Tuesday, October 09, 2007

Kent Greenfield: Supreme Court Preview- One of the Most Important Cases You Haven't Yet Heard About

Supreme Court Preview- One of the Most Important Cases You Haven't Yet Heard About: The Stoneridge Case and "Scheme" Liability Under Federal Security Laws
by Kent Greenfield, Professor of Law at Boston College and Distinguished Faculty Fellow at the Center on Corporations, Law & Society, Seattle University School of Law
American Constitution Society

The Supreme Court will hear arguments today (Tuesday, October 9) in what some are calling the most important business case to come before the Court in a decade -- Stoneridge Investment Partners v. Scientific-Atlanta Inc. The facts pertain to the financial shenanigans of a cable television company, but the Court’s decision could have wide ranging implications for law firms, accounting firms, and banks, among others, and – depending on which side you listen to – could either damage the nation’s international financial competitiveness or leave millions of investors underprotected from fraudulent schemes.

The case arose from an alleged fraudulent scheme initiated by Charter Communications, one of the nation’s largest cable companies. In the summer of 2000, it became clear to Charter executives that it would not meet Wall Street’s expectations for annual cash flow and revenue. (Of course, the fact that companies have to focus increasingly on the short-term to the detriment of the long-term health of the company, much less society, is the root of many evils.) Charter asked two of its suppliers, Scientific-Atlanta and Motorola, to help out by inflating the prices it charged Charter for set-top boxes. The suppliers also had to produce private documents lying about the reason and the timing of the increase.

The suppliers agreed to pay back to Charter the same amount of money – $17 million in total – for advertising, which was really free. This “wash transaction” was done to mislead Charter’s external auditor and thus the market. The amounts paid for the set-top boxes were accounted for as capital expenses, appearing on the books over several years. The advertising “revenue” was reported in a lump sum, which made it appear to the auditor and investors that Charter had met its financial targets, which bolstered the stock price. When the fraud came to light two years later, Charter stock plummeted from $26 to 78 cents, costing shareholders millions.

The plaintiff class is a group of Charter shareholders who sued Charter and its suppliers for a violation of Rule 10b-5 of the federal securities laws, which makes it illegal to engage in a “scheme” to defraud. Charter settled. But the district court threw out the case against the suppliers, and the Eighth Circuit affirmed, saying that the suppliers themselves had not made any misstatements to the market and that the Supreme Court had said a decade ago, in Central Bank of Denver v. First Interstate Bank of Denver, that 10b-5 does not reach those who only “aid or abet” a violation.

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