by T. GormanPosted on Posted in SECActions

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. 

by T. GormanPosted on Posted in SECActions

The Supreme Court’s decision next term in Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc., No. 06-43, will do more than simply resolve the split in the Circuit Courts over the dividing line between primary and secondary liability. At issue in the case is not only who can be held liable in a private securities fraud damage action – directors, officers, auditors, lawyers, outside vendors and perhaps others – but perhaps the very way in which many companies do business.  The potential significance of the decision starts to become apparent when the dichotomy between the issue the Supreme Court agreed to hear and the Eighth Circuit’s decision under consideration is considered.  The question presented in the petition for certiorari is:  “Whether [Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 511 U.S. 164 (1994)] forecloses claims … under Section 10(b) … where Respondents engaged in transactions with a public corporation with no legitimate business or economic purpose except to inflate artificially the public corporation’s financial statements, but where … [respondents] made no statements concerning the transactions.”  Petitioners thus asked, and the Court agreed to resolve, the issue of whether third-party vendors to a public company who engage in sham transactions to permit the public company to falsely inflate earnings are primary violators under Section 10(b).  The Eighth Circuit, however, saw the issue differently.  In affirming the dismissal of claims against the third-party vendors, the Court noted that it was not aware of any decision imposing liability “[o]n a business that entered into an arm’s length non-securities transaction with an entity that then used the transaction to publish false and misleading statements to its investors … imposing such liability would introduce potentially far-reaching duties and uncertainties for those engaged in day-to-day business dealings.  Decisions of this magnitude should be made by Congress.”  In the Circuit Court’s view, the transactions engaged in by the vendors were business deals, not the sham transactions referenced in the question presented in the petition for certiorari.  These divergent views are at the core of Stoneridge and suggest the huge implications of the decision next term.  Indeed, Stoneridge could potentially require every vendor to re-evaluate the way it does business with a public company in order to avoid liability – the lack of certainty in business transactions that the Supreme Court decried in Central Bank. The backdrop to Stoneridge is straight forward. The case is based on the dismissal of a securities fraud class action complaint brought against Charter Communications and its outside vendors.  According to the complaint, Charter and its equipment vendors entered into barter arrangements regarding the sale of television set top cable boxes under which the company agreed to pay the vendors inflated prices for equipment.  In the final phase of the barter arrangements, the inflated portion of the price was returned to Charter.  The company then recognized the amounts received under the barter arrangements as revenue while capitalizing the equipment costs, thereby improperly inflating revenue.

The Eighth Circuit essentially adopted the bright line test, rejecting a scheme liability argument made by plaintiffs.  Following Central Bank, the Court held that “any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission … is at most guilty of aiding and abetting … .”  Since the third- party vendors did not make any statement to the shareholders of Charter, all claims were dismissed as to them.  Subsequently, the Fifth Circuit Court of Appeals adopted a similar position in 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 Enron class action litigation discussed in Part IV of this series on June 28, 2007).  There, a group of banks was alleged to have engaged in sham transactions with Enron, knowing that the company intended to defraud its shareholders.  The allegations in this case, however, claimed that the third party banks had known for a considerable period of time that Enron was falsifying its financial statements.  The Fifth Circuit, like the Eighth, rejected plaintiffs’ claim, refusing to impose liability on third parties for engaging in what it saw as business transactions.  The Enron plaintiffs have requested that the Supreme Court review this decision.  The solicitor general declined to file a brief supporting the plaintiffs (despite a request by the SEC) reportedly based on the opposition of President Bush and the Treasury Department.  If the petition is granted Credit Suisse could be combined with Stoneridge.  Credit Suisse presents the Court with the same key issue concerning a transaction used by a public company to falsify its book:  are the other parties to the transaction liable for securities fraud to the shareholders of the public company?  The answer to this question has potentially huge implications for the way in which business is conducted. Next:  Analysis of the issues before the Supreme Court in Stoneridge.