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Supreme Court Decides Stoneridge:

Today the U.S. Supreme Court decided Stoneridge Investment Partners v. Scientific-Atlanta. By a vote of 5-3, the Court rejected "scheme liability" and held that private rights of action under Section 10(b) of the Securities Act do not reach third-party actions where shareholders did not rely upon the third party's actions or statements. Justice Kennedy wrote the opinion for the Court. Justice Stevens dissented, joined by Justices Ginsburg and Souter. Justice Breyer did not take part in the decision.

For more on the decision see Lyle Denniston on SCOTUSBlog, this Washington Post report, or this LA Times story. Jay Brown also has some thoughts on the Race to the Bottom blog. For more background, see this string of posts, or the Stoneridge resources page at CWRU's Center for Business Law & Regulation.

UPDATE: More from Professor Bainbridge, Ted Frank, and Elizabeth Nowicki.

Pub Editor:
Wow, Mr. Brown is not happy about this decision:


Plaintiffs, according to the Court, alleged that the vendors were liable because they had committed a "deceptive act." (Recall that Section 10(b) makes actionable a "deceptive device" and Rule 10b-5 makes actionable a "device [or] scheme . . . to defraud"). The Court didn't find an absence of deception (how could it? there were allegations of falsified documents) but instead concluded that a deceptive act wasn't enough to establish securities fraud. As the Court noted, if it accepted plaintiff's position, "it would revive in substance the implied cause of action against all aiders and abettors except those who commit no deceptive act in the process of facilitating the fraud;"

Let's try this again. The statute specifically references deceptive behavior. The plaintiff pleads deceptive behavior. Yet the Court concluded that this is nothing more than a type of secondary liability. On this issue, the dissent rightfully has a field day.

This opinion, as we'll talk about later, is nothing more than a policy decision designed to reduce the right of shareholders to bring actions against those who commit securities fraud. It is part of a general approach to reduce the rights of shareholders, with the Commission's denial of access part of that.


Props to Prof. Bainbridge for correctly predicting the outcome.
1.15.2008 1:39pm
Pub Editor:
Prof. Bainbridge has finally (1:40 PM EST) posted on this decision.
1.15.2008 1:42pm
Tony Tutins (mail):
This is the key part of the ruling that Stevens just brushes off in his rather conclusory dissent: Were the Court to adopt petitioner's concept of reliance—i.e., 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—the implied cause of action would reach the whole marketplace in which the issuing company does business.

Making suppliers and customers police the accounting practices of their trade partners is too onerous a burden on the market, especially for international commerce as the opinion points out. The culpability of Motorola was negligible: the biggest evidence of fraud Stevens noted was the (one month, IIRC) backdating of a modification to the contract (to the start of the period of the change's effectiveness).
1.15.2008 1:57pm
srg:
From Scotusblog:

Congress passed that law, Stevens argued, "with the understanding that federal courts respected the principle that every wrong should have a remedy."

To this non-lawyer that seems like an extraordinary and a rather bizarre statement.
1.15.2008 1:58pm
David M. Nieporent (www):
Congress passed that law, Stevens argued, "with the understanding that federal courts respected the principle that every wrong should have a remedy."

To this non-lawyer that seems like an extraordinary and a rather bizarre statement.
It's not that bizarre. But it's bizarrely applied here, because there is a remedy. What there isn't is a private right of action.
1.15.2008 2:01pm
srg:
Would one of you lawyers please deal with Jay Brown's claim that the majority simply ignored the plain meaning of the relevant law.

Also, is there really a general theory that EVERY wrong should have a remedy?
1.15.2008 2:08pm
Houston Lawyer:
Hey, the justices made up the whole private right of action under Section 10b to begin with. The search for a deep pocket has to stock somewhere.
1.15.2008 2:13pm
Adam J:
Houston Lawyer- I assume you meant stop, not stock. But when should the loss sit on the innocent party when we can make a guilty one pay? Not only do we deter future wrongdoing, but we compensate a victim to boot? Seems like a no-brainer to me.
1.15.2008 2:32pm
Joe Jackson:
Would one of you lawyers please deal with Jay Brown's claim that the majority simply ignored the plain meaning of the relevant law.

