Stoneridge: A Victory For Investors

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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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