Risk Management

DoJ: Ease Up on Vendors’ Fraud Liability

A brief filed with the Supreme Court flies in the face of SEC Chairman Christopher Cox's decision in favor of getting tough on "secondary actors."
Sarah JohnsonAugust 16, 2007

The Department of Justice has filed a friend-of-the-court brief with the U.S. Supreme Court opposing lawsuits that hold third parties equally liable for a business partner’s securities fraud.

Filed on Wednesday, the U.S. Solicitor General’s amicus brief flies in the face of Securities and Exchange Commission chairman Christopher Cox’s avowed intention to file a brief on behalf of investors that would have argued that so-called “secondary actors” could be sued for another company’s securities violations. The SEC commissioners had voted to share that view with the Solicitor General, who ultimately files any brief to the Supreme Court that reflects the entire government’s view.

The lawsuit in question could determine the survival of an unrelated suit filed by Enron shareholders. Observers say the case, StoneRidge v. Scientific-Atlanta, provides a test case for the liability of Enron’s secondary actors — the banks accused of helping the now-collapsed energy giant of misrepresenting its financial health. The brief doesn’t mention the Enron case. That case’s appeal hasn’t yet been addressed by the high court.

At the same time, a Supreme Court ruling in favor of the Stoneridge plaintiffs would open the floodgates to costly lawsuits, Solicitor General Paul Clement argued in the brief. If the justices determine that business partners are primary violators of securities laws, that would mean “potentially exposing customers, vendors, and other actors far removed from the market to billions of dollars in liability when issuers of securities make misstatements to the market,” he added.

The question of who can be deemed a “primary violator” is key to the strength of such cases. Under the Private Securities Litigation Reform Act of 1995, private litigants can sue only if they can prove the accused company did more than just aided and abetted the wrongdoing.

On the other hand, the SEC has more leeway and has sued business partners accused of taking part in such clear corporate wrongdoing as that which happened at Enron. By giving the SEC such power, Congress has “struck a balance between exposure to aiding-and-abetting liability and complete immunity,” Clement wrote. Tampering with the equilibrium “would upset that congressional choice and vastly expand liability in unpredictable ways.”

But the June 11 deadline for filing amicus briefs on behalf of the plaintiffs in the StoneRidge case passed without any word from the government. President Bush reportedly weighed in on the matter through a White House lawyer, who told Clement that “unnecessary lawsuits” are burdensome to the U.S. economy and should be reduced.

Indeed, the brief filed on Wednesday notes that it’s the government’s responsibility to make sure that “entities providing services to publicly traded companies are not subject to inappropriate secondary liability.”

Clement claims liability shouldn’t play a role in the StoneRidge case. The suit alleges that vendors of Charter Communications were involved in a sham transaction by the cable company involving behind-the-scenes dealings. Charter’s shareholders haven’t shown that their investment decisions derived from alleged misconduct by the vendors, Clement added. In fact, they have acknowledged that the vendors — including Motorola and Scientific-Atlanta (now owned by Cisco) — were not providing false information about Charter to the securities market, he said.