Risk Management

High Court to Weigh “Scheme Liability”

Appeals courts have reached conflicting opinions on the culpability of ''secondary actors'' that do business with a defendant company.
Dave Cook and Stephen TaubMarch 27, 2007

The Supreme Court has agreed to rule on whether a company’s shareholders can sue its suppliers, or other “secondary actors” that do business with it, when the company is alleged to have committed securities fraud.

The case at hand involves StoneRidge Investment Partners and its stake in cable television provider Charter Communications. StoneRidge alleged that Charter had entered into sham transactions with Motorola and Scientific-Atlanta and inflated Charter’s revenue by $17 million, reported the Associated Press.

StoneRidge sued Motorola and Scientific-Atlanta (now part of Cisco Systems) for participating in a “scheme to defraud” investors. A federal district court and the Eighth U.S. Circuit Court of Appeals each dismissed StoneRidge’s claim, ruling that Motorola and Scientific-Atlanta aided and abetted Charter’s fraud but did not violate securities laws themselves, according to the AP.

Last week, a three-judge panel for the Fifth Circuit also found in favor of “secondary actors” — in this case, three investment banks being sued by former Enron shareholders. The court ruled that the investors cannot combine their litigation against Merrill Lynch, Credit Suisse First Boston, and Barclays Bank into a class action lawsuit. “Presuming plaintiffs’ allegations to be true,” the judges asserted, according to The New York Times, “Enron committed fraud by misstating its accounts, but the banks only aided and abetted that fraud by engaging in transactions to make it more plausible; they owed no duty to Enron’s shareholders.”

Last summer, however, the Ninth Circuit determined that plaintiffs can seek damages from a third party in certain circumstances. The plaintiffs in Simpson v. AOL Time Warner were shareholders in a company that in 1996 launched the real-estate website Homestore.com (now Move.com). According to the AP, plaintiffs could prevail if they proved that the principal purpose and effect of a defendant’s behavior was to create “a false appearance from illegitimate transactions in furtherance of a scheme” to commit fraud.

The conflicting appeals court rulings lays the groundwork for the case before the Supreme Court, noted the AP. Arguments will be heard during next year’s session, which begins in October.