Will Alito kill secondary liability?

Ted Frank writes in today’s WSJ (discussed here) urging the SEC to reject the pleas of the trial bar and their friends in Congress that it file an amicus brief supporting the plaintiffs’ position in a pending case, Stoneridge v. Scientific-Atlanta.  A plaintiff win in that case could seriously erode the Central Bank rule against secondary liability in securities cases. The Court is also considering whether to expand that appeal by reviewing a case dismissing a complaint against an investment bank that helped Enron raise money.

At issue is whether, by doing business with a firm that turns out to be violating the securities laws, you can be liable as a participant in a “scheme” to defraud. A ruling for the plaintiffs would greatly expand the legions of watchdogs who already have been enlisted to the hopeless cause of making securities markets riskless and fraud-free.

As I asked last month:

Should Congress, or the courts, impose what is essentially a federal fiduciary duty on top of extensive state law in this area? If so, how far should the liability extend? What kinds of incentives will banks have if they are forced to join the legions of “gatekeepers” and no longer permitted to be just lenders or financiers? Who will be the winners – the shareholders . . . . J.

J. Robert Brown, writing on the Harvard blog, has an interesting assessment of the litigation’s prospects. Although I disagree with Brown on the merits of the case, I think he correctly concludes that Alito will be the key to the result.

I suspect that Alito will vote against the plaintiffs’ position in the scheme liability cases. I reviewed Alito’s circuit court opinions in a Forbes article when he was nominated. Here’s some excerpts:

Alito is clearly concerned about rules like the purchaser-seller rule that are intended to constrain litigation costs. For example, in his 1997 opinion in the Burlington Coat Factory securities litigation, Judge Alito required plaintiffs to allege specific facts indicating that defendants acted with knowledge of fraud to avoid "subject[ing] public companies to unneeded litigation expenditures.”

In Hakimoglu v. Trump Taj Mahal Associates (1995), Alito refused to hold casinos liable for gambling losses suffered by a patron who drank too much of the casino's free booze, citing "the difficult problems of proof and causation that would result from the recognition of claims such as those involved here.". . .

[F]or Alito, what matters most is what the statutes actually say and how precedent has interpreted them.

I find it hard to believe that Alito would vote to (1) undercut the Central Bank precedent; particularly where (2) that would have the effect of opening a large and ambiguous trap door in securities law liability. And I would add that this case is a reminder of the point I made back at the time of the Alito nomination -- that it really matters to business who we put on the Court.

Of course, what the SEC says may have some influence on the Court. But the politics of Congress’s pressure on the SEC have been so blatant that I wonder if this might diminish the weight of any support the SEC expresses for the plaintiff’s position.

As a purely legal matter, I must add that the issue is not a no-brainer. The basic problem is that the implied right of action is almost completely open-ended, and facts can be manipulated endlessly in a complaint. Lerach’s Enron complaint was 500 pages long. In my article with Kobayashi, Class Action Lawyers as Lawmakers, we compared such complaints to Theodore Dreiser’s reconstruction of a crime in his novel, An American Tragedy.

All the more reason why we need clear rules here. My theory is that the Court took cert on the Stoneridge case to provide that clarity, and that it will add the Enron case to the appeal to increase that clarity. By doing this the Court can make sure that secondary civil liability under 10b-5 is really dead, and stays dead, rather than wandering in scheme liability form like some terrifying zombie.

Comments

[Fred]

I'm not sure I understand your point about adding on top of state law. I thought Congress barred the state court door to class plaintiffs with SLUSA?

[Larry Ribstein]

Not fiduciary actions based on corporate law.