Supreme Court rules against investors in fraud case

by James Oliphant

In one of the largest securities decisions in years, the Supreme Court Tuesday sided with big business and against defrauded investors in ruling that securities fraud claims cannot be brought against third parties such as accountants, bankers, and lawyers who did business with the corporation that perpetrated the fraud.

The 5-3 decision represents a victory for corporate America, the business lobby, and the Bush administration, which urged the court to insulate those third parties from so-called “scheme liability,” which attempts to reach outside companies who allegedly played a role in accounting schemes.

“The Supreme Court today handed down a major victory for the U.S. economy and investor welfare,” said Stephen Shapiro, the Chicago lawyer who argued the case. “The court understood that the trial lawyers’ theory of ‘scheme liability’ was simply a scheme to rake in billions of dollars for themselves at the expense of the investors they purported to represent.”

The case involved investors who sued Scientific-Atlanta, Inc. and Motorola, Inc., two vendors for cable company Charter Communications, Inc., alleging that the vendors were part of a scheme to misrepresent Charter’s revenue and pump up its stock price.

The closely watched dispute was one some observers labeled the "Roe vs. Wade" of securities law, one in which more than 30 friend-of-the-court briefs were filed.

Justice Anthony Kennedy, writing for the five-justice majority, said that because the vendors made no specific representations about the health of the Charter’s finances, they weren’t liable under federal securities laws. Only the Securities and Exchange Commission has the authority to bring such “aid-and-abetter” actions against third parties, the court held.

When the case was argued in October, Kennedy voiced concern that siding with the investors would result in an explosion of securities litigation. And Tuesday, he seemed to echo that concern in writing, “Were the implies cause of action to be extended to the practices described here, there would be a risk that federal power would be used to invite litigation beyond the immediate sphere of securities litigation. . . .”

Kennedy also noted the potential impact on America’s economy, saying that “contracting parties might find it necessary to protect against these threats. Overseas firms with no other exposure to our securities laws could be deterred from doing business here.”

Shapiro, a lawyer with the Chicago firm Mayer Brown, said the outcome actually benefits most investors, because a decision the other way would have driven up the costs of outside legal and financial services.

Along with Kennedy, Justices Antonin Scalia, Clarence Thomas, John Roberts, and Samuel Alito formed the majority. Justice Stephen Breyer recused himself from consideration of the case.

Justice John Paul Stevens, with Justices David Souter and Ruth Bader Ginsberg, dissented. In his dissent, Stevens wrote that Charter could not have pulled off the accounting fraud without the vendors’ help and that the vendors knew that investors would rely on Charter’s inflated stock price as a measure of the company’s worth.

Stevens was also critical of Kennedy’s assertion that the ruling would protect America’s economy. Stevens wrote expanding investors’ litigation rights “will not harm American competitiveness; in fact investor faith in the safety and integrity of our markets is their strength. The fact that our markets are the safest in the world has helped make them the strongest in the world.”

When the case was accepted by the court, speculation mounted as to the position the administration would take. Ultimately, in somewhat of a surprising move, the White House ultimately ignored the advice of the SEC, accepting instead the recommendation of the Justice Department in siding with the business community and groups such as the U.S Chamber of Commerce.