US: Corporate Fraud Lawsuits Restricted

Publisher Name: 
Washington Post

The
Supreme Court yesterday strictly limited the ability of investors who
lost money through corporate fraud to sue other businesses that may
have helped facilitate the crime, a decision that could doom
stockholder efforts to recover billions of dollars lost in Enron and other high-profile cases.

In
a victory for business interests in a case they had identified as their
most important of the year, the court ruled 5 to 3 to protect corporate
partners such as vendors, consultants and others from liability if
stockholders cannot show they relied on deception from such "secondary
actors'' in making their investment decisions.

"That was a complete victory for the defendants," said Georgetown University
law professor Donald C. Langevoort. "The judicial system has become
more conservative and more sensitive to economic rights and business
interests. This is one of many cases that has restricted the scope of
investor recovery."

The case decided yesterday, Stoneridge Investment Partners v. Scientific-Atlanta,
involves a scheme by a cable company and two of its vendors that
allowed the company to disguise a revenue shortfall and present
investors a healthier financial picture. Investors sued the company,
Charter Communications, and then went after the two vendors,
Scientific-Atlanta and Motorola.

Justice Anthony M. Kennedy,
writing for the majority, said stockholders had no knowledge of the
actions of the two vendors and thus cannot show those companies'
actions influenced investors "except in an indirect chain that we find
too remote for liability.''

Kennedy drew from the court's 1994
decision that private suits are not allowed against companies "aiding
and abetting" corporate fraud by others. He wrote that Congress the
following year determined that "this class of defendants should be
pursued by the SEC and not by private litigants,'' referring to the Securities and Exchange Commission.

The
case attracted national attention for its similarity to a case filed by
investors who want to sue banks and others that allegedly allowed the
energy trader Enron to disguise its financial problems before a
collapse that produced heavy losses. It carries implications for other
investor-motivated suits over alleged corporate fraud, including
attempts by shareholders to recover billions of dollars in widening
losses in mortgage industry investments.

The decision continued a
winning streak for business interests in securities cases that extends
back to the court's 2004 case and marked the reemergence this term of
the court's ideological split.

Kennedy was joined by the four more conservative members of the court, Chief Justice John G. Roberts Jr., Antonin Scalia, Clarence Thomas and Samuel A. Alito Jr. Embracing an argument advanced by the U.S. Chamber of Commerce,
the five said expanding the availability of stockholder suits "may
raise the cost of being a publicly traded company under our law and
shift securities offerings away from domestic capital markets.''

Justice John Paul Stevens
said the majority has a "mistaken hostility'' toward such private
actions, allowed by the court long ago under federal securities law.
Stevens wrote such suits play an important role in insuring "investor
faith in the safety and integrity of our markets.''

He said
Congress has acted "with the understanding that federal courts
respected the principle that every wrong would have a remedy.''

His dissent was joined by Justices David H. Souter and Ruth Bader Ginsburg. Justice Stephen G. Breyer, who owns stock in Cisco,
which now owns Scientific-Atlanta, did not take part in the decision.
Roberts had also recused himself from the case, but rejoined it,
apparently after taking action to eliminate a financial conflict.

Plaintiffs'
lawyers say sometimes the only way for investors to recover money lost
because of a company's fraudulent actions is to go after those who
helped perpetrate the fraud. They are often the only ones left with
money after a scheme collapses.

Sean Coffey, a lawyer who
frequently files fraud cases on behalf of shareholders, said the
decision "significantly diluted accountability for wrong-doers at the
same time that investor confidence in the integrity of our capital
markets is suffering yet another body blow, this time from the subprime
debacle."

The ruling intensifies pressure on regulators and
prosecutors to step up their attack on corporate fraud rather than
relying on investor lawsuits to shoulder some of the burden.

Duke University law professor James D. Cox, who follows the government's antifraud
initiatives, noted that neither agency sued Scientific-Atlanta or
Motorola in connection with the Charter scheme. "The SEC is a nonplayer
in these cases," he said.

The SEC had supported weighing in on behalf of plaintiffs in the Stoneridge case, but it was overruled by President Bush and Treasury Secretary Henry M. Paulson Jr., who feared it would hamper business with expensive and frivolous lawsuits.

Corporate lobbyists embraced the ruling.

"This
decision ensures that overzealous litigation does not derail the U.S.
economy," said Ira Hammerman, general counsel at the Securities Industry and Financial Markets Association.
"The wrong ruling would have unleashed a tsunami of damaging side
effects, infecting the entire U.S. economy and harming investors."

Dan
Newman, a spokesman for the attorneys who represent Enron plaintiffs,
said they were analyzing the ruling. The court will consider whether to
review the Enron case at its private conference this week.

"We're
looking at a variety of options because clearly the innocent victims of
the Enron debacle don't deserve to be left holding the bag for the
fraud orchestrated by powerful banks," Newman said.

Some legal
experts said the ruling, while unfavorable to many plaintiffs, could
have been written in a way that was even more damaging. Former SEC
commissioner Harvey J. Goldschmid, who joined in a brief supporting the
plaintiffs, said that investors may find hope in a distinction that
Kennedy appeared to draw between third parties in the securities and
financial services industry and those who handle "ordinary business
operations."

The opinion, Goldschmid said, may leave room for
shareholder lawsuits against underwriters, accountants, lawyers and
bankers while forestalling such cases against vendors selling goods.

AMP Section Name:Regulation
  • 106 Money & Politics
  • 185 Corruption