Corporate Fraud Lawsuits Restricted
Enron and Other Shareholders Limited by Court
Wednesday, January 16, 2008; Page D01
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.