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In January 2008, the U.S. Supreme Court handed down the business-friendly decision of Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc., 128 S. Ct. 761 (2008), in which it rejected the viability of claims for “scheme liability” under 10(b) of the Securities Exchange Act and refused to extend 10(b) liability to actors who allegedly participate in a fraudulent scheme but do not make any false public statements on which a corporation’s shareholders rely. Upon release of the decision, businesses, lawyers, commentators and scholars immediately began to speculate about the impact Stoneridge would have on both the quantity and the nature of securities fraud cases. This article briefly examines some of the post- Stoneridge decisions and considers whether and to what extent the lower federal courts have heeded the admonition of the Supreme Court in Stoneridge that 10(b) not be extended to “reach the whole marketplace in which the issuing company does business.” Stoneridge, 128 S. Ct. at 770. During the past year, more than a dozen federal courts, including the 7th and 9th U.S. circuit courts of appeals, have weighed in on Stoneridge and for the most part have used the decision to dismiss claims against securities fraud defendants despite allegations that place the actions of those defendants at the heart of an alleged fraud. However, a handful of federal courts have declined to dismiss what otherwise appear to be scheme liability claims notwithstanding the holding of Stoneridge. Thus, the door to scheme liability claims may not have been closed completely. Court rejected claims In Stoneridge, the plaintiffs — shareholders in Charter Communications Inc. — claimed that Motorola Inc. and Scientific-Atlanta Inc., alleged to be suppliers and later customers of Charter, participated in a fraudulent scheme to falsely inflate Charter’s subscriber growth and operating cash flow. Neither Motorola nor Scientific-Atlanta was alleged to have had a role in preparing or disseminating Charter’s allegedly fraudulent financial statements. Instead, the plaintiffs alleged that Motorola and Scientific-Atlanta knew, or were reckless in not knowing, of Charter’s intent to use certain transactions in which both companies participated to inflate its revenues. The plaintiffs also alleged that Motorola and Scientific-Atlanta knew that Charter’s allegedly fraudulent financial statements would be relied on by analysts and investors. The Supreme Court rejected the plaintiffs’ attempt to impose liability on Motorola and Scientific-Atlanta, holding that the alleged deceptive acts were not disclosed to the investing public and were too remote to satisfy the requirement of reliance. The court noted that a contrary result would expand the reach of 10(b) beyond the realm of securities markets to the realm of ordinary business markets, exposing a new class of defendants to securities fraud claims and causing parties to protect against this new threat, which in turn would raise the cost of doing business. This decision was hailed by many as a “boon to businesses” — see Daniel Tyukody and Michael Hefter, “Stoneridge alters legal landscape,” NLJ, March 17, 2008, at S1 — because it removed a quiver from the bow of the securities plaintiffs’ bar by limiting the class of potential defendants to those who actually make fraudulent public statements. This sentiment has in large part been justified in the 14 months since Stoneridge was handed down. There are, however, some exceptions. The two circuit courts of appeal that have applied Stoneridge have done so strictly. In In re Peregrine Sys. Inc. Sec. Litig., No. 06-55197, 2009 WL 186165 (9th Cir. Jan. 23, 2009), the 9th Circuit dismissed claims against several defendants despite allegations that they enabled Peregrine to improperly recognize revenue by agreeing to purchase software at the end of fiscal quarters when Peregrine could not otherwise complete legitimate sales in time to properly recognize the revenue. The plaintiff argued that it could demonstrate reliance because press releases referencing a partnership between Peregrine and the other defendants had been issued to the investing public. Analogizing these facts to those in Stoneridge, the 9th Circuit upheld the dismissal of these claims, holding that the press releases announced only the existence of the partnership, did not mention the transactions at issue and therefore did not communicate any allegedly deceptive acts to the public. As in Stoneridge, it was Peregrine that misled the investing public by filing its own false financial statements; nothing the other defendants did made it necessary or inevitable for Peregrine to record the transactions as it did. The 7th Circuit also addressed Stoneridge, holding insufficient to state a claim under 10(b) the allegation that an individual defendant participated in and was the “mastermind” of a scheme to defraud investors. In Pugh v. Tribune Co., 521 F.3d 686 (7th Cir. 2008), the court held that allegations that an executive could have foreseen or even intended the fraudulent scheme would result in improper revenue recognition, and would eventually be reflected in Tribune’s financial statements, were insufficient under Stoneridge. Like the defendants in Stoneridge, the executive was alleged to have participated in the fraudulent scheme, but had no role in preparing or disseminating Tribune’s financial statements. Because the complaint contained no allegations to tie the executive to the actionable fraudulent statements, the court of appeals upheld the district court’s dismissal pursuant to Rule 12(b)(6). The district courts have been active in dismissing scheme liability claims based on Stoneridge. The Eastern District of Pennsylvania refused to certify a class action against Clifford Chance, despite allegations that the law firm played a “unique role in initiating and masterminding certain aspects of the overall scheme” and that its actions were sufficiently related to the injury allegedly suffered by the shareholders. In re DVI Inc. Sec. Litig., 249 F.R.D. 196, 217 (E.D. Pa. 2008). The