Too easy. Jay Brown is the one ignoring the plain language of the relevant law: "in connection with the purchase or sale of any security." Read Section 10(b) and Rule 10b-5, then look at the facts of this case. Nothing the defendants (allegedly) did violates the statute.

You cannot pick and choose which elements of a cause of action you like, while disregarding the elements that do not appply to your case.
1.15.2008 2:34pm
Tony Tutins (mail):

But when should the loss sit on the innocent party when we can make a guilty one pay?

Charter Communications is the guilty party and should pay. Their settop box supplier Motorola merely acquiesced to a co-op advertising plan.
1.15.2008 2:40pm
alias:
Justice Stevens's dissent is very interesting for issues that go beyond the subject of securities law.

I didn't think that there was anything particularly controversial about the Cort v. Ash test or the general reluctance of federal courts to find that every instance of noncompliance with a law can be the basis for a lawsuit whenever there's a plausible claim of resulting injury. I was under the impression in law school that the "where there's a right, there's a remedy" maxim is sort of a naive thing to say if you're a lawyer.
1.15.2008 2:46pm
John Smith (mail):
Along with others, I was troubled that customers and suppliers would potentially be liable for the securities law violations of their public company business partners. While this case substantially reduces this risk in the context of private litigation, it's worth noting the SEC enforcement division has been bringing very similar aiding and abetting cases against customers and suppliers of public companies for the last several years (there is no private right of action for an aiding and abetting claim, but the SEC can bring enforcement actions using the aiding and abetting theory). See, e.g., the Fleming, K Mart and AIG cases (AIG is the pending case in which the defendants may seek to involve Warren Buffett). See also "Liability of Vendors, Customers and Lenders under the Federal Securities Laws," Insights (March 2005). These cases, in essence, attempt to force companies to police the accounting practices of their public company customers and suppliers.

There is language in the Stoneridge opinion that the SEC should consider before bringing any more of these cases. "Were the implied cause of action to be extended to the practices described here, however, there would be a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees." This would seem to apply as much to SEC enforcement actions as private litigation. Perhaps the enforcement division should reconsider its activist approach in these cases.
1.15.2008 2:54pm
Adam J:
Tony Tutins - Obviously, Charter is guilty. How does Charter's guilt make Motorola not guilty? If I help a friend hide some money he stole from a bank, am I not guilty?
1.15.2008 3:10pm
David Drake:
srg--

The private right of action that the courts have found to be implied by Rule 10b-5 is based on the common law of fraud, as the Congress did not create explicitly create a private right of action under that Rule.

The common law of fraud has several elements. One of the elements that the party allegedly defrauded must have relied on a false or misleading misstatement. This requirement is meant to eliminate an action by someone who, for example, knew the seller was lying but bought the stock anyway or who bought the stock but did not know that the seller had made the misrepresentation.

Here, the court found that the plaintiffs did not know about or rely on any statements by the defendants. The defendants made no statements to the plaintiffs or to the "market" and had no duty to inform anyone about the false statements that the issuer was making. Therefore, the plaintiffs did not know about and could not have relied on their statements.

Although the defendants may have aided and abetted the issuer in its "fraud on the market" arising from the issuance of false financial statements---and may have criminal liability under the Act or Rule 10b-5--the Supreme Court held years ago that aiders and abetters are not liable to private plaintiffs under the private right of action implied under Rule 10b-5, and Congress has not amended the securities laws since that decision to change the result.
1.15.2008 3:13pm
Mike O'Shea (mail) (www):
The big meta-issue in Stoneridge is textualism -- a theory of statutory interpretation that entails deep skepticism about the legitimacy of judicially implied rights of action.

Justice Scalia has to be delighted with Part III-C of Justice Kennedy's majority opinion. It calls the 10b-5 private right of action a "judicial construct that Congress did not enact in the text of the relevant statutes." Slip op. at 13. In the next sentence it cites Scalia's archtextualist majority opinion in Alexander v. Sandoval (2001) for the proposition that, whatever may have been the practice back in the carefree Warren Court days, these are new times: it is now "settled that there is an implied cause of action only if the underlying statute can be interpreted to disclose the intent to create one." Id.

This sets up the conclusion in the following paragraph: "Though it remains the law, the 10(b) private right should not be extended beyond its present boundaries." Id. at 14.

