. 337, 368 (H.L.) (appeal taken from Eng.) (U.K.) (Lord Herschell L.J.) ("Any person making [a statement that he intends another to act upon] must always be aware that the person to whom it is made will understand, if not that he who makes it knows, yet at least that he believes it to be true. And if he has no such belief he is as much guilty of fraud as if he had made any other representation which he knew to be false, or did not believe to be true.")
123. See, e.g., 18 U.S.C. § 1344 (2006) (providing a thirty-year maximum prison term for bank fraud).
124. See, e.g., United States v. Jones, 641 F.3d 706, 710 (6th Cir. 2011) (health-care fraud); United States v. Warshak, 631 F.3d 266, 312 (6th Cir. 2010) (bank fraud); Cox v. State, 964 P.2d 1235, 1236 (Wyo. 1998) (check fraud).
125. The U.S. SENTENCING GUIDELINES MANUAL (2010) uses a relatively crude dollar-lossto-the-victim metric, id. § 2B1.1, which has been subject to abundant criticism, see, e.g., Samuel W. Buell, Reforming Punishment of Financial Reporting Fraud, 28 CARDOZO L. REV. 1611, 1612 (2007).
126. In the criminal securities context, Professor Michael Seigel argues for a similar requirement of knowledge of wrongfulness, although Seigel describes the requirement- confusingly, in my view-as affording the defendant a "weak mistake-of-law defense."
127. That is, unless he was delusional. Perhaps many flagrant fraudsters are. But, as in other areas of criminal law, delusion that does not rise to the level of legal insanity cannot negate liability.
128. The rule has sparked thousands of lawsuits, causing billions of dollars to change hands. See Securities Class Action Clearinghouse, STANFORD LAW SCH., http://securities.stanford.edu/settle.html (last visited Nov. 9, 2011) (providing summaries of settlement amounts for securities class action lawsuits).
129. It has produced hundreds of judicial opinions, including opinions by some of the most esteemed jurists of the past century. A Westlaw search limited to federal courts of appeals decisions in which the term "securities fraud"appears in the synopsis of the case produced 1589 opinions as of November 9, 2011. See, e.g., Int'l Bhd. of Teamsters v. Daniel, 439 U.S. 551 (1979) (Powell, J.); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) (Powell, J.); Mallis v. Bankers Trust Co., 615 F.2d 68 (2d Cir. 1980) (Friendly, J.); United States v. Simon, 425 F.2d 796 (2d Cir. 1969) (Friendly, J.). The rule has also routinely spawned headlines in the nation's leading papers. A Westlaw search of The New York Times database since 1980 for items that include "fraud"in the headline and "securities fraud"in the body of the text produced 424 articles as of November 9, 2011. A Westlaw search in The Wall Street Journal abstracts database since 1990 produced 643 article abstracts in which the term "securities fraud"appears, as of November 9, 2011. The rule has sent hundreds of people to prison, some for decades. See, e.g., United States v. Skilling, 554 F.3d 529, 542 (5th Cir. 2009) (reporting that the district court had sentenced the defendant, a former CEO of Enron, to over twenty-four years of imprisonment for one count of conspiracy, twelve counts of fraud, five counts of making false statements, and one count of insider trading), aff'd in part, vacated in part, and remanded, 130 S. Ct. 2896 (2010); United States v. Rigas, 583 F.3d 108, 113, 126 (2d Cir. 2009) (affirming the district court's twelve- and seventeen-year sentences for bank fraud against John and Timothy Rigas, the former CEO and CFO of Adelphia Communications, Corp., respectively); United States v. Ebbers, 458 F.3d 110, 112, 130 (2d Cir. 2006) (affirming a twenty-five-year sentence for conspiracy and securities fraud against the former CEO of WorldCom).
130. The Federal Bureau of Justice Statistics (BJS) shows that over 1100 people were criminally prosecuted for securities fraud between 1994 and 2008. This data was obtained by visiting http://bjs.ojp.usdoj.gov/fjsrc/tsec.cfm and following the prompts to produce a report for the number of total defendants that were prosecuted from 1994 to 2008 under 15 U.S.C. § 78j (Section 10 of the Securities Exchange Act of 1934).
131. And, of course, the rule has been fodder for an enormous literature. As of November 9, 2011, eighty-four papers that use the term "securities fraud"in their titles have been posted on the Social Science Research Network (SSRN). A Westlaw search in the Journals and Law Reviews (JLR) database for articles using the term "securities fraud"in their titles produced 281 works as of November 9, 2011. A similar search in the HeinOnline Law Journal Library database produced 302 articles as of November 9, 2011.
132. See 5B ARNOLD S. JACOBS, DISCLOSURE AND REMEDIES UNDER THE SECURITIES LAWS §§ 6:1-:3, at 6-3 to -11 (2011) (describing the scant legislative and administrative history of the statute and the rule).
133. See also JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET 99 (3d ed. 2003) ("[T]he Securities Exchange Act of 1934 was a marvel of irresolution. On most controversial substantive issues, Congress had been stalemated. Rather than providing the new Commission with a clear mandate, the legislators had granted the agency authority to study the controversy or issue its own rules.")
134. Securities Act of 1933, 15 U.S.C. §§ 77a-77aa (2006).
135. Maldonado v. Dominguez, 137 F.3d 1, 3 (1st Cir. 1998).
136. The language of the two prohibitions varies some. The full texts follow, with points of significant difference in italics. Section 17 of the '33 Act makes it a violation "in the offer or sale of any securities... directly or indirectly": (1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. Securities Act of 1933 § 17 (emphasis added). Rule 10b-5 makes it a violation "directly or indirectly"and "in connection with the purchase or sale of any security": (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. 17 C.F.R. § 240.10b-5 (2011) (emphasis added). Section 17 is thus broader, potentially applying to those who use the false representations of others. See SEC v. Tambone, 597 F.3d 436, 442-48 (1st Cir. 2010) (en banc) (exploring this distinction in depth and rejecting the theory that persons who merely have some role in the dissemination of the misrepresentations of others could be held liable under the second prong of Rule 10b-5). Alas, the origins of Section 17's language-and thus Rule 10b-5's-shed little light on how to construe the text. Congress appears to have borrowed the statutory language primarily from New York's antifraud provision for the securities markets, the Martin Act, N.Y. GEN. BUS. LAW § 352-c (McKinney 1996), which, in turn, had borrowed from Maryland's antifraud statute, Act of Apr. 16, 1920, ch. 552, 1920 Md. Laws 1135, the textual origins of which are obscure. See Federal Securities Act: Hearing on H.R. 4314 Before the H. Comm. on Interstate and Foreign Commerce, 73d Cong. passim (1933) (discussing various state-level antifraud statutes, including those in Maryland and New York); Securities Act: Hearing on S. 875 Before the S. Comm. on Banking & Currency, 73d Cong. passim (1933) (discussing the Martin Act during a debate about the federal securities act).
