On January 22, 2008, the immediate impact of Stoneridge began to emerge: The Court entered an order denying certiorari in in the Enron litigation (Regents of the Univ. of Calif. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (5th Cir. 2007)). Accordingly, the Fifth Circuit’s narrow interpretation of Section 10(b) and the reliance element necessary to plead and prove a private damage action for fraud under that section was left standing. At the same time, the Court granted certiorari and then reversed and remanded the decision in the Homestore case (Simpson v. AOL Time Warner, Inc., 482 F.3d 372 (5th Cir. 2007)). This order reversed the ruling of the Ninth Circuit, which had adopted a version of the SEC’s scheme liability theory and the court’s broad reading of reliance under the fraud-on-the-market theory set forth in Basic Inc. v. Levinson, 485 U.S. 224 (1988).
The rulings in Enron and Homestore reiterate the focused, narrow, pro-business nature of the Supreme Court’s ruling in Stoneridge. At the same time, it would be a mistake to view the decision as a simple constriction of Section 10(b). Stoneridge is carefully crafted to preserve the scope of the remedy under Section 10(b), while effectively drawing a bright line test similar to that used by the Second Circuit to give business certainty of application. At the same time, the decision, when read in conjunction with the Court’s earlier opinions in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007) and Dura Pharmaceuticals. v. Broudo, 544 U.S. 336 (2005) suggests that issuers should carefully consider and evaluate how they disclose transactions in the future.
Initially, Justice Kennedy, in writing for the Court, took great care not to restrict the scope of Section 10(b) or Rule 10b-5. The issue presented to the Court for decision focused on whether certain conduct fell within the parameters of the Section. This approach is consistent with the decision by the Eighth Circuit, which had constricted the scope of the Exchange Act’s catch-all antifraud provision.
The approach of the Eighth Circuit, however, was specifically rejected by the Stoneridge Court. By rejecting any constriction of the Section and turning the issue for decision into one of reliance, the Court carefully preserved the enforcement prerogatives of the SEC, while limiting the scope of private damage actions. Any constriction of Section 10(b) would restrict the ability not only of private plaintiffs, but of the SEC to bring fraud enforcement actions. This point was made clear by the ruling in Central Bank of Denver v. First Interstate of Denver, 511 U.S. 164 (1994), which rejected aiding and abetting liability in a private damage action, but, because it was based on a reading of the Section, required Congressional action the next year with the adoption of Exchange Act Section 20(e) to restore the ability of the Commission to bring suits based on an aiding and abetting theory.
Enforcement of the antifraud provision is a key theme of the Stoneridge Court. One of the Court’s key themes is that investors will still have protection in securities transactions because the SEC has the ability to police the markets. While this is clearly true, it undercuts the SEC frequently argued position that private damage actions are a necessary adjunct to its enforcement program.
A second key to Stoneridge is its impact on private damage actions. By constricting the reliance element and inverting it, the Court, in effect, gave business the bright line test the Second Circuit sought to develop in cases like Shapiro v. Cantor, 123 F.3d 717 (2nd Cir. 1997) and which business groups have long argued must be adopted. The Court’s reliance ruling views that element from the vantage point of the potential defendant, rather than the investor. In contrast, traditionally reliance and the fraud-on-the-market theory focused on what the investor knew or could know, presuming that disclosed material information is absorbed in the price and thus “known” and relied on by the investor.
Under Stoneridge, however, the reliance question is recast to focus on what the potential defendant might know or reasonably be expected to know about the disclosure of their conduct into the market place. That theory – really a transaction causation ruling rather than reliance – is then fortified with a policy decision: the Court simply concluded that third-party vendors are too remote from the actual securities transaction to be held liable as a primary violator. This conclusion refocuses private damage actions on the core securities transaction. See also Credit Suisse Securities (USA) LLC v. Billings, 550 U.S. ___, (June 18, 2007) (holding that there is implied antitrust immunity for IPO transactions based on the pervasive regulation of securities transactions by the SEC and the securities laws).
Finally, the decisions in Stoneridge, Tellabs, and Dura suggest that issuers carefully evaluate their disclosures. While Stoneridge draws a bright line test for issuers, it is based on the inverted reliance test, keyed to what is known about a defendant in the marketplace. Tellabs permits courts to consider SEC filings on a motion to dismiss, a position that some, but not all courts had adopted prior to the case. Dura ties loss causation to the emergence of the truth, which frequently comes from an issuer disclosing facts about a transaction alleged to have been used to falsify the financial statements. Read together, these pro-business rulings put a premium on what issuers disclose. For example, when an issuer discloses details about a specific transaction with third with third parties in the MD&A discussion that later turns out to have been booked improperly, the disclosed facts may be sufficient to bring the third-party within the bright line of Stoneridge and the Dura test. While this topic will be explored in detail in the future, for now suffice it to say that this pro-business trilogy of Supreme Court cases clearly places a premium on disclosure by issuers.