The majority is emphasizing that the judicial decision to create the 10b-5 private cause of action in the first place was seriously incorrect under current norms of statutory interpretation, and persists only by virtue of stare decisis. It won't be overruled, but future cases on the scope of private 10b-5 litigation will be addressed in the light of the flawed basis of the private right of action itself.

Justice Stevens (the Court's liveliest opponent of textualism) is well aware of these larger interpretive issues. He devotes Part III of his opinion to making a historical case for the practice of interpreting federal statutes "in the common law tradition," slip op., diss. at 10, and implying a private remedy for any violation of a right.

Fascinating stuff.
1.15.2008 3:55pm
Tony Tutins (mail):
How does acquiescing to a co-op advertising plan make Charter's supplier guilty? Charter offered to pay more for the set-top boxes if Motorola would rebate the difference as Charter ran ads for digital TV. This gave Charter an incentive to run such ads. It sounds a little odd, but no odder than setting one's watch fifteen minutes ahead to reduce the chance of being late. As another example of this, I once received a set of mixing bowls for opening a bank account. Including them as income would have made the savings and loan company liable to my shareholders, under this theory.
1.15.2008 3:56pm
Adam J:
Tony- How does acquiescing to letting my friends use my car to rob a bank make me guilty? What does it matter what they did? It doesn't matter what Motorola did, so long as what they did was intended to aid and abet Charter's fraud.
1.15.2008 4:20pm
Joe Jackson:
Adam J, since there is no private cause of action for aiding and abetting securities fraud, it does matter.
1.15.2008 4:40pm
Adam J:
Joe Jackson- maybe you should read the entire set of posts I made before you add your two cents. My posts revolved around whether they should be held liable for aiding and abetting. I of course realize they are not, but I said that they should be held liable. Tony then made the rather remarkable claim that Motorola isn't guilty of anything because all they did was backdate a contract and create an unusual transaction. Clearly though, actions that are themselves innocent become bad acts when they are done to help aid a bad act.
1.15.2008 5:02pm
Tony Tutins (mail):

It doesn't matter what Motorola did, so long as what they did was intended to aid and abet Charter's fraud.

Any mischievous "investor" can file suit first, and hope to discover evidence of intent later. In fact I believe the scienter standard is merely "should have known", requiring third party suppliers/customers to do due diligence on how their partners will account for every transaction, drastically increasing the burden of making deals.
1.15.2008 5:10pm
Adam J:
Yes, and I for me to "should have known" that there were drugs in the package that the feller who gave me 1000 bucks to carry across the border is a terrible burden. Come on, lets not be ridiculous- that burden protects against a defendent engaging in willful blindness. Are you actually telling me that a savvy corporation like Motorola needed to engage in ANY due diligence to know Charter was up to no good when it created a zero-sum transaction.
1.15.2008 5:34pm
Adam J:
make that a zero-sum gain transaction... which it then asked to be backdated.
1.15.2008 5:36pm
Adam J:
Clearly, if a company is duped into helping someone commit fraud, they are not, nor should be guilty of anything... but it's hard to make a real argument that this is what happened to Motorola.
1.15.2008 5:38pm
Jiffy:
Tony Tutins wrote:

Any mischievous "investor" can file suit first, and hope to discover evidence of intent later.

This suggests a lack of experience actually litigating securities fraud cases. The standard for even alleging scienter is extremely high under the PSLRA, and plaintiffs are allowed no discovery until after motions to dismiss have been denied. The claim that restrictive decisions such as this are necessary to prevent abusive lawsuits simply ignores post-PSLRA reality.
1.15.2008 5:45pm
Allan (mail):
As I understand it, Motorola cannot be held liable even if there was smoking gun evidence that Motorola knew Charter was using the relationship to commit securities fraud.

I agree that, if Motorola did not know what was going on, they should have no liability. But, if it was knowingly helping Charter defraud its shareholders, it should pay the price.

Who benefitted from Charter's misdeeds? Well, the people in Charter who are now in jail. And Motorola's stockholders. I believe those stockholders got a windfall (perhaps a very small one) and, if they aided and abetted the fraud, they should be required to disgorge the windfall. That is as a matter of policy, if not the law as it currently stands.
1.15.2008 5:57pm
DLM (mail):

Jay Brown is the one ignoring the plain language of the relevant law: "in connection with the purchase or sale of any security."


