Today the U.S. Supreme Court decided Stoneridge Investment Partners v. Scientific-Atlanta. By a vote of 5-3, the Court rejected "scheme liability" and held that private rights of action under Section 10(b) of the Securities Act do not reach third-party actions where shareholders did not rely upon the third party's actions or statements. Justice Kennedy wrote the opinion for the Court. Justice Stevens dissented, joined by Justices Ginsburg and Souter. Justice Breyer did not take part in the decision.
For more on the decision see Lyle Denniston on SCOTUSBlog, this Washington Post report, or this LA Times story. Jay Brown also has some thoughts on the Race to the Bottom blog. For more background, see this string of posts, or the Stoneridge resources page at CWRU's Center for Business Law & Regulation.
UPDATE: More from Professor Bainbridge, Ted Frank, and Elizabeth Nowicki.
Props to Prof. Bainbridge for correctly predicting the outcome.
finally(1:40 PM EST) posted on this decision.Making suppliers and customers police the accounting practices of their trade partners is too onerous a burden on the market, especially for international commerce as the opinion points out. The culpability of Motorola was negligible: the biggest evidence of fraud Stevens noted was the (one month, IIRC) backdating of a modification to the contract (to the start of the period of the change's effectiveness).
Congress passed that law, Stevens argued, “with the understanding that federal courts respected the principle that every wrong should have a remedy."
To this non-lawyer that seems like an extraordinary and a rather bizarre statement.
Also, is there really a general theory that EVERY wrong should have a remedy?
Too easy. Jay Brown is the one ignoring the plain language of the relevant law: "in connection with the purchase or sale of any security." Read Section 10(b) and Rule 10b-5, then look at the facts of this case. Nothing the defendants (allegedly) did violates the statute.
You cannot pick and choose which elements of a cause of action you like, while disregarding the elements that do not appply to your case.
Charter Communications is the guilty party and should pay. Their settop box supplier Motorola merely acquiesced to a co-op advertising plan.
I didn't think that there was anything particularly controversial about the Cort v. Ash test or the general reluctance of federal courts to find that every instance of noncompliance with a law can be the basis for a lawsuit whenever there's a plausible claim of resulting injury. I was under the impression in law school that the "where there's a right, there's a remedy" maxim is sort of a naive thing to say if you're a lawyer.
There is language in the Stoneridge opinion that the SEC should consider before bringing any more of these cases. “Were the implied cause of action to be extended to the practices described here, however, there would be a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees.” This would seem to apply as much to SEC enforcement actions as private litigation. Perhaps the enforcement division should reconsider its activist approach in these cases.
The private right of action that the courts have found to be implied by Rule 10b-5 is based on the common law of fraud, as the Congress did not create explicitly create a private right of action under that Rule.
The common law of fraud has several elements. One of the elements that the party allegedly defrauded must have relied on a false or misleading misstatement. This requirement is meant to eliminate an action by someone who, for example, knew the seller was lying but bought the stock anyway or who bought the stock but did not know that the seller had made the misrepresentation.
Here, the court found that the plaintiffs did not know about or rely on any statements by the defendants. The defendants made no statements to the plaintiffs or to the "market" and had no duty to inform anyone about the false statements that the issuer was making. Therefore, the plaintiffs did not know about and could not have relied on their statements.
Although the defendants may have aided and abetted the issuer in its "fraud on the market" arising from the issuance of false financial statements---and may have criminal liability under the Act or Rule 10b-5--the Supreme Court held years ago that aiders and abetters are not liable to private plaintiffs under the private right of action implied under Rule 10b-5, and Congress has not amended the securities laws since that decision to change the result.
Justice Scalia has to be delighted with Part III-C of Justice Kennedy's majority opinion. It calls the 10b-5 private right of action a "judicial construct that Congress did not enact in the text of the relevant statutes." Slip op. at 13. In the next sentence it cites Scalia's archtextualist majority opinion in Alexander v. Sandoval (2001) for the proposition that, whatever may have been the practice back in the carefree Warren Court days, these are new times: it is now "settled that there is an implied cause of action only if the underlying statute can be interpreted to disclose the intent to create one." Id.
