WASHINGTON -- The Supreme Court will consider later this month whether to review an appeals court ruling that municipal bond lawyers say adversely broadens their liability under the antifraud provisions of securities law.
If the ruling by the U.S. Court of Appeals for the Third Circuit is allowed to stand, attorneys would face enormous liability for securities fraud under Section 10(b) of the Securities Exchange Act of 1934, even though the law does not explicitly recognize such liability, the National Association of Bond Lawyers said.
The bond lawyers asked the high court late last month to take the case in a petition joined by a group of high-powered law firms, led by Skadden, Arps, Slate, Meagher & Flom. The court is scheduled on Oct. 28 to consider reviewing the case, but it is not bound to decide on that date.
The case, Arvey, Hodes, Costello & Burman v. Kline and Knops, involves the reliance of two investors on tax opinions issued by the law firm Arvey Hodes, to a client, First Western Government Securities Inc., about its securities program.
The letters from Arvey Hodes to First Western included numerous disclaimers that they were intended for the internal use of First Western, were not to be relied on by third parties, and contained unverified facts about the transactions that were supplied by First Western. First Western specializes in "forward contracts," agreements to buy or sell a specified security on a fixed future date, involving Government National Mortgage Association and Federal Home Loan Mortgage Corp. securities.
Despite the disclaimers, investors Ernest Kline and Eugene Knops relied on the opinion letters when they purchased portfolios of forward contracts from First Western in late 1980 as part of their income tax strategy, Arvey Hodes said. Kline and Knops told the high court that Arvey Hodes knew that First Western disseminated these opinions to its investors.
Kline and Knops entered into pairs, or "straddles," of these contracts when they agreed to buy one security and sell another later, with the difference between the buy and sell terms creating a spread. Buyers of forward contracts, which bear specified interest rates, bias the spread according to where they think interest rates will go.
Kline and Knops, under terms of their agreements with First Western, canceled obligations before the settlement date and took tax deductions against ordinary income for resulting losses they incurred. Arvey Hodes, in its opinion letters, had concluded that such losses were deductible in the year in which the contract ended.
But the IRS, which had been investigating First Western and its forward contracts program, disallowed the deductions.
As a result, the investors sued Arvey Hodes for misleading them with false "factual" statements about the forward contracts program and for omitting material information such as the IRS investigation.
The federal appeals court largely upheld a U.S. district court ruling in finding that investors like Kline and Knops could reasonably have relied on Arvey Hodes' legal opinions if they lacked the sophistication or information needed to assess First Western's actual trading patterns.
The association's bond lawyers said the appeals court ruling, which conflicts with other circuit court decisions, could change the accepted pattern of investor reliance on legal opinions by member attorneys in connection with issuance of municipal bonds and could raise issuers' legal fees, despite the inclusion of disclaimers.
The case is of "extraordinary importance to both lawyers and their clients," the bond lawyers told the high court.
Arvey Hodes said the lower court ruling would force law firms and other professionals to disclose facts of potential interest to investors as if they were writing "a comprehensive offering prospectus for investors' use, rather than an opinion for its client addressing a limited legal issue."
The costs of factual investigations required under the lower court ruling would be costly for issuer clients and would make lawyers overcautious in their opinions, resulting in an excessive deterrence of activity that is lawful, the bond lawyers said.
They argued that the Third Circuit decision "attempts to limit the guidance" provided by the high court in its ruling last April in Central Bank of Denver v. First Interstate Bank, which held that there is no civil liability for aiding and abetting under Section 10(b).
The Central Bank decision was based on a narrow reading of the law, rather than policy considerations, the bond lawyers said. But the Third Circuit ruling would expand Section l0(b) liability to cover professionals, even though the law "clearly does not recognize civil liability for professionals in these circumstances," they said.