But satisfying that standard is very easy; the fraud need only "touch" a purchase or sale of securities. And engaging in sham transactions that serve only to inflate an issuer's revenue most likely "touch" the open market transactions occurring every day w/r/t Charter's securities.

As a policy matter, this is a good result. Issuers and their D&O insurers have plenty of money to pay damages in these cases. Additional deep pockets are not usually needed.

As a strictly legal matter, the opinion is pretty awful. Of course it is true that Motorola and S-A could not control Charter's accounting, but Charter did not ask them to engage in sham transactions so that it could turn around and accurately report them to shareholders. The whole point of the deal was fraud, and it could not have been accomplished without Motorola and S-A (according to the allegations that had to be accepted as true). Thus, this is not a case where company A buys widgets from company B and company B unilaterally inflates the revenue from those sales. This is A and B agreeing to a sham transaction that has no purpose other than to mislead. Seems to me that's covered by 10b-5.
1.15.2008 6:23pm
CrazyTrain (mail):
The majority is emphasizing that the judicial decision to create the 10b-5 private cause of action in the first place was seriously incorrect under current norms of statutory interpretation, and persists only by virtue of stare decisis.

The bolded portion of your statement is just plain wrong. Congress has specifically endorsed the private right of action over the last half century -- most recently, Republican Congresses put limits on it, but did not eliminate it altogether. It's not simply a matter of stare decisis at all.
1.15.2008 9:12pm
Tony Tutins (mail):
Motorola has a duty to its shareholders to profitably sell settop boxes. It tried to fulfill that duty by acquiescing to a request from its customer. Rebates from co-op advertising are omnipresent in consumer electronics, because it benefits both the manufacturer and the retailer. Only in hindsight could that be seen as a sham transaction. I fail to see the benefit from making customers and suppliers consider how litigious shareholders of their business partners will view every transaction.

The standard for even alleging scienter is extremely high under the PSLRA, and plaintiffs are allowed no discovery until after motions to dismiss have been denied. Apply that standard to the case here, please.
1.15.2008 10:28pm
andy (mail) (www):

Justice Stevens (the Court's liveliest opponent of textualism) is well aware of these larger interpretive issues. He devotes Part III of his opinion to making a historical case for the practice of interpreting federal statutes "in the common law tradition," slip op., diss. at 10, and implying a private remedy for any violation of a right.

Fascinating stuff.



Mike -- thanks for highlighting those issues. I think those issues are pretty interesting as well. Don't know enough about the substance of the controversy to have any opinion one way or another (i.e., i dunno whether third-parties should be liable or not). But, the interpretive issue of when to "imply" a private cause of action and the notion that "every wrong has a remedy" (O RLY?) does pique my interest.
1.15.2008 11:32pm
Adam J:
Tony- A rebate!?!? This rebate was hidden in a liquidated damage contract of another contract... while the advertising contract was backdated so the two contracts didn't seem related!!! I've never heard that called a rebate... Seriously I hope you don't believe your own argument.
1.15.2008 11:39pm
Joe Jackson:
The standard for even alleging scienter is extremely high under the PSLRA, and plaintiffs are allowed no discovery until after motions to dismiss have been denied.

If Tellabs had come out before this case had already been dismissed, the case would have almost certainly been dismissed on the scienter grounds as well.
1.15.2008 11:58pm
Tony Tutins (mail):

This rebate was hidden in a liquidated damage contract of another contract

Really? So, assuming Motorola was never in breach, the rebate was never paid? Why did Charter's shareholders sue?

... while the advertising contract was backdated so the two contracts didn't seem related!!!

