Court takes up shareholder rights

But that suit – the subject of the current Supreme Court case – was dismissed by a federal judge and the Eighth US Circuit Court of Appeals in St. Louis. Both lower courts ruled that such civil lawsuits by shareholders could be pursued against the primary perpetrators of the fraud, but that Motorola and Scientific-Atlanta were not involved deeply enough in the fraud.

The court cited a 1994 Supreme Court case that held that those who merely aided and abetted a fraud could not be sued by shareholders. Instead, the shareholders could only request enforcement action by federal prosecutors or by the Securities and Exchange Commission.

In their appeal to the Supreme Court, the shareholders, Stoneridge Investment Partners, argue that Scientific-Atlanta and Motorola did more than merely aid and abet the fraud at Charter. They "engaged in a series of sham transactions; they then falsified documents in order to conceal the true nature of those transactions," says Stoneridge lawyer Stanley Grossman in his brief to the court.

"This is not a case involving an arm's length transaction in which a party acted honestly but perhaps with knowledge that the transaction would be used to mislead investors," Mr. Grossman writes. "This is a case in which [the suppliers] themselves engaged in fraud."

Lawyers for Scientific-Atlanta and Motorola cite the 1994 Supreme Court decision barring such lawsuits against aiders and abettors. They say it was up to Charter to accurately report its financial position, and that as suppliers the two firms had no duty to disclose information about Charter to its shareholders.

In addition, they say, no investors relied on any information from the suppliers.

"Congress did not intend to turn product suppliers who do not speak to investors into watchdogs for the accounting practices of public companies," says Stephen Shapiro in his brief on behalf of Scientific-Atlanta and Motorola.

Divided on threat

The issue has led to a split among the federal appeals courts. Both the fifth circuit in New Orleans and eighth circuit in St. Louis have adopted the more restrictive approach favored by business. The ninth circuit in San Francisco has embraced the more expansive view of investors.

It is unclear how the justices will attempt to balance the substantial competing interests in the case. Unrestrained class-action suits could bring some companies to their knees. But some analysts discount this threat.

"One of the reasons we have the best capital markets in the world is when you invest in a company in the United States you take a risk, but the risk is a business risk – will the company succeed or fail," says Professor Brown of the University of Denver. You aren't taking a risk of investing in a fraudulent enterprise, he says.

"Enron was a Potemkin village, a house of cards," Brown says. "That wasn't supposed to be able to happen here. It wasn't supposed to be the kind of risk that investors took."

If SEC and Justice Department enforcement was enough, he says, the Enron scandal would have been impossible.

"Civil liability is really the only thing companies are afraid of," Brown says. "It is the civil suit that causes companies to be far more honest in their disclosure [to investors] than they might otherwise be."

But honesty isn't always a perfect shield. Class-action lawsuits can create strong pressures even for honest, well-run companies to settle lawsuits rather than endure litigation costs, analysts say.

"American businesses paid more than $42 billion in securities class-action settlements between 1996 and 2006," says former Solicitor General Kenneth Starr in a friend-of-the-court brief on behalf of the Washington Legal Foundation.

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