High Court Bars Secondary Liability in Securities Case

The U.S. Supreme Court ruled in a major securities fraud case that secondary parties—essentially aiders and abettors—can’t be held liable when the companies they work with mislead investors.

Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc., et al., docket no. 06-43, threatened to expand the reach of investor lawsuits beyond parties that misrepresent facts to investors. Specifically, the Supreme Court on Jan. 15 affirmed a lower court ruling that barred the investor lawsuit against the secondary parties, which, it found, made no statements relied upon by the investors and were at most aiders and abettors in the Stoneridge case.

Stoneridge, an investment firm, sued Scientific-Atlanta and Motorola—vendors who were allegedly involved in a scheme that allowed a public cable television company to inflate earnings to meet analysts’ expectations. The cable television provider Charter Communications allegedly overpaid Scientific-Atlanta and Motorola by $17 million for cable boxes it had already agreed to purchase from the vendors at lower prices, according to filings in the lawsuit. The vendors in turn allegedly paid back the excess to Charter in the form of advertising fees. The vendors allegedly fabricated paperwork to dupe Charter’s accountants and conceal the fabricated transactions.

While Scientific-Atlanta and Motorola made no public statements concerning the allegedly sham transactions, Stoneridge sued the vendors, citing section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 promulgated thereunder. The plaintiff argued that the vendors engaged in their own deceptive conduct in transactions with a public company to create a false appearance of fact that allowed Charter to publish artificially inflated financial statements.

The vendors sought to have the Stoneridge case dismissed on the grounds that there could be no claim under section 10(b) and rule 10b-5 because Charter investors never relied on statements made by the vendors. A district court dismissed the claims against Scientific-Atlanta and Motorola, holding that they were not primary violators of § 10(b) and rule 10b-5, but rather were, at most, aiders and abettors of Charter in its violation of § 10(b). The Eighth Circuit affirmed the district court’s dismissal of the claims.

Richard I. Miller, AICPA general counsel and secretary, filed a friend-of-thecourt brief in the case (available at www.aicpa.org/About+the+AICPA/Legal+Briefs) on behalf of the AICPA. The AICPA contended that extending the liability for false statements to parties who didn’t make the statements would have resurrected aiding and abetting liability to third parties, which the Supreme Court earlier ruled in Central Bank N.A. v. First Interstate Bank N.A., 511 U.S. 164 (1994), was not available as a cause of action.

In addition, the AICPA had argued that “if auditors face the prospect of bet-the-firm litigation based on a peripheral connection to statements they have not made, and transactions they have not audited, every auditor’s relationship with its public company clients will be changed for the worse,” the AICPA brief states.

“CPAs are paradigmatic ‘secondary actors,’ who for many years were sued under [s]ection 10(b) not because they had committed a manipulative or deceptive act, but on the theory that they had assisted those who had. Central Bank put an end to such private actions,” the AICPA stated in the brief. “Since then, however, the plaintiffs’ class action bar has tried to revive in several different guises the very claims that Central Bank held were unavailable. This case is the culmination of that misbegotten project.”