Analysis: No big threat to investment houses
If some of Wall Street’s major players — the giant invesment houses — were looking nervously toward the Supreme Court on Tuesday morning, as they reportedly were, by midday they were entitled to take a breath and relax. As the Court concluded an hourlong hearing in a vitally important securities case, there seemed hardly a chance — even a remote one — that federal law against stock fraud would be read to give investors a significant new tool to go after stock fraud themselves. With the seeming exception of only Justice Ruth Bader Ginsburg, and the possible added exception of Justice David H. Souter, members of the Court showed little to no sympathy for opening up a broad new category of liability to investors.
The case was Stoneridge Investment Partners v. Scientific-Atlanta (06-43), but looming ominously in the background is another case involving a $40 billion claim by investors aimed at investment bankers and other business partners who allegedly played roles in the Enron scandal.
Stoneridge was heard Tuesday by an eight-member Court; Justice Stephen G. Breyer disqualified himself. But as the argument unfolded, the private attorney arguing for so-called “third party liability” to investor lawsuits seemed notably short of the five notes needed to establish that principle. Chief Justice John G. Roberts, Jr., who previously had taken himself out of the case and then took steps to get back in, made it clear early on that he was firmly opposed to the Court using its own powers to add liability where Congress had not done so explicitly.
“Congress has kind of taken over for us….They picked up the ball and are running with it….My suggestion is that we should get out of the business of expanding [the key securities fraud section]; Congress has taken over,” the Chief Justice told New York attorney Stanley M. Grossman, who was arguing for investors who seek the right to file private lawsuits to reach business partners of those who directly engage in securities fraud, on a theory that the partners were critical to making the deception work.
Justice Antonin Scalia suggested that, since it was the Court’s own creation to allow private lawsuits by investors for fraud, “why couldn’t we limit it so that schemes, such as that alleged here, can be attacked by the SEC [Securities and Exchange Commission] but not by ‘private attorneys general’?”
Grossman did not appear to make much headway with the argument that Congress had already indicated that it favored exactly the kind of lawsuit undertaken in this case. The law, he said, applies to “any deceptive device” used by “any person, directly or indirectly” to influence stock prices. “This case involves conduct that is squarely covered by the statute.” The business partners sued here, Grossman said, “were not passive bystanders. Their conduct was integral to the scheme” to mislead investors by falsely inflating the revenues of a cable communications company whose stock investors had bought.
Grossman, tested by the Chief Justice and others on how far his argument would take third-party liability, tried to keep it within limits by saying that liability would require proof that the partners acted “for the purpose of furthering the scheme.” Justice Anthony M. Kennedy bluntly told Grossman: “I see no limitation to your proposal for liability.” Kennedy suggested that, in the real world of investing, most people know that if someone engages in fraud, it is going to have an effect on stock market prices, so anyone who had a knowledge of a fraudulent scheme would become liable, under what he took to be Grossman’s theory.
With Justice Samual A. Alito, Jr., Grossman appeared to be having difficulty showing that the lawsuit he was pressing was anything more than a claim that the business partners had “aided and abetted” the securities fraud — aiding-and-abetting claims have already been put beyond the reach of private investor lawsuits by the Supreme Court in a 1994 decision (Central Bank v. First Interstate Bank).
With eight Justices, even if it turned out that the Court was split 4-4, the suing investors would lose in this case, because the Eighth Circuit Court here rejected the claim of third-party liability. It thus would take five votes to reverse that ruling. (Justice Clarence M. Thomas said nothing during the hearing and Justice John Paul Stevens said very little, bugt there is little reason to doubt that, at most, their votes in the case would offset each other — Thomas possibly against further business party liability, Stevens possibly in favor.)
Chicago lawyer Stephen M. Shapiro, representing the business partners sued by the Stoneridge investors, encountered difficulty at various points in his argument — but almost entirely with Justice Ginsburg alone. Otherwise, he was left quite free to make what essentially was his preferred key point: that Congress wanted “cases like this to be handled by an expert agency” — the SEC. Congress, in fact, has legislated precisely for such cases — in a statute “that fits this case like a glove.” For private investors to be abled to sue, they must be able to show that there was “a communication to the market,” that they relied directly upon that communication, and their stocks declined as a direct result.
Ginsburg, however, suggested there must be a “middle category” — between primary liability for the party that directly deceived the market, and aid-or-abet conduct that is not liable to private lawsuits. That middle zone, she suggested, would apply to “a company that made it possible for deception to happen.”
If the deception at work in this case were actually shared with investors, Ginsburg contended, “the whole thing would fail. This can work only if the vendors [the business partners] are silent…Silence, not speech, is what counts.” Thus, arguing to her approach, the fact that the business partners themselves did not communicate to the market what was going on should not absolve them. “The essence of the scheme,” she suggested, was that the business partners “set up” the company to make the fraudulent statements it did make to the investing public.
Justice Souter, in a few remarks, appeared to find some significance in Ginsburg’s approach, but he was nowhere nearly as energetic in pressing the investors’ liability argument.
Shapiro countered almost all comments from the bench with the suggestion that this should be a matter for the SEC. “Congress has said it twice,” he said, making it clear that it felt lawsuits like this one were “hurting our economy.” The SEC’s “panoply of remedies,” the lawyer argued, “is the better mousetrap.”
Deputy Solicitor General Thomas G. Hungar, representing the government position that appears to be an attempt to straddle the opposing arguments, suggested that the ultimate test to be used for such investor lawsuits was whether they could show “reliance” on a deception. Here, he said, “the only deceptive conduct was never disclosed to the market.” Like Shaprio, Hungar noted that Congress had “looked twice” at the kind of liability advanced in Stoneridge, and has declined to provide it.
The Court is expected to issue a final decision this winter or next spring.