Risk & Compliance

The StoneRidge Case: Whom Do You Trust?

That'll be a harder question to answer if a securities-fraud case in front of the Supreme Court tilts in the plaintiffs' favor.
Sarah JohnsonOctober 9, 2007

On Tuesday, the Supreme Court justices will listen to arguments in a case that could have a wide effect on how companies do business with each other. What’s more, a majority opinion issued against the vendors in the case could even affect interpretations of the Sarbanes-Oxley Act, theorizes Stephen Bainbridge, a law professor at the University of California.

While Sarbox requires CEOs and CFOs to sign off on their companies’ internal controls, StoneRidge v. Scientific-Atlanta brings up the question of whether executives should be concerned over their business partners’ internal controls. The case could have a lasting effect on companies’ relationships with their vendors, suppliers, auditors, customers, and other partners, according to Bainbridge.

At the same time, it could add to the time and expense of complying with Sarbox, Bainbridge said during a symposium at Case Western Reserve University School of Law last week. Would companies have to start checking how their vendors account for transactions they share? “It’s bad enough trying to monitor your own internal controls,” he said, noting that overseeing another company’s “is more difficult and more expensive.”

Indeed, the StoneRidge case brings up the question of whether a business partner of a company that partook in a sham transaction can also be held culpable of fraud, even if the business partner itself did not issue any publicly disseminated statements that could have misled investors.

It’s been an issue that has divided current and former government officials. While Securities and Exchange Commission chairman Christopher Cox had promised to file a friend-of-the-court brief on behalf of investors in the case to say that so-called “secondary actors” could be sued for another company’s securities violations, the Department of Justice issued a brief on behalf of the entire government that said the opposite.

Solicitor General Paul Clement, who ultimately files any brief to the Supreme Court to share the entire government’s view, said in his August brief that a ruling in the investors’ favor in this case could lead to an influx of lawsuits.

If the justices find 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.

To be sure, the government’s allegiance with businesses in this case has investor advocates worried. “If you’re going to allow secondary market players to escape liability, then we’re not providing the investor the [protection] the securities laws are intended to provide,” said Andrea Seidt, deputy chief counsel in the Ohio attorney general’s office.

StoneRidge has received particular attention and pressure on government officials to take positions on the case because it could affect the ongoing litigation between Enron shareholders and the banks accused of helping the now-collapsed energy giant of misrepresenting its financial health. Observers say a ruling in favor of investors in StoneRidge could give the Enron case a second life. The justices have not yet addressed whether they will hear an appeal in that suit.

However, despite the doomsday scenarios Bainbridge envisions for companies if a decision in StoneRidge favors investors, he’s betting that the High Court justices will keep things the way the are, with secondary actors not as equally liable as their business partners that committed fraud. He suspects the majority opinion from the court will be based largely from Clement’s brief. Securities law is not the justices’ specialty, he added.