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Supreme Court wary 3rd-party lawsuits

  Breaking Legal News  -   POSTED: 2007/10/10 15:09

The Supreme Court voiced skepticism Tuesday about efforts to allow lawyers, accountants and others who do business with large corporations to be the targets of class-action securities suits. At issue in the high-profile case is whether victims of large-scale corporate fraud can sue third parties that may have played a significant role in the scheme. Think Enron, Global Crossing or any other massive fraud that involved a web of business relationships, where outside experts allegedly signed off on questionable corporate practices.

The Supreme Court and other federal courts have largely frowned on such suits, saying that only the Securities and Exchange Commission has the authority to bring suit against third parties as so-called aiders and abetters. But following the wave of corporate implosions, class-action suits seeking to hold those entities accountable have been on the rise, largely because those outside parties often are the only ones left standing holding any assets. Tuesday, one of those investor class-action cases reached the justices, with several suggesting they are not inclined to allow the suit to go forward.

That's a view that will be welcomed by a range of powerful business groups, including the U.S. Chamber of Commerce and the American Bankers Association. Along with the Bush administration, they warn that making third parties vulnerable to such suits would result in an explosion of securities litigation, damaging American competitiveness in the global marketplace.

The closely watched dispute is one some observers have labeled the "Roe vs. Wade" of securities law, one in which more than 30 friend-of-the-court briefs were filed, and it played to an electric atmosphere in a packed Supreme Court chamber.

While business groups largely lined up one side, such consumer advocates as AARP, the senior citizen lobby, and the Council of Institutional Investors stood with the investor plaintiffs.

"The stakes are enormous," said Jeffrey McFadden, a Washington securities lawyer who attended the arguments.

The case involves Charter Communications Inc., a cable television provider that entered into side deals with Motorola Inc. and Scientific-Atlanta Inc., two makers of set-top cable boxes. In 2000, in a scheme to pump up its revenues, Charter agreed to overpay the vendors for the boxes. The vendors then returned part of the money to Charter in the form of advertising fees, adding about $17 million to Charter's balance sheet.

After the machinations were revealed and Charter's stock price plummeted, investors brought suit against all of the parties. Charter eventually settled, leaving the two vendors in the suit.

Lawyers for the vendors argued that the companies never knew the extent of Charter's scheme to inflate its revenues and that they never made any false representations directly to Charter's shareholders, something required to find a violation of federal securities law.

A Missouri federal court dismissed the case against the vendors and the federal appeals court in St. Louis affirmed, citing Supreme Court precedent that has interpreted federal securities laws to bar private causes of action against third-parties.

Chief Justice John Roberts on Tuesday demonstrated little interest in departing from precedent, saying that Congress had clearly decided who could and could not bring suit under federal securities laws.

"We don't get in this business of implying private rights of actions anymore," Roberts said. "We haven't done it in quite some time."

And Justice Anthony Kennedy seemed to worry that once the door to such suits was opened there would be no end to them -- and that companies would simply stop doing business with publicly traded companies as a result.

"I see no limitations to your proposal," he said to the counsel for the investors, New York lawyer Stanley Grossman.

But Grossman argued that there would be no litigation free-for-all, saying that a requirement that third parties must actively participate in an intentional effort to deceive the public would eliminate most prospective actions.

Among the justices, Ruth Bader Ginsburg appeared most likely to come down on the side of the plaintiff investors. She was critical of the vendors' conduct in the case, saying it was possible they knew about Charter's plans but sat by passively. The scheme "can only work if the vendors are silent. Silence, not speech, is what counts," she said. "They set up Charter to make those statements to swell their revenues, revenues they didn't have."

Ginsburg repeatedly expressed a desire to find some sort of middle ground between barring the suits altogether and elevating third parties to the level of the primary corporate defrauders. She noted that it was unlikely the SEC could ever make fraud victims whole by suing third-parties on its own, since the government is not in a position to distribute large damage awards.

Chicago lawyer Stephen Shapiro, arguing for the defendant companies, said Congress had rewritten the securities laws in the 1990s to allow only for the SEC actions and the court needed to recognize that.

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