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Current Issue : 2008 Spring

Showdown Over Stoneridge - Supreme Court Case Spotlights BLS Securities Law Heavyweights - by Michele Bowman

Presenting one of the most important securities law issues to reach the United States Supreme Court in years, Stoneridge v. Scientific-Atlanta was a special case to the Brooklyn Law School community. Two of its securities law heavyweights faced each other from opposite sides of the case: BLS alumnus Stanley Grossman '67 argued the case before the Court on behalf of the shareholder class. And Roberta Karmel, Centennial Professor of Law at BLS, in two articles — one published seven months before the decision came down — identified the surprising issue that the Court would find the case turned on.

In Stoneridge, which came down in January, the Supreme Court held that plaintiffs bringing securities fraud claims must be able to show that in deciding to buy stock, they "relied" on the deceptive behavior of secondary actors — law firms, auditors, investment banks, and vendors.

Of keen interest to the trial lawyers' bar and to the securities industry, the case was also closely watched by those "secondary actors" who wanted to know more about the potential liability that appeared to come with advising or working closely with companies that are sued for securities fraud. In finding no liability, the Court also appears to have effectively signed the death warrant on the better-known Enron case, closing the door on a case that was very similar to Stoneridge.

The Facts

Grossman filed the case on behalf of a class of investors led by investment manager Stoneridge Investment Partners, LLC. The investors bought common stock in Charter Communications, Inc., a cable operating company. Despite the company's efforts to portray otherwise, by late 2000, its executives realized it would miss projected operating cash flow by $15 to $20 million and embarked on a plan to alter its arrangements with vendor defendant companies Scientific-Atlanta and Motorola, which supplied Charter with the digital cable converter boxes that the company provided its customers. The goal was for Charter's quarterly reports to meet Wall Street expectations for cable subscriber growth and operating cash flow.

Under an admittedly fraudulent arrangement, Charter had arranged to overpay its vendors Scientific-Atlanta and Motorola for each converter box, and the companies then returned the overpayment by buying advertising from Charter, which recorded the advertising purchases as revenue and capitalized the purchase of the converter boxes. A wash to the defendant vendor companies, this arrangement — all written in contracts — allowed Charter to trick its auditor into approving a financial statement that showed it met projected revenue and operating cash flow numbers. Charter reported numbers to the Securities and Exchange Commission and the public that inflated its revenue and cash flow by about $17 million.

The Parties Square Off

In the securities fraud class action he filed in the Eastern District of Missouri on behalf of the purchasers of Charter stock, Grossman alleged that Scientific-Atlanta and Motorola violated §10(b) of the Securities Exchange Act of 1934 and the related SEC Rule 10b-5.

Section 10(b) of the Securities Exchange Act protects investors from "any manipulative or deceptive device or contrivance" surrounding the purchase or sale of securities that contravenes the Commission's rules. SEC Rule §10(b)5 makes it unlawful "to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made...not misleading."

According to Grossman, the vendor companies' conduct fell squarely within Rule 10(b)5. Focusing on the "deceptive device or contrivance" language in the rule, he maintained that Motorola and Scientific-Atlanta committed deceptive acts themselves; they were not merely assisting Charter to create its deceptive revenue inflations. "They themselves issued false documents and signed contracts that were deceptive," Grossman says. "Unlike in Central Bank, we had secondary actors actually committing deceptive acts."

In 1994, the Supreme Court held in the Central Bank case that no private cause of action for aiding and abetting existed under §10(b). Congress responded to Central Bank in 1995 by allowing the SEC to bring actions alleging that secondary actors aided and abetted fraudulent activity in stock issuance. But private plaintiffs still needed to prove secondary actors like the vendors in Stoneridge were liable under the statute in what is called "primary liability"; there is still no private cause of action for aiding and abetting.

Roberta S. Karmel

Roberta S. Karmel is the Centennial Professor of Law at Brooklyn Law School, where she has taught securities law for over 20 years. An internationally recognized expert in international and domestic securities regulation, she is widely called upon to teach and lecture all over the world on this subject. She is a former Commissioner of the Securities and Exchange Commission and Public Director of the New York Stock Exchange. She was in private practice for many years before joining academia.

Karmel studied the harmonization of securities laws in the European Union as a Fulbright Scholar and is a widely published author. In addition to numerous scholarly articles on securities regulation and international securities law, she also authors a monthly column on securities regulation that appears in the New York Law Journal.

Karmel's professional activities, affiliations and awards are numerous. In August, the American Bar Association's Commission on Women in the Profession will present her with a 2008 Margaret Brent Women Lawyers of Achievement Award in recognition of her path-breaking accomplishments. She is a trustee of the Practising Law Institute, a member of the American Law Institute, a fellow of the American Bar Foundation, and vice-chair of the International Coordinating Committee of the ABA's Business Law Section. She serves as co-director of the Dennis J. Block Center for the Study of International Business Law at Brooklyn Law School.