Primary Securities Fraud Liability: Stoneridge Investment v. Scientific-Atlanta, Inc.

Primary Securities Fraud Liability:
Stoneridge Investment v.
Scientific-Atlanta, Inc.
Michael V. Seitzinger
Legislative Attorney
American Law Division
Summary
On January 15, 2008, the United States Supreme Court issued its decision in
Stoneridge Investment Partners v. Scientific-Atlanta, Inc., which was appealed from a
decision by the Court of Appeals for the Eighth Circuit. The case concerned whether
secondary actors who make no public statements concerning deceptive transactions
engaged in by primary actors may be liable for fraud under the federal securities laws.
The Court held that these secondary actors had not violated the major antifraud statute
of the federal securities laws.
On January 15, 2008, the United States Supreme Court issued its decision in the case
Stoneridge Investment Partners v. Scientific-Atlanta, Inc.,¹ a case appealed from a
decision by the United States Court of Appeals for the Eighth Circuit.² The questions
presented to the Supreme Court were whether the Supreme Court’s decision in Central
Bank, N.A. v. First Interstate Bank, N.A.³ foreclosed claims for deceptive conduct under
section 10(b) of the Securities Exchange Act of 1934⁴ and Rule 10b-5(a) and (c),⁵ where
Respondents engaged in transactions with a public corporation with no legitimate
business or economic purpose except to inflate artificially the public corporation’s
financial statements but where Respondents themselves made no public statements
concerning those transactions. The Court held that Respondents had not violated the
major antifraud statute of the federal securities laws.

¹ No. 06-43.
² In Re Charter Communications, Inc., Securities Litigation, 443 F.3d 987 (8^th Cir. 2006).
³ 511 U.S. 164 (1994).
⁴ 15 U.S.C. § 78j(b).
⁵ 17 C.F.R. § 240.10b-5(a) and (c).

In this case plaintiff investors brought a securities fraud class action, alleging that
Charter, one of the country’s largest cable television providers, engaged in fraud to boost
artificially its reported financial results by such actions as deliberately delaying the
disconnecting of customers no longer paying their bills, improperly capitalizing labor
costs, and entering into sham transactions with two equipment vendors that improperly
inflated Charter’s reported operating revenues and cash flow. In addition to naming
Charter, Charter’s executives, and Charter’s independent auditor as defendants, plaintiff
investors also named the two equipment vendors, Scientific-Atlanta, Inc., and Motorola,
Inc. (called the “Vendors” in this case). Plaintiff investors alleged that the Vendors
entered into sham transactions with the knowledge that Charter intended to account for
them improperly and that analysts would rely on inflated revenues and operating cash
flow in making stock recommendations. However, plaintiff investors did not allege that
the Vendors prepared or disseminated the fraudulent financial statements and press
releases which Charter published to deceive analysts and investors.
Plaintiff investors alleged that the Vendors’ actions violated section 10(b) of the
Securities Exchange Act of 1934, the general antifraud statute, and Rule 10b-5,
implemented by the Securities and Exchange Commission (SEC) to carry out the
antifraud statute. Section 10(b) makes it unlawful, directly or indirectly, “[t]o use or
employ, in connection with the purchase or sale of any security ... any manipulative or
deceptive device or contrivance in contravention of such rules and regulations as the
[Securities and Exchange Commission] may prescribe.” Rule 10b-5 provides:
It shall be unlawful for any person, directly or indirectly ... (a) [t]o employ any device,
scheme, or artifice to defraud, (b) [t]o make any untrue statement of a material fact or
to omit to state a material fact necessary in order to make the statements made, in light
of the circumstances under which they were made, not misleading, or (c) [t]o engage
in any act, practice, or course of business which operates or would operate as a fraud
or deceit upon any person in connection with the purchase or sale of any security.
The Eighth Circuit held that plaintiff investors’ allegations did not state a section
10(b) securities fraud claim against the Vendors as primary violators. Much of the
reasoning of the court relied upon the Supreme Court’s decision in Central Bank of⁶
Denver v. First Interstate Bank of Denver. In Central Bank the Supreme Court held that
section 10(b) does not allow investors to bring civil suits against those who have aided
securities fraud. Instead, according to the Court, section 10(b) may be applied only to
those who “use or employ ... any manipulative or deceptive device or contrivance....”
As in earlier cases considering conduct prohibited by § 10(b), we again conclude
that the statute prohibits only the making of a material misstatement (or omission) or
the commission of a manipulative act.... The proscription does not include giving aid⁷
to a person who commits a manipulative or deceptive act.
Extending the 10b-5 cause of action to aiders and abettors no doubt makes
the civil remedy more far-reaching, but it does not follow that the objectives of
the statute are better served. Secondary liability for aiders and abettors exacts