137. Decatur H. Miller, A Prospectus on the Maryland Securities Act, 23 MD. L. REV. 289, 293-94 (1963) (discussing the origins of Maryland's antifraud statute).
138. Letter from George W. Hodges to Tracy Stagg (Apr. 25, 1921), reprinted in N.Y. STATE LIBRARY, BILL JACKET COLLECTION, ch. 649, at 6 (discussing the need to pass an antifraud law in New York that is similar to the Maryland antifraud law).
139. See, e.g., Aaron v. SEC, 446 U.S. 680, 687-700 (1980) (examining the SEC's duty to establish scienter when seeking injunctions for violations of Section 17 or Rule 10b-5 and holding that scienter is required to establish violations of Rule 10b-5 and Section 17(a)(1) but not Sections 17(a)(2) or 17(a)(3)).
140. United States v. Naftalin, 441 U.S. 768, 774 (1979) (explaining that Section 17 prohibits three distinct categories of misconduct).
141. Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78oo (2006 & Supp. III 2009).
142. 17 C.F.R. § 240.10b-5.
143. See In re Enron Corp. Sec. Derivative & "ERISA"Litig., 529 F. Supp. 2d 644, 678-90 (S.D. Tex. 2006) (discussing the differences between Rule 10b-5 cases based on misrepresentations and cases based on failures of disclosure); Swack v. Credit Suisse First Bos., 383 F. Supp. 2d 223, 238-39 (D. Mass. 2004) (discussing the three different categories of conduct that can implicate Rule 10b-5).
144. Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 13 n.9 (1971); Kardon v. Nat'l Gypsum Co., 69 F. Supp. 512, 513-14 (E.D. Pa. 1946); see also Maldonado v. Dominguez, 137 F.2d 1, 6, 9-10 (1st Cir. 1998) (permitting the plaintiff's Rule 10b-5 claims to proceed but dismissing the plaintiff's Section 17 claims because there is no implied private cause of action under Section 17).
145. See, e.g., In re Am. Cont'l/Lincoln Sav. & Loan Sec. Litig., 140 F.R.D. 425, 428-29 (D. Ariz. 1992) (explaining that plaintiffs must prove either a scheme to defraud, a false statement or omission, or a fraudulent act or practice to succeed in their Rule 10b-5 claims).
146. Securities Act of 1933 § 8, 15 U.S.C. § 77h-1 (2006).
147. Securities Act of 1933 § 8
148. Securities Act of 1933 § 24; Securities Exchange Act of 1934 § 32. Since 2002, the Department of Justice has also been able to prosecute for securities fraud under 18 U.S.C. § 1348 (2006), which covers any person who knowingly executes, or attempts to execute, a scheme or artifice (1) to defraud any person in connection with... any security of an issuer [required to register or report under the '34 Act]; or (2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of... any security of an issuer [required to register or report under the '34 Act].
149. The case law on this statute is not well developed. See United States v. Mahaffy, No. 05-CR-613, 2006 WL 2224518, at *10-19 (E.D.N.Y. Aug. 2, 2006) (explaining that the statute had been patterned on mail and wire fraud statutes and thus should be interpreted similarly and exploring the relevance of Title 15 securities law to the "in connection with"requirement of the statute). Notice that this statute does not include a parallel provision to the second (misrepresentation or omission) prongs of Rule 10b-5 and Section 17. It could, and probably should, be argued that this statute covers only core fraud and requires proof of a purpose to deceive.
150. Securities Act of 1933 § 24; Securities Exchange Act of 1934 § 32; 18 U.S.C. § 3551 (2006). See generally 18 U.S.C. §§ 3551-3586 (2006) (detailing sentencing procedures and available penalties).
151. The Enron affair, for example, resulted in criminal prosecutions, e.g., United States v. Skilling, 638 F.3d 480, 481 (5th Cir. 2011); a class action lawsuit, Newby v. Enron Corp., 542 F.3d 463, 467 (5th Cir. 2008).
152. And various SEC enforcement actions, see Spotlight on Enron, SEC, http://www.sec.gov/spotlight/enron.htm (last modified May 11, 2010).
153. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737 (1975).
154. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005) (emphasis omitted).
155. See Chiarella v. United States, 445 U.S. 222, 227-30 (1980) (explaining how silence in the face of a duty to disclose can constitute fraud); Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 152-54 (1972) (explaining how nondisclosure can constitute fraud); see also Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 472-74 (1977) (holding that a breach of fiduciary duty alone does not constitute securities fraud in the absence of some form of deception); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 181-82 (1963) (holding that a registered investment advisor commits fraud when he purchases "shares of security for his own account shortly before recommending that security for long-term investment and then immediately sell[s] the shares at a profit"); Regents of the Univ. of Cal. v. Credit Suisse First Bos. (USA), Inc., 482 F.3d 372, 383-85 (5th Cir. 2007) (discussing in depth the necessity of a showing of a duty to support a Rule 10b-5 claim based on a theory of fraud by nondisclosure). But see United States v. Schiff, 602 F.3d 152, 162-63 (3d Cir. 2010) (stating that a duty to disclose under Rule 10b-5 does not arise from a corporate executive's general fiduciary relationship with shareholders).
156. See, e.g., SEC v. Rana Research, Inc., 8 F.3d 1358, 1363-64 (9th Cir. 1993) (explaining that the SEC need not prove reliance to establish a Rule 10b-5 cause of action).
157. See Securities Exchange Act of 1934 § 21, 15 U.S.C. § 78u-2(b)(1)(2) (2006).
158. Securities Exchange Act of 1934 § 20; Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761, 769 (2008); Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994).
159. TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 445-47 (1976).
160. See, e.g., SEC v. Rana Research, Inc., 8 F.3d 1358, 1363-64 (9th Cir. 1993) (noting that the SEC must establish scienter to sue under Rule 10b-5).
161. See, e.g., SEC v. Tambone, 597 F.3d 436, 443 (1st Cir. 2010) (explaining that the SEC's authority under Section 10(b) is limited to actions that are in connection with the purchase or sale of securities); SEC v. Wolfson, 539 F.3d 1249, 1256 (10th Cir. 2008) (same); Geman v. SEC, 334 F.3d 1183, 1190-92 (10th Cir. 2003) (same); Rana Research, 8 F.3d at 1363-64 (same).
