The Supreme Court on Tuesday handed a solid win to third-party defendants in securities litigation — including law firms, accountants and bankers — by shielding them from broad “scheme liability” for their tangential role in corporate fraud.
The victory came in the much-awaited case of Stoneridge Investment Partners v. Scientific-Atlanta Inc. and Motorola Inc., in which investor groups that sued the cable operator Charter Communications for fraud also pursued the companies that sold cable boxes that figured in some of Charter’s fraudulent transactions.
By a 5-3 vote, the Court said that because investors victimized by Charter did not rely on any statements or omissions made by the vendors Scientific-Atlanta and Motorola, the vendors could not be held liable under Section 10(b) of the Securities Exchange Act of 1934.
The ruling, authored by Justice Anthony Kennedy, may curb what business defendants have portrayed as a relentless search by plaintiffs for alternative deep pockets in securities class actions when the main company involved has collapsed. One such piece of litigation, by Enron investors seeking billions in damages from bankers and Wall Street firms that did business with Enron, may be directly affected by Tuesday’s ruling.
“The proper way to look at it, I think, is that the Enron case is dead after today,” says Ted Frank of the American Enterprise Institute. Mayer Brown’s Stephen Shapiro, who won the case for respondents Scientific-Atlanta and Motorola, was happy with the decision and said it should not be viewed as a loss for investors. “It is a win for investors, because suits like this one take money from one group of investors at the expense of another group of investors, with big rake-offs for lawyers. And it is a win for the U.S. economy.”
John Engler, president of the National Association of Manufacturers, said in a statement, “The petitioners in this case were seeking an opening to go far beyond the law in search of deep pockets, and we really don’t need any more of that in our country. This decision will prevent creeping liability in this area of securities law.”
Lawyers representing investor-plaintiffs attacked the Court for succumbing to overblown corporate complaints and also cautioned that the ruling leaves the door open for suits against third parties, especially financial institutions, in some circumstances.
Stanley Grossman, a partner at Pomerantz Haudek Block Grossman & Gross in New York who represented Stoneridge, says bankers, lawyers and others who are directly involved in a corporation’s fraud should feel “little comfort.”
Steven Toll, a plaintiffs litigator in class actions at Cohen, Milstein, Hausfeld & Toll in Washington, says the Court took too narrow a view of “reliance,” when in the case before the Court, investors relied on financial statements by Charter that had been rendered false by its transactions with the vendors.
“The Supreme Court’s decision is yet another unfortunate example of the pro-business, anti-investor sentiment of a majority of judges on the Supreme Court,” says Toll.
The Stoneridge case took on larger-than-life proportions as it made its way before the Supreme Court, with some commentators billing it as the Roe v. Wade of securities law. Intrigue increased when Chief Justice John Roberts Jr. recused in the case, and then rejoined it — apparently after selling stock in Cisco, which is Scientific-Atlanta’s parent company. Justice Stephen Breyer, who also reported owning Cisco stock and apparently did not sell it, remained out of the case. Adding to the mix was conflicting pressure on Solicitor General Paul Clement — first from the Securities and Exchange Commission to side with investor-plaintiffs, and then from President George W. Bush and other top administration officials to side with corporate defendants. Clement ultimately filed a brief favoring the defendants.
But as important as Stoneridge was, it was also just the latest in a series of recent rulings by the high court that have raised the bar for securities class actions.
“Stoneridge completes the trifecta of recent securities fraud cases before the Supreme Court that have been decided in favor of business,” said Lisa Wood, a securities litigator at Foley Hoag in Boston, in a statement. She added that the ruling will “help relieve a huge amount of anxiety on the part of professional service providers working for public companies.”
The other rulings she referred to were last year’s Tellabs Inc. v. Makor and Dura Pharmaceuticals v. Broudo in 2005, which tightened pleading and causation standards for securities class actions, respectively.
Kennedy, the Court’s swing vote, was joined by Roberts and Justices Antonin Scalia, Clarence Thomas and Samuel Alito Jr.
Kennedy’s majority opinion displayed the Court’s distaste for class actions, asserting that expanding causes of action in securities litigation “would allow plaintiffs with weak claims to extort settlements from innocent companies.”
Kennedy also voiced policy concerns that “overseas firms with no other exposure to our securities laws could be deterred from doing business here. … That, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets.”
But third parties with unclean hands are, Kennedy cautioned, still subject to prosecution by the SEC and other kinds of civil litigation. Congress, Kennedy said, had decided that the SEC, not civil litigation, should be the arena in which third parties in fraud should be handled.
Justice John Paul Stevens, joined by Justices David Souter and Ruth Bader Ginsburg, dissented. Stevens criticized the majority’s “mistaken hostility towards the 10(b) private cause of action.” He invoked the old common law rule that “every wrong shall have a remedy” and even cited a 1980 decision by the 2nd U.S. Circuit Court of Appeals, Leist v. Simplot, written by Judge Henry Friendly during the year that Roberts, now chief justice, clerked for Friendly. In that decision, Friendly reviewed the history of implied causes of action in securities and other laws.
