High Court Rejects “Scheme Liability” Under Antifraud Provisions of 1934 Act
 
January 28, 2008
 

On January 15, 2008, the U.S. Supreme Court ruled that plaintiffs may state securities fraud claims under Section 10(b) and Rule 10b-5 of the 1934 Act against secondary actors only if they relied on their representations or deceptive acts. In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. No. 06-43, 1/15/08, the Court rejected the “scheme liability” theory that had been developed by the plaintiffs’ securities bar as a way to circumvent the Court’s earlier ruling in Central Bank that there was no private cause of action for aiding and abetting for securities fraud. Central Bank Denver N.A. v. First Interstate Bank of Denver N.A., 511 U.S. 164 (1994). Scheme liability theories had been the basis of claims against secondary actors such as lawyers, accountants and investment banks in Enron, Parmalot and WorldCom.

In Stoneridge, the plaintiffs alleged that the suppliers and customers of Charter Communications, a cable television company, engaged in sham barter transactions to help Charter “cook” its books. These business partners of the cable company allegedly knew or recklessly disregarded that the cable company was using such transactions to falsify its financials. The plaintiffs also alleged that the defendants knew that investors, auditors and analysts would rely on these false financials.

In a 5-3 decision, the Court held that the defendants could not be held liable as primary violators under Section 10(b). The Court’s decision was based on the reliance element of Section 10(b). Because investors did not rely on the statements or deceptive acts of the defendants, the Court held that the allegedly deceptive acts amounted to an aiding and abetting claim which could not be maintained under Central Bank. The Court’s decision does not affect the ability of the SEC or state/federal prosecutors to assert aiding and abetting claims against secondary actors based on deceptive conduct.

The decision also reinforces the Court’s concern about the impact of securities class actions on U.S. capital markets. The Court noted that such expansive theories of liabilities could dissuade overseas firms from participating in our markets due to unjustifiably increased costs of doing business in the United States. This decision continues the trend of several recent decisions which have tightened the requirements for pursuing private securities litigation specifically and limited the scope of implied actions generally. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) (tightening pleading standards); Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) (tightening loss causation standards).

For more information about this case, email Tracy A. Nichols at tracy.nichols@hklaw.com or call 305.789.7717.