162. E.g., United States v. Frey, 42 F.3d 795, 800 (3d Cir. 1994) (explaining that success is not a required element for fraud).
163. See, e.g., United States v. Teyibo, 877 F. Supp. 846, 861 (S.D.N.Y. 1995) (outlining the elements of securities fraud).
164. As I will discuss, insider trading law is largely based on a requirement to "disclose or abstain"from trading. Compare Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 472-74 (1977) (holding that a breach of fiduciary duty alone does not constitute fraud under the '34 Act in the absence of some form of deception), with SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 192-95 (1963) (holding that, in an action by the SEC for injunctive relief, a fiduciary's nondisclosure of disloyal conduct can constitute fraud under the Investment Advisers Act of 1940, 31 U.S.C. §§ 3729-3731 (2006), in part because, in actions at equity, the common law of fraud did not always require proof of harm or intent to defraud).
165. See Donald C. Langevoort & G. Mitu Gulati, The Muddled Duty To Disclose Under Rule 10b-5, 57 VAND. L. REV. 1639, 1646-74 (2004) (highlighting "major areas in which there is inconsistency on the basic duty question").
166. See also Gregory Klass, Meaning, Purpose and Cause in the Law of Deception 2-3 (Georgetown Pub. Law & Legal Theory Research Paper Series, Research Paper No. 11-18, 2011), available at http://ssrn.com/abstract=1756831.
167. ("[T]here is a deep error in the common law tendency to conflate fraud by misrepresentation, fraud by concealment, and fraud by nondisclosure, which in fact involve different regulatory approaches....")
168. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42 (2004) (emphasis omitted).
169. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976).
170. See, e.g., Theoharous v. Fong, 256 F.3d 1219, 1225 (11th Cir. 2001) (defining recklessness in the super-negligence sense, that is, as "an extreme departure from the standards of ordinary care,"and stating that recklessness is sufficient to make out scienter (quoting Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1282 n.18 (11th Cir. 1999))); In re Phillips Petrol. Sec. Litig., 881 F.2d 1236, 1244 (3d Cir. 1989) ("We have also recognized that recklessness on the part of a defendant meets the scienter requirement of Section 10(b) and Rule 10b-5."(citing Healey v. Catalyst Recovery of Pa., Inc., 616 F.2d 641, 649 (3d Cir. 1980))).
171. Joseph A. Grundfest & A.C. Pritchard, Statutes with Multiple Personality Disorders: The Value of Ambiguity in Statutory Design and Interpretation, 54 STAN. L. REV. 627, 651 (2002) ("Since [Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976),] every court of appeals that has addressed the issue has held that recklessness satisfies the scienter requirement of Section 10(b).")
172. See, e.g., United States v. Precision Med. Labs., Inc., 593 F.2d 434, 446 (2d Cir. 1978) ("The phrases 'reckless disregard of whether the statements made were true' and 'conscious purpose to avoid learning the truth' mean essentially the same thing."(quoting United States v. Sarantos, 455 F.2d 877, 882 (2d Cir. 1972))); United States v. Hanlon, 548 F.2d 1096, 1101-02 (2d Cir. 1977) (noting that trial courts have confused the concepts of reckless indifference and conscious avoidance); Slakoff v. United States, 8 F.2d 9, 10 (3d Cir. 1925) ("If he did not do this, but acted with such gross carelessness and indifference to the truth of the representations contained in the statements as to warrant the conclusion that he acted fraudulently, then his conviction may stand.")
173. See STEPHANIE PLANCICH & SVETLANA STARYKH, NERA ECON. CONSULTING, RECENT TRENDS IN SECURITIES CLASS ACTION LITIGATION: 2009 YEAR-END UPDATE 9-13 (2009) (providing statistical data on the promulgation and settlement rates of private securities class action suits).
174. James D. Cox & Randall S. Thomas, Letting Billions Slip Through Your Fingers: Empirical Evidence and Legal Implications of the Failure of Financial Institutions To Participate in Securities Class Action Settlements, 58 STAN. L. REV. 411, 418 (2005) ("Settlements are the end game for securities class action suits.... [S]everal hundred securities class actions are settled annually, [but] fewer than one or two securities class action suits are tried in any year.")
175. STEPHEN J. CHOI & A.C. PRITCHARD, SECURITIES REGULATION: CASES AND ANALYSIS 238-40, 246-48, (2d ed. 2008).
176. See also, e.g., In re Synchronoss Sec. Litig., 705 F. Supp. 2d 367, 398-401 (D.N.J. 2010) (conducting an analysis of whether scienter had been established under the standard of proof required at the pleading stage).
177. Private Securities Litigation Reform Act (PSLRA) of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified as amended in scattered sections of 15 and 18 U.S.C.).
178. Securities Exchange Act of 1934 § 21D, 15 U.S.C. 78u-4(b)(2) (2006).
179. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2510 (2007).
180. See Greebel v. FTP Software, Inc., 194 F.3d 185, 199-201 (1st Cir. 1999) ("[T]he PSLRA did not address the substantive definition of scienter."); Phillips v. LCI Int'l, Inc., 190 F.3d 609, 620 (4th Cir. 1999) ("The PSLRA did not change... the kind of evidence a plaintiff must adduce to demonstrate scienter... [b]ut... the PSLRA does seek to heighten the standard for pleading scienter...."); Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1281-84 (11th Cir. 1999) ("[W]e hold that the [PSLRA] does not prohibit the practice of alleging scienter by pleading facts that denote severe recklessness, the standard previously approved of by this Circuit...."); In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 549-52 (6th Cir. 1999) ("[I]t is clear that Congress changed the pleading, but not the state of mind, requirements applicable to § 10(b) and Rule 10b-5 cases."); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 532-35 (3d Cir. 1999) ("[W]e believe [the PSLRA] was intended to modify procedural requirements while leaving substantive law undisturbed.") Interestingly, courts disagree over whether a pleading based on facts about the defendant's "motive and opportunity"to commit fraud can be sufficient to clear the scienter hurdle. See, e.g., Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242, 276-79 (3d Cir. 2009) (discussing the three different standards applied by the various circuits to determine whether a plaintiff sufficiently pled scienter under the PSLRA).
181. See, e.g., Second Amended Complaint at 297, In re Fannie Mae Sec. Litig., No. 1:04-CV-1639 (D.D.C. Aug. 15, 2006) ("These Defendants knew, or should have known in the exercise of reasonable care, that their statements regarding the Company's financial statements, accounting policies and practices, and internal financial controls during the Loss Period were materially false and misleading."); Second Consolidated Amended Complaint at 7, In re Tommy Hilfiger Sec. Litig., No. 1:04-CV-07678-RO (S.D.N.Y. Sept. 28, 2004) ("[D]efendants... were aware, or recklessly disregarded, that the false and misleading statements were being issued regarding the Company, and approved or ratified these statements, in violation of the federal securities laws.")
