Will 2007 be the year known as the year the corporate fraudsters were given a "walk" by the Supreme Court? Right now the fraudsters have been pitched four ball, and it certainly looks like a walk for the fraudsters:
- Ball One: In Bell Atlantic Corp. v. Twombly,127 S. Ct. 1955 (May 21, 2007), the Supreme Court tossed the long standing pleading standard in corporate conspiracy cases, requiring injured parties to plead enough facts " to raise a reasonable expectation that discovery will reveal evidence of illegal agreement,” noting that "discovery can be expensive;"
- Ball Two: In Credit Suisse Securities v. Billing, 127 S. Ct. 2383 (June 18, 2007), the Court tossed a private antitrust suit alleging anticompetitive activities by underwriters in the issuance of initial public offerings, stating in the most conclusory and broadly speculative terms, that "the threat of antitrust lawsuits, through error and disincentive, could seriously alter underwriter conduct in undesirable ways" and was, in essence, preempted by the securities laws;
- Ball Three: In Tellabs, Inc. v. Makor Issues & Rights, Ltd , 127 S. Ct. 2499, 2007 WL 1773208 (June 21, 2007), tossed the notion that at the pleading stage, before any discovery had begun, that the injured securities purchaser was entitled to all inferences being drawn in the plaintiffs favor. Instead, “to curb perceived abuses of the § 10(b) private action—‘nuisance filings, targeting of deep-pocket defendants, vexatious discovery requests and manipulation by class action lawyers’” a "complaint will survive...only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged;” and
- BALL FOUR....WALK: The U.S. Supreme Court decision today in Stoneridge Investment Partners v. Scientific-Atlanta, where, by a vote of 5-3, the Court tossed wide of home plate, any notion that "scheme liability" exists in the context of private causes of actions under the securities laws because investors cannot be said to rely on fraudulent schemes they do not know exist. This leaves sole enforcement and recovery in the hands of that same under-funded, under-manned, out-gunned, SEC that now has to handle all those antitrust issues( See Ball Three ), at least until a new Congress and a new President, untethered to Corporate Lobbyists, come to the rescue, and rectify this unintelligible and illogical mess. Of course I would not be so critical if this were anything other than a policy decision devoid of fact.
In throwing ball four, and hence a walk to corporate conspirators committing deceptive acts, the Court reasoned that even though the act may be deceptive, and intentionally so, the Court will not allow a presumption that investors rely upon a third party's actions or statements. Justice Kennedy wrote:
Though §10(b) is “not ‘limited to preserving the integrity of the securities markets,’” Bankers Life, 404 U. S., at 12, it does not reach all commercial transactions that are fraudulent and affect the price of a security in some attenuated way.
To do so might sweep all conspiring suppliers and customers out of the game of accountability for the huge damage they contribute too. The Court, in outright protectionism of Corporate Fraud, rejected the irrefutable fact and logic 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 the Court to adopt petitioner’s concept of reliance—i.e., 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—the implied cause of action would reach the whole marketplace in which the issuing company does business.
Whew!!!! I didn't know that deception was such a part of our society that we needed to protect fraud conspirators from their own wrongdoing. Rather, the Court decided, as a matter of unsupported fact and law that these conspiring vendors:
had no duty to disclose; and their deceptive acts were not communicated to the public. [please ignore the inflated revenues] No member of the investing public had knowledge, either actual or presumed, of [the two companies’] deceptive acts during the relevant times. [as long as the deceptive act is hidden the fraudsters can't be held liable] [Stoneridge], as a result, cannot show reliance upon any of [the companies’] actions except in an indirect chain that we find too remote for liability. [and what is the factual basis of this finding?]
So, even though the vendors knew their deceptive billings would inflate Stoneridge's revenues, and that there was no other purpose for the deception, since the public only relied on the false aggregate revenue numbers and not the vendors bills themselves, the Court finds as a matter of law and fact that there can be no reliance???? What happened to the requirement of evidentiary proof and the jury system?
Ohhh, yes, I remember now what the Court said about that. If we hold corporate conspirators liable:
[o]verseas firms with no other exposure to our securities laws could be deterred from doing business here.
No, we would not want that. We need foreign corporate conspirators to keep our economy running!!!!
Even more confusing is the Court's implication that state law remedies are sufficient:
“Were the implied cause of action to be extended to the practices described here, however, there would be a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees.”
What state law guarantees is the Court talking about? Has the Supreme Court forgotten about the Securities Litigation Uniform Standards Act of 1998 that preempts class actions that allege fraud under state law "in connection with the purchase or sale" of securities?
Today's ruling will be followed soon by the Ernon case against the investment banking firms who helped Enron create the fraudulent financial vehicles that dupped investors to buy Enron stock— California Regents v. Merrill Lynch, et al. (06-1341) ("Enron").
Can the Court find a difference where the wrongdoer is not a supplier or a customer? Can it be said that investors do not rely on fraudulent transactions with customers but do rely on fraudulent transactions with those more closely engaged in keeping the issuer involved in the securities market, such as lawyers, auditors, bankers and underwriters?
Letting a customer off the hook, when the customer actually bought the goods is one thing, but letting off the lawyers, auditors, bankers and underwriters off the hook when they actually got paid to help commit the fraud, is another. No one will riot over the first. The second will rally a lot of troops as we sit in the middle of this subprime mortgage meltdown.
There is a hint that the Court is not dull and could pick off one or two of these corporate conspirators who take too big of a lead-off.
First, the Court notes, in talking about these supplier/customer defendants, that their actions were "beyond the securities markets—the realm of financing business – to purchase and supply contracts – the realm of ordinary business." Clearly a distinction would be drawn against the investment bankers in Enron.
Second, the Court states that:
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.
***
Here respondents were acting in concert with Charter in the ordinary course as suppliers and, as matters then evolved in the not so ordinary course, as customers. Unconventional as the arrangement was, it took place in the marketplace for goods and services, not in the investment sphere. Charter was free to do as it chose in preparing its books, conferring with its auditor, and preparing and then issuing its financial statements. In these circumstances the investors cannot be said to have relied upon any of respondents’ deceptive acts in the decision to purchase or sell securities; and as the requisite reliance cannot be shown, respondents have no liability to petitioner under the implied right of action.
It may be arguable, in Enron, that the investment bankers misled or acted with the auditors, or did take action that that "made it necessary or inevitable for [Enron] to record the transactions the way it did." Or the Court may see what they did in Enron as being in the "investment sphere," which it was.
Finally, in another good omen for investors, the Supreme Court rejected, out right, the oft repeated contention that one must make a deceptive statement to be liable under §10(b):
The Court of Appeals concluded petitioner had not alleged that respondents engaged in a deceptive act within the reach of the §10(b) private right of action, noting that only misstatements, omissions by one who has a duty to disclose, and manipulative trading practices (where “manipulative” is a term of art, see, e.g., Santa Fe Industries, Inc. v. Green, 430 U. S. 462, 476– 477 (1977)) are deceptive within the meaning of the rule.443 F. 3d, at 992. If this conclusion were read to suggest there must be a specific oral or written statement before there could be liability under §10(b) or Rule 10b–5, it would be erroneous. Conduct itself can be deceptive, as respondents concede. In this case, moreover, respondents’ course of conduct included both oral and written statements, such as the backdated contracts agreed to by Charter and respondents.
So the game is not over. Traditional suppliers and customers of goods are safe on base and off. The bankers, the lawyers, the accountants, and the underwriters better keep tight on base....at least until the next pitch....
For more see Jay Brown's weblog.
Supreme Court Oral Argument Transcript
