In a much-anticipated decision, the U.S. Supreme Court continued on its recent course of limiting the reach of private securities fraud lawsuits under section 10(b) of the Securities Exchange Act of 1934. The Court concluded, in Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc.,1 that investors cannot assert securities fraud claims against secondary actors (alleged to have engaged in deceptive transactions that enabled an issuer to commit primary violations of the securities laws) if the public had no knowledge of the deceptive transactions. In such circumstances, the Court reasoned, investors “cannot show reliance upon any … actions except in an indirect chain that we find too remote for liability.” The Court’s ruling likely forecloses the theory of “scheme liability,” on which plaintiffs have attempted to rely to reach deep-pocketed defendants, such as accountants, banks and lawyers, who are alleged to be implicated in misrepresentations by issuers to the investing public.
In Stoneridge, shareholders of cable television provider Charter Communications alleged that the company agreed to pay two of its suppliers of set-top cable boxes (defendants Scientific- Atlanta and Motorola) an additional $20 per box in exchange for the suppliers’ agreement to return the additional payments to Charter in the form of advertising purchases. The plaintiffs alleged that Charter and the defendants entered into these sham agreements as part of a scheme to inflate Charter’s revenues to meet Wall Street expectations. The plaintiffs did not allege, however, that the defendants made any fraudulent statement or omission or owed any duty to Charter’s shareholders. Rather, they alleged that the defendants participated in the sham transactions as part of a scheme to defraud Charter’s shareholders in violation of section 10(b) and SEC Rule 10b-5. The district court rejected the plaintiffs’ argument and dismissed their section 10(b) claims, concluding that they alleged nothing more than aiding and abetting, which the Supreme Court held to be beyond the scope of section 10(b) in the 1994 decision Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.2 The U.S. Court of Appeals for the Eighth Circuit affirmed on the same grounds, holding that allegations of a scheme to defraud do not state a section 10(b) claim unless a defendant has made a misrepresentation upon which the plaintiff relied.
Although it affirmed the Eighth Circuit’s decision, the Supreme Court did not fully endorse the lower court’s reasoning. The Court acknowledged that a defendant can be liable for securities fraud even if it did not make a “specific oral or written statement” because “[c]onduct itself can be deceptive.” The problem for the Stoneridge plaintiffs, however, was that they were deceived not by the defendants’ conduct but by Charter’s financial statements. The allegedly sham transactions were not communicated to Charter’s investors. Accordingly, “the investors cannot be said to have relied upon any of [the defendants’] deceptive acts in the decision to purchase or sell securities; and as the requisite reliance cannot be shown, [the defendants] have no liability.” The Court continued to leave the door open, as it had in Central Bank, to permit private securities fraud actions against “secondary actors who commit primary violations.” It seems clear after Stoneridge, however, that plaintiffs cannot use “scheme liability” to take advantage of the Central Bank exception.
Indeed, the Court was not reticent in revealing the pro-business stance – notably in favor of foreign investment – that supports the result. Considering the “practical consequences” of permitting liability in Stoneridge, the Court observed that a new class of defendants would be exposed to the risks of uncertainty and disruption that follow when plaintiffs with weak claims “extort” settlements from innocent companies. The Court echoed the concerns of business interests such as the Organization for International Investment and NASDAQ (which submitted amicus curiae briefs in Stoneridge), noting that overseas firms with no exposure to U.S. securities laws might be deterred from doing business in the U.S. “This, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets.” The Court’s ruling seeks to avert such obstacles to foreign investment in the United States.
Stoneridge is the third Supreme Court decision in the last two years that circumscribes securities fraud lawsuits. Last term, in Tellabs, Inc. v. Makor Issues & Rights, Ltd.,3 the Court increased the burden on plaintiffs to plead fraudulent intent (“scienter”) in securities cases, and in the 2005 decision Dura Pharmaceuticals, Inc. v. Broudo,4 the Court made it more difficult to plead and prove the element of loss causation. The effect of the Stoneridge decision will probably be felt immediately, as the filing of securities fraud lawsuits has increased dramatically in recent months in the wake of the subprime mortgage crisis. Secondary actors named in those cases now have a strong weapon in their efforts to be dismissed at an early stage and many may now escape being named at all.