182. See also 8 LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATION 3688-89 (3d rev. ed. 2004) (warning against the tendency of a definition of recklessness such as, for example, "an extreme departure from the standards of ordinary care"to slide too close to allowing liability for negligence (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977))).
183. Even a leading case that stressed the importance of recklessness's being "the functional equivalent of intent"defined it in negligence-like terms: "[T]he danger of misleading buyers must be actually known or so obvious that any reasonable man would be legally bound as knowing.... [This definition] measures conduct against an external standard which, under the circumstances of a given case, results in the conclusion that the reckless man should bear the risk of his omission."Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977).
184. See, e.g., [Corrected] Second Consolidated Amended Class Action Complaint at A-55, In re Scholastic Corp. Sec. Litig., No. 99 CIV. 2447 JFK, 2000 WL 91939 (S.D.N.Y. Jan. 27, 2000), rev'd, 252 F.3d 63 (2d Cir. 2001) (stating that "defendants knew, or were reckless in not knowing,"that the rate of return for certain book titles was rising).
185. See, e.g., Robin v. Arthur Young & Co., 915 F.2d 1120, 1127-28 (7th Cir. 1990) (holding that the plaintiffs' allegations that the defendant "should have known"the relevant facts were insufficient to allege recklessness in a private action for securities fraud).
186. See Tellabs, 127 S. Ct. at 2504-05 ("To qualify as 'strong' within the intendment of § 21D(b)(2), we hold, an inference of scienter must be more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.")
187. Chiarella v. United States, 445 U.S. 222, 234-35 (1980).
188. See Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 173-74 (1994) ("[T]he words 'manipulative or deceptive' used in conjunction with 'device or contrivance' strongly suggest that § 10(b) was intended to proscribe knowing or intentional misconduct."(quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976)) (internal quotation marks omitted)).
189. TOM BAKER & SEAN J. GRIFFITH, ENSURING CORPORATE MISCONDUCT: HOW LIABILITY INSURANCE UNDERMINES SHAREHOLDER LITIGATION 186-87 (2010).
190. Aaron v. SEC, 446 U.S. 680, 697 (1980).
191. Securities Exchange Act of 1934 § 10, 15 U.S.C. § 78j (2006).
192. Aaron, 446 U.S. at 691-97. This reading, of course, raises the question why the Court has not found the parallel second prong of Rule 10b-5 to be invalid as exceeding the SEC's rulemaking authority under Section 10 of the '34 Act.
193. See, e.g., Complaint at 6, SEC v. Noncek, No. 09-CV-02387 (D.D.C. Dec. 15, 2009); Complaint at 6, SEC v. Queri, No. 08CV01367 (W.D. Pa. Sept. 30, 2008); Complaint at 2, SEC v. Pliner, No. 07-CV-00495 (D.D.C. Mar. 15, 2007).
194. The Dodd-Frank legislation promises to make the matter more opaque. It includes a provision that authorizes the SEC to proceed against persons who "recklessly"aid and abet the securities fraud violations of others. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 929O, 124 Stat. 1376, 1862 (codified at 15 U.S.C. § 78t(e) (Supp. IV 2011)). The idea of reckless accessorial liability is even more elusive than the idea of reckless fraud. It is black-letter criminal law that, with few exceptions, one cannot aid another in committing an offense without intending for the offense to succeed.
195. JOSHUA DRESSLER, UNDERSTANDING CRIMINAL LAW 477-82 (5th ed. 2009).
196. Helping another in a particular endeavor is a goal-oriented behavior. And criminal law does not exculpate accomplices who fail to succeed in their efforts to assist criminal ventures. See MODEL PENAL CODE § 5.01(3) (1962) (imposing attempt liability on a person who acts as an accomplice to a person who did not successfully complete a planned crime). A reckless state of mind does not suffice for accomplice liability because it is nonsensical to speak, for example, of a person consciously disregarding the risk that her work as a lookout might help a bank robber escape. She is either acting as a lookout in the hopes that he will get away, or she is not a lookout at all.
197. See, e.g., SEC Charges Securities Fraud in Internet Foreign Currency Trading Scheme, Litigation Release No. 16,055, 69 SEC Docket 287 (Feb. 8, 1999); SEC Charges Investment Adviser with Securities Fraud, Litigation Release No. 15,988, 68 SEC Docket 1998 (Nov. 30, 1998).
198. Securities Act of 1933 § 24, 15 U.S.C. § 77x (2006); Securities Exchange Act of 1934 § 32, 15 U.S.C. § 78ff (2006).
199. Compare, e.g., 17 C.F.R. § 240.10b-5 (2011), with, e.g., 17 C.F.R. § 230.164 (2011).
200. Securities Exchange Act of 1934 § 32. The '33 Act has no parallel language, which is surprising, given that the '33 Act's rules are often more arcane than those of the '34 Act. See Securities Act of 1933 § 24.
201. United States v. Tarallo, 380 F.3d 1174, 1188 (9th Cir. 2004).
202. TRW Inc. v. Andrews, 534 U.S. 19, 31 (2001).
203. United States v. Reyes, 577 F.3d 1069, 1079-81 (9th Cir. 2009); Tarallo, 380 F.3d at 1185-88; United States v. Stockheimer, 157 F.3d 1082, 1088-89 (7th Cir. 1998); United States v. Hollis, 971 F.2d 1441, 1451-52 (10th Cir. 1992); United States v. Knueppel, 293 F. Supp. 2d 199, 203 n.1 (E.D.N.Y. 2003). Some courts, however, have permitted a defendant, at least under the strict terms of the statute, to argue an affirmative defense of lack of knowledge of the existence of Rule 10b-5, though I know of no case in which such an argument has been successful. See United States v. Behrens, 644 F.3d 754, 755 (8th Cir. 2011) (holding that a defendant was entitled to a defense that he had no knowledge of Rule 10b-5 and remanding to the district court to determine whether he had met his burden of proof); see also Ratzlaf v. United States, 510 U.S. 135, 149 (1994) (noting the "venerable principle that ignorance of the law generally is no defense"before holding that "Congress may decree otherwise"in particular contexts, such as the regulatory crime of structuring financial transactions); Cheek v. United States, 498 U.S. 192, 199-200 (1991) (noting the same principle before finding that Congress has created a mistakeof-law defense in limited contexts, including the nonpayment of taxes).
