Court takes up shareholder rights
In its biggest business case of the term, the high court examines the scope of investors' rights to sue in the wake of corporate fraud.
It is being called the most important business case in a generation. One legal analyst has referred to it as the Roe v. Wade of securities law.Skip to next paragraph
Subscribe Today to the Monitor
The case is Stoneridge v. Scientific-Atlanta and it arrives on Tuesday at the US Supreme Court amid the kind of hyperbole usually reserved for high-octane cases about abortion or race.
"This is a big one, and lots and lots of money is riding on the outcome," says Georgetown Law Center professor Donald Langevoort.
Jay Brown, a University of Denver law professor, says the case is a "watershed event." It is likely to establish the rules and boundaries for a string of pending shareholder suits, including those that involve the Enron scandal.
At issue in Stoneridge is who can be sued by angry investors in the wake of a major financial fraud at a publicly traded company.
Securities laws and regulations make clear that company officials directly responsible for such fraud can be sued. But what about consultants, vendors, investment bankers, lawyers, accountants, and others who may have had knowledge of the fraud and engaged in deceptive actions that helped keep it quiet?
Possible effect on economy
The case is being closely watched and extensively lawyered, with more than 30 friend-of-the-court briefs filed. It could dramatically expand the legal liability of a significant cross-section of American business. Some analysts are warning that if the Supreme Court rules for investors it would inflict a substantial drag on the US economy by encouraging an avalanche of class-action lawsuits against lawyers, accountants, bankers, and others on behalf of investors.
At the same time, investors – both big and small – argue that corporations and their business associates should be accountable to the investing public when they engage in deceptive and illegal activities. Putting executives on notice that investors expect them to be honest and truthful is a boost to the economy, they say, not a drag on it.
A fraudulent history
The case stems from a financial scandal at Charter Communications. At the time, the St. Louis-based firm was the nation's fourth-largest cable television company.
In August 2000, executives at the company realized they were more than $15 million short of projected cash flow for the year. They worried that if stock analysts discovered the company's weak performance, their share price might suffer. They needed an infusion of cash – fast.
Instead of earning it, company officials devised a plan to artificially boost Charter's bottom line. They set up a system in which they overpaid two of their suppliers for television cable boxes. They paid $20 per box above the usual price – generating $17 million in overpayments. The suppliers – Scientific-Atlanta and Motorola – then agreed to pay $17 million to Charter to purchase advertising from Charter.
In effect, Charter was giving the suppliers free advertising but booking the recycled $17 million as new revenue.
To help throw Charter's auditors off the trail, Scientific-Atlanta and Motorola backdated phony contracts and were asked to send letters to Charter justifying the $20 extra charge per box, according to a federal indictment. One supplier sent false invoices, the indictment says.
The moves inflated Charter's bottom line and prevented a stock plunge, but only temporarily. When Charter's true financial situation was revealed (amid other questionable activities), the company's stock fell from $26 per share in 2000 to 76 cents per share by 2002.
A shareholder suit against Charter's top executives was settled out of court. Shareholders then turned their attention to the alleged roles played by Scientific-Atlanta and Motorola.