In its long-awaited decision announced on Tuesday in Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc., 552 U.S. __ (2008) (the Court's slip opinion is here), the Supreme Court ruled that so-called scheme liability under SEC Rules 10b-5(a) and (c) -- claims based on deceptive conduct and manipulative acts and practices (and/or on the participation of secondary actors in deceptive or manipulative schemes to defraud) rather than on material misrepresentations or omissions -- may continue to state a valid claim under the federal securities laws. At the same time, the Court upheld the dismissal of the complaint by focusing its analysis on the reliance (i.e., causation-in-fact) element of such claims and finding it lacking in Stoneridge. From this precarious vantage point, scheme liability survives, even if perhaps only for another day or Term.
Writing for a 5-3 majority, Justice Kennedy's opinion for the Court reaffirms the principle that claims seeking to impose liability on “secondary actors who commit primary violations” of the securities laws are actionable under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5. Stoneridge, 552 U.S. at __, slip op. at 15, citing Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994). In other words, even though the Section 10(b) implied private right of action does not extend to mere aiders and abettors, id., slip op. at 6-7, following the holding of Central Bank of Denver, supra, 511 U.S. at 177, 180, 191, a secondary actor can be liable if its conduct independently satisfies each of the elements for liability under Section 10(b) and Rule 10b-5. After Stoneridge, status as a secondary actor cannot be argued to automatically and concomitantly confer immunity from civil liability as a mere aider and abettor.
The Court of Appeals for the Eighth Circuit had upheld the dismissal of the plaintiffs’ complaint in Stoneridge on the basis that (i) the complaint did not allege that the defendants had made any misstatements relied upon by the public, and (ii) the defendants (suppliers and customers of the company, Charter Communications, Inc. (“Charter”), in which the plaintiffs had invested) did not have a duty to disclose and therefore did not (indeed, could not) violate such duty. The Eighth Circuit based its decision on the belief that only misstatements and omissions by one who has a duty to disclose are deceptive within the meaning of Section 10(b) and Rule 10b-5. Slip op. at 4, 7, citing In re Charter Communications, Inc. Securities Litigation, 443 F.3d 987, 992 (8th Cir. 2006).
The Supreme Court affirmed the result reached by the Eighth Circuit but not on the same grounds or based on the same reasoning. Indeed, the Court explicitly concluded (contrary to the views of the Fifth and Eighth Circuits) that conduct standing alone, without statements or omissions, can constitute actionable deception or manipulation, and that any suggestion that “there must be a specific oral or written statement before there [can] be liability under § 10(b) or Rule 10b-5” would be “erroneous.” Stoneridge, slip op. at 7.
The Supreme Court affirmed the dismissal of the complaint in Stoneridge because the investor-plaintiffs did not rely in deciding to purchase or sell securities on any of the deceptive acts committed by the defendants in that case. The decision was based solely on the missing element of reliance.
A plaintiff’s reliance on a defendant’s deceptive act (or false or misleading statement or omission) is an essential element of the Section 10(b) private cause of action. Reliance ensures the “requisite causal connection” between a defendant’s misrepresentation or omission, or deceptive or manipulative conduct, on the one hand and the plaintiff’s injury on the other. Id., slip op. at 8, citing Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988); Afiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 154 (1972) (requiring “causation in fact”). As the Court noted, “reliance is tied to causation” -- “whether [the defendants’] acts were immediate or remote to the injury.” Slip op. at 9. The Court further noted that the deceptive act must not only be relied on in a meaningful way, it must also be committed “in connection with the purchase or sale of any security.” Id., quoting 15 U.S.C. § 78j(b).
The suppliers/customers in Stoneridge had no duty to disclose and their deceptive acts were not communicated to investors. Slip op. at 8. Therefore, no cognizable claim was asserted against them because “[n]o member of the investing public had knowledge, either actual or presumed, of [their] deceptive acts during the relevant times [and,] as a result, [plaintiff] cannot show reliance upon any of [defendants’] actions except in an indirect chain that we find too remote for liability.” Id. The deceptive acts of the suppliers/customers were too remote because “[i]t was Charter not [defendants] that misled its auditor and filed fraudulent financial statements; nothing [defendants] did made it necessary or inevitable for Charter to record the transactions as it did.” Id. at 10.
Finally, the Court noted that the plaintiff in Stoneridge sought to apply the Section 10(b) private cause of action in the realm of ordinary business transactions, such as purchase and supply contracts, which are outside of the securities markets. Id. The deceptive acts committed by Charter’s suppliers and customers “took place in the marketplace for goods and services, not in the investment sphere.” Id. at 16. The Court stated that Section 10(b) “does not reach all commercial transactions that are fraudulent” (id. at 11), and that it “should not be interpreted to provide a private cause of action against the entire marketplace in which the issuing company operates.” Id. The Court found this limitation on the reach of Section 10(b) private causes of action to be in accord with both Congress’ intent in responding to the decision in Central Bank of Denver (id. at 11-12) and enacting the PSLRA (id. at 13-15), and sound policy considerations. Id. at 12-13 (“[o]verseas firms with no other exposure to our securities laws could be deterred from doing business here” which may, in turn, “raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets”).
Early blog commentary on Stoneridge has been as widely disparate as the 30 amicus briefs filed with the Court and spans the entire political spectrum. Among the more thoughtful examples, Lyle Denniston has this post on the case for Scotusblog, and Lyle Roberts provides his typically cogent analysis for The 10b-5 Daily here. Elizabeth Nowicki's criticism of the opinion at the Truth on the Market blog can be found here. Meanwhile, the National Association of Shareholder and Consumer Attorneys (NASCAT) apparently agrees with much of my reading of the opinion, as reported here. And Larry Ribstein's provocative and insightful critique, per usual, is here.
We will have more coverage of and comments on the Stoneridge decision and the evolving contours of scheme liability under Section 10(b) and Rule 10b-5(a) and (c) in the coming days and weeks as developments warrant.