WASHINGTON - It has been a good rule of thumb: To be held liable for aiding and abetting a securities fraud violation, an individual or a firm must be found to have acted with an express intent to deceive, manipulate, or defraud.

But that may change within the next year when the U.S. Supreme Court takes up Central Bank of Denver v. First Interstate Bank of Denver, a case that sprang from a municipal bond default.

Central Bank was the indenture trustee for the bonds, which were issued by a Colorado Springs building authority. The bank claims it complied with all its indenture duties, but nonetheless was sued by bondholders who said the bank should have let them know there were questions about the adequacy of a land appraisal.

The case is attracting widespread interest because the justices could use the dispute to make it easier for plaintiffs to win suits against bond underwriters, trustees, and others involved in bond sales.

"There's a lot at stake," said William Fitzpatrick, general counsel of the Securities Industry Association. "The lower you cut the criteria, the easier it is to sue somebody."

The court will hear arguments and issue a decision in the dispute during its 1993-94 term, which begins Oct. 4. No date has been set for oral arguments.

The issue of most interest to market participants is whether recklessness, as opposed to actual knowledge, satisfies the so-called scienter requirement for liability. The scienter requirement typically has meant that a defendant had to know he was aiding and abetting fraud before being held subject to legal liability.

Recklessness, by contrast, would mean that a defendant could be held liable for an aiding and abetting charge even if he did not intentionally do anything wrong. Instead, a court could find him liable if he acted with reckless disregard for the potential harm his actions could cause.

But before the court decides that issue, it first will need to address the threshold question of whether plaintiffs have an implied right to sue bond underwriting participants for allegedly aiding and abetting securities fraud.

Federal securities law does not specifically authorize such suits, but lower courts have inferred from the general tenor of the Securities Exchange Act of 1934 an implied cause of action under the law's Section 10(b) and the Securities and Exchange Commission's Rule 10(b)5.

Securities industry lawyers say the high court is likely to find an implied right to sue, especially given recent precedent. For example, the court two terms ago found an implied statute of limitations for 10(b)5 violations.

And last term, the court said defendants in securities fraud cases and the companies that insure them may attempt to force people who advised the defendants, such as lawyers and accountants, to compensate them for damages arising from allegedly fraudulent underwritings. The court found an implied right to bring such suits even though federal law does not authorize them.

"At this point in time, it's hard to see why the court wouldn't follow [those cases] and spell it all out, find an implied right to sue," one lawyer said.

Assuming the justices do find a right to sue, they then would turn their attention to the question of whether a finding of recklessness satisfies the scienter requirement, an issue that has divided lower courts.

"What the plaintiffs' bar has attempted to do is whittle down scienter to more of a negligence standard," said Fitzpatrick of the securities association. "It's a lot more difficult to prove that someone knowingly did something wrong" than it is to show that someone acted without adequate consideration of the consequences, he said.

If the court decides that recklessness is sufficient to trigger liability, then the litigation floodgates would open, driving up issuance costs, securities lawyers say.

But don't expect underwriting professionals to eat the added cost. "Usually, that gets passed on to the public," Fitzpatrick said. "Otherwise, you wouldn't be talking about a Supreme Court case. You'd be talking about bankruptcy court."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.