The future of scheme liability

Many participants in the securities markets, including lawyers, auditors and investment bankers, are breathing easier after the Supreme Court's opinion in Stoneridge. And, indeed, they should be, since they don’t face the potentially open-ended liability that the plaintiffs’ “scheme liability” theory in that case might have imposed.

But they aren’t completely out of the woods. The Court didn’t totally bar liability based on deceptive acts – the basis of scheme liability. Indeed, as I’ve written, it’s not an easy theory to completely kill. Part of my problem (here and here) with the Court's opinion is that its reliance theory didn’t provide a clear enough roadmap for future cases.

Consider for example a lawyer or investment banker who assists in structuring special purpose entities that allegedly help deceive investors as to the true worth of the company -- part of the plaintiffs' theory in Enron. Are they off the hook after Stoneridge? Here’s the relevant language from the opinion:

Respondents had no duty to disclose; and their deceptive acts were not communicated to the public. No member of the investing public had knowledge, either actual or presumed, of respondents’ deceptive acts during the relevant times.* * *

[W]e conclude respondents’ deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance. It was Charter, not respondents, that misled its auditor and filed fraudulent financial statements; nothing respondents did made it necessary or inevitable for Charter to record the transactions as it did. * * *

Here respondents were acting in concert with Charter in the ordinary course as suppliers and, as matters then evolved in the not so ordinary course, as customers. Unconventional as the arrangement was, it took place in the marketplace for goods and services, not in the investment sphere. Charter was free to do as it chose in preparing its books, conferring with its auditor, and preparing and then issuing its financial statements. In these circumstances the investors cannot be said to have relied upon any of respondents’ deceptive acts in the decision to purchase or sell securities; and as the requisite reliance cannot be shown, respondents have no liability to petitioner under the implied right of action. This conclusion is consistent with the narrow dimensions we must give to a right of action Congress did not authorize when it first enacted the statute and did not expand when it revisited the law.

Those acting as advisers in securities transactions might find themselves treated differently from supplier/customers. They would arguably not be in “the marketplace for goods and services,” but “in the investment sphere.” The question, then, is when there would be the “requisite reliance”?

Maybe that would depend on whether “a member of the investing public had knowledge, either actual or presumed, of respondents’ deceptive acts during the relevant times.” The fraud on the market theory, of course, supplies “presumed” knowledge. If the lawyer’s or investment banker’s participation were communicated to that market by sophisticated intermediaries – e.g., the market relies on their participation as a seal of approval – then they could be in trouble.

I'm not arguing for such liability. What I’m saying is that the Court should have drawn a clearer line to prevent it than reliance can provide – a line based on the sort of conduct securities liability should reach. Although the Court explicitly declined to rule on the “in connection with” requirement, that's one possible place to draw the line.

Another possible move would have to be for Congress or the SEC. As Stoneridge illustrates, the problem with the implied right of action is that it cannot easily be confined.  But the implied right can be disimplied.