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.
from the October 9, 2007 edition
Page 2 of 3
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.
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.
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