On January 15, 2008, the Supreme Court dealt another blow to the securities plaintiffs' bar in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. - the latest of several recent decisions limiting private plaintiffs' attempts to expand the reach of the federal securities laws.1In its long-anticipated opainion, the Court, ruling 5-3,2concluded that the implied private right of action under10(b) of the Securities Exchange Act of 1934 does not reach those whose acts or statements are not relied upon by investors. In so holding, the Court rejected the concept of "scheme liability" through which plaintiffs have sought to impose liability on defendants who neither made a public misstatement nor violated a duty to disclose but, rather, allegedly participated in a scheme to violate the securities laws.
The opinion is particularly notable for the Court's unequivocal refusal to extend the reach of the10(b) private right of action "beyond its present boundaries" to alleged "aiders and abettors" of securities fraud (such as customers, suppliers, banks and law firms), and for the Court's extensive discussion of the negative "practical consequences" of such an expansion.
In Stoneridge , plaintiffs alleged that Scientific-Atlanta and Motorola, suppliers and customers of Charter Communications, engaged in sham transactions with Charter that allowed Charter to mislead its auditor and inflate its revenue. Although these transactions were not disclosed to the public, Scientific-Atlanta and Motorola were alleged to have known or recklessly disregarded that the transactions would be used to inflate Charter's revenue and that Charter's financial statements would be relied upon by the market.
The Supreme Court's Opinion
In reaching its decision, the Court first noted - relying on its 1994 opinion in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. 3 - that the " 10(b) implied right of action does not extend to aiders and abettors" and, thus, the "conduct of a secondary actor must satisfy each of the elements or preconditions for [ 10(b)] liability." The Court further explained that "[r]eliance by the plaintiff upon the defendant's deceptive acts is an essential element of the10(b) private cause of action" and that plaintiffs could not satisfy10(b)'s reliance requirement:
[Scientific-Atlanta's and Moto-rola's] deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance. It was Charter, not [Scientific-Atlanta or Motorola], that misled its auditor and filed fraudulent fianancial statements; nothing [Scientific-Atlanta or Motorola] did made it necessary or inevitable for Charter to record the transactions as it did.
The Court, therefore, concluded that Scientific-Atlanta and Motorola "have no liability to [plaintiffs] under the [ 10(b)] implied right of action" because "the investors did not rely upon their statements or representations." The Court stated that its holding was consistent not only with Central Bank , but also Congress' express delegation to the Securities and Exchange Commission ("SEC") in the Private Securities Litigation Reform Act of 1995 (the "PSLRA") of the authority to prosecute aiders and abettors. According to the Court, to adopt the construction advocated by plaintiffs - i.e. , that Charter's false financial statements were a "natural and expected consequence of [Scientific-Atlanta's and Motorola's] deceptive acts" - "would revive in substance the implied cause of action against all aiders and abettors except those who committed no deceptive act in the process of facilitating the fraud; andwould undermine Congress' determination that this class of defendants should be pursued by the SEC and not by private litigants."
Notably, the Court also engaged in a lengthy discussion of the negative practical implications of expanding the reach of10(b)'s implied private right of action. Although characterized by the dissent as a "continuing campaign to render the private cause of action under10(b) toothless" and a "hostility towards the10(b) private cause of action," the majority expressed concern that plaintiffs' reliance theory - "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" - "would reach the whole marketplace in which the issuing company does business" and, thus, expand application of the federal securities laws "beyond the securities markets" to "the realm of financing business - to purchase and supply contracts - the realm of ordinary business operations." Such an expansion, the Court stated, would improperly thrust the federal securities laws into "areas already governed by functioning and effective state-law guarantees" and unnecessarily impinge upon already sufficient criminal penalties and civil enforcement by the SEC. In addition, the Court feared "expos[ing] a new class of defendants" to the risks of private securities lawsuits, including "extensive discovery and the potential for uncertainty" that "allow plaintiffs with weak claims to extort settlement from innocent companies." The Court described the potential adverse consequences of such an expansion of the10(b) private right of action as including increased "costs of doing business," the deterrence of "[o]verseas firms with no other exposure to our securities laws . . . from doing business here" and an ultimate shifting of "securities offerings away from domestic capital markets."
Consistent with recent decisions in the securities litigation context, Stoneridge is a clear indication that the present Court will continue to construe the federal securities laws narrowly and that, in the case of secondary actors, enforcement will be left to the SEC, not private litigants.
1See also Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) (holding that a plaintiff in a securities fraud action must allege, and ultimately prove at trial, that the defendant's fraud actually caused the plaintiff's economic loss); Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit , 547 U.S. 71 (2006); Tellabs, Inc. v. Makor Issues & Rights, Ltd . , 127 S.Ct. 2499 (2007) (holding that in order to establish the10(b) element of scienter, an inference of fraudulent intent must be more than merely permissible or even reasonable, but "cogent and compelling" when compared to competing explanations of non-fraudulent intent).
2 Justice Kennedy delivered the majority opinion, joined by Chief Justice Roberts and Justices Scalia, Thomas and Alito. Justice Stevens wrote a dissenting opinion, joined by Justices Souter and Ginsburg. Justice Breyer did not participate in the consideration or decision of the case .
3 511 U.S. 164 (1994).
John A. Neuwirth is a Partner and Stacy Nettleton is an Associate in the Securities/Corporate Governance Practice Group of Weil, Gotshal & Manges LLP.