⁶ 511 U.S. 164 (1994).
⁷ Id. at 177.

costs that may disserve the goals of fair dealing and efficiency in the securities
market s.⁸
The Eighth Circuit stated in its decision that, because the focus of plaintiffs’ section
10(b) and Rule 10b-5 claims was deception by Charter and that neither Motorola nor
Scientific-Atlanta was alleged to have engaged in any deceptive act of the type engaged
in by Charter, “the district court properly dismissed the claims against the Vendors as
nothing more than claims, barred by Central Bank, that the Vendors knowingly aided and
abetted the Charter defendants in deceiving the investor plaintiffs.”⁹
[W]e are aware of no case imposing § 10(b) or Rule 10b-5 liability on a business that
entered into an arm’s length non-securities transaction with an entity that then used
the transaction to publish false and misleading statements to its investors and analysts.
The point is significant. To impose liability for securities fraud on one party to an
arm’s length business transaction in goods or services other than securities because
that party knew or should have known that the other party would use the transaction
to mislead investors in its stock would introduce potentially far-reaching duties and
uncertainties for those engaged in day-to-day business dealings. Decisions of this¹⁰
magnitude should be made by Congress.
It should be noted that the Central Bank case stated that secondary actors are not
always free from liability under the securities acts.
The absence of § 10(b) aiding and abetting liability does not mean
that secondary actors in the securities markets are always free from
liability under the securities Acts. Any person or entity, including a
lawyer, accountant, or bank, who employs a manipulative device or
makes a material misstatement (or omission) on which a purchaser
or seller of securities relies may be liable as a primary violator under

10b-5 assuming all of the requirements for primary liability under¹¹

Rule 10b-5 are met.
The Supreme Court affirmed the Eighth Circuit decision. The Court stated that
Central Bank had rejected aiding and abetting liability because aiding and abetting
liability is not mentioned in section 10(b). Recognizing aiding and abetting liability,
according to the Court, would allow plaintiffs to avoid the 10(b) requirement that they
show reliance on the aider or abettor’s misstatements or deceptions. In Stoneridge,
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

⁸ Central Bank at 188.
⁹ Charter Communications at 992.
¹⁰ Id. at 992-993.
¹¹ Central Bank at 191.

result, cannot show reliance upon any of respondents’ actions except in an indirect¹²
chain that we find too remote for liability.
In response to plaintiffs’ argument that Charter’s released financial statement was
to be expected from the secondary parties’ deceptive acts and therefore was a kind of
“scheme liability” engaged in by the secondary parties, the Court stated that the plaintiffs
could not prove that they had relied on the deceptive acts of the secondary parties.
In effect petitioner contends 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 implied cause of
action would reach the whole marketplace in which the issuing company does¹³
business; and there is no authority for this rule.
Further, the Court stated that plaintiffs’ argument conflicted with section 104 of the¹⁴
Private Securities Litigation Reform Act, which was a response by Congress to Central
Bank. This statute provides that aiding and abetting liability is authorized in actions
brought by the SEC but not by private parties.
Were we to adopt this [plaintiffs’] construction of § 10(b), 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; and we would
undermine Congress’ determination that this class of defendants should be pursued¹⁵
by the SEC and not by private litigants.
On January 22, 2008, the Supreme Court declined without comment to hear an
appeal by Enron investors suing major banks which had allegedly aided Enron to disguise¹⁶
its financial problems. It is likely that the Court’s refusal to grant certiorari in this case
is based upon its holding in Stoneridge.

¹² Stoneridge, slip op. at 8.
¹³ Stoneridge, slip op. at 9.
¹⁴ 15 U.S.C. § 78t(e).
¹⁵ Stoneridge, slip op. At 11-12.
¹⁶ Regents of the University of California v. Merrill Lynch, No. 06-1341.