204. Dan M. Kahan, Ignorance of the Law Is an Excuse-But Only for the Virtuous, 96 MICH. L. REV. 127, 145-49 (1997) (describing Cheek v. United States, 498 U.S. 192 (1991), as providing an ignorance defense solely for honest mistakes that violate laws not backed by moral norms).
205. United States v. Kaiser, 609 F.3d 556, 567-70 (2d Cir. 2010); Reyes, 577 F.3d at 1079-80; United States v. Peltz, 433 F.2d 48, 54-55 (2d Cir. 1970).
206. United States v. English, 92 F.3d 909, 914-15 (9th Cir. 1996).
207. United States v. Piepgrass, 425 F.2d 194, 199-200 (9th Cir. 1970); Rice v. United States, 149 F.2d 601, 603 (10th Cir. 1945).
208. United States v. Gentile, 530 F.2d 461, 469-70 (2d Cir. 1976); United States v. Mackay, 491 F.2d 616, 623 (10th Cir. 1973); United States v. Amick, 439 F.2d 351, 363-64 (7th Cir. 1971); United States v. Benjamin, 328 F.2d 854, 862-63 (2d Cir. 1964).
209. United States v. DeSantis, 134 F.3d 760, 764 (6th Cir. 1998); United States v. Natelli, 527 F.2d 311, 320-23 (2d Cir. 1975).
210. United States v. Tarallo, 380 F.3d 1174, 1188-89 & n.5 (9th Cir. 2004); United States v. Sawyer, 799 F.2d 1494, 1501-02 (11th Cir. 1986); United States v. Farris, 614 F.2d 634, 638 (9th Cir. 1979); United States v. Henderson, 446 F.2d 960, 966 (8th Cir. 1971); Elbel v. United States, 364 F.2d 127, 133-34 (10th Cir. 1966); United States v. Goyal, No. CR 04-00201 MJJ, 2008 WL 755010, at *8 (N.D. Cal. Mar. 21, 2008); United States v. Cen-Card Agency/C.C.A.C., 724 F. Supp. 313, 316-17 (D.N.J. 1989); United States v. Koenig, 388 F. Supp. 670, 711-12 (S.D.N.Y. 1974).
211. Koenig, 388 F. Supp. at 711-12.
212. United States v. Gutstein, No. 91-50704, 1992 WL 354151, at *1 (9th Cir. Nov. 30, 1992); Williams v. United States, No. 92-1110, 1992 WL 332029, at *3 (1st Cir. Nov. 13, 1992); United States v. Boyer, 694 F.2d 58, 59-60 (3d Cir. 1982); Sparrow v. United States, 402 F.2d 826, 828 (10th Cir. 1968); see also United States v. Charnay, 537 F.2d 341, 348 (9th Cir. 1976) (stating that the law of Rule 10b-5 does not vary in civil and criminal contexts except as to the government's burden of proof).
213. United States v. Schaefer, 299 F.2d 625, 629 (7th Cir. 1962); Stone v. United States, 113 F.2d 70, 75 (6th Cir. 1940); see also United States v. Meyer, 359 F.2d 837, 839 (7th Cir. 1966) (holding that a defendant cannot prevail on a good-faith defense to a securities fraud charge "if he could have ascertained the true facts by the exercise of that degree of care expected of a reasonably prudent person").
214. United States v. Isaiah, 434 F.3d 513, 520-21 (6th Cir. 2006); United States v. Munoz, 233 F.3d 1117, 1135-36 (9th Cir. 2000); United States v. Prows, 118 F.3d 686, 692 (10th Cir. 1997); United States v. Cochran, 109 F.3d 660, 664-65 (10th Cir. 1997); United States v. Coyle, 63 F.3d 1239, 1243 (3d Cir. 1995); United States v. Reddick, 22 F.3d 1504, 1507-08 (10th Cir. 1994); United States v. Gay, 967 F.2d 322, 326-27 (9th Cir. 1992); United States v. Mann, 884 F.2d 532, 535-36 (10th Cir. 1989); United States v. Woods, 877 F.2d 477, 480 (6th Cir. 1989); United States v. Dick, 744 F.2d 546, 551 (7th Cir. 1984); United States v. Cusino, 694 F.2d 185, 187 (9th Cir. 1982); United States v. Frick, 588 F.2d 531, 536 (5th Cir. 1979); United States v. McDonald, 576 F.2d 1350, 1358-59 (9th Cir. 1978); United States v. Love, 535 F.2d 1152, 1157-58 (9th Cir. 1976); United States v. Reicen, 497 F.2d 563, 571 (7th Cir. 1974); United States v. Edwards, 458 F.2d 875, 881 (5th Cir. 1972); Gusow v. United States, 347 F.2d 755, 756 (10th Cir. 1965); Irwin v. United States, 338 F.2d 770, 774 (9th Cir. 1964); Babson v. United States, 330 F.2d 662, 664 (9th Cir. 1964); Bentel v. United States, 13 F.2d 327, 329 (2d Cir. 1926); Slakoff v. United States, 8 F.2d 9, 10 (3d Cir. 1925); Corliss v. United States, 7 F.2d 455, 456-57 (8th Cir. 1925); Kaplan v. United States, 229 F. 389, 389 (2d Cir. 1916); United States v. Philip Morris USA, Inc., 449 F. Supp. 2d 1, 897 (D.D.C. 2006); United States v. Epstein, 152 F. Supp. 583, 588-89 (E.D. Pa. 1957). But see United States v. Precision Med. Labs., Inc., 593 F.2d 434, 445-46 (2d Cir. 1978) (stating that recklessness suffices to establish the mental state for mail fraud only if it rises to the level of "conscious purpose to avoid learning the truth"). The nadir in this line of cases might be this formulation: "In order to convict, the jury [is] required to find not only the presence of 'reckless indifference' in the making of the statements in question, but that [the statements] were made with 'intent to defraud.' Though the definitions are faintly circular, they present the concept fairly."United States v. Cronn, 717 F.2d 164, 170 (5th Cir. 1983); see also United States v. Themy, 624 F.2d 963, 965 (10th Cir. 1980) (providing the ipse dixit that "indifference to the truth of statements made to induce others to action amounts to fraudulent intent"(emphasis added)); United States v. Quadro Corp., 928 F. Supp. 688, 696 (E.D. Tex. 1996) (stating that the elements of mail fraud include both intent to defraud and knowledge or recklessness as to falsity, but later stating that "[i]f specific intent cannot be proven, the government must show that the defendants 'made material misrepresentations of fact with reckless disregard to their truth or falsity'"(quoting Cen-Card Agency, 724 F. Supp. at 316-17)).
