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scheme liability January 16, 2008

Posted by Bradley in : Uncategorized , trackback

Yesterday’s long-awaited decision of the Supreme Court in Stoneridge Investment Partners v Scientific-Atlanta Inc (the scheme liability case) has provoked many thoughtful comments (see 10b-5 daily, truth on the market, scotusblog, and ideoblog). The plaintiffs claimed that the defendants colluded in sham transactions to enable the issuer to make its financial statements more attractive to investors than they should have been. The court says that conduct (and not just statements and omissions) can give rise to liability under s 10(b) and rule10b-5 (“[c]onduct itself can be deceptive, as respondents concede”), but finds that the plaintiffs must establish more than indirect reliance, despite a pretty broad endorsement of the fraud on the market theory:

We have found a rebuttable presumption of reliance in two different circumstances. First, if there is an omission of a material fact by one with a duty to disclose, the investor to whom the duty was owed need not provide specific proof of reliance…Second, under the fraud-on-the-market doctrine, reliance is presumed when the statements at issue become public. The public information is reflected in the market price of the security. Then it can be assumed that an investor who buys or sells stock at the market price relies upon the statement.”

The court goes on to state that under the plaintiffs’ theory of reliance:

the implied cause of action would reach the whole market-place in which the issuing company does business.

This cannot be:

we conclude respondents’ deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance. It was Charter, not respondents, that misled its auditor and filed fraudulent financial statements; nothing respondents did made it necessary or inevitable for Charter to record the transactions as it did.

On this subject, I love footnote 4 to the dissent:

Because the kind of sham transactions alleged in this complaint are unquestionably isolated departures from the ordinary course of business in the American marketplace, it is hyperbolic for the Court to conclude that petitioner’s concept of reliance would authorize actions against the entire marketplace in which the issuing company operates.

Reliance is really slippery (and especially so after Basic, given that it slithers about between a subjective and an objective concept) and seems to me to defy the sort of line-drawing the court wants to engage in here. For example the court wants to distinguish between the “marketplace for goods and services” and the “investment sphere” as though they are completely separate. I don’t really understand how the court puts together the idea that conduct alone can be enough for liability with the other idea that the deceptive acts have to be “disclosed” to the investing public for the fraud on the market presumption to apply. And does it really make sense to have a rule that reliance is presumed in respect of statements which are actually made to the market but not in respect of conduct on which those statements are based (and without which the statements would not have been made)? But, of course, requiring plaintiffs to plead and prove reliance does make it harder for them to win.

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