Geneva
43, rue du Rhône
1204 Geneva, Switzerland
41 22 317-75-75
Fax: 41 22 317-75-00

London
99 Gresham Street
London EC2V 7NG, UK
44 (0)20 7105 0000
Fax: 44 (0)20 7105 0100

Los Angeles
333 S. Grand Avenue
Los Angeles, CA 90071
(213) 615-1700
Fax: (213) 615-1750

Moscow
4 Stasovoy Ulitsa
117071 Moscow
Russian Federation
7095-975-0623
Fax: 7095-975-0624

New York
200 Park Avenue
New York, NY 10166
(212) 294-6700
Fax: (212) 294-4700

Paris
25, avenue Marceau
75116 Paris, France
33 1-53-64-82-82
Fax: 33 1-53-64-82-20

San Francisco
101 California Street
San Francisco, CA 94111
(415) 591-1000
Fax: (415) 591-1400

Washington, D.C.
1700 K Street, N.W.
Washington, D.C. 20006
(202) 282-5000
Fax: (202) 282-5100

www.winston.com

Revisiting Secondary Liability and the Federal Securities Laws: Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.

On Tuesday, October 9, 2007, the U.S. Supreme Court heard oral argument in a case that could impact substantially the scope of secondary liability under the federal securities laws.  The plaintiffs in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., No. 06-43, seek to hold two companies responsible for a third party’s violation of the securities laws, claiming that the companies engaged in “deceptive” conduct by participating in the third party’s scheme to artificially inflate its own public financial statements.  This notwithstanding Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994), in which the Supreme Court held that conduct actionable in private suits under the Exchange Act “does not include giving aid to a person who commits a manipulative or deceptive act.”  The Stoneridge plaintiffs faced a skeptical Supreme Court, but an intermediate position championed by the Solicitor General—shifting the focus in the case from the defendants’ conduct to the plaintiffs’ lack of reliance on it—could postpone the Court’s resolution of the larger issue.

Charter Communications, Inc., a cable television provider, allegedly reached an agreement with two of its equipment vendors, whereby Charter would pay an extra $20 for each set-top cable box the vendors provided, and the vendors would return that money to Charter in the form of advertising fees.  Charter allegedly used this arrangement to fraudulently inflate its financial health by capitalizing its extra costs as an equipment expense and reporting the vendors’ payments as revenue.  The vendors themselves did not make any public statements about their agreements with Charter, nor were they under any obligation to do so.  Nonetheless, Charter’s investors sued the vendors for securities fraud, contending that they were liable because entering these “sham transactions” was deceptive conduct prohibited by §10(b).  The Eighth Circuit disagreed, holding that the vendors could not be held liable in a private lawsuit because they had made no deceptive statement or omission to the market.  (Since that decision, similar claims have been rejected by the Fifth Circuit in Regents of the Univ. of Calif. v. Credit Suisse First Boston (USA), Inc., but accepted by the Ninth Circuit in Simpson v. AOL Time Warner Inc.  Petitions for certiorari are pending in both cases.)

At oral argument this week, the Justices questioned plaintiffs’ counsel about how to distinguish these claims from the aider-abettor liability placed out-of-bounds by Central Bank.  Four of the Justices (Chief Justice Roberts and Justices Scalia, Souter, and Alito) asked questions suggesting that they perceived little, if any, difference between plaintiffs’ theory and aider-abettor liability.  Similarly, Justice Kennedy expressed concern about holding the vendors liable even though they were indifferent to Charter’s investors, noting that if it is enough that a defendant behave recklessly with respect to harm to investors, the securities laws will too readily be put in play because “most people that engage in frauds on business know that if it’s a publicly held corporation, it’s going to hurt the price of the shares or affect the price of the shares.”  Justice Souter and Justice Scalia both followed up to emphasize this point, with Justice Scalia in particular appearing wary of a theory that would impose primary liability on “all aiders and abettors who commit deceptive acts.”

In addition, Chief Justice Roberts—who initially recused himself, but took steps to clear the conflict and is now participating in the case—picked up on a theme much stressed by the defendants: Congress has authorized the SEC to bring enforcement actions against aiders and abettors, and the Court “should get out of the business of expanding [the private right of action], because Congress has taken over and is legislating the area in the way they weren’t back when we implied the right of action under 10(b).”

Conversely, Justice Ginsburg, and to a lesser extent Justices Kennedy and Souter, challenged the vendors’ counsel as to whether the defendants might fit into a “middle category,” between principals and aiders and abettors.  Justice Ginsburg seemed to have in mind people who “made it possible” for the primary violation to happen—not control persons, and not helpers, but rather enablers.  These same three Justices also expressed some concern about the vendors’ argument that a defendant simply cannot engage in “deceptive” conduct for purposes of §10(b) without making a statement to the market. 

The Solicitor General, as amicus in support of the vendors, took a position that some of the Justices might find less troublesome—that the problem with plaintiffs’ claim was not the lack of any statement by the defendants but rather the lack of reliance by the market.  In other words, if the vendors did engage in “deceptive” conduct, the investors knew nothing about it and thus cannot have relied on it.  Chief Justice Roberts and Justice Ginsburg, however, both questioned whether this reliance argument was presented and decided by the Eighth Circuit in this case.

Justice Breyer is recused from the case.  In the event of a 4-4 split, the decision below in favor of the vendors will stand.  A decision is expected this winter.

If you no longer wish to receive Appellate and Critical Motions briefings from Winston & Strawn LLP, please contact us at appellatecriticalmotionsupdate@winston.com or write us at Winston & Strawn LLP, Attention: Business Development Clerk, 35 W. Wacker Drive, Chicago, IL 60601.

These materials have been prepared by Winston & Strawn LLP for informational purposes only and are not legal advice. Receipt of this information does not create an attorney-client relationship.

Along with this Briefing, an archive of all Winston & Strawn LLP Briefings published to date can be accessed by visiting the Publications section of Winston & Strawn LLP’s web site (www.winston.com).

Copyright © 2007. Winston & Strawn LLP.