The Supreme Court Limits “Scheme” Liability in Securities Fraud Actions for Advisors and Other Professionals

Many in the business community collectively breathed a sigh of relief on January 15, when the Supreme Court confirmed that private, nongovernmental litigants cannot sue companies for securities fraud unless they, themselves, make direct, material misrepresentations or improper omissions to the market. In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., et al., Docket No. 06-43, a 5-3 decision authored by Justice Anthony Kennedy (with Justice Breyer recused), the Court resolved a split in the circuits by affirming that Congress had not created a private right of action for Section 10(b) lawsuits except for “direct” actors. Some lower courts had approved of so-called “scheme” liability under Section 10(b), whereby a group of secondary actors, such as investment bankers, advisors, or others acting in concert with the Company, could collectively be held liable for the misrepresentations or omissions of their client. However, the Supreme Court held—as it did in 1994 in Central Bank v. First Interstate Bank (regarding aiding and abetting liability)—that Congress did not provide a private right of action for “scheme” liability, and that it could not be judicially endorsed by implying a right where none existed.

In Stoneridge, the plaintiffs were a class of investors in Charter Communications, a cable television operator. The plaintiff class not only sued the alleged “direct” actor, Charter, but also two of Charter’s suppliers, Scientific- Atlanta and Motorola, who provided Charter with set-top cable boxes for sale and use by its customers. The plaintiffs claimed that Charter had misrepresented its value in its public disclosures through a series of alleged fraudulent transactions with Motorola and Scientific- Atlanta. Plaintiffs alleged that Motorola and Scientific- Atlanta joined Charter in a scheme in which Charter would purchase the set-top boxes for more than their real value and Scientific-Atlanta and Motorola would then use the excess money to purchase advertising time from Charter. Plaintiffs claimed that this arrangement improperly allowed Charter to reflect higher revenue to Wall Street, and thereby artificially inflate the stock price. The issue before the Supreme Court was whether Scientific-Atlanta and Motorola’s alleged actions could subject those companies to securities fraud liability when they never made any representations to the market.

In deciding that secondary actors like Scientific-Atlanta and Motorola should not be liable under a “scheme” theory, the Court emphasized the lack of possible reliance by the plaintiffs on Scientific-Atlanta and Motorola’s statements or actions. It was not enough, according to the Court, to claim that they participated in a “scheme” if their participation was not relied upon by the plaintiffs. In addition, the Court noted the lack of any direct connection (or “proximate cause”) between Motorola’s or Scientific- Atlanta’s sale of boxes and purchase of advertising time and any statements made by Charter to its shareholders.

In sum, the Court approached this decision with the same analysis it followed over a decade ago in Central Bank—asking not who may have helped or assisted in the misrepresentation that was relied upon, but who actually made the misrepresentation to investors. The decision clarifies that business partners, professionals and other advisors who work with publicly traded issuers, absent a direct role, will not be held liable for the company’s statements to investors.