Stoneridge: A Victory For Investors

Posted by John Carney, Jan 15, 2008, 3:17pm

The Supreme Court’s decision in the case known as Stoneridge is probably one of important securities law rulings in years. The ruling today declared that fraud claims brought under federal securities laws are not allowed against third parties—investment bankers, vendors, accountants, lawyers—that did not mislead investors but did business with companies that did. Already self-styled shareholder advocates are crying foul, declaring that the decision is a major blow to shareholder rights.

We’ll leave the technical legal questions aside for now. (But watch for a round-up of reactions later today.) For now let us simply say that as a policy matter, the scheme liability claim that trial lawyers urged the courts to adopt promised to be a disaster for shareholders. Although securities fraud from misleading company statements can be highly damaging to individuals with concentrated holdings in fraudulent companies, these individuals are rare. The broader investing public is far more diversified, and this type of fraud rarely damages diversified investors. Over time, a diversified investors gains and losses from misstatements tend to balance each other.

Think about it this way. A diversified investor has an even chance of being a buyer or a seller of shares in a company whose price is inflated due to fraud. In some transactions, the investor will buy stock at fraud-inflated prices. In others, he will sell stock at fraud-inflated prices. Over time, these gains and losses tend to cancel each other out.

While an overall reduction of fraud would benefit investors, it’s unlikely that scheme liability for third-parties would have this effect. But the cost of avoiding or insuring against scheme liability could be enormous. In short, the scheme liability theory rejected by the court today would have been a huge dead-weight cost on business profits—and therefore on returns to investors. Far from ruling against shareholder interests, the Supreme Court today handed investors an enormous victory against special interests and trial lawyers.

Earlier on DealBreaker: Stoneridge discussed.

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Posted in: Legal, Stoneridge

Comments

Posted by , Jan 15, 2008 4:53PM

Yeah, and thanks to this case you can't sue the Scientologists for making him this way.

Posted by Bill Lerach, Jan 15, 2008 5:51PM

This ruling sucks

Posted by , Jan 15, 2008 6:43PM

Averaging out only works that way if 1. there is no net insider selling during the frauds, and 2. after the fraud is eventually revealed, the company is no worse off than it would have been if there had never been any fraud.

Posted by Anonymous, Jan 15, 2008 8:11PM

This argument assumes that you are either a 1.) large diversified institutional investor OR 2.) a buy and hold mutual fund investor. It doesn't take into account smaller active investors or employees of said companies who are incentivized to invest in their employers.

Posted by Erik E, Jan 15, 2008 8:24PM

I'm wondering if this argument proves too much: why have any insider trading laws? If you're a diversified investor, chances "a diversified investor[']s gains and losses from misstatements tend to balance each other." What am I missing?

Posted by NotNasser, Jan 15, 2008 10:35PM

Average Schmaverage. Let's start from the hypothesis that the old common-law definition of fraud is more-or-less right.

I'm quoting from Black's law dict. Fraud is "an intentional perversion of truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him or to surrender a legal right."

If fraud in this sense isn't civilly liable in the securities law context, because of the particularity of the language of 10(b), then statutory law has overridden the intuitions of the common law in an distressing manner, and Congress should remedy the matter, applying civil liability for common law fraud as so understood, in the securities context, explicitly.

If fraud in the above sense IS something for which people can be held liable in federal courts in the securities contexts, then the underlying CENTRAL BANK decision is misguided, as is this decision for relying thereon.

Posted by Hugh, Jan 16, 2008 9:28AM

Carney, your first argument is a bit weak and leans too much on economic theory. Averages are good and well, but fraud is fraud (credits to above poster for the definition).
However, your second point is spot on. Expanded scheme liability, beyond the current restrictions (which actually do sweep up about 90+% of those perpetrating fraud), will hurt no one but the investing public and the American economy.

Posted by , Jan 16, 2008 11:04AM

"While an overall reduction of fraud would benefit investors, it’s unlikely that scheme liability for third-parties would have this effect."

So you don't believe in supply and demand? The result basically means you can't be punished for benefiting from fraud if you aren;t the main architect. This is equivalent to saying someone can’t be prosecuted for knowingly buying stolen jewelry from a fence. This will increase demand for stolen jewelry, no?

Posted by , Jan 20, 2008 7:49AM

What a fucklng moronic explanation for why this is a good decision. Investors in total own stock. Fraud that costs equity holders money is a type of stealing from them. There should always be legal recoursee against fraud.

Now there are good reasons why you might not want
shareholders to sue third parties directly. You can argue that the shareholder should sue the company.
Then if the company perpetrated the fraud because of bad or fraudulent advice, it can sue its advisers.

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