WASHINGTON – A case stemming from Allen Stanford's spectacular $7 billion fraud will be argued before the U.S. Supreme Court on Oct. 7, the first day of the court's fall term.

But law firms won't be watching to learn more details about Stanford's Ponzi scheme, which earned him a 110-year prison term last year. Instead, they fret that the outcome could expose fraudsters' law firms and other third parties to billions of dollars of liability in securities class actions in state courts.

Their concern is that when frauds like Stanford's collapse and principals go to jail, few assets remain for victims to tap for compensation. As a result, plaintiffs go court-hunting for other deep pockets—and law firms, insurers and accountants tend to have them. Federal law and U.S. Supreme Court precedent discourage such litigation at the federal level, but some state courts are fertile ground for plaintiffs. Now, defendants in class actions want to shut off that avenue as well.

"The risk is that the third-party professional becomes the insurer for the entire fraud," said Linda Coberly, a Winston & Strawn partner who contributed a brief in the case on behalf of DRI—The Voice of the Defense Bar. "But the professionals don't have the money." DRI has 22,000 lawyer-members involved in civil-litigation defense.

The case before the high court pits noted firms Proskauer Rose and Chad­bourne & Parke, as well as Willis Group Holdings and other insurers, against a group of Latin American investors who purchased Stanford's fraudulent certificates of deposit. The three cases, Chad­bourne & Parke v. Troice, 12-79 (See Briefs), Proskauer Rose v. Troice, 12-88 (See Briefs), and Willis v. Troice, 12-86 (See Briefs), have been consolidated for one hour of argument.

Former solicitor general Paul Clement, now with Bancroft in D.C., will argue for Willis and the law firms. Tom Goldstein of Goldstein & Russell, also in D.C., will represent the defrauded investors. Both are veteran advocates before the justices.

Plaintiffs targeted Proskauer and Chadbourne as aiding and abetting Stanford's fraud because of the role of Tom Sjoblom, a partner first at Proskauer and then Chadbourne, as an attorney for Stanford who allegedly stalled investigations by the U.S. Securities and Exchange Commission. Goldstein's brief asserts that Sjoblom "lied to regulators and suborned perjury" by Stanford company officials. As for Willis, the plaintiffs claim the insurer "knew that Stanford was engaged in a massive fraud," according to Goldstein, but instead of disclosing it, aided it by misrepresenting the certificates as safe.

The suits were filed under Texas law but in federal court. The defendants moved to dismiss, invoking the federal Securities Litigation Uniform Standards Act (SLUSA), a 1998 law specifically aimed at discouraging state law claims for misrepresentation or omission of material facts "in connection with the purchase or sale of a covered security." A district judge granted the motion to dismiss, but the U.S. Court of Appeals for the Fifth Circuit reversed.

The appeals court found that the certificates at issue were not a "covered security," also ruling that the plaintiffs made other claims unrelated to covered securities that put the suits outside the jurisdiction of SLUSA. As a result, the Fifth Circuit said, the litigation could continue under state law.

The defendants appealed to the Supreme Court, asserting that the Stan­ford certificates were covered and that the lawsuit was just the kind that SLUSA was passed to preclude. The ruling "frustrates Congress's intent," according to Proskauer's brief, authored by James Rouhandeh of Davis Polk & Wardwell.

Clement asserts in his brief on behalf of Willis and other third-party companies that his clients provided routine services to Stanford's operations, "completely unrelated" to the certificates that formed the basis of the fraud. Willis never profited from the Ponzi scheme, Clement added. And he accused the plaintiffs of seeking out "deep-pocketed third parties with any remote connection to Stanford." Walter Dellinger of O'Melveny & Myers, representing Chadbourne, told the court the plaintiffs were making an "end-run" around the intent of Congress to bar suits against third parties.

The third-party defendants also invoked two Supreme Court precedents—Merrill, Lynch, Pierce, Fenner & Smith v. Dabit, 547 U.S. 71, a 2006 decision, and Stoneridge v. Scientific-Atlanta, 552 U.S. 148, in 2008, both of which point toward a broad reading of federal laws that would prevent class actions based on state law.

The defense bar asserts that allowing the Fifth Circuit ruling to stand would only speed the forum-shopping rush to state courts that began after SLUSA and its predecessor, the Private Securities Litigation Reform Act, were passed. Coberly said that in her own practice defending auditors in securities actions, most of the litigation has been filed under state law. She said that existing federal law gives the government all the tools needed to prosecute legitimate cases against participants in a fraud, without allowing class actions to proliferate at the state level.

Another brief offers an example of the kind of litigation that law firms are worried about. Other Stanford investors sued the Louisiana law firm Breazeale, Sachse & Wilson in federal court but under Texas state law over partner Claude Reynaud Jr.'s role as one of many of Stanford's outside counsel.

The Breazeale firm's brief, written by Arnold & Porter's Lisa Blatt, says the lawsuit seeks to hold the firm liable for at least $300 million and "potentially all of the financial losses resulting from the entire Stanford Ponzi scheme" under a state theory of joint and several liability. Because of the Fifth Circuit's stance, Blatt said, the Louisiana firm has been unable to seek dismissal of the lawsuit.

The Roberts Court has generally supported efforts to curtail class actions. But the issue keeps returning, no matter what laws Congress passes, and the outcome in the Stanford-related cases is uncertain. The uncertainty of the law and the abusive nature of class actions, according to Coberly, "drives up the cost of doing business in the United States and reduces the competitiveness of U.S. capital markets."

The court is also being told that the defendants in the three Stanford cases are not necessarily innocent bystanders or far-removed players who deserve to be protected from liability.

A brief filed by the court-appointed receiver and examiner in the Stanford fraud case details the role Sjoblom allegedly played in using his credentials as a former SEC attorney to forestall SEC investigations into Stanford's operations. It also recites allegations that Willis provided "safety and soundness letters" to Stanford from 1996 through 2008 that attracted thousands of investors to Stanford's offerings.