Skeptical Court Considers Investors Case
Tuesday, October 9, 2007; 1:28 PM
WASHINGTON -- A lawyer for corporate investors ran into tough questioning Tuesday from a Supreme Court that is trying to set boundaries in stockholder lawsuits for securities fraud.
Investors in Charter Communications Inc., one of the country's largest cable TV companies, are suing two suppliers that allegedly schemed with Charter executives to mislead stockholders about the company's revenue growth.
The outcome of the case will determine the fate of a separate suit by Enron shareholders who are seeking over $30 billion from banks that allegedly colluded with the energy company to hide its debts.
The justices will decide whether banks, lawyers, accountants and suppliers can be held liable for scheming with publicly held companies that deceive their stockholders.
"Their conduct was integral to the scheme," investor attorney Stanley Grossman said of the two suppliers, Scientific-Atlanta Inc. and Motorola Inc.
Grossman's assertion prompted skeptical questioning from Chief Justice John Roberts and Justice Antonin Scalia, who suggested federal law imposes strict limits on shareholders' ability to sue companies and firms other than the one in which the investors hold stock.
The court must "sensibly limit" the circumstances under which such lawsuits can be filed, said Scalia.
Grossman pointed to a court precedent from more than 35 years ago helpful to shareholder claims in securities fraud cases.
"We did that sort of thing in 1971," said Roberts. "We should get out of the business of expanding" the rights shareholders already have.
"We are not asking for an expansion. The other side is asking for a cutback," Grossman said outside the Supreme Court after the arguments.
In court, the attorney for Scientific-Atlanta and Motorola said the law requires that stockholders rely on the alleged misconduct of the two suppliers in order for the lawsuit to proceed, a comment that Justice Ruth Bader Ginsburg took issue with.
The success of the scheme depended on the two suppliers remaining silent, replied Ginsburg. "Silence, not speech, counts," said Ginsburg.
But the suppliers had no duty under the law to disclose anything to Charter's shareholders, replied attorney Stephen Shapiro, triggering more questions from Ginsburg about the alleged misconduct of Scientific-Atlanta and Motorola.
The investors' suit against Scientific-Atlanta and Motorola has its origins in the late 1990s. Charter and other companies spent billions upgrading their networks for cable TV and Internet service, an undertaking that cut into their earnings.
Wall Street analysts responded by focusing on revenue growth. To meet the imperatives of Wall Street, Charter falsely inflated its revenue. Charter eventually corrected its financial statements, cutting revenue by $292 million from 2000 through 2002. Four Charter executives pleaded guilty to criminal charges after a lengthy federal investigation.
The question now is whether Motorola and Scientific-Atlanta, which is now owned by Cisco Systems Inc., can be sued for their role.
In the transactions that Charter persuaded Motorola and Scientific-Atlanta to engage in, the two suppliers bought advertising that was bankrolled with money from Charter, which paid a $20 premium on each of hundreds of thousands of cable TV set-top boxes, for a total of $17 million.
The amount of the overpayments equaled the amount the two suppliers paid for the advertising.
Charter reported the advertising payments as revenue, a step that helped Charter paint a rosy financial picture for the fourth quarter of 2000, a move designed to artificially inflate the price of the stock.
Charter gave no indication to the investing public that the deals had occurred because Charter simply lumped in the $17 million with Charter's quarterly totals.
In the lawsuit brought by Charter's investors, Scientific-Atlanta and Motorola prevailed in the lower courts. The government took no action against anyone from the two firms regarding the deals with Charter.
Motorola and Scientific-Atlanta argue in papers before the Supreme Court that they should not be held liable in a lawsuit for engaging in conduct that the 8th U.S. Circuit Court of Appeals said at most amounted to an investors' claim of aiding and abetting fraud by Charter's executives.
The Supreme Court barred aiding and abetting claims for securities fraud 13 years ago.
Lawyers for Charter's investors argued to the Supreme Court that the two suppliers took an active part in the fraud, creating a phony paper trail to conceal the "sham" nature of what they were doing.