What Scheme Liability Really Would Have Deterred

It bothers the legal scholars to see the court make decisions based on policy rather than legal doctrine but we couldn’t help but smile when we read Justice Anthony Kennedy noticing that the “scheme liability” scam urged on the court by trial lawyers would likely deter companies from offering securities on U.S. exchanges.
“Overseas firms with no other exposure to our securities laws could be deterred from doing business here,” Kennedy wrote in the majority opinion for Stoneridge. “This, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets.”
Maybe it’s not properly the court’s job to worry about that but it’s nice to know that someone is.

  • 15 Jan 2008 at 3:17 PM
  • legal

Stoneridge: A Victory For Investors

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.

  • 15 Jan 2008 at 10:47 AM
  • legal

Stoneridge: Court Slaps Down Scheme Liability

Breaking: The Supreme Court ruled against scheme liability in the closely watched Stoneridge case. The result is a blow to self-styled shareholder advocates and their friends in the plaintiff’s bar but ultimately a win for actual shareholders who faced losses from a potential litigations explosion under the scheme liability theory. Here and hear (heh) are two early reports from DealBreaker on the case.
What’s “scheme liability?” It was the idea that third parties could be held liable for securities fraud committed by companies with whom they do business. This would have made investment bankers, accountants law firms and suppliers liable for fraud committed by their public company clients. Today’s decision greatly curbs this risk.
We’ll probably have more to say on this once we’ve properly digested the opinions.
Update: The Associated Press tags the story with a stupidly misleading headline: “Court Rules Against Investors.” Hey, AP, pay attention: not all investors were on the side of the plaintiff’s bar in this case that threatened to let shareholders of companies that misstate earnings and commit fraud raid the treasuries of other companies that did business with them.
Shareholder Suits Against Vendors, Banks Limited by High Court [Bloomberg]

  • 10 Oct 2007 at 3:54 PM
  • legal

More On Stoneridge, Scheme Liability And Shareholder Suits

We’ve allowed our concern over the possible fate of shareholder proxy access rules to take a back seat over the last couple of days to our following the Stoneridge case. You know, the one about whether shareholders of one company can bring a securities law fraud case against another company on the theory of”scheme liability.” Today is no different.
So just in case your obsessions track ours, we’ll speed things up for you with a host of links to some of the relevant commentary.
• Jonathan Alder on the Volokh conspiracy explains why everyone is paying attention to this little case about cable set-top boxes. “A decision for the petitioners (the plaintiff shareholders) could ease the way for lawsuits against bankers, accountants, and perhaps even lawyers who provide services to firms that misstate their earnings or otherwise defraud their investors,” he writes.
• “As the Court concluded an hourlong hearing in a vitally important securities case, there seemed hardly a chance — even a remote one — that federal law against stock fraud would be read to give investors a significant new tool to go after stock fraud themselves,” the Scotus blog writes.
• Law Professor Stephen Bainbridge has no fewer than four posts on Stoneridge up and seems to be generating new ones every time we look. Just go to his main business associations page and start reading.
• Larry Ribstein thinks this might not be a total victory for the defendants and those worried about corporate liability to a new type of shareholder suit. He’s betting the Supreme Court will “deny liability in this case but throw some bone to the plaintiffs to resurrect some form of aiding and abetting liability in some future case with incredibly strong allegations.”
• If you’re still with us at this point, then you’ll probably want to read the pdf transcript of the oral arguments. Because you’re a shareholder rights or corporate governance nerd. (Smile when you call yourself that.)