Stoneridge v. Scientific-Atlanta is the most explosive securities case to hit the U.S. Supreme Court in the last 10 years. The appeal will test the reach of federal securities laws and force the sharply divided court to decide whether corporate shareholders can sue lawyers, accountants, banks and vendors that dealt with companies alleged to have committed securities fraud, even if the service providers themselves didn't mislead investors.
Stoneridge Investment Partners LLC, the petitioner and a shareholder of Charter Communications Inc., accused Motorola Inc. and Scientific-Atlanta Inc., now a unit of Cisco Systems Inc., of engaging in sham transactions with Charter to fraudulently boost its revenue by $17 million and thereby buoy its stock price.
Although Schaumburg-based Motorola and Scientific-Atlanta were never alleged to have acted deceptively, Stoneridge insists that they "aided and abetted" the fraud and should be held to account, an argument lower courts rejected. Now, the Supreme Court will decide whether the suppliers can be sued for damages by Charter investors.
At first blush, Stoneridge's appeal looks like a winner. The common law of torts holds liable those who help others cause harm. No one would exonerate Fagin, Charles Dickens' archetypal villain who recruited hungry and homeless children to pick pockets and innocently exchange their loot for food and shelter, but who didn't steal a peppercorn himself.
But Motorola and Scientific-Atlanta correctly accounted for Charter's fraudulent transactions on their own financial statements. They dealt only with Charter, which acted alone in cooking its books. And they misrepresented nothing to Charter's investors or accountants.
As sympathetic as the investors' plight is, allowing them money damages may not compensate them at all. Columbia University law professor John Coffee recently found that the average securities fraud suit settles for no more than 3 cents on the dollar of alleged losses, and that lawyers walk away with about one-third of that amount. After figuring in the costs of business interruption, any recovery to investors may prove illusory.
Wrongdoing by peripheral players is effectively deterred by public enforcement. The Securities and Exchange Commission reports that, in 2006 alone, it initiated 900 investigations, brought 218 suits and 356 administrative proceedings, and obtained court orders for disgorgement and the payment of penalties totaling more than $3.3 billion.
Dragging companies that acted lawfully into private securities fraud actions would itself invite fraud. Professionals whose services are essential to capital formation would have to raise fees or decline higher-risk engagements.
If Stoneridge's radical liability theory prevails, added litigation and compliance costs would penalize already weakened U.S. capital markets. Let's hope the court strikes the right balance between investor protection and market competitiveness.
This month's Lane Report is adapted from a guest editorial published in Crain's Chicago Business on December 10, 2007.
Marc J. Lane is the President of The Law Offices of Marc J. Lane, a Professional Corporation, and of its financial-services affiliates. He is a business and tax attorney, a Master Registered Financial Planner, and an Adjunct Professor of Law at Northwestern University School of Law.
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