215. See, e.g., Boyer, 694 F.2d at 59-60; United States v. Natelli, 527 F.2d 311, 320-24 (2d Cir. 1975); Henderson, 446 F.2d at 966; Elbel, 364 F.2d at 133-34; Stone, 113 F.2d at 75; see also Prows, 118 F.3d at 692 (implying, in a mail fraud case, that specific intent to defraud can be inferred from recklessness as to falsity); United States v. Hoffman, 918 F.2d 44, 46-47 (6th Cir. 1990) (suggesting, in a bank fraud case, that recklessness can equate to specific intent to defraud because it is evidence of intent); United States v. Welch, 248 F. Supp. 2d 1061, 1070-71 (D. Utah 2001) (stating, in a mail fraud case, that a scheme to defraud requires intent but that indifference to truth can be evidence of intent).
216. New York's famous securities antifraud statute, the Martin Act, is even broader than the federal scheme in its statutory language; serves as an all-purpose tool for civil, regulatory, and criminal liability; and has produced judicial fogginess about fault standards and the distinction between fraud and misrepresentation. Engaging in "[a]ny fraud, deception, concealment, suppression, false pretense or fictitious or pretended purchase or sale"or making "[a]ny promise or representation as to the future which is beyond reasonable expectation or unwarranted by existing circumstances"is a misdemeanor violation of the Martin Act. Martin Act § 1, N.Y. GEN. BUS. LAW § 352-c(1) (McKinney 1996). But felony liability attaches only if one "intentionally engages in any scheme constituting a systematic ongoing course of conduct with intent to defraud ten or more persons or to obtain property from ten or more persons by false or fraudulent pretenses, representations or promises."
217. See also, e.g., People v. Landes, 645 N.E.2d 716, 717-18 (N.Y. 1994) (stating that the Martin Act covers conduct "which, in some instances, may be criminal because deceptive or misleading even absent proof of scienter or intent"); People v. Rachmani, 525 N.E.2d 704, 707-08 (N.Y. 1988) (stating that in an injunctive action, the Martin Act imposes strict liability for all deceitful practices); People v. Federated Radio Corp., 154 N.E. 655, 657 (N.Y. 1926) (stating that the Martin Act covers "all deceitful practices contrary to the plain rules of common honesty"); People v. Sala, 695 N.Y.S.2d 169, 177 (App. Div. 1999) (stating that intent to defraud is necessary for a felony conviction under the Martin Act, but then stating that intent can be inferred from knowledge and that intent means simply "an intentional act constituting fraud,"defined as including all "deceitful practices"); People v. Tellier, 155 N.Y.S.2d 245, 255 (Sup. Ct. 1956) (stating that negligence is sufficient for civil liability under the Martin Act); People v. Photocolor Corp., 281 N.Y.S. 130, 137 (Sup. Ct. 1935) (stating that "something less than legal fraud will suffice to invoke the injunctive powers of the Martin Act").
218. See, e.g., Staples v. United States, 511 U.S. 600, 605 (1994) ("[W]e must construe the statute in light of the background rules of the common law, in which the requirement of some mens rea for a crime is fairly embedded."(citation omitted)).
219. See generally Joseph E. Kennedy, Making the Crime Fit the Punishment, 51 EMORY L.J. 753 (2002) (demonstrating how the Supreme Court has increasingly required proof of higher levels of mens rea in the area of regulatory crimes as statutory and guidelines punishments for those crimes have increased).
220. But see 17 C.F.R. §§ 240.10b5-1 to -2 (2011) (codifying certain aspects of insider trading doctrine and providing certain safe harbors).
221. See Thomas Lee Hazen, Identifying the Duty Prohibiting Outsider Trading on Material Nonpublic Information, 61 HASTINGS L.J. 881, 889 (2010) ("[D]ealing with insider trading through an antifraud rule is like trying to fit a square peg into a round hole.")
222. See United States v. O'Hagan, 521 U.S. 642, 658 (1997) ("Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law."); see also Basic Inc. v. Levinson, 485 U.S. 224, 247 (1988) ("Who would knowingly roll the dice in a crooked crap game?"(quoting Schlanger v. Four-Phase Sys. Inc., 555 F. Supp. 535, 538 (S.D.N.Y. 1982)) (internal quotation mark omitted)).
223. The standard arguments for and against insider trading prohibitions are reviewed-and supplemented with an argument that these prohibitions enhance the quality of corporate governance-in James D. Cox, Insider Trading and Contracting: A Critical Response to the "Chicago School,"1986 DUKE L.J. 628.
224. See also Kimberly D. Krawiec, Fairness, Efficiency, and Insider Trading: Deconstructing the Coin of the Realm in the Information Age, 95 NW. U. L. REV. 443, 444 (2001) ("[N]either the courts, the legislature, nor the Securities and Exchange Commission... has clearly or convincingly articulated what social policy the insider trading prohibition is meant to further....")
225. Henry G. Manne, Insider Trading: Hayek, Virtual Markets, and the Dog That Did Not Bark, 31 J. CORP. L. 167, 167 (2005) ("This Article briefly reexamines the great debates on the role of insider trading in the corporate system from the perspectives of efficiency of capital markets, harm to individual investors, and executive compensation.")
226. M. Todd Henderson, Insider Trading and CEO Pay 3 (Univ. of Chi. Law Sch. Inst. for Law & Econ., Working Paper No. 521, 2010), available at http://ssrn.com/abstract=1605170 ("[T]here is a missing piece to the pay debate-the compensation insiders implicitly receive through the ability to convert their equity into cash. This Paper provides new evidence that the size of the insider-trading component of implicit compensation is significant....")
227. See Chiarella v. United States, 445 U.S. 222, 230 (1980) ("[S]ilence in connection with the purchase or sale of securities may operate as a fraud actionable under § 10(b).... But such liability is premised upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction.")
228. See Cady, Roberts & Co., Exchange Act Release No. 6668, 40 SEC Docket 907, 911 (Nov. 8, 1961) ("If... disclosure prior to effecting a purchase or sale would be improper or unrealistic under the circumstances, we believe the alternative is to forego the transaction.")
229. See, e.g., Chiarella, 445 U.S. at 231-33 (reversing the insider trading conviction of an employee of a financial printer based on the theory that he used information acquired at work to purchase stock because such a theory would impose a duty upon such persons to the market as a whole).
230. See Dirks v. SEC, 463 U.S. 646, 654 (1983) ("In an inside-trading case... fraud derives from the 'inherent unfairness involved where one takes advantage' of 'information intended to be available only for a corporate purpose and not for the personal benefit of anyone."(quoting Merrill Lynch, Pierce, Fenner & Smith, Inc., Exchange Act Release No. 8459, 43 SEC Docket 933, 936 (Nov. 25, 1968))).
