High Court Rejects a Claim of Third-Party Fraud Liability

Article excerpt

In a case watched closely by corporate lenders, the Supreme Court ruled 5 to 3 Tuesday that fraud claims cannot be extended to third parties if investors did not rely on their statements or actions.

Lenders had worried that the case, Stoneridge Investment Partners v. Scientific Atlanta Inc., could spark similar suits against banks that did business with troubled companies like Enron Corp. and WorldCom Inc.

"The case could have had a lot of implications for exposing third-party advisers, including bankers, to potential liability," said Gil Schwartz, a partner at Schwartz & Ballen LLP. "It's refreshing to see the court recognize the business reality that advisers aren't responsible for some of the misdeeds of the company."

In the majority decision, Associate Justice Anthony M. Kennedy ruled that implied right of action does not reach the third parties if investors did not rely on their statements or representations.

"Respondents' acts or statements were not relied upon by the investors and that, as a result, liability cannot be imposed upon respondents," Justice Kennedy wrote. "Reliance by the plaintiff upon the defendant's deceptive acts is an essential element of the private cause of action."

The case arose from an accounting scandal at Charter Communications Inc. Stoneridge accused Scientific Atlanta, now a unit of Cisco Systems Inc., and Motorola Inc. of participating in a scheme to inflate prices for cable boxes on the condition that the suppliers use the additional funds to purchase advertising from Charter.

The case asked whether Scientific Atlanta should be held responsible, but during oral arguments in October the justices sounded reluctant to extending such liability.

The U.S. District Court for the Eastern District of Missouri had dismissed Stoneridge's lawsuit, citing the 1994 case Central Bank NA v. First Interstate Bank. In that case, the court refused to allow suits by private investors against defendants accused of aiding and abetting another company's securities fraud.

Congress followed in 1995 with a securities litigation reform law that gave the Securities and Exchange Commission more power to go after third parties. The oral arguments in the Stoneridge case focused on whether Congress intended that authority to extend to private shareholder litigation. In Tuesday's decision, Justice Kennedy ruled that Congress did not.

Tom Dewey, a partner at Dewey Pegno & Kramarsky LLP in New York, said the Supreme Court's decision is unlikely to spur tougher laws. …