The Future of Securities Litigation

Abstract

In this article, I analyze the implications of the Supreme Court's 2008 decision in Stoneridge Investment Partners v. Scientific-Atlanta. The case arose as a result of a scheme to increase reported advertising earnings of a struggling cable television company involving two suppliers who agreed to sell set-top boxes to the cable company at inflated prices and then to use the excess to buy advertising from the cable company. While it seems clear that the cable company was guilty of securities fraud under SEC Rule 10b-5, the issue in Stoneridge was whether the suppliers could be held liable for damages in a private action as participants in the fraud. The Court ruled that because the plaintiffs did not rely on any statement made by the suppliers, the case should be dismissed. Although the circuit courts were split on the question, it would have been easy for the Supreme Court to rule that the allegations amounted to a claim of aiding and abetting and were prohibited by precedent as codified by Congress. The question is why did the Court go out of its way to base its holding on lack of reliance? The ruling is all the more curious because it also required the Court to explain that conduct may nonetheless be deceiving. As I argue in this piece, in light of other recent decisions, the answer appears to be that the Court is particularly interested in causation as it relates to securities fraud. This suggests that the Court may be receptive to arguments that securities fraud under Rule 10b-5 is a zero-sum game and that for diversified investors - the vast majority of investors - the costs of securities litigation are a deadweight loss that reduces portfolio returns because the company pays. Thus, diversified investors would prefer a rule that prohibits securities fraud class actions except in cases in which officers or agents of the corporation have appropriated or reduced stockholder wealth. And in such cases they would prefer that the action be prosecuted as a derivative action - or an action by the corporation - to recover from the wrongdoers for the benefit of the corporation. In short, because securities fraud causes no net harm to most investors, Stoneridge may signal that the Supreme Court is inclined to reconsider whether there exists a private cause of action under Rule 10b-5 by disgruntled investors against non-trading issuers.

Keywords: Stoneridge, reliance, causation, scheme, participant, private cause of action, aiding and abetting, securities litigation, enforcement, stock-drop action, diversification, circularity, feedback, cost of capital, zero-sum game, deadweight loss, market failure, class action, direct action, derivative

JEL Classification: G10, G20, G30, K22, K41