231. See, e.g., United States v. O'Hagan, 521 U.S. 642, 658-59 (1997) ("An investor's informational disadvantage vis-á-vis a misappropriator with material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill.")
232. Donna M. Nagy, Insider Trading and the Gradual Demise of Fiduciary Principles, 94 IOWA L. REV. 1315, 1331, 1373-78 (2009) (arguing that misappropriation cases, in which existing law treats the conduct as fraud on the person or entity from whom the information is improperly acquired and then used, are better treated as cases of fraud on the trading counterparty, due to the unfair advantage gained from the use of information that has been stolen or otherwise improperly obtained).
233. Dirks, 463 U.S. at 660 (emphasis added).
234. In Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court strangely added in a footnote that there must be a purpose to defraud and that the issue in the case was not whether the insider or tippee acted with scienter "but rather whether there was any deceptive or fraudulent conduct at all."
235. David I. Walker, Unpacking Backdating: Economic Analysis and Observations on the Stock Option Scandal, 87 B.U. L. REV. 561, 567-70 (2007).
236. According to the courts and the executive branch, so far at least, the answer has been "all of the above."See United States v. Reyes, 577 F.3d 1069, 1083 (9th Cir. 2009) (affirming a criminal conviction for options backdating); In re Juniper Networks, Inc. Sec. Litig., 264 F.R.D. 584, 594-95 (N.D. Cal. 2009) (granting a motion to certify a class action claim challenging options backdating); SEC v. Berry, 580 F. Supp. 2d 911, 912-13 (N.D. Cal. 2008) (reviewing an SEC enforcement action brought against a corporate officer for involvement in an optionsbackdating scheme); Indictment at 23-40, United States v. Alexander, No. 1:06-CR-00628-NGG-RER (E.D.N.Y. Sept. 20, 2006) (indicting the chief executive officer of a corporation for criminal offenses related to options backdating).
237. See generally Steven J. Mintz, Wave of Lawsuits Follows Stock Options Backdating, LITIG. NEWS, Jan. 2007, at 1 (describing criminal and SEC enforcement actions targeting the practice of options backdating).
238. See, e.g., Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 173 (2008) (Stevens, J., dissenting) ("[T]o the extent that 'the antifraud provisions of the securities laws are not coextensive with common-law doctrines of fraud,' it is because common-law fraud doctrines might be too restrictive."(quoting Herman & MacLean v. Huddleston, 459 U.S. 375, 388-89 (1983))); Basic Inc. v. Levinson, 485 U.S. 224, 230 (1988) ("Underlying the adoption of extensive disclosure requirements was a legislative philosophy: 'There cannot be honest markets without honest publicity. Manipulation and dishonest practices of the market place thrive upon mystery and secrecy.' This Court 'repeatedly has described the fundamental purpose of the Act as implementing a philosophy of full disclosure.'"(citation omitted) (quoting H.R. REP. NO. 73-1383, at 11 (1934); Santa Fe Indus., Inc. v. Green, 430 U.S. 467, 477-78 (1977)) (internal quotation marks omitted)); Herman, 459 U.S. at 382 ("[Section] 10(b) is a 'catchall' antifraud provision....")
239. But see SEC v. Zandford, 535 U.S. 813, 820 (2002) ("[T]he statute must not be construed so broadly as to convert every common-law fraud that happens to involve securities into a violation of § 10(b)....")
240. Compare Herman, 459 U.S. at 386 ("The effectiveness of the broad proscription against fraud in § 10(b) would be undermined if its scope were restricted by the existence of an express remedy under § 11."), with Stoneridge, 552 U.S. at 165 ("Though it remains the law, the § 10(b) private right should not be extended beyond its present boundaries.")
241. See Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 345 (2005) ("[Securities fraud] statutes make [private] actions available, not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause.")
242. See, e.g., Mark A. Sargent, State Disclosure Regulation and the Allocation of Regulatory Responsibilities, 46 MD. L. REV. 1027, 1039 (1987) ("The establishment of a disclosure-based federal securities regulatory system in 1933 can be described as a rejection of the first indigenous tradition of American securities regulation, the merit-based system prevalent in the midwestern states, in favor of a disclosure-based system derived from a British model and from the broader tradition of Progressive disclosure legislation.")
243. See generally LOUIS D. BRANDEIS, OTHER PEOPLE'S MONEY AND HOW THE BANKERS USE IT 89-96 (Melvin I. Urofsky ed., Bedford Books of St. Martin's Press 1995) (1914) ("Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.")
244. JAMES D. COX, ROBERT W. HILLMAN & DONALD C. LANGEVOORT, SECURITIES REGULATION: CASES AND MATERIALS 3 (5th ed. 2006) (describing how the federal securities laws were enacted pursuant to "debate on the merits of a mandatory disclosure system"and explaining that the '33 Act "embrace[d]"disclosure as a remedy for the securities abuses of the 1920s).
245. Merritt B. Fox, Civil Liability and Mandatory Disclosure, 109 COLUM. L. REV. 237, 273-97 (2000).
246. Zohar Goshen & Gideon Parchomovsky, The Essential Role of Securities Regulation, 55 DUKE L.J. 711, 714 (2006).
247. Paul G. Mahoney, Mandatory Disclosure as a Solution to Agency Problems, 62 U. CHI. L. REV. 1047, 1049 (1995).
248. Edward Rock, Securities Regulation as Lobster Trap: A Credible Commitment Theory of Mandatory Disclosure, 23 CARDOZO L. REV. 675, 675 (2002).
249. Forcing actors to state things on the record may also make them more careful about telling the truth
250. See, e.g., Securities Exchange Act of 1934 § 13, 15 U.S.C. § 78m(b) (2006) (requiring public companies to record and disclose information, authorizing the SEC to issue disclosure rules, and sanctioning violations of disclosure requirements).
251. See generally MICHAEL PERINO, THE HELLHOUND OF WALL STREET: HOW FERDINAND PECORA'S INVESTIGATION OF THE GREAT CRASH FOREVER CHANGED AMERICAN FINANCE (2010) (recounting the congressional investigation into the causes of the 1929 stock-market crash and related unfair practices on Wall Street)
252. See, e.g., LARRY ALEXANDER & KIMBERLY KESSLER FERZAN, CRIME AND CULPABILITY: A THEORY OF CRIMINAL LAW 23-68 (2009) (examining recklessness as a basis for criminal liability).
253. See Elizabeth S. Anderson & Richard H. Pildes, Expressive Theories of Law: A General Restatement, 148 U. PA. L. REV. 1503, 1511 (2000) ("[E]xpressive norms regulate actions....")
