Sunday, October 07, 2007

Can Third Parties be Sued for Doing Business with Companies Who Commit Fraud?

Sources: Wall Street Journal, Financial Times

The U.S. Supreme Court will take up the case Stoneridge v. Scientific-Atlanta this term. The main issue in the case is whether third parties can face private lawsuits simply by doing business with companies that commit fraud. This is considered a high-profile case because it could eventually permit investors to sue accountants, attorneys, consultants, and advisors to any public company that commits fraud. Currently, investors are generally not allowed to sue third parties, but the Securities and Exchange Commission has the authority to sue third parties who “aid and abet” fraud.

The Stoneridge case began during the Charter Communications scandal. Investors sued Scientific-Atlanta, a vendor for the cable company, for allegedly participating in the accounting fraud. The case was dismissed by the trial court, and was affirmed by the U.S. Court of Appeals for the Eighth Circuit. Most U.S. courts have ruled that third parties are subject to these private suits, as only primary violators are subjected to liability.

Big business has hired some of the Who’s Who of U.S. law firms, and has painted a grim picture of what may happen if third-parties become subject to liability. Plaintiff’s lawyers have fought back, claiming that justice mandates allowing investor lawsuits against those who “help others commit fraud.” This suit has also drawn a high amount of political interest. The SEC, to a limited extent, supports investor rights to sue third parties. The Bush Administration, however, has sided with corporations in its friend-of-the-court brief. Not to be outdone, former SEC commissioners have filed their own friend-of-the-court brief favoring liability.

The Supreme Court has heard a case similar to Stoneridge before. In 1994, the Supreme Court, in Central Bank of Denver, stated aiding and abetting lawsuits are not allowed. Currently six justices from that case are still on the Court. Those six were divided 3-3, thereby leaving Chief Justice Roberts and Justice Alito to make the final decision. Justice Breyer is recused from the case.


1. If the Supreme Court rules that third parties can be held liable, what impact do you think this will have on the consulting, legal, and accounting industries? What precautions can these companies take to prevent lawsuits?

1 comment:

Bill Hobbs said...

It’s worth remembering that a ruling for the defendants in Stoneridge would leave current law unchanged, while a ruling for the plaintiffs would radically alter current law.

The Court and every federal circuit court but one have made secondary
liability (the plaintiffs call it “scheme” liability) off limits for private suits.

However, neither the Court
nor Congress have set prosecution of accomplices off bounds in securities
cases - they have simply left that task solely to the SEC and the Justice Department.

This balances the need for justice in such cases with the need to protect the economy from being hamstrung and hog-tied by an avalanche of lawsuits.

The blog “10b-5 Daily” had an interesting post last week headlined “NERA Releases Study on “Recent Trends In Shareholder Class Action Litigation”

The gist of it is that the NERA Economic Consulting study, included the following info:

The number of such filings has increased, with 76 new filings through the first half of 2007. The projected annual total of 152 would be a 12% increase over last year.

The average settlement value during the first half of 2007 (excluding settlements over $1 billion) hit a new high of $30 million. There is evidence, however, that this trend may reverse direction based on a decline: (i) in the investor losses associated with recent filings; and (ii) in the prevalence of accounting allegations in recent filings.

Eight of the top ten settlements of all time have resolved in 2006 or 2007, or are pending. Tyco’s announced preliminary settlement of $2.975 billion would be the largest amount ever paid by a single settling defendant.

Here’s the link:

Now, imagine if the Stoneridge case was decided for the plaintiffs. The number of such lawsuits would skyrocket, putting a “scheme liability” tax on the economy.