A little noticed provision of the Senate's sweeping financial service reform bill would over-ride a major Supreme Court ruling that bars individuals from suing so-called secondary actors in a securities fraud case.
The provision comes on the heels of a bill proposed by Senator Arlen Spector that would have the same effect.
The amendment on page 795 of Senator Chris Dodd's proposed 1,136-page tome would allow plaintiffs to sue aiders and abetters such as accountants, underwriters, lawyers, customers, and suppliers without having to prove they relied upon their statements or representations when purchasing or selling securities.
"The Stoneridge decision identified the reasons why eliminating reliance as an essential element of a private cause of action in order to create a private cause of action for aiding and abetting is simply not a good idea," according to an analysis by K. Stewart Evans, Jr. of the Pepper Hamilton law firm, who "discovered" the provision. "(Senator Chris) Dodd's rejection of those reasons illustrates how destructive and dangerous the amendment would be to American business."
In case you forgot, in Stoneridge Investment Partners v. Scientific-Atlanta, investors in the cable company Charter Communications claimed that Scientific-Atlanta and Motorola, Charter suppliers and customers, participated in an elaborate scheme by Charter. In order to meet various financial quarterly projections, Charter allegedly worked out a deal whereby it would overpay Scientific-Atlanta, Inc., and Motorola, Inc. for set-top boxes by $20. They would then use the overpayments to buy advertising from Charter.
Stoneridge alleged that Scientific-Atlanta, Inc., and Motorola, Inc. "knew or were in reckless disregard of Charter's intention to use the transactions to inflate its revenues and knew the resulting financial statements issued by Charter would be relied upon by research analysts and investors," Evans points out.
A federal district court and then an appeals court both dismissed Stoneridge Partners' claim, ruling that Scientific-Atlanta and Motorola did assist in Charter's fraud but did not violate federal securities law themselves.
In early 2008, the Supreme Court ruled that when such "secondary actors" do business with a company and their transactions are part of the company's false financial statements, they may not be held liable for damages in a private securities lawsuit-even if those secondary actors knew that the company intended to defraud investors. Because the actions of those third parties were "not disclosed to the investing public" and "not relied upon by the investors," the Court ruled that a third party's conduct is not within the scope of a private lawsuit under the Exchange Act.
"This conclusion is consistent with the narrow dimensions we must give to a right of action Congress did not authorize when it first enacted the statute and did not expand when it revisited the law," the Court wrote.
Keep in mind that the ruling only applied to private lawsuits. The Securities Exchange Commission can bring its own enforcement actions against third parties for their role in another company's fraud.
Dodd, however, goes where the Supreme Court chose not to. "Under Dodd's amendment, participation in transactions that underlie public statements can be the basis of a securities violation absent a public statement with the result that the implied cause of action for aiding and abetting will extend to the entire marketplace in which the issuing company does business," Evans points out.
He asserts that the amendment "would expose a new class of defendants" to the risk that plaintiffs with weak claims might use the expense of extensive discovery and the potential for uncertainty and disruption that accompany lawsuits to extort settlements from innocent companies identified by the court in Blue Chip Stamps v. Manor Drug Stores.
Evans also predicts the Dodd Amendment will raise the cost of doing business in the United States and could deter foreign companies from doing business in the United States. "Given these significant, predictable consequences of Senator Dodd's amendment, one must question his judgment," Evans writes. "Certainly, he is not committed to facilitating our country's economic recovery. Instead, he sees himself as a sort of new populist who in that tradition points his finger at bankers as the new enemy around which his constituency, he hopes, will rally."