Stern v. American Bankshares Corp.

District Court, E.D. Wisconsin
429 F. Supp 818 (1977)

ELI5:

Rule of Law:

To state a claim for aiding and abetting a securities law violation, a plaintiff must allege that the defendant had knowledge of the fraud (or acted so recklessly that knowledge may be imputed) and either (a) actively participated in the transaction to assist the primary violator, or (b) failed to disclose the fraud in breach of a specific duty to disclose owed to the plaintiff.

Facts:

A plaintiff purchased securities from American Bankshares Corporation.
Prior to the purchase, agents of American Bankshares allegedly made materially false communications and omitted material facts to the plaintiff.
The individual defendants were principal officers and/or directors of American Bankshares Corporation and/or its affiliate, American City Bank.
The plaintiff executed a promissory note to American City Bank to finance the stock purchase.
Subsequently, American City Bank was declared insolvent.
The Federal Deposit Insurance Corporation (FDIC) was appointed as receiver for the bank.
The plaintiff's note was sold by the FDIC, in its capacity as receiver, to the FDIC in its separate corporate capacity.

Procedural Posture:

Plaintiff filed a complaint in the U.S. District Court for the Eastern District of Wisconsin against American Bankshares Corporation, American City Bank, individual officers and directors, and the FDIC as receiver.
The complaint asserted claims of primary securities law violations, as well as secondary liability under 'controlling person' and 'aiding and abetting' theories.
Multiple defendants filed motions to dismiss the complaint under Federal Rules of Civil Procedure 12(b)(6) for failure to state a claim and 9(b) for failing to plead fraud with particularity.
The FDIC, in its capacity as receiver, also moved to dismiss the plaintiff's request for a declaration that a promissory note was null and void.

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Issue:

Does a complaint sufficiently state a claim for aiding and abetting a securities law violation against corporate officers and directors if it alleges they knew of material facts and failed to disclose them, without also alleging they had knowledge of the fraud itself or a specific duty to disclose to the plaintiff?

Opinions:

Majority - Warren, District Judge

No. A complaint for aiding and abetting a securities law violation is insufficient because it must allege more than a defendant's knowledge of underlying material facts and subsequent failure to disclose. The plaintiff must allege that the defendant possessed the requisite scienter—knowledge of the actual fraud or recklessness toward it—and provided substantial assistance to the primary violator. The court reasoned that substantial assistance can be shown in one of two ways: either through active participation in the fraudulent transaction or through a failure to act (i.e., non-disclosure) when the defendant had an independent duty to disclose the fraud to the plaintiff. Here, the complaint was deficient because it alleged only that the individual defendants knew of the 'material facts,' not the 'fraud,' and it failed to plead any basis for a duty owed by these defendants to disclose those facts to the plaintiff. Pleading mere participation does not, by itself, create a duty to disclose.

Analysis:

This case is significant for articulating a clear pleading standard for aiding and abetting liability in securities fraud in the wake of the Supreme Court's decision in Hochfelder, which left the issue open. By creating a two-pronged test for 'substantial assistance'—distinguishing between active participation and a breach of a duty to disclose—the court requires plaintiffs to be more precise in their allegations. This framework prevents plaintiffs from broadly suing secondary actors like officers or directors without alleging their specific knowledge of the fraud and the precise nature of their assistance. It solidifies the requirement of pleading scienter for aiding and abetting claims and clarifies that mere inaction is only culpable when there is a pre-existing duty to act.

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