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WASHINGTON — The hundreds of pages of arguments in the more than 30 briefs filed in what many call the most important securities case in a generation boil down to one question: Who, besides the chief actor in a securities fraud, can be sued in private securities litigation? And the answer, agree the two sides who agree on virtually nothing else, could have major ramifications for law firms and accounting firms, in particular. The U.S. Supreme Court on Oct. 9 will hear arguments in Stoneridge Investment Partners v. Scientific-Atlanta Inc. and Motorola Inc., 06-43, a securities class action challenge stemming from fraud by a cable communications company. Stoneridge is dwarfed by an even bigger lawsuit, one the Supreme Court has yet to decide whether to hear or not — a securities class action arising out of the Enron debacle. The case is Regents of the University of California v. Merrill Lynch, 06-1341. Nonetheless, Stoneridge has captured the attention of almost every major securities law scholar and litigator, business and investor group, and denizen of the Supreme Court bar. The facts in Stoneridge involve a suit against vendors of the cable company, Charter Communications Inc., noted securities scholar J. Robert Brown of the University of Denver Sturm College of Law, who runs a corporate governance blog. But, “The language of the opinion could easily affect the standard of liability for accounting firms and law firms, both of whom are very involved in the compliance process and, at least under the law now, can sometimes be liable in connection with a company’s disclosure,” added Brown. While lawyers, accountants, bankers, vendors and others fear an increased potential liability if Stoneridge prevails, shareholders and investors have more at stake than a possibly lucrative category of new defendants. “I think there is fear among shareholder and investor groups that as a matter of policy, the Supreme Court will rewrite [Securities and Exchange Commission] Rule 10b-5 to continue to make it very difficult to use,” said Brown. “This case will provide a clear signal about that.” IN DISGUISE? Key to the Stoneridge case is the high court’s 1994 decision in Central Bank of Denver v. First Interstate Bank, 511 U.S. 164, in which the justices held that there is no liability against aiders and abettors of securities fraud under §10(b) of the 1934 Securities Exchange Act and SEC Rule 10b-5. The court limited liability to “primary” actors — those that make fraudulent statements — or secondary actors who meet all of the requirements of primary actors. But what about a company, such as Scientific-Atlanta and Motorola, that allegedly engages in a scheme involving a sham transaction with a primary actor, such as Charter, knowing that the primary actor will use the transaction to inflate revenues to deceive Wall Street analysts? Can that company be a primary actor if it doesn’t make public fraudulent statements of its own? The Eighth Circuit U.S. Court of Appeals in Stoneridge, and the Fifth Circuit in the Enron case, have said no. Without a misstatement by the secondary actor, they contend, so-called scheme liability is aiding and abetting liability and Central Bank prohibits it. The Ninth Circuit has disagreed. Stoneridge’s counsel, veteran securities litigator Stanley Grossman of New York’s Pomerantz Haudek Block Grossman & Gross, claims that Scientific-Atlanta and Motorola committed a primary violation by engaging in a scheme with Charter to inflate Charter’s cash flow by $17 million in one quarter to meet Wall Street expectations. The two vendors, he said, agreed to accept additional, above-price money for their cable television set-top boxes and to return the money to Charter in the form of advertising fees. They falsified documents to conceal the sham transactions, according to the lawsuit. The two vendors’ conduct was “garden variety securities fraud,” claimed Grossman, who is supported by shareholder and investor groups, senior lobby group AARP, 32 states, former SEC chairmen and others. Section 10(b) makes it unlawful for “any person, directly or indirectly” to “use or employ,” in connection with the purchase or sale of securities, “any … deceptive device or contrivance” in violation of implementing SEC regulations. The vendors’ conduct, he argues, “fits easily” within the plain language of §10(b) as well as of Rule 10b-5. The Eighth Circuit, he adds, “rewrote the statute” by limiting its reach to verbal misrepresentations. Veteran high court litigator Stephen Shapiro of Chicago’s Mayer Brown, who represents the vendors, counters that scheme liability is simply aiding and abetting liability in disguise. Central Bank, he argues, requires a plaintiff to show reliance on each individual defendant’s misstatement or omission. The plaintiffs in Stoneridge, he said, claim to have relied on Charter’s public financial misstatements, and do not claim any public misstatements were made by the vendors. Shapiro, supported by an array of amicus curiae briefs from business, banks and even the major lawyers’ insurance association, said that the scheme theory “would impose upon anyone doing business with a public company legal responsibility for that company’s financial reporting,” and expose them to such disproportionate liability that “irresistible pressure to settle even meritless claims would result.” But professor Jill Fisch, director of the Corporate Law Center at Fordham University School of Law, who filed an amicus brief supporting Stoneridge on behalf of a group of legal experts, countered that argument, saying that a “key limiting principle” is the requirement that any defendant actually engage in deceptive conduct. “That’s going to protect any third-party actor, any lawyer, accountant, customer supplier who engages in legitimate transactions,” she said. “But a legitimate transaction doesn’t include phony documents and transactions the counterparty knows has no substance.” Only seven justices are expected to hear the Stoneridge challenge. Chief Justice John Roberts and Justice Stephen Breyer have recused themselves. Based on the votes in Central Bank in 1994, said Denver’s Brown, the outcome may rest on the shoulders of Justice Samuel Alito. Marcia Coyle is a reporter with The National Law Journal, a Recorder affiliate based in New York City.

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