Supreme Court Maintains Limits on Third-Party Liability in Securities Cases

WASHINGTON, Jan 15, 2008 (A. M. Best via COMTEX) -- SFA | news | PowerRating | PR Charts -- The U.S. Supreme Court has ruled 5-3 that securities lawsuits may target third-party vendors and advisers under fraudulent "scheme" liability theories only where an investor specifically relied on the third party's services when choosing to invest. The case could have broadly expanded exposure for insurers that offer liability coverage to banks, law firms, and accountants, if the court had ruled differently.

Writing for the majority in the case, Stoneridge Investment Partners vs. Scientific-Atlanta, Associate Justice Anthony Kennedy expressed the court's unwillingness to overturn its 1994 decision in Central Bank vs. First Interstate Bank, which struck down the Securities Exchange Act of 1934's "aiding and abetting" cause of action for securities fraud.

Petitioners were appealing a decision by the 8th U.S. Circuit Court of Appeals that Stoneridge and other investors in cable provider Charter Communications had no viable claims against Scientific-Atlanta and Motorola. Charter allegedly engaged in "sham" transactions with the equipment providers to fraudulently claim $17 million of additional revenues on its balance sheet.

Kennedy, who was joined in his decision by Chief Justice John Roberts and Associate Justices Samuel Alito, Antonin Scalia and Clarence Thomas, wrote that if Congress had intended to so broaden private causes of action in such cases, it would have done so when it passed the Private Security Law Reform Act in 1995, which empowered the U.S. Securities and Exchange Commission to bring charges of aiding and abetting securities fraud.

"Were the implied cause of action to be extended to the practices described here, however, there would be a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees," Kennedy wrote. "Our precedents counsel against this extension."

David H. Kistenbroker, chairman of the securities litigation practice with Chicago-based Katten Muchin Rosenman LLP, called the decision "certainly expected," adding that it would "maintain the status quo of the structure and parameters of these cases, which is, in my mind, the correct course of action."

In the dissent -- authored by Associate Justice John Paul Stevens and joined by Justices David Souter and Ruth Bader Ginsburg -- the minority argued that the majority justices had misinterpreted the Central Bank decision, as "this case is critically different from Central Bank because the bank in that case did not engage in any deceptive act."

In contrast, Stevens wrote, "investors relied on Charter's revenue statements in deciding whether to invest in Charter and in doing so relied on respondents' fraud, which was itself a 'deceptive device' prohibited by...the Securities Exchange Act."

Ted Frank, director of the American Enterprise Institute Legal Center for the Public Interest, said the dissent "went broader than the mere question of securities litigation."

"There's a surprisingly fervent defense of the judiciary as an activist branch of government, going out and creating new rights of action, and that really clarifies what Supreme Court judicial selection is all about," Frank said. "Do you want a Justice Roberts who knows what the role of the judiciary is, or do you want a Justice Stevens, a Justice Ginsburg, who treats the judiciary as another law-making branch of government?"

Among those filing friend of the court briefs in the case was the Attorneys' Liability Assurance Society Inc., the largest lawyer-owned mutual insurance company in the United States. In its brief, ALAS argued that overturning the Central Bank decision would expose attorneys to such enormous civil liability that it would force some to abandon their traditional roles as client advisers.

(By R.J. Lehmann, Washington bureau manager: raymond.lehmann@ambest.com)

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