January 15, 2008
On January 15, 2008, the Supreme Court issued an important decision clarifying the contours of private actions under the key anti-fraud provision of the securities laws. In an opinion authored by Justice Kennedy (joined by Chief Justice Roberts and Justices Scalia, Thomas, and Alito), the Court reaffirmed its decision in Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164, 191 (1994), that liability under Section 10(b) of the Securities Exchange Act of 1934 does "not extend to aiders and abettors," and held that, to be actionable, "[t]he conduct of a secondary actor must" itself "satisfy each of the elements or preconditions for liability" under §10(b) or the SEC’s Rule 10b-5.
In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. __ (2008), the petitioner alleged, on behalf of a class of investors in defendant Charter Communications, Inc., that respondents–certain equipment vendors of Charter–had "agreed to arrangements that allowed [Charter] to mislead its auditor and issue a misleading financial statement," even though respondents themselves "had no role in preparing or disseminating Charter’s financial statements." The Supreme Court affirmed the Eighth Circuit’s judgment upholding the dismissal of petitioner’s claim against respondents, because the petitioner failed to adequately allege "[r]eliance . . . upon the [respondents’] deceptive acts," which "is an essential element of the §10(b) private cause of action." Specifically, the Court "conclude[d] [that] the implied right of action does not reach the customer/supplier companies because the investors did not rely upon their statements or representations." In doing so, the Court noted that there need not "be a specific oral or written statement before there could be liability under §10(b) or Rule 10b-5," given that "[c]onduct itself can be deceptive," but insisted on an adequate showing of reliance to "ensur[e] that . . . the ‘requisite causal connection between a defendant’s misrepresentation and a plaintiff’s injury’ exists as a predicate for liability.’"
The Court explained that it has "found a rebuttable presumption of reliance in two different circumstances"–when "there is an omission of a material fact by one with a duty to disclose," and "under the fraud-on-the-market doctrine, . . . when the statements at issue become public"–neither of which applied in the case before it:
Respondents had no duty to disclose; and their deceptive acts were not communicated to the public. No member of the investing public had knowledge, either actual or presumed, of respondents’ deceptive acts during the relevant times. Petitioner, as a result, cannot show reliance upon any of respondents’ actions except in an indirect chain that we find too remote for liability.
The Court also specifically refused to impose liability on respondents under the so-called "‘scheme liability’" "concept of reliance," which posits that in "an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect." "Were this concept of reliance to be adopted," the Court cautioned, "the implied cause of action would reach the whole marketplace in which the issuing company does business; and there is no authority for this rule." Rather, the rule has always been that defendants’ alleged deceptive acts must be sufficiently close or "immediate" to the plaintiffs’ alleged injury in order for plaintiffs to have reasonably relied on those alleged deceptive acts. The Court observed that because "[i]t was Charter, not respondents, that misled its auditor and filed fraudulent financial statements," therefore "respondents’ deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance." Because "Charter was free to do as it chose in preparing its books, conferring with its auditor, and preparing and then issuing its financial statements," "the investors cannot be said to have relied upon any of" the allegedly "deceptive acts" by respondents–certain of Charter’s suppliers and customers–"in the decision to purchase or sell securities." Therefore, the Court concluded, "the requisite reliance cannot be shown," and respondents thus "have no liability to petitioner under the implied right of action."
The Court’s decision in Stoneridge is significant not only because of its rejection of theories of reliance that rest on chains of inference so attenuated as to extend "the private cause of action under §10(b) . . . beyond the securities markets," but also because the Court grounded its decision on its traditional reluctance to extend this private cause of action into "areas already governed by functioning and effective state-law guarantees." Explaining that "Section 10(b) does not incorporate common-law fraud into federal law," the Court also relied on Congress’s amendment of the securities laws, in the wake of Central Bank, "after the Court [had] moved away from a broad willingness to imply private rights of action," "to provide for limited coverage of aiders and abettors" only "in certain cases but not others." "Were we to adopt [petitioner’s] construction of §10(b)," the Court reasoned, "it would revive in substance the implied cause of action against all aiders and abettors except those who committed no deceptive act in the process of facilitating the fraud," thereby "undermin[ing] Congress'[s] determination that this class of defendants should be pursued by the SEC and not by private litigants." Notably, the Court reaffirmed its recent jurisprudence recognizing that "[t]he §10(b) private cause of action is a judicial construct that Congress did not enact in the text of the relevant statutes" and declining to broadly construe that implied cause of action. "Though it remains the law, the §10(b) private right should not be extended beyond its present boundaries," as "[t]he decision to extend the cause of action is for Congress, not for [the Court]."
The Court also underscored the adverse "practical consequences of" petitioner’s contended-for "expansion" of §10(b)’s private cause of action, including: (i) the increased risk that "innocent companies" would have to pay "extort[ionate] settlements" in order to avoid the cost, uncertainty, and disruption that even "weak claims" under §10(b) cause; (ii) the deterrent effect on "[o]verseas firms with no other exposure to our securities laws," and (iii) the resultant "shift [of] securities offerings away from domestic capital markets."
Finally, the Court underscored that "[s]econdary actors are subject to criminal penalties . . . and civil enforcement by the SEC," that "[t]he enforcement power is not toothless," and that "some state securities laws permit state authorities to seek fines and restitution from aiders and abettors." Accordingly, the Court found that investors would not be left without an effective remedy to redress any perceived wrongful conduct by secondary actors, such as the equipment suppliers to Charter.
The Supreme Court’s decision is available at:
Gibson Dunn filed an amicus brief on behalf of former SEC Commissioners and officials, and law and finance professors urging the result that was adopted by the Court.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work or Mark A. Perry (202-887-3667, email@example.com) in the Washington, D.C. office, Jonathan C. Dickey (212-351-2399, firstname.lastname@example.org) in the firm’s New York office, Julian W. Poon (213-229-7758, email@example.com) in the firm’s Los Angeles office, or any of the following:
Appellate and Constitutional Law Practice Group:
Miguel A. Estrada (202-955-8500, firstname.lastname@example.org) or
Theodore B. Olson (202-955-8500, email@example.com) in Washington, D.C.,
Theodore J. Boutrous, Jr. (213-229-7000, firstname.lastname@example.org) in Los Angeles, or
Daniel M. Kolkey (415-393-8200, email@example.com) in San Francisco.
© 2008 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.