On January 15, 2008, in the Stoneridge case,1 the US Supreme Court held that private federal securities law claims generally may not be asserted against parties that allegedly helped an issuer make misleading public statements. The decision is welcome news for financial institutions which, among others, routinely work on transactions that affect the financial statements of public companies. Nevertheless, it should be noted that the Court may have left open a narrow window for certain types of these so-called aiding and abetting claims.

Plaintiff-shareholders of Charter Communications, a public company in the cable TV business, alleged that Charter — aware that its earnings would not meet expectations — arranged a series of sham transactions with two of its suppliers that would make Charter appear more profitable than it actually was. The suppliers had no role in preparing Charter's public financial statements, and the suppliers' financial statements were not changed by the transactions. Plaintiffs sued Charter and the suppliers alleging that the suppliers knew that Charter would use the transactions to inflate earnings. A lower court held that the suppliers could not be sued for helping Charter create false financial statements under Section 10(b) of the Securities Exchange Act of 1934 ("34 Act") and SEC Rule 10b-5 under that Act, which make it unlawful for any person "to employ any device, scheme or artifice to defraud...in connection with the purchase or sale of any security." Although the statute does not provide for private civil claims, the Supreme Court has previously held such claims to be implied under Section 10(b) and Rule 10b-5.

In affirming the lower court, the Supreme Court first noted that the '34 Act does not by its terms allow for private claims for aiding and abetting a securities fraud, and it was for Congress, not the Court, to add such claims to the Act.2 Accordingly, a non-issuer only could be liable if a plaintiff could otherwise make out a claim against them under Section 10(b) by pleading and proving all the required elements of Section 10(b). A key element of any claim premised on a scheme to defraud is that the plaintiff relied on the defendant's wrongful act in buying or selling a security. The Court held that if the non-issuer's conduct, although deceptive, is not publicly disclosed in some way, a plaintiff cannot demonstrate the required reliance.3

The Court held that, here, the suppliers' "deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance. It was Charter, not [the suppliers], who misled its auditor and filed fraudulent financial statements; nothing [the suppliers] did made it necessary or inevitable for Charter to record the transactions as it did." In so holding, the Court noted its concern that allowing these types of aiding and abetting claims absent an express mandate in the '34 Act could have grave consequences. Plaintiffs would be able to use the threat of class action litigation — with potentially large damages and extensive and expensive discovery — to parlay weak claims into large settlements from innocent third-parties.4 The Court was especially sensitive to the effect such claims could have on deterring overseas companies from doing business in the United States.

Stoneridge is a significant victory for any entity, doing business with a public company, especially financial institutions, whose transactions often do affect an issuer's financial statements. Indeed, the Court specifically rejected the reasoning applied against major financial institutions in the Enron cases, in which securities claims were based on allegations that banks helped Enron defraud investors by completing transactions that allowed Enron to create misleading financial statements. It should be noted, however, that the Court may have left an opening for plaintiffs. The Court held that Charter's suppliers could not be sued because nothing they did made it "necessary or inevitable" that Charter would incorrectly book the transactions at issue. Query whether a plaintiff could sustain a claim under Section 10(b) by alleging that a defendant created a fraudulent or wrongful transaction specifically to allow an issuer to account for that transaction in a certain way. Under those circumstances, especially if that transaction was somehow disclosed, a plaintiff might claim that a defendant's alleged actions made it "necessary or inevitable" that the public would be misled by the issuer.5 This issue may be of particular interest with respect to structured finance transactions, where parties proposing transactions may advise potential counterparties on the accounting consequences of the transactions.

Materials of Interest

Supreme Court Further Limits Securities Claims Against Non-Issuers (PDF)

US Supreme Court — Stoneridge / Full Decision (PDF)