Supreme Court keeps investor suits narrow
In a 5-to-3 ruling, justices say firms that merely abetted fraud can't be sued.
By Warren Richey | Staff writer of The Christian Science Monitorfrom the January 16, 2008 edition
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Vendors, accountants, lawyers, and others who conduct business with a corporation that engages in securities fraud cannot be sued for damages by outraged investors when they merely aided or abetted in the fraud.
Instead, in a 5-to-3 decision announced on Tuesday, the US Supreme Court ruled that investors must focus their legal efforts on the offending corporation itself and its officers.
The much-anticipated decision is considered one of the most important securities-law rulings in a generation.
In adopting a narrow reading of the securities laws governing class-action lawsuits, the high court has made it harder for investors to hold a wide spectrum of business players legally responsible for unlawful business practices at publicly traded companies.
The decision comes in a case called Stoneridge Investment Partners v. Scientific-Atlanta and Motorola. It marks a significant setback for investors, including those seeking to recover losses in the massive Enron scandal. It's also a setback for corporate watchdogs who were hoping the justices would adopt a broad enough reading of the securities laws to put all business associates on notice that they could be held accountable for involvement in business fraud.
The decision marks a victory for various business groups that had argued that broad liability in securities-fraud cases could unleash a flood of class-action litigation that would hurt the US economy and American competitiveness.
In the majority opinion, Justice Anthony Kennedy writes that US securities laws authorize investor class-action suits only when the investors have relied on false or deceptive statements from a business official who has a duty under securities laws to disclose accurate information to the investing public.
The suing investors in the Stoneridge case had purchased stock in Charter Communications, a cable TV company. After settling their suit against Charter, the investors then sued two of Charter's vendors, Scientific-Atlanta and Motorola for their alleged involvement in helping cover up an ongoing fraud at Charter.
In disallowing the second suit against Scientific-Atlanta and Motorola, the high court declared the two companies were too remote from any investor deception at Charter to trigger legal liability for the vendors.
"It was Charter, not [Scientific-Atlanta and Motorola] that misled its auditor and filed fraudulent financial statements," Justice Kennedy writes. "Nothing [the vendors] did made it necessary or inevitable for Charter to record the transactions as it did."
In a dissent, Justice John Paul Stevens accused the majority justices of waging a continuing campaign to render "toothless" regulations authorizing private investors to sue to remedy corporate wrongdoing.
He said the ongoing fraud at Charter Communications could not have been kept secret from its auditor and investors were it not for the deceptive actions of Scientific-Atlanta and Motorola. Because they used deceptive methods in their dealings with Charter, they should also be legally liable to investors, Justice Stevens writes.
The case stems from a financial scandal at St. Louis-based Charter Communications. In August 2000, executives at the company realized they were more than $15 million short of projected cash flow for the year. If stock analysts discovered the company's weak performance, their share price might have suffered. The executives needed an infusion of cash.
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