It is, by general consent, the most important securities-litigation clash for a generation. A case now before the Supreme Court, Stoneridge v Scientific-Atlanta, is shaping up to be a key test of attitudes towards shareholder class actions. A decision in favour of aggrieved investors would greatly increase the number of companies on which trial lawyers could train their sights. A ruling the other way would be a crushing defeat for the plaintiff’s bar. Adding to the suspense, the government bodies with an interest in the case cannot agree on a common position.
The case involves a cable company, Charter Communications, which used a transaction with two suppliers of set-top boxes to inflate its revenues. Shareholders sued not only the company but the vendors too, claiming that they participated in the fraud, even though they may not have been aware of the misreporting. Led by the legendary Bill Lerach, plaintiff lawyers have lobbied ferociously for the principle of going after third parties, known as “scheme liability.”
The Securities and Exchange Commission (SEC) is backing Mr Lerach’s lot, thanks to a change of heart by its Republican chairman, Christopher Cox, traditionally no friend of the plaintiff’s bar. Mr Cox urged the Department of Justice to fall in behind it, but this week it declined to do so. It has a month to decide whether to support the defendants or offer no opinion.
The Treasury is at odds with the SEC, too, fearing that a ruling in favour of investors would further damage American competitiveness. Many foreign firms that choose to list their shares elsewhere point to America’s “litigation lottery” as the principal reason. Although filings of securities class actions have been falling since 2005, the overall value of settlements has continued to rise.
Bankers and accountants are watching just as closely as cable-box makers. In a similar case, Mr Lerach’s firm sued Enron’s financial advisers on behalf of shareholders, claiming that they facilitated the book-keeping shenanigans at the now-defunct energy trader. He lost—though not before collecting billions from banks that settled early. He has lodged an appeal with the Supreme Court and wants the case joined with Stoneridge.
What will the court do? Business is encouraged by its track record: a steady pruning of plaintiffs’ rights since the 1970s. (Congress, too, has made it harder to bring class actions.) A number of its justices are thought to sympathise with the view that scheme liability is best left to the SEC, which has the power to pursue aiders and abettors under its Rule 10b-5.
Some lawyers in Washington even suggest that Mr Cox only sided with investors because he was convinced that they had almost no chance of support from the Supreme Court. “He’s been accused of being too close to business and this is a convenient way to dispel that notion without really changing anything,” says one.
But with numerous fine legal points at issue, the outcome is uncertain. An unfavourable ruling would send a chill through boardrooms, and not only in America.
If suppliers and advisers can be dragged into class actions, it would no longer even be necessary to issue shares in the United States to incur securities liability, points out Peter Wallison of the American Enterprise Institute, a think-tank. Any firm, anywhere, doing business with American companies would have to live with the risk that the transaction could later be portrayed as fraudulent or deceptive. And painting such pictures is what trial lawyers do best.