SCOTUS Limits Scope of Securities Fraud Actions
Today, the Supreme Court held 5-3 that investors may not recover against third parties whose business partners fraudulently misled them. Boston College law professor Kent Greenfield previewed Stoneridge Investment Partners v. Scientific-Atlanta for ACSBlog, calling it "the most important business case to come before the Court in a decade."
In this case, Scientific-Atlanta agreed to help Charter mislead its auditor and the markets by inflating prices (among other things), thus making it appear as if Charter had met its revenue targets. The question before the Court was whether Rule 10b-5 of federal securities law reached Scientific-Atlanta under "scheme" liability. Justice Kennedy held it did not, because the investors "did not rely upon [Scientific-Atlanta's] statements or misrepresentations."
Justice Kennedy's majority opinion began as follows:
We consider the reach of the private right of action the Court has found implied in §10(b) of the Securities Exchange Act of 1934 . . . and SEC Rule 10b–5 . . . . In this suit investors alleged losses after purchasing common stock. They sought to impose liability on entities who, acting both as customers and suppliers, agreed to arrangements that allowed the investors’ company to mislead its auditor and issue a misleading financial statement affecting the stock price. We conclude the implied right of action does not reach the customer/supplier companies because the investors did not rely upon their statements or representations. We affirm the judgment of the Court of Appeals.
Justice Kennedy was joined by Justices Scalia, Thomas, Alito, and Chief Justice Roberts. Justice Breyer did not take part in the consideration of the case. Justice Stevens wrote a dissenting opinion, and was joined by Justices Souter and Ginsburg. That opinion began:
Charter Communications, Inc., inflated its revenues by $17 million in order to cover up a $15 to $20 million expected cash flow shortfall. It could not have done so absent the knowingly fraudulent actions of Scientific- Atlanta, Inc., and Motorola, Inc. Investors relied on Charter’s revenue statements in deciding whether to invest in Charter and in doing so relied on respondents’ fraud, which was itself a “deceptive device” prohibited by §10(b) of the Securities Exchange Act of 1934. 15 U. S. C. §78j(b). This is enough to satisfy the requirements of §10(b) and enough to distinguish this case from Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164 (1994).
The Court seems to assume that respondents’ alleged conduct could subject them to liability in an enforcement proceeding initiated by the Government, ante, at 15, but nevertheless concludes that they are not subject to liability in a private action brought by injured investors because they are, at most, guilty of aiding and abetting a violation of §10(b), rather than an actual violation of the statute. While that conclusion results in an affirmance of the judgment of the Court of Appeals, it rests on a rejection of that court’s reasoning. Furthermore, while the Court frequently refers to petitioner’s attempt to “expand” the implied cause of action,—a conclusion that begs the question of the contours of that cause of action—it is today’s decision that results in a significant departure from Central Bank.
The Court’s conclusion that no violation of §10(b) giving rise to a private right of action has been alleged in this case rests on two faulty premises: (1) the Court’s overly broad reading of Central Bank, and (2) the view that reliance requires a kind of super-causation—a view contrary to both the Securities and Exchange Commission’s (SEC) position in a recent Ninth Circuit case and our holding in Basic Inc. v. Levinson, 485 U. S. 224 (1988).
Lyle Denniston analyzed the decision on SCOTUSBlog. For more ACS materials on Supreme Court cases, visit www.acslaw.org/SCOTUS.