ESG Capital v. Venable LLP, a lesson in Rule 10(b)5

In ESG Capital v. Venable, — F.4th — (9th Cir July, 2016), a “group of investors” formed a limited partnership expecting to buy some Facebook shares before the company went “public.” It entered into a contract with a guy who basically stole their money then disappeared.  The investors sued the individual as well as his attorney, Venable LLP.  The investors alleged that Venable violated Rule 10(b)5 as well as “nonfraud state law claims for conversion, unjust enrichment, unfair competition, aiding and abetting fraud, and conspiracy to commit fraud.”  The Firm filed a Motion to Dismiss, FRCP 12(b)(6), and after one amendment, the district court dismissed the case with prejudice.

A couple of weeks ago the 9th Circuit reversed sending the case back to the district court for trial.  You can watch oral argument at the 9th Circuit here.  The 9th Circuit said

To state a federal securities fraud claim, in violation of § 10(b), a plaintiff must show: “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” Thompson v. Paul, 547 F.3d 1055, 1061 (9th Cir. 2008) (quoting Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 157 (2008)).

Section 10(b) is the general anti-fraud provision of the Securities Exchange Act of 1934. 15 U.S.C. § 78j(b). Its requirements operate in conjunction with Securities and Exchange Commission Rule 10b–5.

As this court has explained,

Section 10(b) of the Exchange Act of 1934, 15 U.S.C. § 78j(b), makes it unlawful “for any person . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe[.]” SEC Rule 10b–5, promulgated under the authority of section 10(b), in turn, provides:

It shall be unlawful for any person . . . (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b–5.

The attorney could be liable if he made a false statement.  That is an issue of fact and Plaintiff’s have the right to try to prove that.  The firm would be liable for omitting to disclose a fact only if there is a duty to disclose.  Did the attorney have a duty to disclose something to the buyers?     The court said that “An attorney who undertakes to make representations to prospective purchasers of securities is under an obligation, imposed by Section 10(b), to tell the truth about those securities.”   The attorney  “had an independent legal duty to the plaintiff, or an attorney who went beyond a professional duty as part of a conspiracy for the attorney’s financial gain.”

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