The Stoneridge Decision—Curtailing Private Securities Fraud Claims against Secondary Actors (such

On January 15, 2008, the Supreme Court of the United States issued a decision (5-3) in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., et al., which clarified and curtailed the investing public’s right to bring a federal securities fraud action against secondary actors under both primary and aiding and abetting theories of liability.  The Court, focusing on the requirement that the allegedly injured investors directly relied upon the alleged fraud, and pointing to the decision by Congress in its 1995 legislation specifically limiting the authority to bring an action for aiding and abetting securities fraud to the SEC, found that there is no implied private right of action against secondary actors under the federal securities laws even where the secondary actors themselves allegedly engaged in fraudulent conduct.  This decision has particular importance for accounting firms that advise public companies or provide audit services for publicly traded companies.

 

Facts of Stoneridge

 

Charter Communications was a publicly traded cable provider.  When management realized the company would not meet analyst expectations on several key financial indicators, they took a series of steps and began a series of transactions, which were designed to inflate subscriber numbers, boost advertising revenue and decrease expenses.  At issue in the case were transactions with Scientific-Atlanta and Motorola, providers of cable boxes and other equipment to Charter Communications and advertising customers on the cable system.

 

At the request of Charter, Scientific-Atlanta and Motorola agreed to restructure already existing agreements in which they would increase the cost of their cable boxes by $20. The total amount of the increase would be repaid to Charter by the companies as an amount Scientific-Atlanta and Motorola would pay for advertising time on the cable system above fair market value.  The various transactions were drawn up in separate contracts, some of which was backdated to hide the fact that they were related transactions, and false correspondence was sent by Scientific-Atlanta indicating that the increase in cable box price was done in the ordinary course of business.  For purposes of the decision, the Court assumed that Charter’s auditor, Arthur Andersen, was not complicit in the scheme and the only purpose of the transaction was to manipulate Charter’s financial statements.  Charter then issued and filed financial statements incorporating these transactions, which failed to identify their true nature.  Scientific-Atlanta’s and Motorola’s financial statements accurately reflected the transactions as a wash in accordance with GAAP.

 

Eventually, the scheme was uncovered and an investor class action suit was commenced pursuant to Section 10(b) of the Securities Exchange Act of 1934 and the rules promulgated thereunder.  Although the class action plaintiffs plead that Scientific-Atlanta and Motorola actually engaged in fraudulent conduct in furtherance of the scheme, the district court dismissed the claims against Scientific-Atlanta and Motorola because they were secondary actors not directly involved in the dissemination of the information upon which the plaintiffs supposedly relied.  The Court of Appeals affirmed.  Plaintiff’s appealed to the U.S. Supreme Court.

 

Relevant History of Private Actions Pursuant to § 10(b) of the Securities Exchange Act of 1934

 

Section 10(b) of the Securities Exchange Act of 1934 makes it “unlawful for any person, directly or indirectly,…[to] use or employ,…any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe….”  Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it unlawful, among other things, “(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”  It has long been held that this section of the Act provides for a private cause of action against principal wrongdoers.  However, in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994), the Supreme Court determined that the scope of the statute and subsequent rule did not provide for aiding and abetting claims. 

 

As part of a legislative initiative to reform certain aspects of the federal securities laws, and to address issues with private securities actions in particular, the Central Bank ruling eliminating aiding and abetting claims was reviewed, resulting in Congress receiving testimony calling for the creation of a private right of action for aiding and abetting.  However, Congress did not do so.  Instead, as part of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), Congress permitted prosecution of aiders and abetters, but only by the SEC through enforcement actions.

 

The Stoneridge Decision

 

The Supreme Court rejected plaintiff’s attempt to impose aiding and abetting liability upon Scientific-Atlanta and Motorola.  In a succinct review of the history of private claims under the federal securities law, the Court noted that private claims are only implied by Section 10(b) and, accordingly, have been strictly limited in furtherance of the apparent intent of the legislature.  Private claims for aiding and abetting were specifically considered by Congress prior to passing the PSLRA, but not incorporated in the final legislation.  

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