This sets up the conclusion in the following paragraph: "Though it remains the law, the 10(b) private right should not be extended beyond its present boundaries." Id. at 14.
The majority is emphasizing that the judicial decision to create the 10b-5 private cause of action in the first place was seriously incorrect under current norms of statutory interpretation, and persists only by virtue of stare decisis. It won't be overruled, but future cases on the scope of private 10b-5 litigation will be addressed in the light of the flawed basis of the private right of action itself.
Justice Stevens (the Court's liveliest opponent of textualism) is well aware of these larger interpretive issues. He devotes Part III of his opinion to making a historical case for the practice of interpreting federal statutes "in the common law tradition," slip op., diss. at 10, and implying a private remedy for any violation of a right.
Fascinating stuff.
Any mischievous "investor" can file suit first, and hope to discover evidence of intent later. In fact I believe the scienter standard is merely "should have known", requiring third party suppliers/customers to do due diligence on how their partners will account for every transaction, drastically increasing the burden of making deals.
This suggests a lack of experience actually litigating securities fraud cases. The standard for even alleging scienter is extremely high under the PSLRA, and plaintiffs are allowed no discovery until after motions to dismiss have been denied. The claim that restrictive decisions such as this are necessary to prevent abusive lawsuits simply ignores post-PSLRA reality.
I agree that, if Motorola did not know what was going on, they should have no liability. But, if it was knowingly helping Charter defraud its shareholders, it should pay the price.
Who benefitted from Charter's misdeeds? Well, the people in Charter who are now in jail. And Motorola's stockholders. I believe those stockholders got a windfall (perhaps a very small one) and, if they aided and abetted the fraud, they should be required to disgorge the windfall. That is as a matter of policy, if not the law as it currently stands.
But satisfying that standard is very easy; the fraud need only "touch" a purchase or sale of securities. And engaging in sham transactions that serve only to inflate an issuer's revenue most likely "touch" the open market transactions occurring every day w/r/t Charter's securities.
As a policy matter, this is a good result. Issuers and their D&O insurers have plenty of money to pay damages in these cases. Additional deep pockets are not usually needed.
As a strictly legal matter, the opinion is pretty awful. Of course it is true that Motorola and S-A could not control Charter's accounting, but Charter did not ask them to engage in sham transactions so that it could turn around and accurately report them to shareholders. The whole point of the deal was fraud, and it could not have been accomplished without Motorola and S-A (according to the allegations that had to be accepted as true). Thus, this is not a case where company A buys widgets from company B and company B unilaterally inflates the revenue from those sales. This is A and B agreeing to a sham transaction that has no purpose other than to mislead. Seems to me that's covered by 10b-5.
The bolded portion of your statement is just plain wrong. Congress has specifically endorsed the private right of action over the last half century -- most recently, Republican Congresses put limits on it, but did not eliminate it altogether. It's not simply a matter of stare decisis at all.
The standard for even alleging scienter is extremely high under the PSLRA, and plaintiffs are allowed no discovery until after motions to dismiss have been denied. Apply that standard to the case here, please.
Mike -- thanks for highlighting those issues. I think those issues are pretty interesting as well. Don't know enough about the substance of the controversy to have any opinion one way or another (i.e., i dunno whether third-parties should be liable or not). But, the interpretive issue of when to "imply" a private cause of action and the notion that "every wrong has a remedy" (O RLY?) does pique my interest.
If Tellabs had come out before this case had already been dismissed, the case would have almost certainly been dismissed on the scienter grounds as well.
Really? So, assuming Motorola was never in breach, the rebate was never paid? Why did Charter's shareholders sue?
As I recall, the advertising contract was backdated one month to cover the start of set-top box shipments.
Although not involved in this case my personal rule is I am willing to forgo 100% of any class action receipts providing the attorneys similarly get nothing. In all previous cases I got bubkus and the lawyers came out like bandits. General rule - follow the money.
Wouldn't it be wonderful now if the original plaintiff had to pay the entire legal fee of the winner?
Assuming you can prove this, can you also look into Safeway, who since introducing their loyalty card, has jacked up the everyday prices of everything so that their customers have the illusion of saving money by using the card? Also, please look into the sham of cents-off coupons, and rebates that purport to make items "free" to the consumer after the rebate is paid.