Professor Bainbridge...on law, politics, religion, culture & food

Stoneridge Decided

The Supreme Court’s 5-3 opinion is here. For an excellent and extensive collection of background materials, go here.

From SCOTUS Blog:

The Supreme Court, in one of the most important securities law rulings in years, decided Tuesday that fraud claims are not allowed against third parties that did not directly mislead investors but were business partners with those who did. The 5-3 ruling came in Stoneridge Investment Partners v. Scientific-Atlanta (06-43).

Investors, the Court said, may only sue those who issued statements or otherwise took direct action that the investors had relied upon in buying or selling stock — whether that involved public statements, omissions of key facts, manipulative trading, or conduct that was itself deceptive. One impact of the decision is likely to be the scuttling of a massive $40 billion lawsuit against financial institutions growing out of the Enron scandal. The Court has a case on its docket involving that very dispute, and Tuesday’s ruling will be followed up soon, perhaps by next week, with action on that case — California Regents v. Merrill Lynch, et al. (06-1341). ...

Justice Anthony M. Kennedy, who wrote the Stoneridge ruling, said the private right to sue for securities fraud “does not reach the customer/companies because the investors did not rely upon their statements or misrepresentations.” The ruling upheld a decision by the Eighth Circuit Court rejecting claims against Scientific Atlanta, Inc., and Motorola, Inc.  The investors contended that those two companies helped a giant cable TV firm, Charter Communications, inflate artificially its financial staements in order to bolster its stock’s price.  The investors contended that the two companies should be treated as “primary violators,” even though they had not themselves issued any public statements to advance the alleged manipulation plot. ...

The private right to sue at issue is one that has been created by court decisions, not by a direct federal statute. Justice Kennedy said that Tuesday’s ruling limiting the range of such a lawsuit was “consistent with the narrow dimenions we must give to a right of action Congress did not authorize when it first enacted the [Securities Exchange Act of 1934] and did not expand when it revisited the law.”

In ruling Tuesday that Scientific Atlanta and Motorola could not be sued, Kennedy wrote that the two outside companies “had no duty to disclose; and their deceptive acts were not communicated to the public.  No member of the investing public had knowledge, either actual or presumed, of [the two companies’] deceptive acts during the relevant times. [Stoneridge], as a result, cannot show reliance upon any of [the companies’] actions except in an indirect chain that we find too remote for liability.”

Noting that the investors had argued that Scientific Atlanta and Motorola had done what they did with the aim, and the result, that a false appearance was created about Charter’s revenues, and that what Charter said publicly was “a natural and expected consequence” of the suppliers’ deception, the Court said this was not a sufficient link in the chain toward liability.

“In effect,” Kennedy wrote, Stoneridge “contends that in an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect. Were this concept of reliance to be adopted, the implied cause of action would reach the whole marketplace in which the issuing company does business; and there is no authority for this rule.” ...

Go read the whole excellent report.

For prior analysis by yours truly see my posts:

Stoneridge Investment Partners versus Scientific-Atlanta: An Introduction and Overview

and

Stoneridge and SOX Section 404: Conference Remarks

I think this is the right result both from a doctrinal and a policy perspective. As to the latter, a Law.com article issued today proves quite timely:

Stephen Bainbridge, William D. Warren Professor of Law at the University of California at Los Angeles, who has written extensively about Stoneridge, said the case exemplifies European perceptions of capricious litigation risk when doing business in the United States.

“[The defendants] allegedly knew this was essentially a straw man transaction for accounting considerations, but they never lied to the investors and that is what the securities laws are designed to address,” Bainbridge said.

“It’s the kind of case that conveys the notion our law casts a very broad net and you face significant liability risks [in the United States] that are not present elsewhere,” he said. “Companies find they can raise capital from investors who will purchase their securities even in jurisdictions that seemingly offer fewer protections. Maybe the investors are making a big mistake, but the fact is investors are buying those securities, so the question is: Have we gone overboard here in the U.S.?”

Meanwhile, Jay Brown’s no fan of the result, but he did have some kind words to say about yours truly:

… we have to hand it to Steve Bainbridge at UCLA who got this case exactly right.  He noted that the Supreme Court was largely incapable of analyzing securities issues on their own.  He predicted that, as a result, the Court would decide the case by largely duplicating the brief of the government.  With almost all of the participants fighting over whether deceptive behavior could violate Rule 10b-5, the solicitor general’s brief took the position that the case turned on the element of reliance.  Guess what?  Justice Kennedy’s opinion turned on the issue of reliance.

Heh.