Home / News / High court could expand securities liability

High court could expand securities liability

WASHINGTON – It is rare that a securities liability case, even one before the U.S. Supreme Court, captures such widespread attention that every seat in the court’s press alcove is filled.
But that was the case when the court heard argument Oct. 9 in Stoneridge Investment Partners v. Scientific-Atlanta Inc. (No. 06-43).
And for good reason, since the court could potentially allow defrauded shareholders to not only sue companies, but also their advisers, lawyers and accountants.
Investors in a company that committed fraud are seeking to impose liability under the Securities Exchange Act against the company’s vendors for their role in the scheme – even though the vendors never made a false or misleading statement to the market.
The word “Enron” was never mentioned during the hour-long argument session. But some observers say the case is also about determining what remedies are available for investors who lost millions after the collapse of other high-profile companies.
“What the court is really going to determine is how far liability goes in cases like Enron, Worldcom, or Tyco,” said Wendy Wildung, a partner in the Minneapolis office of Faegre & Benson.

Scheme to boost earnings

Stoneridge stems from a fraudulent plan by cable company Charter Communications. The company, in an attempt to boost earnings numbers for stock purposes, agreed to overpay Scientific-Atlanta and Motorola for cable boxes so the vendors could use the funds to “purchase” advertising. Under the plan, the vendors would essentially get free advertising, while Charter could boost its revenue numbers.
The plaintiffs – Charter investors who were ultimately defrauded in the scheme – sued to hold Scientific-Atlanta and Motorola responsible.
“They were not passive bystanders,” Stanley M. Grossman, the New York City-based attorney representing the investors, argued before the justices. “Their conduct was integral to the scheme.”
Grossman contended: “It would be no different than if Charter went up to [Motorola and Scientific-Atlanta] with a suitcase of cash and said: ‘Buy advertising with it.’”
But Chief Justice John G. Roberts, Jr., indicated he was wary of finding an implied private right of action under the Securities Act against third-party actors.
Although the court has created such rights in the past, Roberts said, it stopped doing so once Congress passed the Act.
“We don’t get into the business of implying private rights of action anymore,” Roberts said. “Isn’t the effort by Congress to legislate a good signal that they have kind of picked up the ball and they are running with it and we shouldn’t?”
Grossman pointed out that Congress had, in part, codified some private rights of action created by the court in the past.
“My suggestion is not that we should go back and say there is no private right of action,” Roberts responded. “My suggestion is that we should get out of the business of expanding it, because Congress has taken over and is legislating in the area in a way they weren’t back when we implied a private right of action.”
But Grossman said there was room for both lawmakers and the courts.
“I would agree, Congress has taken over,” Grossman said. “[But] they had an understanding of what the court believed up to that time [in] holding that there is a private right of action.”
The fact that the cable box vendors may have taken part in the plan simply to get free advertising – not to defraud shareholders – seemed to bother some justices.
“I don’t see … what’s in it for Scientific-Atlantic to defraud the shareholders,” Justice Antonin Scalia said. “They didn’t care what Charter was going to do.”
Justice Anthony Kennedy also expressed concern over the breadth of the remedy being sought.
“There are any number of kickbacks and mismanagements and petty frauds that go on in business, and business people know that any publicly held company’s shares are going to be affected by its profits,” Kennedy said. “So I see no limitation to your proposal for liability.”
Grossman replied: “I think the limitations [are that] there has to be the purpose of furthering a scheme to defraud shareholders [and] the test has an element of materiality.”
Kennedy responded: “I agree with Justice Scalia’s earlier comment. I don’t think that Scientific-Atlanta or Motorola really cared one way or the other about the investors.”
Grossman said, “They may not have cared, but that would be reckless.”
To which Kennedy replied: “But [recklessness is] far different from having a purpose. You said they have to have a purpose.”

Erosion of precedent?

