WASHINGTON - The Supreme Court agreed yesterday to decide whether federal securities law allows bondholders to sue bond trustees for allegedly aiding and abetting a bond-fraud scheme.
If such lawsuits are permitted, the justices indicated that they also would decide whether recklessness by bond trustees is sufficient to trigger fraud liability even if the trustees have not breached their indenture duties.
No date was announced for oral arguments in the case, Central Bank of Denver v. First Interstate Bank of Denver. However, the justices are not scheduled to hear arguments until the 1993-94 term begins on Oct. 6. The court's 1992-93 term is expected to close by the end of this month.
The dispute arose in the aftermath of the 1989 default of two issues of tax-exempt municipal bonds issued in 1986 and 1988 by the Colorado Springs-Stetson Hills Public Building Authority.
Bondholders sued Central Bank, the bond trustee, charging that the bank did not insist on an independent review of a tainted land appraisal or demand a new appraisal prior to the issuance of the second set of bonds. 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.
Bondholders charged that Central Bank knew or should have known that the appraisal was inflated, but decided to postpone another appraisal until after the 1988 bonds were issued.
Section 10(b) of the Securities Exchange Act of 1934 and tne Securities and Exchange Commission's Rule 10b-5 are widely used to challenge alleged securities fraud. In general. plaintiffs are required to prove "scienter," or the intent to defraud, as an element of their case. But federal courts have been split on the issue of whether recklessness is sufficient to satisfy the scienter requirement.
The U.S. District Court for the District of Colorado ruled that under federal securities law and SEC regulations, the scienter requirement for aiding-and-abetting liability "may not be satisfied by showing recklessness" unless trustees are shown to have had an additional duty to disclose material facts.
The U.S. Court of Appeals for the 10th Circuit agreed that Central Bank owed bondholders no duty to disclose. The appeals court said that under the federal Trust Indenture Act of 1939, the bank's duties as bond indenture trustee were "strictly defined and limited to the terms of the indenture."
However, the appeals court said, the trust indenture law does not address the "rights, obligations, duties or liabilities" imposed by federal securities laws. Consequently, the bank could be liable for aiding and abetting securities fraud even though it hid no duty to disclose.
The appeals court 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 agreed to delay seeking another appraisal, the appeals court said the district court should look at the case to determine whether the bank's action was reckless. If so, it could be held liable for aiding and abetting fraud, the appeals court said.
In other action yesterday, the Supreme Court agreed to review whether airport user fees assessed against commercial airlines by municipally owned airports are reasonable under federal law.
The justices said they would hear arguments in Northwest Airlines Inc. v. Kent County, Mich., in which Northwest and other major airlines allege that fees at the Kent County International Airport are unreasonable and place an undue burden on interstate commerce in violation of the Constitution's commerce clause. The commerce clause generally prohibits states from imposing barriers to the free flow of goods and services across state lines.
A federal district court and the U.S. Court of Appeals for the Sixth Circuit upheld the fees, prompting the appeal of the airlines to the Supreme Court.
The high court agreed to hear the case even though the solicitor general, the federal government's top courtroom lawyer, urged against review. The solicitor general, invited by the court to file the views of the federal government, said that the case had been properly decided by the lower courts.