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Freedom to con?

The high court says investors can't punish firms that plot to dupe the market. Congress must change that.

January 16, 2008

In a major ruling on securities law, the Supreme Court on Tuesday effectively capped the penalties for aiding and abetting the kind of fraud that Enron made infamous. Now it's up to Congress to create a meaningful deterrent to such schemes before Wall Street bankers try again to make foundering money pits look like fast-growing businesses.

The case in question, Stoneridge Investment Partners vs. Scientific-Atlanta Inc., involved a class-action lawsuit by investors against two set-top box manufacturers that allegedly helped cable TV operator Charter Communications Inc. deceive shareholders. According to the Securities and Exchange Commission, Charter paid Scientific-Atlanta and Motorola Inc. artificially high prices for their cable converter boxes in return for the manufacturers buying commercial time on Charter's cable systems, which enabled Charter to report deceptively high revenue from the advertising side of its business.

The court's 5-3 majority, led by Justice Anthony M. Kennedy, held that the law allows investors to file securities fraud lawsuits against a company only if they relied on its financial statements or representations. If a company secretly aids or abets another firm's fraud, as Scientific-Atlanta and Motorola were accused of doing, the SEC can file criminal charges, but investors can't touch it.

The three dissenters on the court (Justice Stephen G. Breyer recused himself), led by Justice John Paul Stevens, said the majority misinterpreted the law and shielded illegal behavior from liability. When companies deliberately make deals designed to let their business partners post deceptive results, they aren't merely aiding and abetting -- they're committing securities fraud themselves, Stevens argued.

For The Record
Los Angeles Times Tuesday, January 22, 2008 Home Edition Main News Part A Page 18 Editorial pages Desk 2 inches; 60 words Type of Material: Correction
SEC: A Jan. 16 editorial about the Supreme Court's ruling in a shareholder lawsuit case incorrectly stated that the Securities and Exchange Commission can bring criminal as well as civil cases against companies accused of securities fraud. The SEC can instigate investigations and refer cases to the Justice Department for prosecution, but it has no authority to file criminal charges.

Although the SEC prosecutes those who aid securities fraud, it can't collect penalties large enough to protect investors. In the Enron case, for example, the SEC collected tens of millions of dollars in penalties from some of the company's banking partners, while investors have been seeking tens of billions through class-action lawsuits.

Unless companies can be held accountable by investors for plotting to dupe the market, it will be hard to deter such schemes. Lawmakers have been reluctant to give investors the power to punish companies merely for losing money, and rightly so, but the situation here is different. The country's financial system depends on complete and honest disclosures, and Congress shouldn't provide exceptions for anyone deliberately trying to con the public.

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