Supreme Court to Consider Broader Liability in Securities Fraud

By | March 27, 2007

The Supreme Court said this week that it will consider whether shareholders of companies that commit securities fraud should be able to sue investment banks, lawyers and others that allegedly participated in the fraud.

The case, which won’t be argued until the court’s next term beginning in October, will be closely-watched on Wall Street and in law firms around the country as federal appeals courts have split on whether such “secondary actors” can be held liable.

Last week, the 5th U.S. Circuit Court of Appeals ruled against a class action lawsuit brought by former Enron shareholders against several investment banks, including Merrill Lynch & Co. Inc. and Credit Suisse Group, over their alleged role in Enron’s collapse.

The 5th Circuit found that the banks only “aided and abetted” Enron’s fraud. Under a 1994 Supreme Court ruling, companies are generally protected from shareholder lawsuits if they aid and abet fraud, though the Securities and Exchange Commission can pursue civil actions against them.

The case the justices agreed to hear stems from an episode of alleged securities fraud by cable television provider Charter Communications Inc. in 2000. The company entered into several sham transactions with Motorola Inc. and Scientific-Atlanta Inc., now owned by Cisco Systems Inc., designed to inflate its revenue by $17 million, according to court filings by StoneRidge Investment Partners LLC, which sued the two companies.

StoneRidge accused Motorola and Scientific-Atlanta of participating in a “scheme to defraud” investors.

A federal district court and the 8th Circuit Court of Appeals dismissed the claim, however, finding that the two companies aided and abetted the fraud but did not violate securities laws themselves.

The 9th Circuit Court of Appeals, however, subsequently ruled in a separate case that a secondary actor can be held liable in some circumstances — specifically, if its conduct had “the principal purpose and effect of creating a false appearance of fact” in support of a scheme to defraud. That ruling set up a conflict in the federal appeals courts, which can sometimes spur the Supreme Court to weigh in.

The case is Stoneridge Investment v. Scientific-Atlanta (06-43).

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