district court held that the plaintiffs’ failure to allege that Clifford Chance made any public misrepresentations that affected the market for DVI securities was fatal to their claims. A similar analysis resulted in the dismissal of claims against three executives in In re Int’l Rectifier Corp. Secs. Litig., No. 07-02544, 2008 WL 4555794 (C.D. Calif. May 23, 2008), even though the plaintiffs alleged that the executives authorized bogus product shipments in order to meet sales forecasts and profit margins and accepted products they had no intention of keeping. Having failed to plead that these admittedly fraudulent acts were disclosed to the public, the plaintiffs’ claims failed. These cases and several others from the lower federal courts are early indications that Stoneridge will have the effect of trimming the size of the net cast by the § 10(b) private right of action. See Katz v. Image Innovations Holdings Inc., 542 F. Supp. 2d 269, 272-73 (S.D.N.Y. 2008) (holding that Stoneridge mandated dismissal of § 10(b) claims against three executive defendants because the complaint failed to allege how their actions were relied upon by purchasers of the company’s stock and noting that the complaint alleged that the defendants were “liable as participants in a fraudulent scheme”); In re Dura Pharms. Inc. Sec. Litig., 548 F. Supp. 2d 1126, 1141 (S.D. Calif. 2008) (scheme liability claim against executive in pharmaceutical company dismissed based on finding that he did not make any fraudulent statements to analysts or in press releases); In re Nature Sunshine Prods. Sec. Litig., No. 2:06-267, 2008 WL 4442150 (D. Utah Sept. 23, 2008) (dismissing claims against an executive who prepared an allegedly false management representation letter that was sent to the company’s external auditor because there was no allegation that the letter itself was publicly disclosed). Some district courts allow suits Although lawyers representing businesses, law firms, banks and executives have used Stoneridge to extricate their clients from costly litigation at the pleading and summary judgment stage, several decisions suggest that aspects of scheme liability remain alive and well. Three examples demonstrate this point. In Ritter v. Small, No. 08-3074, 2008 WL 4766740 (N.D. Calif. Oct. 31, 2008), the plaintiff alleged that a defendant company submitted a false purchase order that was used to inflate the amount of product orders for the purpose of inducing the plaintiff to invest more money. Despite the citation to Stoneridge, the district court held that the allegation of a deceptive act within the reach of 10(b) was sufficient to state a claim. The district did not address the issue of reliance. In In re Able Labs. Sec. Litig., No. 05-2681, 2008 WL 1967509 (D.N.J. March 24, 2008), the district court acknowledged that under Stoneridge, more than participation in a scheme to defraud investors is required to state a claim under 10(b). However, the district court distinguished Stoneridge as involving outside third parties, whereas Able involved high-ranking officers. The court did not address whether the alleged conduct was disclosed to investors such that they could rely upon it. The plaintiff alleged that certain officers of Able participated in specific instances of manipulative and deceptive conduct, i.e., falsification of test results, data tampering and forging and fabricating data, and that the conduct “effectuated the continued manufacturing and distribution of Able’s products, while concealing its noncompliance with [Food and Drug Administration] regulations.” Id. at *21. The district court held these allegations sufficient to state a claim under 10(b). The status of these defendants as high-ranking officers certainly played a role in the district court’s decision. The court overseeing litigation concerning Bristol-Myers Squibb Co.’s public disclosures about its attempt to settle patent litigation with a generic drug manufacturer presents another example. In In re Bristol-Myers Squibb Co. Sec. Litig., 586 F. Supp. 2d 148 (S.D.N.Y. 2008), the plaintiffs alleged that Bristol-Myers failed to disclose that it had agreed to relinquish certain material rights under a settlement agreement with the generic manufacturer and that it had entered into secret side agreements with them. An executive sought to escape liability under Stoneridge and the district court refused, despite a finding that the executive made no public statements at all. The district court found that investors relied on the executive’s good faith in negotiating the settlement agreement and committing the company to its terms. Although the district court did find that the executive’s misconduct was communicated to the public through the disclosure of the rejection of the settlement and its amended terms and the revelation of the secret side agreements, this analysis arguably strayed from the strict application of Stoneridge in the cases discussed above. This decision suggests that, notwithstanding Stoneridge, courts may look beyond the absence of public statements by a securities fraud defendant to other public actions or events that occur as a result of allegedly fraudulent conduct. It is no surprise that the lower federal courts are not applying Stoneridge in a uniform manner. But it cannot be disputed that the first year of the post- Stoneridge era has demonstrated a willingness by most courts to prevent the application of the securities laws from reaching “the whole marketplace in which the issuing company does business,” by requiring plaintiffs to plead and prove 10(b) liability by alleging a deceptive statement or act that is actually communicated to the public. Continued application of both the legal and policy underpinnings of Stoneridge should continue to limit the claims that businesses need to defend, or at least give them one more tool with which to defend them. Elizabeth F. Edwards and Anne Bentley McCray are partners, and Brian E. Pumphrey is an associate, in the business and securities litigation department of Richmond, Va.-based McGuireWoods.

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