With Chief Justice John G. Roberts Jr. taking the lead in arguments in the Stoneridge case — one of the most closely watched business cases in years — the court appeared strongly inclined to leave it to Congress to define the circumstances under which secondary players like investment banks, auditors and vendors can be sued in private securities fraud actions.
The justices gave every sign that they would uphold the lower courts’ dismissal of a shareholders’ suit against two vendors whose dealings with a cable television company allowed the company, Charter Communications, to inflate its earnings and mask its failure to achieve its financial targets.
But the real significance of the Supreme Court’s decision, when it comes in the next several months, will lie in the opinion’s implications for other securities cases and the answer to the all-important question of who can be sued and who cannot.
The argument took place in the shadow of ongoing Enron litigation, and it was far from certain that the court would provide the kind of blanket immunity that Wall Street and the business community were looking to this case to obtain.
The importance of the case for the future of private securities litigation was also underscored by a scuffle within the Bush administration over which side to support.
The Bush administration’s position, which had an element of split-the-difference, was the end result of a vigorous and unusually public lobbying effort.
The five Securities and Exchange Commission members voted 3 to 2 to come into the case on behalf of the shareholders, consistent with the commission’s longstanding position on the issue. But the secretary of the Treasury, Henry M. Paulson Jr., strongly opposed that position and won the support of President Bush.
While the S.E.C. is an independent agency, it needs authorization from the solicitor general to file a Supreme Court brief. Solicitor General Paul D. Clement refused to authorize the filing.
That did not keep former chairmen and members of the S.E.C. from giving the justices the benefit of their views. Two former chairmen and one former commissioner signed briefs for the plaintiff, Stoneridge Investment Partners. Three other former chairmen and 11 former commissioners signed briefs for the vendors.
The justices displayed great familiarity both with the details of the case and with the policy context in which it has attained unusual prominence on the Supreme Court’s docket. That was clear in an exchange between Justice Antonin Scalia and the shareholders’ lawyer, Stanley M. Grossman, who was arguing that the test he advocated for liability would set the bar high enough so that “it will not ensnare someone who does engage in a deceptive act but doesn’t understand that the reason for it is to further a scheme.”
“Sure,” Justice Scalia responded with evident sarcasm. “After trial — you know, after trial which causes your stock to tank, you may indeed be able to show that you didn’t know it was going to be used for that purpose. I mean, that’s what this is all about, isn’t it? Getting it by the summary judgment stage.”
Justice Scalia’s comments echoed the often-heard complaints of the defense bar that shareholder litigation poses such a threat to a public company that it forces the defendant to settle even unmeritorious lawsuits.
Whether the Stoneridge suit against Charter Communications’ two vendors, Scientific-Atlanta and Motorola, is an example of such a lawsuit was, of course, hotly disputed, both in the courtroom and in the dozens of briefs filed on behalf of both sides.
Mr. Grossman argued that the vendors entered into a sham bookkeeping transaction with Charter that met the federal definition of a prohibited deceptive practice. At the request of Charter, which in mid-2000 was falling short of its annual target for operating cash flow, the two vendors agreed to increase their prices for the cable boxes they sold to Charter and to use the resulting windfall to buy advertising on Charter’s cable stations.
The plan allowed Charter to book the money it spent on the cable boxes as a capital expense while treating the advertising purchases as current revenue. The transactions, a wash for the two vendors, amounted to about $17 million, a tiny fraction of what turned out to be a much bigger ongoing fraud on the part of Charter. Four of its executives pleaded guilty to criminal charges, and the company paid $144 million to settle a civil suit brought by Stoneridge on behalf of shareholders.
Stephen M. Shapiro, the lawyer representing the vendors, did not dispute the facts, but argued that at most, his clients had “aided and abetted” Charter’s fraud and were not themselves primary violators of any securities law.
The difference between aiding and abetting and a primary violation is crucial to the outcome of the case, Stoneridge Investment Partners v. Scientific-Atlanta Inc., No. 06-43, and was the subject of intense debate during the argument. The reason was that in a 1994 case, Central Bank of Denver v. First Interstate Bank, the Supreme Court ruled there was no “aiding and abetting” liability under the securities laws. Congress responded by giving the S.E.C. the authority to bring such suits, while withholding the same authority from private litigation.
The court’s focus on the details of the vendors’ conduct in this case suggested that the eventual decision, even if a victory for them, might not necessarily help defendants in other cases whose participation in a fraudulent scheme was more active and actually helped persuade investors to buy the stock.
Justice Stephen G. Breyer did not take part in the case, presumably because of an investment in one of the companies. A 4-to-4 tie would result in affirming the appeals court’s ruling.