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Ruling limits reach of investor suits

The Supreme Court decision in a cable firm's fraud case is a victory for businesses.

January 16, 2008|David G. Savage | Times Staff Writer

WASHINGTON — The Supreme Court on Tuesday sharply limited the reach of securities fraud lawsuits by shielding bankers, accountants and others from being held liable for participating in a scheme to inflate a company's stock.

The 5-3 ruling came in a case involving Charter Communications and Scientific Atlanta, but it has broader implications for securities litigation. It is a big win for Wall Street investment bankers accused of aiding other schemes such as those that brought down Enron and WorldCom.

In the Enron case, lawyers for major pension funds, including the University of California's, had sued the energy company's investment bankers, arguing that these outside players made the scheme possible and should be held liable.

Those claims, still pending, may be doomed after Tuesday's ruling, in which the justices specifically rejected the notion of "scheme liability." As Justice Anthony M. Kennedy put it, these "secondary actors" are "too remote for liability."

Business advocates called it a major victory.

"This has huge significance for companies because it prohibits a litigation free-for-all," said Robin Conrad, a lawyer for the U.S. Chamber of Commerce. "It's not just the Enrons. These cases can involve ordinary business transactions, like when a supplier sells to another company."

Not surprisingly, plaintiffs' lawyers see a trend, and one not to their liking.

The ruling was the latest in a line of "pro-business, anti-investor opinions from the court" that "strikes another blow to kill securities class-action suits," said Steven Toll, a private securities lawyer at Cohen, Milstein, Hausfeld & Toll in Washington. "The message seems to be, 'Leave business alone.' "

Tuesday's was the third major ruling by the court in recent years to limit securities fraud suits.

In 2005, it said the plaintiffs must have some proof that a company's deceit caused its stock price to plunge. Sometimes, a stock sinks in value and disgruntled investors sue, even though the executives had nothing to do with the decline.

Last year, the court ruled these suits should be dismissed unless the initial complaint showed real evidence that the company's executives intended to fool investors.

The case decided Tuesday began when Charter Communications was sued, suspected of inflating its earnings by $17 million in 2000. Charter, one of the nation's largest cable TV firms, allegedly schemed with one of its suppliers, Scientific Atlanta, to overpay it for cable boxes with the understanding that the money would be used to buy advertising on its channels.

These deals made it look as though Charter was gaining more customers and more advertising. Executives also "backdated" the deals to fool the auditors, according to the lawsuit.

When Charter was later sued, it settled the claims. The legal battle turned to whether Scientific Atlanta could be sued for its role.

Last year, the Supreme Court took up StoneRidge Investment Partners vs. Scientific Atlanta to decide whether the outside participants could be held liable in stock fraud cases.

The majority ruled Tuesday that the suit against the supplier must be thrown out because investors relied on the word of Charter Communications when they bought its stock but did not rely on what Scientific Atlanta was doing when it sold boxes to Charter.

The supplier had "no duty to disclose" to the public and its "deceptive acts were not communicated to the public," Kennedy wrote. Chief Justice John G. Roberts Jr. and Justices Antonin Scalia, Clarence Thomas and Samuel A. Alito Jr. joined with him to form the majority.

The three dissenters faulted colleagues for making it harder to hold cheaters liable for their schemes and noted that since 1934, federal law has made it illegal to use "any device, scheme or artifice" to defraud.

"I respectfully dissent from the court's continuing campaign to render . . . toothless" private suits to enforce the anti-fraud laws, Justice John Paul Stevens said. Justices Ruth Bader Ginsburg and David H. Souter agreed with him in dissent. Justice Stephen G. Breyer sat out the case due to a conflict -- he owns stock in Cisco Systems, the parent company of Scientific Atlanta.

Tuesday's outcome was not a major surprise. In 1994, the court in a 5-4 ruling shielded "secondary" actors such as outside lawyers or accountants who were accused of having "aided or abetted" a stock fraud. The latest ruling goes a step further because it also shields those who knowingly participated in a scheme to fool stockholders.

Kennedy stressed, however, that these schemers need not get off scot-free. The Securities and Exchange Commission, unlike private lawyers, has the legal authority to sue companies that participate in deceptive schemes.

"The enforcement power is not toothless," he said, noting that the SEC has collected more than $10 billion in fines and penalties since 2002. Some of this money is distributed to cheated investors, he said.

William Sullivan, a securities-law expert at Paul Hastings in Los Angeles, said: "The real question is, do you leave it with the SEC, with their wisdom and expertise, or do you leave it to private litigants who may be looking for deep pockets?"

david.savage@latimes.com

Times staff writer Walter Hamilton in New York contributed to this report.

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