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Kreindler Partner Mark Labaton Quoted in Daily Journal Regarding Share-Holder Lawsuits.
Mr. Labaton was asked to comment on the potential impact of a recent Supreme Court decision that limited claims against third-parties who assist a corporation to commit fraud unless the share-holders can show that they relied on the deceptive third-party conduct when they purchased or sold stock.
DAILY JOURNAL NEWSWIRE ARTICLE
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January 16, 2008
HIGH COURT RULES AGAINST INVESTORSJustices Curb Right to Sue Third Parties Aiding Fraud
By Brent Kendall
Daily Journal Staff Writer
This article appears on Page 1.
WASHINGTON — The business community won a big legal victory over investors Tuesday when the U.S. Supreme Court ruled that shareholders cannot sue third parties who assist a corporation in committing securities fraud unless they can show they relied on the deceptive third-party conduct when they decided to buy or sell stock.
The ruling will make it difficult for shareholders to sue secondary actors such as investment banks, business partners and lawyers for securities fraud, and it undercuts a controversial theory of liability that trial lawyers developed in the wake of a 1994 Supreme Court decision that also went against investors.
The decision is a blow to a number of current shareholder lawsuits, most notably one against leading investment banks for their alleged role in the massive collapse at former energy giant Enron Corp.
"There's no question it's a very anti-investor decision," said Patrick J. Coughlin of Coughlin Stoia Geller Rudman & Robbins, the lead plaintiff's attorney in the Enron case.
Coughlin, who said he was studying what the decision meant for his Enron lawsuit, said investors would have a tough time with the high court's insistence that they prove they relied on shady corporate conduct in making investment decisions.
"By its very definition, deceptive conduct is hidden and concealed, so it's a real problem," he said.
Los Angeles attorney William F. Sullivan, who heads the national securities litigation practice at Paul, Hastings, Janofsky & Walker, said the decision was a thorough win for business.
The investors' position, Sullivan said, "would just open the cases up to endless lists of defendants and make them much more difficult and expensive to resolve. This clearly limits that."
"It's what a lot of people predicted would happen," he said. "The Supreme Court is now charting a consistent course in a more defendant-friendly perspective."
At issue in the highly anticipated case was an accounting scandal at cable-television provider Charter Communications. Stoneridge Investment Partners v. Scientific-Atlanta, U.S. Supreme Court, DAR p. 569.
Charter allegedly entered into sham transactions with Scientific-Atlanta and Motorola in which the cable provider agreed to pay inflated prices for the companies' set-top cable boxes, with the understanding that the companies would use the excess revenue to purchase advertising from Charter.
The transactions allowed Charter to boost its financial statements artificially in order to meet Wall Street expectations. Charter settled its legal liability, but investors also went after Scientific-Atlanta and Motorola for their roles, under the so-called theory of "scheme liability."
The companies, investors argued, were liable because they purposely engaged in a scheme designed to allow Charter to misrepresent its revenue.
But Justice Anthony M. Kennedy, writing for a 5-3 court, said deceptive acts by third-party business partners are not enough to put them on the hook for liability unless investors could show that they were aware of, and relied on, the third-party actions.
Scientific-Atlanta and Motorola "had no duty to disclose; and their deceptive acts were not communicated to the public," Kennedy wrote. "No member of the investing public had knowledge, either actual or presumed, of [their] deceptive acts during the relevant times."
Investors, he said, could not show that they relied on the actions of Charter's partners "except in an indirect chain that we find too remote for liability."
The business partners, he said, accounted for the transactions correctly and did nothing that "made it necessary or inevitable" that Charter would falsify its own financial statements.
While the Securities and Exchange Commission can take legal action against third parties for deceptive conduct, private investors cannot, Kennedy said.
That rule, he said, reflected a conscious choice by Congress and was necessitated by the "practical consequences" of permitting such investor lawsuits.
Allowing the lawsuits, he said, would raise business costs, deter overseas firms from doing business in the United States and shift stock offerings away from U.S. markets.
Joining Kennedy, a moderate conservative, were the four more conservative members of the court: Chief Justice John G. Roberts Jr. and Justices Antonin Scalia, Clarence Thomas and Samuel A. Alito Jr.
Justice John Paul Stevens, joined by Justices David H. Souter and Ruth Bader Ginsburg, dissented, saying the majority was on a "continuing campaign" to render federal securities law "toothless" when it comes to allowing investor lawsuits.
"Investors relied on Charter's revenue statements in deciding whether to invest in Charter and in doing so relied on [the business partners'] fraud," Stevens said.
Because of personal stock holdings, Justice Stephen G. Breyer was recused in the case.
The high court's ruling is at odds with the pro-investor legal position favored by the SEC, though in the Charter case, U.S. Solicitor Paul Clement, the Bush administration's lawyer at the Supreme Court, rejected the SEC's recommendation that the government support the shareholders.
Instead, Clement filed an amicus brief in support of the business defendants.
Notably for local practitioners, the Supreme Court's decision changes the law in the San Francisco-based 9th U.S. Circuit Court of Appeals, which ruled in 2006 that investors could bring securities-fraud lawsuits against secondary actors for participating in a fraudulent scheme. Simpson v. AOL Time Warner Inc., 452 F.3d 1040.
That case involved investor allegations that America Online and others entered into sham transactions that enabled Homestore.com to artificially inflate its revenue.
Steven N. Williams of Cotchett, Pitre & McCarthy in Burlingame, who is representing the California State Teachers' Retirement System as the lead plaintiff in the 9th Circuit case, said the Supreme Court decision was "a blow for investors and the integrity of the market."
"The result will be to shield from liability a huge amount of conduct that clearly is false and fraudulent, and that is designed to let public companies lie to the investing public," Williams said.
As for the Enron case, the plaintiff investors, led by the Regents of the University of California, lost at the New Orleans-based 5th Circuit. Their case was on hold at the Supreme Court pending the Charter decision. Regents of California v. Merrill Lynch, 06-1341.
The justices now could choose to let the 5th Circuit ruling stand, which would end the case, or they could send it back to the appeals court for a second look under the high court's new ruling.
For all that Tuesday's case decided, there are still question marks, at least to some lawyers, about whether private securities lawsuits against third parties can go forward in some circumstances.
San Francisco lawyer Bruce A. Ericson of Pillsbury Winthrop Shaw Pittman, co-chair of the firm's securities litigation team, said he was a little surprised by the court's reasoning, which focused on the idea that Charter's transactions with its business partners were too remote from the securities markets to render the partners liable as third parties.
"That kind of reasoning in a case like this is a little unusual," Ericson said. "And it makes you think, 'If this is too remote, what's not too remote?'" Ericson said it was not completely clear how the court's reasoning would apply to lawyers, investment banks and auditors that worked more closely with financial markets.
Plaintiffs lawyer Mark Labaton of Kreindler & Kreindler in Los Angeles agreed. Investor lawsuits against third parties may not be dead "when it comes to liability based on conduct directly impinging on an investment rather than when it pertains to conduct in more distant commercial marketplace transactions," Labaton said. "The Supreme Court," he said, "appears to have made a clear distinction between these two spheres."
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