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Los Angeles-Vendors, lawyers, accountants and other secondary players in alleged shareholder actions must have committed independent acts of fraud to be sued as primary violators under the Securities Exchange Act, according to a recent 9th U.S. Circuit Court of Appeals ruling. The ruling is one of only two federal circuit decisions to clarify the issue of who may be held liable for having engaged in a scheme to defraud shareholders, other than a defendant company and its officers. T. Jeffrey Simpson v. AOL Time Warner Inc., No. 04-55665 (9th Cir.). Both rulings sought to clarify a 1994 U.S. Supreme Court decision that said private parties are not allowed to sue secondary players who aid and abet alleged fraud, but that the same secondary players could be proven to be primary violators. Central Bank of Denver N.A. v. First Interstate Bank of Denver N..A., 511 U.S. 164. In the wake of corporate scandals such as Enron, district courts nationwide have ruled various ways in interpreting the Supreme Court’s decision. The 9th Circuit, in its decision issued on June 30 in a shareholder case involving vendors to online real estate seller Homestore, carved out circumstances in which secondary players are liable for involvement in a securities fraud scheme. “If you’re a third party and your conduct is misleading only when it is funneled through the conduct of someone else, that’s aiding and abetting by another name,” said Lawrence Robbins, a partner at Washington-based Robbins, Russell, Englert, Orseck & Untereiner, who filed an amicus brief in the 9th Circuit case on behalf of the American Institute of Certified Public Accountants. “You have to have done something which by itself has the effect of being misleading by shareholders. That is a helpful development for people defending these cases.” Since Central Bank, district courts have attempted to clarify what constitutes primary liability, as opposed to aiding and abetting, under the Supreme Court’s definition. In April, the 8th U.S. Circuit Court of Appeals said Charter Communications Inc.’s vendors were not primary violators under Central Bank because they did not make fraudulent misstatements to investors. In re Charter Communications Inc. Securities Litigation, No. 05-1974. In the 9th Circuit case, the vendors are alleged to have engaged in sham round-trip transactions that provided revenue for Homestore’s financial reports. Homestore, an online real estate company now called Move Inc. that restated millions of dollars in revenues four years ago, paid about $71 million to settle the underlying shareholder suit in 2003. Last month, the company’s former chief executive, Stuart Wolff, became the 11th former executive at Homestore to plead guilty or be convicted on charges related to the accounting misstatements. Partners dismissed In the shareholder suit, a district judge in Los Angeles, relying on Central Bank, granted a motion to dismiss the case against other defendants that were business partners to Homestore. On appeal were six defendants: AOL Time Warner Inc., now Time Warner Inc., and two of its officers; Cendant Corp. and one of its officers; and L90, now called MaxWorldwide Inc. The 9th Circuit said that the defendant’s conduct must be viewed on its own to determine whether it constitutes a primary violation. Defense lawyers praised the similarities between the recent appellate decisions. “The two decisions are really very consistent with each other,” said Daniel Tyukody, a partner in the Los Angeles office of Orrick, Herrington & Sutcliffe who represents MaxWorldwide. But unlike the 8th Circuit, the 9th Circuit refused to restrict primary liability to defendants who make material misstatements. Instead, the court left a roadmap for plaintiffs’ lawyers to use in proving primary liability against secondary players in future shareholder cases, said Nancy Fineman, a partner at Cotchett, Pitre, Simon & McCarthy, who represents the California State Teachers’ Retirement System, the lead plaintiff in the Homestore case. “The 9th Circuit recognizes that people who want to defraud shareholders think of novel ways to accomplish that goal, so the Securities Act can’t be read restrictively, but broadly,” she said.

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