Supreme Court Restricts Securities Lawsuits

In one of the most closely watched business cases in years, the Supreme Court on Tuesday upheld protections for secondary players in securities-fraud schemes, as opposed to the primary engineers of those plots.
The court ruled, 5 to 3, against plaintiffs who had sued two cable television equipment suppliers whose dealings with a cable television company had allowed the cable outfit to inflate its earnings and hide its failure to achieve its financial goals.
Although the outcome of the case, Stoneridge Investment Partners v. Scientific-Atlanta, No. 06-43, hinged on terminology that might seem technical and arcane to a layman, the case is likely to be felt far beyond Wall Street, as lawyers for investors and businesses fight over who can be sued and who cannot.
The majority noted that, whatever deception was committed by the defendants, “their deceptive acts were not communicated to the investing public during the relevant times,” and that it was Charter that misled auditors and filed fraudulent financial statements.
The plaintiffs were unable to show any public reliance on the defendants’ actions “except in an indirect chain that we find too remote for liability,” Justice Anthony M. Kennedy wrote for the majority.
The Stoneridge ruling appears to offer protection for accountants, lawyers and others who may know about corporate shenanigans but can establish that they are not directly involved in them. Defense lawyers in shareholders’ suits often complain that defendants can be forced to settle claims with little merit rather than risk prolonged and costly litigation.
“The court held that you are not your brother’s bookkeeper,” said Jerrold J. Ganzfried, a former assistant to the solicitor general and now head of the Howrey law firm’s Supreme Court and appellate litigation group.
A key question in the case decided on Tuesday was whether Scientific-Atlanta and the other defendant, Motorola, were “primary violators” in a sham bookkeeping transaction with Charter, or if they were guilty only of “aiding and abetting” a fraud engineered by Charter.
At the request of Charter, which in mid-2000 was falling short of its cash-flow target, Scientific-Atlanta and Motorola agreed to increase their prices for the cable boxes they sold to Charter and to use the extra money to buy advertising on Charter’s cable stations. The arrangement allowed Charter to treat the advertising purchases as current revenue while listing the money spent on cable boxes as a capital expense.
Four Charter executives eventually pleaded guilty to criminal charges, and Charter paid $144 million to settle a suit brought by Stoneridge on behalf of shareholders.
When the case was argued before the justices on Oct. 9, the lawyer for Scientific-Atlanta and Motorola asserted that, at worst, his clients had aided and abetted Charter’s fraud, and thus should not be liable.
Subtle or not, the difference between a primary violation and aiding and abetting was all-important in the case decided on Tuesday. The reason is that in a 1994 case, Central Bank of Denver v. First Interstate Bank, the Supreme Court ruled that laws governing securities did not provide for any liability for “aiding and abetting.”
Although Congress responded to that decision by giving the Securities and Exchange Commission the authority to bring lawsuits for aiding and abetting, it did not give private plaintiffs the authority to do so.
Any decision to give private litigants the power to sue aiders and abetters “is thus for the Congress, not for this court,” Justice Kennedy wrote. Joining him were Chief Justice John G. Roberts Jr. and Justices Antonin Scalia, Clarence Thomas and Samuel A. Alito Jr.
Lawyers involved in securities litigation said the ruling continues a trend in which the court shows itself “less inclined to finish up legislation for Congress” than earlier lineups of justices, as Bob Pietrzak, co-head of litigation in Sidley Austin’s New York City office put it.
“The court’s decision continues its recognition that expanding the U.S. securities laws beyond the reach expressly intended by Congress is not only legally incorrect but endangers the competitive position of the United States in the global marketplaces,” Mr. Pietrzak said. “Non-U.S. entities can feel more comfortable that doing business in the United States will not have the unintended consequence of exposing them to liability under the U.S. securities laws.”
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