On January 15, 2008, the United States Supreme Court issued a much-anticipated decision that significantly reduces the risk that a third party – such as a vendor or financial institution – that does business with an issuer who files financial statements that violate the federal securities laws, would itself be held liable for violations of Section 10(b) of the Securities and Exchange Act of 1934, as amended, and Securities and Exchange Commission Rule 10b-5. This decision should significantly insulate financial institutions and others who work with issuers of publicly traded securities from federal securities law liability based on a claim that, but for the conduct of the third party, the issuer would not have been able to make an actionable misstatement.
In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., et al, No. 06-43 (U.S. January 15, 2008), plaintiff – an investor in Charter Communications, Inc. ("Charter") – brought suit against, among others, two vendors of set-top cable boxes to Charter. Plaintiff contended that the vendors entered into transactions with Charter that "had no economic substance," but rather were intended to and did allow Charter to "mislead its auditor and issue a misleading financial statement." This, plaintiff contended, had the effect of artificially inflating the price of Charter's stock.
Although the vendors accounted for the underlying transactions correctly, Charter did not. It was undisputed, however, that the vendors neither made a public statement about the underlying transactions nor were under any independent duty to disclose them. The question, therefore, was whether the vendors were liable because they participated with Charter in a "scheme" to violate Section 10(b) and Rule 10b-5.
The Stoneridge Court answered this question in the negative. The Court first reiterated the well-accepted proposition that "[r]eliance by the plaintiff upon the defendant's deceptive acts is an essential element of the § 10(b) private cause of action." The Court then explained that, because "[n]o member of the investing public had knowledge, either actual or presumed, of [the vendors'] deceptive acts during the relevant times," plaintiff could not adequately plead reliance.
The Court held that the concept of "scheme liability" does not cure this defect. As the Court explained, plaintiff "contends that in an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect. Were this concept of reliance to be adopted, the implied cause of action would reach the whole marketplace in which the issuing company does business; and there is no authority for this rule. . . . It was Charter, not [the vendors], that misled its auditor and filed fraudulent financial statements; nothing [the vendors] did made it necessary or inevitable for Charter to record the transactions as it did."
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