Supreme Court Limits Lawsuits by Shareholders

Source: New York Times
By LINDA GREENHOUSE
Published: January 16, 2008
WASHINGTON — Ruling in its most important securities fraud case in years, the Supreme Court on Tuesday placed a towering obstacle in the path of shareholders looking for someone to sue when a stock purchase turns sour.
The decision in the case, Stoneridge Investment Partners v. Scientific-Atlanta Inc., was a major and ardently sought victory for investment banks, accountants and vendors — the deep pockets that have become nearly automatic targets of class-action lawsuits that accuse them of having engaged in a fraudulent scheme with the company that actually issued the stock. The notion of “scheme liability,” as the theory behind such lawsuits is known, now appears to be dead.
The 5-to-3 decision held that in order to proceed with such a lawsuit, plaintiffs must be able to show that they had relied, in making their decision to acquire or hold stock, on the deceptive behind-the-scenes behavior of these financial institutions, often called secondary actors. But behavior that was never communicated to the marketplace cannot be said to have induced reliance, Justice Anthony M. Kennedy wrote for the majority.
Without such a limitation on the concept of reliance, potential liability “would reach the whole marketplace in which the issuing company does business,” Justice Kennedy said. He added that Section 10(b) of the Securities Exchange Act, the legal foundation for securities fraud cases, “does not reach all commercial transactions that are fraudulent and affect the price of a security in some attenuated way.”
“Section 10(b) does not incorporate common-law fraud into federal law,” he said....
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