As I recall, the advertising contract was backdated one month to cover the start of set-top box shipments.
1.16.2008 11:13am
George Smith (mail):
Tony - Charter's shareholders sued because the class action bar smelled money.
1.16.2008 11:49am
Adam J:
Tony- Yes, really. Next time read the whole case, not just the parts you like- it quite clearly spells out the transaction. The "rebate" was a liquidated damages payment made by Charter for failing to buy a certain number of set-top boxes. The overpriced advertising contract was made at the same time as this contract, but backdated so that the two contracts seemed unrelated. This is a hidden, zero-sum transaction where the liquidated damages were intended to offset the overpriced advertising fees. You think Motorola blithely went along, without a clue in the world that this was a sham?
1.16.2008 11:59am
Adam J:
George Smith - yeah, smelled the money that they had lost from fraud.
1.16.2008 12:00pm
George Smith (mail):
Adam - they smelled a contingency fee. Thats what this was really about. The recovery to each shareholder would have been squat. Its about Bentleys and condos on Hilton Head for the lawyers. No matter how tangential, almost anything can be scammed.
1.16.2008 12:13pm
Adam J:
George Smith- Well, the named plaintiff in the case is an institutional investor, and somehow I think they would have gotten more then "squat". And do you think its better if the company is free to swindle money from investors? Or do you think its better for the investor to get nothing, instead of a partial recovery? And what the heck are you talking about tangential? Scientific and Motorola directly and knowingly participated in fraud (unless you buy Tony's "rebate" story), there's nothing tangential about that.
1.16.2008 12:34pm
George Smith (mail):
Corporations bad.
1.16.2008 2:39pm
Libertarian1 (mail):
Well, the named plaintiff in the case is an institutional investor, and somehow I think they would have gotten more then "squat". And do you think its better if the company is free to swindle money from investors? Or do you think its better for the investor to get nothing, instead of a partial recovery? And what the heck are you talking about tangential? Scientific and Motorola directly and knowingly participated in fraud (unless you buy Tony's "rebate" story), there's nothing tangential about that.



Although not involved in this case my personal rule is I am willing to forgo 100% of any class action receipts providing the attorneys similarly get nothing. In all previous cases I got bubkus and the lawyers came out like bandits. General rule - follow the money.

Wouldn't it be wonderful now if the original plaintiff had to pay the entire legal fee of the winner?
1.16.2008 7:47pm
Adam J:
Libertarian1 - Interesting, you and George appear to be in favor of allowing companies to commit fraud. Silly me, I thought we were interested in deterring corporations from committing fraud. So you think that Stoneridge, a completely innocent investor who lost a significant amount of money as a result of fraud, should have to pay for the legal fees of Scientific America and Motorola, who knowingly created a sham transaction to defraud investors?
1.17.2008 1:46pm
Tony Tutins (mail):

Scientific America and Motorola, who knowingly created a sham transaction to defraud investors?

Assuming you can prove this, can you also look into Safeway, who since introducing their loyalty card, has jacked up the everyday prices of everything so that their customers have the illusion of saving money by using the card? Also, please look into the sham of cents-off coupons, and rebates that purport to make items "free" to the consumer after the rebate is paid.
1.17.2008 2:20pm
Adam J:
Tony Tutins- why should I try to compare apples and oranges. You obviously can't take a remotely honest view of the facts of this case if you think your example is remotely similar.
1.17.2008 3:45pm
DiverDan (mail):
Alright, for all you folks who think the Majority got it wrong, it seems to me that the Majority did not foreclose all remedies -- they just said that you don't have a Securities Exchange Act violation under Section 10(b) because, even assuming that what Motorola and Scientific American did was a deceptive act, it was not "in connection with the offer or sale of securities", as the law expressly requires. Notably, both Motorola and Scientific American booked the transactions as wash transactions, and reported their income that way on their own public statements under the Securities laws, so there was nothing false, deceptive or misleading about the way that either of the Defendants reported these transactions to the investing public. So, all you plaintiffs lawyers out there, you are still free to bring common law fraud claims against Motorola and Scientific American -- except that would require you to show both (1) that the Defendants either made a false statement or failed to disclose material information that they had a duty to disclose; and (2) actual (and reasonable) reliance upon that false statement or omission. You just hate the case bacause Section 10(b) relieved you of the burden of proving reliance (which of course you can never prove, at least not for a whole class of all shareholders) through the "fraud on the market" theory.
1.17.2008 4:33pm
David M. Nieporent (www):
DiverDan: Scientific Atlanta, not American :)
1.18.2008 12:39am
DiverDan (mail):
Sorry - not thinking (????) while ranting about Class action lawyers (I get the same way about Plaintiffs' PI lawyers -- they seem to want a remedy for EVERY injury done in America EXCEPT the injury done by the proliferation of questionable lawsuits). :-)
1.18.2008 12:30pm