On January 15, 2008, the Supreme Court issued its decision in Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc. and Motorola, Inc.1 In a five-three decision, the Court affirmed the prior decision of the Eighth Circuit Court of Appeals, holding that so-called “scheme liability” claims under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5 against certain non-speaking defendants were properly dismissed. Specifically, the Court stated that the implied right of action it had previously recognized under Section 10(b) does not reach non-speaking defendants where the investors could not and did not rely on any statements or representations made by those defendants in making their purchase or sale decisions.2

Overview of Claims on Appeal

Stoneridge involved Section 10(b) claims brought against two equipment suppliers that did business with Charter Communications, Inc. — one of whom was represented by Alston & Bird. The suppliers entered into a business transaction with their mutual customer, Charter, which Charter failed to account for properly on its books.3 It was undisputed that the suppliers’ accounting for the transaction was proper and they had no role in Charter’s accounting decisions or the preparation of its financial statements.4 Also, it was without question that the suppliers had made no statements to Charter shareholders nor had a duty to speak to these shareholders. Charter alone made the allegedly false and misleading statements that supposedly caused injury to its shareholders.5

The Eighth Circuit Court of Appeals had affirmed the dismissal with prejudice of the claims against the suppliers. The Circuit Court ruled that there could be no violation of Section 10(b) because the supplier defendants had made no misstatements relied upon by the public nor violated any duty of disclosure.6 Thus, at the most, the claims against them were for aiding and abetting Charter’s misstatement and, therefore, barred by the Supreme Court’s decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.7 The Eighth Circuit’s view was later adopted by the Fifth Circuit Court of Appeals in an appeal taken from the Enron case.8 Only the Ninth Circuit came to a different conclusion on whether such claims were viable under the federal securities law, but did so largely based on existing Ninth Circuit precedent.9

The Supreme Court’s Analysis Focused on the Critical Element of Reliance

Justice Kennedy, writing for the majority,10 began the discussion of the issues on appeal by acknowledging, as a threshold matter, that the express language of Section 10(b) does not provide for a private cause of action for investors, but that such a right has been implied by courts from the text of the statute.11 For this implied right of action, courts have required that a shareholder plaintiff must be able to plead and prove reliance on the alleged misrepresentation or omission of the defendant, among other mandatory requirements.12 Indeed, one of the reasons why the Supreme Court rejected private aiding and abetting liability in Central Bank was that such claims would “[a]llow[] plaintiffs to circumvent the reliance requirement [and thereby] disregard the careful limits on 10b-5 recovery mandated by [the Supreme Court’s] earlier cases.”13 Thus, the Court’s decision in Central Bank, which Justice Kennedy also authored, made clear that a defendant can be primarily liable under Section 10(b) only if each of the elements or preconditions of liability are satisfied as that defendant.14

The Supreme Court agreed with the lower courts that the investors in Stoneridge did not rely on any actions or statements of the supplier defendants and, as a result, liability could not be imposed on them as a matter of law.15 The Court reiterated that reliance is an essential element of Section 10(b) because “[i]t ensures that, for liability to arise, the ‘requisite causal connection between a defendant’s misrepresentation and a plaintiff’s injury’ exists as a predicate for liability.”16 The Court acknowledged that it had previously recognized a rebuttable presumption of reliance in two different circumstances. The first time was in the context of an omission made by one with a duty to speak.17 The second time was in conjunction with the “fraud-on-the-market” theory, which assumes that public information about a company, whose stock trades in an efficient market, will be reflected in that company’s stock price.18 Thus, in making a purchase or sale decision, the investors are presumed to be relying on the company’s stock price, which is supposedly a reflection of all publicly available information about that company.19

The Court concluded that neither presumption applied to the facts presented on appeal. The supplier defendants had no duty to disclose and no alleged actions by them were ever communicated to the public.20 Thus, “[n]o member of the investing public had knowledge, either actual or presumed, of [defendants’ supposedly] deceptive acts during the relevant time times.”21 Plaintiffs could not show reliance except in an indirect chain that the Court deemed to be too remote and attenuated for liability.22 Plaintiffs had argued that investors relied not only on public statements regarding a security, but also on the transactions that those statements reflect.23 The Court held that, “[w]ere this concept of reliance to be adopted the implied cause of action would reach the whole marketplace in which the issuing company does business” and “there is no authority for this rule.”24

Plaintiffs’ theory, if adopted, would have had the effect of applying Section 10(b) causes of action “beyond the securities markets — the realm of financing business — to purchase and supply contracts — the realm of ordinary business operations.”25 At present, if business operations are used to affect the securities markets, the SEC’s enforcement power is available to reach culpable actors.26 But if a private implied cause of action extended to such operations, there would be a risk of inviting litigation in areas which are already effectively governed through these civil enforcement actions by the SEC or through the imposition of criminal penalties. 27 The Court observed that precedent counseled against such an expansion. The federal securities laws were not designed to “reach all commercial transactions that are [alleged to be] fraudulent and affect the price of a security in some attenuated way.”28 There is no basis for interpreting the laws “to provide a private cause of action against the entire marketplace in which the issuing company operates.”29

Deference to Congress and Practical Considerations Factored Into the Court’s Analysis

As further support for its conclusions, the Court looked to Congress’ specific response to Central Bank, which was codified in the Private Securities Litigation Reform Act (the “Reform Act”).30 A year after Central Bank, Congress was asked to create a private cause of action for aiding and abetting liability, but instead chose to amend the securities laws to provide only limited coverage of aiders and abettors through suits brought exclusively by the SEC and not private parties.31 The plaintiffs’ view of primary liability under Section 10(b) would have revived in substance an implied cause of action against aiders and abettors and thereby undermine Congress’ determination that this class of defendants should be pursued only by the SEC.32 The Court determined that it must give weight to Congress’ decision “to restor[e] aiding and abetting liability in some cases but not others.”33

Practical considerations similarly counseled in favor of no liability. The Court recognized the potential coercive effect of securities litigation being imposed on a new, broader class of defendants and the increased cost of doing business to protect against the threat such litigation poses.34 Overseas companies with no other exposure to this country’s securities laws might be deterred from doing business here. Also, the increased cost of being a publicly traded company in this country as a result of a different ruling could shift securities offerings away from domestic capital markets.35

Conclusions

The Supreme Court reached the correct conclusion here, which was “consistent with the narrow dimension that the [C]ourt must give to a right of action Congress did not authorize when if first enacted the statute and did not expand when it revisited the law.” 36 The risk of abusive litigation is simply too great to extend private liability to conduct that “took place in the marketplace for goods and services, not in the investment sphere.”37 Existing remedies adequately police culpable conduct and to expand the scope of liability in private litigation would harm shareholders who ultimately pay the price of defending against frivolous claims.