Client Alert

On January 15, 2008, the United States Supreme Court issued its long-awaited opinion in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. et al.¹ In its decision, the Supreme Court held that the private cause of action under Section 10(b) of the Securities Exchange Act of 1934 does not reach participation by secondary actors, such as customers and suppliers, in a "scheme" to defraud investors. This case is expected to have a broad impact on third-party liability in securities fraud cases, such as the current Enron litigation in which plaintiffs' lawyers have targeted Enron's investment bankers and other advisers.

Background
Stoneridge filed this class action on behalf of shareholders of Charter Communications, Inc., a cable television provider, against Charter, its executives, its auditor and two vendors that supplied cable converter boxes for Charter, Scientific-Atlanta, Inc. and Motorola, Inc. (the "Vendors"). The plaintiffs alleged that the Vendors bought advertising from Charter for a price greater than fair value in consideration of Charter's purchase of converter boxes at inflated prices and thus enabled Charter to inflate its financial statements and meet its revenue projections. According to the plaintiffs' claims, the Vendors were liable under Section 10(b) because they knew or were in reckless disregard of Charter's intention to use the transactions to inflate its revenues and knew that the resulting financial statements issued by Charter would be relied upon by research analysts and investors. The District Court dismissed the claims against the Vendors, holding that the Vendors' alleged conduct constituted aiding and abetting, for which there is no Section 10(b) private right of action.² The Eighth Circuit Court of Appeals affirmed the District Court's decision.

Supreme Court Decision
The Supreme Court accepted the Stoneridge case in order to determine when, if ever, an injured investor may rely upon Section 10(b) to recover from a party that participates in a scheme to violate Section 10(b) but neither makes a public misstatement nor violates a duty to disclose.

To establish a Section 10(b) claim, a plaintiff must prove:

• a material misrepresentation or omission by the defendant;
• scienter;
• a connection between the misrepresentation or omission and the purchase or sale of a security;
• reliance upon the misrepresentation or omission;
• economic loss; and
• loss causation.

Because the private right of action under Section 10(b) does not include aiding and abetting, the conduct of a secondary actor must satisfy each of the Section 10(b) elements. The Supreme Court found that the plaintiffs did not prove that the investors relied on the Vendors’ acts or statements. The plaintiffs argued that reliance should be presumed because the Vendors engaged in "conduct with the purpose and effect of creating a false appearance of material fact to further a scheme to misrepresent Charter's revenue." Thus, "the financial statement Charter released to the public was a natural and expected consequence of respondents' deceptive acts."

The Supreme Court rejected the plaintiffs’ theory as unsupported by authority and noted that "[w]ere this concept of reliance to be adopted, the implied cause of action would reach the whole marketplace in which the issuing company does business" and would expose a new class of defendants to the risk of meritless securities fraud lawsuits.

Conclusion
The Supreme Court's decision should have a significant impact in foreclosing scheme liability claims against third parties. For example, the day after the Stoneridge decision was issued, the plaintiffs in the Enron litigation petitioned the Supreme Court to determine whether the Stoneridge holding barred their claims against Enron's investment banking firms. On January 22, 2008, the Supreme Court refused to hear the matter, effectively putting an end to the investors' attempt to recoup their losses from Enron's investment bankers.

Contact Information
If you have any questions regarding this ruling, please contact Meredith Burbank, the principal drafter of this client alert, or you may contact the Womble Carlyle attorney with whom you usually work or one of our Corporate and Securities attorneys.

Notes
¹ Slip op. No. 06-43, ­­­ ___ S. Ct. ___ (2008), available at http://www.knowledgemosaic.com/gateway/courtcase/Stoneridge.011508.pdf.

² See Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994). After the Central Bank decision, Congress considered creating a private cause of action for aiding and abetting but declined to do so. Instead, Congress authorized the Securities and Exchange Commission to prosecute aiders and abettors. See Section 20(e) of the Exchange Act.