High Court curbs investor lawsuits

The court rules against investors who accused suppliers of conspiring to dupe stockholders and manipulate prices.

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From CNN Supreme Court Producer Bill Mears

WASHINGTON (CNN) -- The Supreme Court dealt a blow Tuesday to investors seeking to recover damages from alleged corporate fraud, a potentially huge liability case being closely watched by owners of stock, the business community and government regulators.

The 5-3 ruling curbs the ability of shareholders to recover damages from "secondary" parties - such as investment banks, vendors, and accountants - accused of hiding corporate wrongdoing.

The outcome of this appeal could have a swift impact on a separate lawsuit filed against onetime energy giant Enron. Company investors want $30 billion from accounting firms and banks accused of helping that company deceive shareholders over hidden debts.

The case before the justices centered on an investor lawsuit seeking shared liability against suppliers of one of the largest cable TV operators. Equipment vendors Scientific-Atlanta and Motorola (MOT, Fortune 500) were accused of engaging in efforts to help Charter Communications artificially inflate financial statements in order to bolster its stock's price. The deal involved an alleged "sham" transaction that generated some $17 million in phony revenues from the supposed sale of TV set-top boxes.

In the majority opinion, Justice Anthony Kennedy said Charter investors could not "rely" on any deceptive statements made by Charter's suppliers to link liability to them.

Scientific-Atlantic leaders "had no duty to disclose, and their deceptive acts were not communicated to the public," he said. Investors, "as a result, cannot show reliance upon any of the (company's) actions except in an indirect claim chain that we find too remote for liability."

Four conservatives sided with Kennedy, including Chief Justice John Roberts, and Justices Antonin Scalia, Clarence Thomas, and Samuel Alito.

Stoneridge Investment Partners' lawsuit claims securities fraud through collusion. The Supreme Court re-examined its 1994 ruling that private securities fraud lawsuits may not be based on claims of "aiding and abetting" deception. But the justices in that case also said secondary parties were not automatically off the hook from liability for securities violations.

The key for investors was to prove Charter and the secondary companies engaged in an illegal "scheme," involving "deceptive" conduct, under federal securities law. The two words were key under the legal language, and the majority opinion repeatedly sought to clarify that standard in their ruling. It cited congressional legislation aimed at setting proper legal boundaries in these kinds of limited class-action cases, and the continuing role of the Securities and Exchange Commission to investigate and punish corporate misdeeds.

The high court earlier last year issued rulings making it tougher to prove corporate fraud in general, which the business community applauded.

The Bush administration created controversy by siding with the defendant companies, rejecting the recommendation of the Securities and Exchange Commission, which voted to support the investors.

The Charter (CHTR, Fortune 500) case has yet to go to trial, and remains on hold until the constitutional questions were settled.

In dissent, Justice John Paul Stevens criticized his more conservative colleagues from their "continuing campaign to render the private cause of action toothless."

He added, "The court is simply wrong when it states that Congress did not impliedly authorize this private cause of action. ... Today's decision simply cuts back further on Congress' intended remedy."

Stevens was supported by Justices David Souter and Ruth Bader Ginsburg.

It is rare for class-action investor lawsuits to go to trial, as the vast majority are settled out of court or dismissed by federal judges. The Securities Class Action Clearinghouse at Stanford Law School said $42 billion has been recovered from corporations accused of fraud by investors in the new century.

Enron investors were eagerly awaiting the high court's decision on the current case. The Texas-based energy firm collapsed in late 2001 after revelations of fraudulent accounting practices, ushering in a wave of similar corporate financial scandals. Their appeal is pending before the justices.

Similar lawsuits involve such onetime corporate giants as WorldCom and Tyco.

Justice Stephen Breyer did not participate in the Stoneridge case, and offered no reason. But financial disclosure records for calendar year 2006 show he owned stock in Cisco Systems (CSCO, Fortune 500), parent of Scientific-Atlanta.

The case is Stoneridge Investment v. Scientific-Atlanta (06-43).

The separate Enron case pending before the high court is Regents of the University of California v. Merrill Lynch (MER, Fortune 500) (06-1341). To top of page

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.