254. Samuel W. Buell, The Blaming Function of Entity Criminal Liability, 81 IND. L.J. 473, 519 (2006) ("[Expressive theorists] have asserted that the imposition of... criminal liability expresses important values even if it cannot inflict sanctions that differ materially from civil penalties.")
255. Dan M. Kahan, Social Influence, Social Meaning, and Deterrence, 83 VA. L. REV. 349, 352 (1997) ("[I]f the expressive significance of one form of punishment (say, imprisonment) more effectively expresses community disapprobation than does another one (say, fines or community service), the effect of the former in directing social influence may justify selecting it even if the latter imposes the same price on crime at a lesser social cost.")
256. Richard H. McAdams, An Attitudinal Theory of Expressive Law, 79 OR. L. REV. 339, 340 (2000) ("Because people are motivated to gain approval and avoid disapproval, the information signaled by legislation and other law affects their behavior.")
257. Cass R. Sunstein, On the Expressive Function of Law, 144 U. PA. L. REV. 2021, 2025 (1996) (exploring "how legal 'statements' might be designed to change social norms").
258. But see Matthew D. Adler, Expressive Theories of Law: A Skeptical Overview, 148 U. PA. L. REV. 1363, 1364 (2000) (arguing that expressive theories of law, properly understood, are not persuasive).
259. It is suggestive, however, that there is clear evidence that initial media reports of fraud affect the market's assessment of a firm's value long before legal proceedings resolve the question of liability
260. See, e.g., Stephen Choi & Marcel Kahan, The Market Penalty for Mutual Fund Scandals, 87 B.U. L. REV. 1021, 1047-50 (2007) (finding that investor outflow is greater when a scandal that harms investors is first discovered by the press rather than the SEC).
261. Jonathan M. Karpoff, D. Scott Lee & Gerald S. Martin, The Cost to Firms of Cooking the Books, 43 J. FIN. & QUANT. ANALYSIS 581, 582 (2008) (arguing that financial penalties imposed by courts for misconduct are far outweighed by the financial impact of reputational losses suffered because of the misconduct).
262. Donald C. Langevoort, Rule 10b-5 as an Adaptive Organism, 61 FORDHAM L. REV. S7, S7-S8, S16-S19 (1993) (arguing that the adaptability of Rule 10b-5 is a virtue "because we as a culture have not yet created a consistent, persuasive story of what the business of investing is all about").
263. See Henry M. Hart, Jr., The Aims of the Criminal Law, 23 LAW & CONTEMP. PROBS. 401, 431 (1958) ("What sense does it make to insist upon procedural safeguards in criminal prosecutions if anything whatever can be made a crime in the first place? What sense does it make to prohibit ex post facto laws (to take the one explicit guarantee of the Federal Constitution on the substantive side) if a man can, in any event, be convicted of an infamous crime for inadvertent violation of a prior law of the existence of which he had no reason to know and which he had no reason to believe he was violating, even if he had known of its existence?").
264. John C. Coffee, Jr., Does "Unlawful"Mean "Criminal"?: Reflections on the Disappearing Tort/Crime Distinction in American Law, 71 B.U. L. REV. 193, 200 (1991) ("[T]he criminal sanction is increasingly being used by regulators as a preferred enforcement tool without regard to the traditional limitations on its use.")
265. Whether-or how-the D&O insurance market might adjust, if at all, were the law of securities fraud to clearly distinguish cases of intentional fraud from cases of careless misrepresentation is an interesting question, but that question is beyond the scope of this Article
266. The single comprehensive redrafting exercise since adoption of the securities laws-the American Law Institute's proposal of a never-adopted Federal Securities Code-did not suggest changing the existing law by dividing fraud and misrepresentation or distinguishing among levels of awareness. See FED. SEC. CODE §§ 202(61), 202(86), 202(96), 202(147), 1602, 1604 (Proposed Official Draft 1978). A House bill preceding enactment of the PSLRA did propose that in private lawsuits, securities fraud could only be established with proof of both intent to deceive and knowledge of falsity or recklessness as to falsity, which was explicitly defined in the gross-negligence sense. H.R. 1058, 104th Cong. § 4 (as passed by House, Mar. 10, 1995). The proposal was not enacted.
267. See John W. Avery, Securities Litigation Reform: The Long and Winding Road to the Private Securities Litigation Reform Act of 1995, 51 BUS. LAW. 335, 335 (1995) ("On December 22, 1995, the U.S. Senate voted to override President Clinton's veto of [the PSLRA], concluding a long and often rancorous legislative effort to bring about a sweeping revision of both substantive and procedural law governing private actions under the federal securities laws.")
268. Brian S. Sommer, The PSLRA Decade of Decadence: Improving Balance in the Private Securities Litigation Arena with a Screening Panel Approach, 44 WASHBURN L.J. 413, 413 (2005) ("Notwithstanding debate, controversy, and a presidential veto, the United States Congress enacted [the PLSRA] in December of 1995.")
269. See 156 CONG. REC. S3569, S3618 (daily ed. May 12, 2010) (introducing legislation amending the '34 Act to allow private actions against aiders and abettors); see also 156 CONG. REC. S3663, S3670 (daily ed. May 13, 2010) (discussing the reasons for amending the '34 Act); 156 CONG. REC. S3385, S3399-S3400 (daily ed. May 7, 2010) (same). Congress did not pass the proposal, instead directing "a study on the impact of authorizing a private right of action against any person who aids or abets another person in violation of the securities laws."Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 929Z, 124 Stat. 1376, 1871 (2010).
270. (Quoting Milton Freeman, Administrative Procedures, 22 BUS. LAW. 891, 922 (1967)) (internal quotation marks omitted).
271. William W. Bratton & Michael L. Wachter, The Political Economy of Fraud on the Market 5 (Univ. of Pa. Inst. for Law & Econ., Research Paper No. 11-17, 2011), available at http://ssrn.com/abstract=1824324.
272. Cf. United States v. Sheiner, 273 F. Supp. 977, 982-83 (S.D.N.Y. 1967) ("If the defendants' acts were done inadvertently, mistakenly, or in good faith without an intention to defraud, then... the defendants must be acquitted.... On the other hand, if the defendants acted wilfully and purposely with an evil intent, or with a reckless indifference to the truth, then they are chargeable with the requisite knowledge and criminal intent."(emphasis added)), aff'd, 410 F.2d 337 (2d Cir. 1969). A poor argument, however, is to say, in a bootstrap maneuver, that "one who acts with reckless indifference to whether a representation is true or false is chargeable with knowledge of its falsity."United States v. Beecroft, 608 F.2d 753, 757 (9th Cir. 1979).