Stoneridge: The Supreme Court’s Ruling and Its Impact: Part 5
The Supreme Court’s decision in Stoneridge is based on a fact pattern which is similar to those in Enron litigation (Regents of the Univ. of Calif. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (5th Cir. 2007)) and the Homestore case (Simpson v. AOL Time Warner, Inc., 482 F.3d 372 (5th Cir. 2007)). Those fact patterns raised the question of whether third-party vendors who participated in a round trip transaction used by the issuer – here, Charter Communications – to falsify its books and defraud its shareholders could be held liable under Section 10(b) and Rule 10b-5. The Eighth Circuit affirmed the dismissal of the suit as to the third-party vendors, rejecting plaintiff’s “scheme liability” argument. In reaching its conclusion, the Circuit Court narrowly defined Section 10(b) deception, limiting it primarily to a misstatement or a failure to disclose where there is a duty to do so. The court went on to note that the defendant must engage in deception or the conduct is simply aiding and abetting. The Court concluded by noting that it was unaware of any case imposing Section 10(b) liability “on a business that entered into an arm’s length non-securities transaction with an entity that then used the transaction to publish a false and misleading statement to investors … .”
The Supreme Court granted certiorari. In doing so, the Court agreed to determine whether Central Bank of Denver v. First Interstate of Denver, 511 U.S. 164 (1994) forecloses a Section 10(b) claim “where Respondents engaged in a transaction with a public corporation with no legitimate business purpose except to inflate artificially the public corporation’s statements, but where Respondents themselves made no statements concerning those transactions.”
Justice Kennedy, writing for the majority, rejected petitioner’s scheme liability arguments. The Court began by noting that if the decision of the Eighth Circuit is read to hold that there is no deception in this case, it is wrong. If, however, the Circuit Court’s opinion is read to mean that there is no proximate cause, then it is consistent with the decision reached by the Court. Essentially, Justice Kennedy recast the holding of the Circuit Court to present the reliance issue, which became the predicate of the Supreme Court’s decision. The Court took this position despite the comment of Chief Justice Roberts during oral argument that the reliance issue had not been squarely presented by the record from the lower court.
Justice Kennedy went on to note that two presumptions are typically used to establish reliance. Under the Court’s decision in Affiliated Ute Citizens of Utah v. United States, 406, U.S. 128 (1972), reliance is presumed if there is a material omission and a duty to disclose. Under Basic Inc. v. Levinson, 485 U.S. 224 (1988), reliance is presumed using the fraud-on the-market doctrine “when the statements at issue become public. The public information is reflected in the market price of the security.” The Court concluded that neither presumption applies here.
Petitioner’s “scheme liability” argument, the Court noted, in effect presumes that investors rely not only on the public statements relating to the security, but also on the transactions those statements reflect. “Were this concept of reliance to be adopted, the implied cause of action would reach the whole market-place in which the issuing company does business, and there is no authority for this rule,” according to the Court.
Here, the acts of the defendants are simply too remote to establish reliance. Indeed, petitioner seeks to apply Section 10(b) “beyond the securities markets – the realm of ordinary business operations …,” in the realm governed by state law. This raises separation of powers concerns between federal and state law.
Justice Stevens’ dissent, joined by Justices Souter and Ginsburg, begins by agreeing with the majority that the deceptive conduct of the defendants falls within the scope of Section 10(b)’s prohibitions. The sole question then, is one of reliance. Since this issue was not squarely decided by the Circuit Court, the dissent stated that the case should be remanded for consideration of this point.
Justice Stevens went on to note that the majority had the reliance question backwards. Basic is premised on the fraud-on-the-market theory and is surely broad enough to support reliance here. That decision has nothing to do with what a person must do to have caused the information to reach investors or whether those investors are subjectively aware of those specific acts as the majority concludes. Indeed, the sham transactions here are the same as a false entry.
Justice Stevens argued that finding liability for the type of acts here will not inhibit business as the majority contends. The type of transactions here are isolated exceptions, not ordinary business deals. In any event, it has traditionally been the province of the courts to provide a remedy where a regulatory statute designed to protect a particular class has been breached to the detriment of those it was designed to protect.
Next: The Concluding installment of this series: An analysis of Stoneridge and the new questions about disclosure it raises when considered with Dura Pharmaceuticals. v. Broudo, 544 U.S. 336 (2005) and Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007).