The Supreme Court recently heard oral argument in the latest in a string of highly consequential securities fraud cases: Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. , No. 06-43.At issue is so-called "scheme liability" - specifically, whether the Supreme Court's 1994 Central Bank decision rejecting "aiding and abetting" liability in private securities fraud actions can be evaded by pleading that third parties participated in a "scheme" that allowed a publicly-traded company to defraud its shareholders. Stoneridge , which follows on the heels of Tellabs, Inc. v. Makor Issues & Rights , No. 06-484 (June 21, 2007), and Dura Pharmaceuticals, Inc. v. Broudo , 544 U.S. 336 (2005), continues a recent reawakening of the Supreme Court's interest in business cases generally and securities fraud litigation in particular. Both Tellabs (which enforced a strict pleading burden) and Dura (which required plaintiffs to plead and prove that their stock market losses were actually caused by the alleged fraud) significantly enhanced the arsenals of entities defending securities fraud class actions, and there is good reason to believe Stoneridge will continue that trend.
The "scheme liability" theory, if validated by the Supreme Court, would greatly expand the private right of action under Section 10(b) of the Securities Exchange Act; it would render "secondary actors" - i.e. , third parties such as banks, professional advisers, and vendors - potentially liable to a client's or customer's shareholders when the company mischaracterizes its dealings with the third party. The theory holds that a third party can be considered a "principal violator," rather than a mere aider and abettor, when it is alleged that the "purpose and effect" of its conduct was to create a false appearance of material fact in furtherance of a larger scheme that defrauded investors - even where the deceptive conduct is only tenuously related to any securities transaction. The theory has been employed, for example, in lawsuits against banks who are alleged to have engaged in transactions with companies like Enron and Parmalat that the companies later accounted for falsely in their financial statements. It can also be employed against professionals and advisers, or even - as in Stoneridge itself - vendors who sell products to a public company. The decision in Stoneridge therefore has potential consequences for practically all businesses that deal in any way with public companies.
At oral argument on October 9, 2007, the Supreme Court expressed considerable skepticism about scheme liability. Justice Kennedy, for example, expressed concern that there was "no limitation" to the plaintiff's theory of liability, and both Chief Justice Roberts and Justice Scalia alluded to the Court's general reluctance to expand a private right of action that was not expressly authorized by Congress, but rather implied, as well as concern about the potential for strike suits against a wide variety of American businesses. Only Justice Ginsburg seemed interested in defining a category of defendants that falls somewhere between primary violators and traditional aiders and abettors - a concept that appeared to draw little interest from her colleagues.
In the end, Stoneridge appears likely to follow Dura and Tellabs as a decision imposing further meaningful limits on the exposure of businesses to widespread securities fraud lawsuits. The full effects of these cases, moreover, cannot yet be measured. The implications of the decision in Dura , for example, have yet to be fully explored in the lower courts, and careful attention to the rapid development of the principles laid down by the Supreme Court in that case is essential for defendants seeking to take full advantage of opportunities for disposing of cases or sharply reducing settlement values that did not exist in the pre- Dura environment. The implications of Stoneridge are also unlikely to be fully clear for some time. The Supreme Court has been presented with several plausible arguments against scheme liability, and - even assuming the Court rejects scheme liability - there are potentially significant consequences to which argument the Court chooses to adopt, as well as potentially significant opportunities for attentive defense counsel in a careful parsing of the court's reasoning.
Those consequences and opportunities cannot be reliably predicted from this vantage point. What does appear highly likely, as of this writing, is that securities defendants will yet again end a Supreme Court Term in a significantly stronger position than when the Term began.
Published January 1, 2008.