Stephen M. Shapiro, the Chicago-based attorney for the defendants, argued that imposing liability in this situation ignores the requirement that a company must make statements investors rely upon.
He also said imposing liability would “erode” the court’s 1994 holding in Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164, that private parties cannot bring aiding and abetting liability actions under Sect. 10(b) of the Securities Exchange Act.
“It was up to Charter to account for these transactions properly,” Shapiro told the justices, arguing his clients had no duty make any statements to investors. To find liability, at the very least “you have to use deception in connection with securities trading,” he said.
Some attorneys said comments by Roberts and other justices during oral arguments gave a strong indication that the court is not inclined to allow primary liability against third-party actors.
“I thought the comments of the Chief Justice were very compelling,” said Jeffrey McFadden, partner in the Washington office of Steptoe & Johnson.
According to McFadden, while cases such as Enron may have created more interest in this case, that won’t weigh on the minds of the justices.
“It’s not [their] job to provide an implied remedy simply because there are problems out there,” he said. “Congress is [also] fully aware of those problems, and if they want something done about it, they can do something about it.”
Just days before the argument, during a panel discussion at the American Enterprise Institute (AEI) in Washington, D.C., Louis M. Bograd, a senior litigation counsel at the Center for Constitutional Litigation and the principal author of an amicus brief submitted on behalf of the trial lawyers group American Association for Justice, had a different view.
“This should be an easy case,” Bograd said, pointing out that the vendors didn’t just agree to the pricing scheme, but also backdated and falsified documents in order to cover up the plan.
“They were active and knowing participants in a scheme to defraud investors,” he said.
But Ted Frank, director of the AEI Legal Center for the Public Interest – who is also a reputed class member because he owned stock affected by the scheme – said a ruling in favor of the investors would create an impossible situation for businesses.
“How can you police what your [business] partners are doing in terms of their accounting practices?” he asked.
A decision in the case is expected later this term. The case will be decided by only eight justices since Justice Stephen Breyer recused himself.

* * *

Business-related cases before Supreme Court

The U.S. Supreme Court has agreed to review the following cases of interest to in-house counsel:

Age Discrimination
Is the issue of age as a factor in a retirement plan facially discriminatory in violation of the Age Discrimination in Employ-ment Act?
Kentucky Retirement Systems v. EEOC. Docket No. 06-1037. Ruling below: 467 F.3d 571 (6th Cir. 2006).

Does the federal-sector provision of the Age Discrimination in Employment Act prohibit retaliation against employees who complain of age discrimination?
Gomez-Perez v. Potter. Docket No. 06-1321. Ruling below: 476 F.3d 54 (1st Cir. 2007).

Does the Federal Arbitration Act preempt a California state law regulating talent agencies that requires claims be submitted to an administration agency?
Preston v. Ferrer. Docket No. 06-1463. Ruling below: 145 Cal. App. 4th 440 (Cal. Ct. App. 2006).

Civil Rights
Is race retaliation a cognizable claim under 42 U.S.C. §1981?
CBOCS West, Inc. v. Humphries. Docket No. 06-1431. Ruling below: 474 F.3d 387.

Energy Contracts
Can the Federal Energy Regulatory Commission retroactively undo energy contracts absent a showing of public necessity?
Morgan Stanley Capital Group v. Public Utility District 1, Docket No. 06-1457 (consolidated with Calpine Energy Services v. Public Utility District 1, Docket No. 06-1462). Ruling below: 471 F.3d 1053 (9th Cir. 2006).

When a licensee sells products containing patented technology in different combinations, can the patent holder sue for infringement?
Quanta Computer, Inc. v. LG Electronics. Docket No. 06-937. Ruling below: 453 F.3d 1364 (Fed. Cir. 2006).

Does federal law preempt state law in a case alleging the defendant committed fraud on a federal agency?
Warner-Lambert Co. v. Kent. Docket No. 06-1498. Ruling below: 467 F.3d 85 (2nd Cir. 2006).

Leave a Reply

Your email address will not be published. Required fields are marked *