Quantcast
Home / News / Defrauded investors can’t sue third party vendors

Defrauded investors can’t sue third party vendors

WASHINGTON – The U.S. Supreme Court recently decided that defrauded stockholders couldn’t sue third parties under the Securities Exchange Act because they failed to establish the reliance necessary for liability under the Act.
This ruling, coupled with the court’s decision not to consider a similar suit stemming from the Enron scandal, has given a double defeat to investors.
A day after the opinion in Stoneridge Investment Partners v. Scientific-Atlanta Inc., No. 06-43, was handed down, Enron investors, citing “critical differences between Enron and Stoneridge,” petitioned the Supreme Court to distinguish the holding so as not to bar their pending suit against the Wall Street banking firms they say colluded with Enron officials. That class action, California Regents v. Merrill Lynch, 06-1341, sought billions from large banks and investment firms that dealt with Enron before the company’s collapse in 2001.
But the court declined to reconsider a 5th Circuit decision which barred the case from proceeding as a class action, ending the investors bid for restitution against the bankers.
Both decisions were cheered by pro-business groups.
“The high costs of frivolous litigation in the U.S. [is] putting future investments in our markets at risk,” said Tom Donohue, president and CEO of the U.S. Chamber of Commerce. “This [is] a positive step for investors and all those concerned about America’s competitive disadvantage in the global marketplace.”
Jeff McFadden, a partner in the Washington, D.C. office of Steptoe & Johnson, said the Stoneridge decision recognized that expanding §10(b) of the Security Exchange Act beyond its intended scope was not the way to give investors recourse against third party wrongdoer.
“The court’s decision is eminently reasonable and takes a very common-sense approach to the question of whether the plaintiffs could ever satisfy all of the elements of a §10(b) claim against secondary actors,” McFadden said. “As the court recognized, those elements are there for a reason: To draw a clear, public-policy line of demarcation between those causally linked to the harm and those who are not.”

Financial scheme

The Stoneridge case stems from an action by investors of the cable company Charter Communications, Inc., which fraudulently inflated its financial numbers by overpaying Scientific-Atlanta and Motorola for cable boxes so that the companies could use the extra money to buy advertising with Charter. The scheme allowed Charter to boost its revenue by about $17 million.
The investors sought to impose liability under the Securities Exchange Act against the vendors for their role in the scheme, even though the vendors never made a false or misleading statement to the market.
The court ruled they could not use §10(b) of the Act to do so because no reliance on the third parties was demonstrated.
“Reliance by the plaintiff upon the defendant’s deceptive acts is an essential element of the §10(b) private cause of action,” Justice Anthony Kennedy wrote in the 5-3 opinion. (Justice Stephen Breyer recused himself from the case because he owns stock in the parent company of one of the parties.)
But here, Kennedy said, the vendors “had no duty to disclose and their deceptive acts were not communicated to the public. No member of the investing public had knowledge, either actual or presumed, of [vendors’] deceptive acts during the relevant times.”
The court also rejected the investors’ suggestion of “scheme liability,” for which they claimed no public statement was necessary.
“Were this concept of reliance to be adopted the implied cause of action would reach the whole marketplace in which the issuing company does business; and there is no authority for this rule,” Kennedy wrote. “It was Charter, not [the vendors], that misled its auditor and filed fraudulent financial statements. Nothing respondents did made it necessary or inevitable for Charter to record the transactions as it did.”
Justice John Paul Stevens dissented from what he called “the court’s continuing campaign to render the private cause of action under §10(b) toothless.” His dissent was joined by Justices Ruth Bader Ginsburg and David Souter.

Leave a Reply

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

*