Supreme Court Limits Investors’ Securities Lawsuits

January 15, 2008

In a decision sought by corporate America to stem the tide of securities lawsuits, the U.S. Supreme Court today pulled the plug on investors trying to sue some suppliers of a company whose stock price was inflated with the aid of the suppliers.

The high court held that the investors did not have the private right to sue because they did not rely upon the statements or representations made by the suppliers.

The investors had sought to impose liability on two entities who, acting both as customers and suppliers, agreed to arrangements that allowed the investors’ company to mislead its auditor and issue a misleading financial statement affecting its stock price.

But the Supreme Court concluded that “the implied right of action does not reach the customer/supplier companies because the investors did not rely upon their statements or representations.”

In the case, investors accused two suppliers and customers of cable television company, Charter Communications, of allowing Charter to mislead its auditor and issue a misleading financial statement that inflated its revenue by $17 million and affected the company’s stock price.

The deal involved Charter overpaying for supplies it purchased in 2000, with the understanding that the suppliers would return the overpayment by purchasing advertising from Charter. Charter was able to post the advertising as revenue and then claim it met revenue projections for the year.

The suppliers had no role in actually preparing the financial statements.

The decision written by Justice Anthony Kennedy said that it is up to Congress and not the courts to decide whether to extend the reach of the cause of action in such circumstances.

The ruling came in a suit by Stoneridge Investment Partners against Motorola Inc. and Scientific-Atlanta Inc., suppliers to Charter.

Lower courts had rejected Stoneridge’s claims and in a 5-3 vote the Supreme Court also rejected them.

Attorney Robert Pietrzak, co-head of litigation in Sidley Austin’s New York office, who filed an amicus brief on behalf of the U.S. Chamber of Commerce in the case, applauded the decision.

“The court’s decision continues its recognition that expanding the U.S. securities laws beyond the reach expressly intended by Congress is not only legally incorrect but endangers the competitive position of the U.S. in the global marketplaces. Non-U.S. entities can feel more comfortable that doing business in the U.S. will not have the unintended consequence of exposing them to liability under the U.S. securities laws,” said Pietrzak

Edward L. Yingling, president and CEO, Amercian Bar Association, agreed that the decision was the right one.

“We are pleased that the Supreme Court rejected attempts by class-action lawyers to tie unknowing third parties to securities fraud schemes. This decision appropriately protects banks and other innocent businesses from weak claims and frivolous lawsuits that increase costs for everyone. If this case had been decided otherwise, investors would have been discouraged from doing business in this country at just the wrong time in our economic cycle,” Yingling said in a statement.

Securities lawyers said the decision could affect the fate of a similar shareholder class-action lawsuit involving Enron Corp.

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