LIABILITY IN SECURITIES FRAUD DAMAGE ACTIONS: Part VIII – The Implications of Stoneridge
Since Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc., No. 06-43 will determine the parameters of a securities fraud cause of action in damage cases, it may be the most significant securities law decision in years for all of those who deal with public companies. The key question the Court will decide is just how far antifraud Section 10(b) goes – does it cover, for example, only those directly responsible for a fraud, those who were also key participants or perhaps others who knew about it and without whose participation it could not go have occurred? Stated differently, does the Section only cover the company and its insiders or can others be liable such as outside auditors, lawyers and even vendors?
At least three key factors will impact the Supreme Court’s decision. First, Stoneridge is rooted in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 511 U.S. 164 (1994) and a long line of Court decisions on which that case is based such as Santa Fe Industries v. Green, 430 U.S. 462 (1977), Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) and Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). In each of those cases, as the Court did this last term in Tellabs (which will be discussed in the next segment of this series), the Court hewed closely to the literal text of the statute. Indeed, the Central Bank opinion is little more that a reading of the statute to determine that the phrase “aiding and abetting” does not appear in the text. In view of this approach, it is little wonder that the Central Bank Court called terms its conclusion “unremarkable.”
Those cases however, stand for more than just simple text reading. An underlying current is the concern for what is frequently called the “vexatious” nature of securities litigation and the lack of certainty which can be caused by those cases for business leaders in directing the activities of their companies. It is this quest for certainty which translated into the so-called bright line test after Central Bank. No doubt these themes will emerge in Stoneridge.
These themes will also be apparent in the way the facts of the case are viewed. The Eighth Circuit, for example, viewed the transaction in which plaintiffs sought to hold the third-party vendor defendants liable in Stoneridge as a legitimate business transaction despite the fact that the complaint alleged that at a minimum it had a sham component (the inflated cost for the TV set top boxes) which was used by the company as a key part of its fraudulent scheme. In re Charter Commc’n, Inc., Sec. Litig., 443 F.3d 987 (8th Cir. 2006). If the Supreme Court views the transactions in Stoneridge in a manner similar to the Eighth Circuit, the application of the Central Bank themes should leave little doubt about the outcome.
In contrast, if the Court decides to hear the Enron case (Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (5th Cir. 2007); Pet. For Cert. filed, 75 U.S.L.W. 3557 (March 5, 2007) (No. 06-13)), the view of the transactions may be different. In that case, petitioners have argued that the third party-bank defendants engaged in sham transactions with Enron and knew that the company had been cooking the books for years. Such a view of the facts could cause the Court to draw a line similar to the one adopted by Judge Kaplan in In re Parmalat Sec. Litig., 376 F. Supp 2d 472 (S.D.N.Y. 2005), essentially putting legitimate business transactions misused by a company to commit fraud outside Section 10(b), but those which are complete shams inside the scope of the antifraud provision.
A final point of consideration is the composition of the Court. In Stoneridge, Chief Justice Roberts and Justice Breyer have recused themselves. This leaves three Justices from the Central Bank majority (Justices Kennedy, Scalia and Thomas) and three from the dissent (Justices Stevens, Souter and Ginsburg). Under these circumstances Justice Alito will be the swing vote. In Tellabs, Inc. v. Makor Issues & Rights, Ltd., No. 06-484, 2007 WL 1773208 (June 21, 2007), Justice Alito concurred with the majority but argued for a test of “strong inference” of scienter which was the most conservative on the Court. This suggests a narrow decision.
In contrast, if the Court hears Credit Suisse, it appears that, for now, all of the Justices will participate in the decision. This changes the composition of the Court and may alter the outcome.
As Stoneridge is argued and moves to decision next term, no doubt many groups will be watching closely. The stakes in this case are very high. The Court’s decision will in many ways define the future course of securities damage cases in a manner that no court decision in years has done. At the same time the case will have a significant impact on the business community and all those who interact with public companies.
This series is reviewing three key case and their impact on securities fraud damage actions – Stoneridge, Tellabs and Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005). This concludes the segment on Stoneridge. Next, Tellabs.