WASHINGTON -- A Colorado municipal bond trustee's alleged reckless behavior in administering a troubled bond issue constitutes aiding and abetting the issuer in committing securities fraud, a lawyer for bondholders told the Supreme Court yesterday.
The role of the trustee "was one of assisting actively and substantively, aiding and abetting, a series of acts over two or three months" that defrauded investors, attorney Miles M. Gersh told the court in oral arguments in the case, Central Bank of Denver v. First Interstate Bank of Denver.
The high court is expected to rule on the case, which could set new parameters for aiding-and-abetting liability in securities transactions, next spring.
The case revolves around the 1989 default of two issues of tax-exempt municipal bonds sold in 1986 and 1988 by the Colorado Springs-Stetson Hills Public Building Authority. The bonds were backed by land that was required under the bond indenture to have an appraised value of at least 160% of the outstanding principal and interest on the bonds.
The issuer, however, misstated the value of the land in the official statement, Gersh said. Central Bank, the bond trustee, made matters worse by failing to insist on an independent review of a tainted land appraisal or to demand a new appraisal Prior to the issuance of the second set of bonds, Gersh said.
But Central Bank's lawyer, Tucker K. Trautman, argued that the bondholders sued his client simply because the bank "was around the transaction, was there, and had deep pockets." Central Bank "did not engage in any deceptive or manipulative practices," Trautman said.
In suing the bond trustee, the bondholders alleged that Central Bank had aided and abetted the issuer in violating Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission's Rule 10b-5, which are widely used to prosecute securities fraud.
Trautman argued that the bondholders had no standing to sue because Congress never intended Section 10(b) to be used by private individuals. Deputy U.S. Solicitor General Edwin S. Kneedler disagreed, saying that lawsuits brought by individuals under Section 10(b) constitute "a process so embedded [in securities law] that it should not lightly be overturned."
In deciding suits brought under Section 10(b), the courts have generally required plaintiffs to prove "scienter," or the intent to defraud. But federal courts have been split on the issue of whether recklessness is sufficient to satisfy the scienter requirement.
In the Central Bank case, the U.S. District Court for the District of Colorado ruled that under federal securities law and SEC regulations, recklessness alone is not enough to meet the scienter requirement for aiding-and-abetting liability, unless trustees are shown to have had an additional duty to disclose material facts.
However, the U.S Court of Appeals for the 10th Circuit said that when a defendant takes action to assist a violation of the securities law, recklessness is sufficient to satisfy the scienter requirement for aiding-and-abetting liability. Because Central Bank delayed seeking another land appraisal, the appeals court said the district court should reevaluate the case to determine whether the bank's action was reckless, and thus indicative of aiding and abetting fraud.
In questioning the lawyers who appeared before them yesterday, several justices grappled with the issue of whether reckless behavior is enough to constitute aiding and abetting an act of fraud.
Justice Antonin Scalia said it appeared that there would have to be a certain amount of forethought and planning for aiding and abetting to occur. "I don't know how you could aid and abet recklessly," he said.
If the justices embrace the recklessness standard, it would mean that peripheral participants in a bond deal would find that their liability under the fraud statutes would increase, said Amy K. Dunbar, the director of governmental affairs for the National Association of Bond Lawyers.
"If they find recklessness is adequate for scienter, then the scope of the application of aiding-and-abetting liability will be expanded to incorporate a much broader group of municipal finance participants," Dunbar said.
