552 U.S. ___ (2008)
Parties Who Have "Aided and Abetted" a Public Corporation's Securities Fraud Violation, but Have Made no Public Misstatements or Violated a Duty to Disclose, Cannot be Directly Liable for Securities Fraud under Section 10(b) of the Securities Exchange Act of 1934.
In a case which many are calling the most important securities fraud case in years, the United States Supreme Court held on January 15, 2008 that a Section 10(b) private right of action does not reach parties who merely "aid and abet" a public corporation's Section 10(b) securities fraud violation. In affirming the judgment of the United States Court of Appeals for the Eighth Circuit, the Supreme Court emphasized that in order to bring a Section 10(b) private right of action, a plaintiff must be able to prove reliance upon a material misrepresentation or omission by the defendant.
Alleging losses after purchasing Charter Communications, Inc. common stock, petitioner Stoneridge, a shareholder, filed suit under Section 10(b) of the Securities Exchange Act of 1934 and Securities Exchange Commission ("SEC") Rule 10b-5. Section 10(b) makes it unlawful, directly or indirectly, "[t]o use or employ, in connection with the purchase or sale of any security... any manipulative or deceptive device or contrivance in contravention" of SEC rules promulgated pursuant to that section. In addition, SEC Rule 10b-5 prohibits the employment of "any device, scheme or artifice to defraud" and makes it unlawful to "engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person."
Stoneridge claimed that Charter and two of its vendors, Scientific-Atlanta and Motorola, engaged in a "scheme to defraud" by entering into sham transactions that improperly inflated Charter's reported revenues and cash flow. Specifically, the two vendors agreed that Charter would overpay them $20 for each cable set top box purchased, with the understanding that the vendors would then return the overpayment to Charter by purchasing advertising at a price higher than fair value. According to the suit, the two vendors entered into the sham transactions knowing that Charter intended to account for them improperly. Stoneridge alleged that by participating in these transactions, the vendors violated Section 10(b) and SEC Rule 10b-5.
The Eighth Circuit held that Stoneridge's allegations were insufficient to state a Section 10(b) securities fraud claim against the vendors. In upholding the district court's dismissal of petitioner's claims against the vendors, the Eighth Circuit found that the vendors could at most be accused of aiding and abetting Charter's improper accounting statements, and that claims against anyone who simply "aids and abets" corporate fraud are barred under a Section 10(b) private cause of action. The Eighth Circuit emphasized that the vendors did not make any false public statements on which Stoneridge relied, were not involved in the preparation of Charter's allegedly misleading financial statements, and did not owe any duty to Charter's investors.
The question presented before the Supreme Court was whether an injured investor could bring a Section 10(b) action to recover from a party that neither makes a public misstatement nor violates a duty to disclose, but who does participate in a scheme to violate Section 10(b). In affirming the judgment of the Eighth Circuit, the Supreme Court held that a Section 10(b) private right of action does not extend to parties who "aid and abet" a Section 10(b) violation.1 The Supreme Court emphasized that in order to establish Section 10(b) liability, a plaintiff must prove reliance upon a material misrepresentation or omission by the defendant. Since Stoneridge did not rely upon the vendors' statements or representations, the requisite reliance could not be shown, and therefore, vendors had no liability under Section 10(b).
Invoking what some courts call "scheme liability," Stoneridge argued that it did in fact rely on the vendors' deceptive acts, claiming that the misleading financial statement that Charter released to the public was a natural and expected consequence of the vendors' deceptive acts. This causal link, Stoneridge argued, was sufficient to presume it relied on the vendors' actions. The Supreme Court disagreed, opining that without limitations on the concept of reliance, potential liability would reach the whole marketplace in which a corporation does business. Furthermore, such an expansive definition of reliance would allow plaintiffs with weak claims to extort settlements from innocent companies and raise the cost of being a publicly traded company under U.S. law.
The Supreme Court's Opinion was a 5-3 decision that split among conservative-liberal lines, with Justice Breyer taking no part in the consideration or decision of the case.
Footnotes
1 The Supreme Court noted that aiding and abetting liability is authorized in actions brought by the SEC, but not by private parties.
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