January 17, 2008
In a refreshing act of judicial restraint, the Supreme Court
yesterday resolved one of the most important business cases of this
term. In a 5-3 decision (Justice Breyer recused himself, presumably
because of his stock holdings), the Court in Stoneridge
Investment Partners v. Scientific-Atlanta
ignored the pressure brought by the trial lawyers to engage in
judicial legislation. The Court ignored the call to create by
judicial fiat a new "implied" right for shareholders to sue any
third party that does business with an allegedly corrupt
corporation whose stock the investors own.
Stoneridge deserves significant attention, and yet the general public is largely unaware of it. This is because business- and securities-law cases are often overlooked among the Court's "sexier" and more controversial social and constitutional cases. And yet business law remains an extremely important part of the Court's caseload. Had the Court decided Stoneridge so as to permit investor actions against companies who enter into ordinary business transactions with corporations accused of securities fraud - imagine the company that sold Enron its pens and paper being held liable for the latter company's stock-price manipulation - we would see an exponential expansion of frivolous securities litigation. The prospects of an entirely new class of securities torts, one with an incalculable risk of litigation for anyone doing business with a publicly traded company, would have been disastrous for the U.S. economy - or rather, for everyone except the trial bar.
The facts of the case are as follows: Stoneridge Investment Partners sued cable provider Charter Communications for an accounting fraud that Charter committed near the end of the dot-com bubble in order to boost its reported revenue to meet market analysts' expectations. After four of the company's former employees pleaded guilty to federal conspiracy charges, Charter settled with Stoneridge for $144 million. But Stoneridge also sued Motorola and Scientific-Atlanta, two of Charter's cable-box equipment suppliers, on a re-treaded legal theory that the Court had rejected in its 1994 decision in Central Bank v. First Interstate Bank. The investors who sued in Central Bank had labeled their theory "aiding and abetting liability." The Stoneridge attorneys renamed it "scheme liability."
The Stoneridge investors alleged that Motorola and Scientific-Atlanta charged Charter artificially inflated prices for their cable boxes, then kicked the extra amount back to Charter, ostensibly by "buying" advertising from the cable company. Charter then used this ad income to pad its revenue figures. Even taking these allegations to be true, the Court said, the two suppliers still played no role in Charter's financial statements. This is important, because a plaintiff seeking damages under securities law ordinarily must show reliance on a misrepresentation or omission of material fact-and here there was neither.
So Stoneridge's attorneys argued that Charter's fraudulent financial statement was a "natural and expected consequence" of the two suppliers' deceptive transactions with Charter. If not for these transactions, Charter's accountant would not have been fooled. If the accountant had not been fooled, Charter's financial statement would have been more accurate, and their clients would have been millions of dollars richer. The Supreme Court, however, still clung to the quaint notions of reliance and "law":
In effect [Stoneridge] contends that in an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect. Were this concept of reliance to be adopted, the implied cause of action [for aiding and abetting] would reach the whole marketplace in which the issuing company does business . . . .
The Court concluded succinctly, "[T]here is no authority for
Yesterday's decision should have been unanimous. Congress considered - and rejected - the idea of a private right to sue for aiding and abetting when it passed the Private Securities Litigation Reform Act of 1995 (PSLRA). And this was after the Supreme Court's 1994 decision rejecting an implied right of action for aiding and abetting liability in Central Bank. If Congress really wanted the courts to address aiding and abetting allegations brought by private plaintiffs, it could have said so. Congress instead gave the SEC authority to pursue those who aid and abet securities fraud. If a company genuinely assists a publicly traded company in committing fraud against shareholders, the SEC has adequate authority to sanction them. The bad guys get their due, the policymakers in Congress still get to be the ones who make the law, and the enforcement agents at the SEC - rather than plaintiffs' lawyers chasing a pay day - get to make the decisions about which cases are worth pursuing. The Court's Stoneridge decision shows the proper deference both to Congress and to the SEC.
Stoneridge is a decisive loss for plaintiffs' attorneys. "Scheme fraud" cases would have been a lucrative new business line for the lawsuit industry. Even the threat of such a lawsuit would cause most deep-pocketed companies to settle, thereby avoiding the painful exposure of discovery proceedings. In that respect, the U.S. economy is the big winner. It is also an important victory for the separation of powers, and for those who believe that Congress, rather than the courts, should be making policy. Because this exemplifies the rule of law as opposed to the rule of men, such results should be commonplace. Because they are no longer commonplace, each one should be applauded.
Robert Alt is an NRO contributor, and deputy director of the Center for Legal and Judicial Studies at the Heritage Foundation. Brian Walsh is a senior legal research fellow at the Heritage Foundation.
First appeared in National Review Online