The United States Supreme Court on January 15, 2008 rejected claims to recover damages against secondary actors whose conduct played no immediate role in an investor’s decision to trade in a company’s securities. The decision in Stoneridge Investment Partners LLC held that the implied right of action under Section 10(b) of the Securities Exchange Act of 1934 does not reach non-issuer third parties since the investors did not rely upon their statements or representations.
Stoneridge was a class-action suit by investors of Charter Communications. Defendants Scientific Atlanta and Motorola supplied Charter with digital cable converters that Charter in turn provided to its customers. Charter arranged to overpay the defendants for each converter box with the understanding that the defendants would return the overpayment by purchasing advertising from Charter. The pleadings (accepted as true for purposes of the decision) stated that the transaction had no economic substance. Charter recorded the advertising purchases as revenue and capitalized its purchase of the converters, thus allowing Charter to falsely report revenue and operating cash flow numbers. The documents with Scientific Atlanta and Motorola were backdated and contained the false purchase price numbers. Scientific Atlanta and Motorola had no role in preparing or disseminating the false financial statements of Charter.
The class-action plaintiffs claimed that the defendants knew or were reckless with respect to Charter’s intention to use the transaction to inflate its revenues.
The Supreme Court reaffirmed its 1994 Central Bank decision which held that Section 10(b) liability does not extend to aiders and abettors because plaintiffs do not rely upon those who merely provide assistance to the “primary” violator. The court went on to state that reliance is an essential element of the Section 10(b) private cause of action. The Supreme Court held that to hold the defendants liable under the facts as pled would create an implied cause of action that would “reach the entire marketplace in which the company did business”, and the Court held there was no authority for such a position.
The Court’s decision represents a victory to many actors — including banks, suppliers, customers, auditors, lawyers and other advisors — who transact business with public companies but make no statements to investors and undertake no duty to disclose material information to them. The Supreme Court effectively shielded such actors from private claims. The Court did note that the SEC and the Department of Justice have power to bring civil enforcement and potential criminal actions against such actors in appropriate cases for aiding and abetting securities fraud.