The Stoneridge opinion

The Court affirmed the denial of securities law liability of customers and suppliers in Stoneridge. Many other bloggers have discussed the opinion. See Bainbridge, Nowicki, Brown, Scotusblog, 6th Circuit blog.

I’m very sympathetic with the result. The amicus brief I signed onto argued against a 10b-5 private right of action “against a non-trading, non-speaking entity that merely ‘enables’ the commission of an alleged fraud by a public company on its shareholders.”

My problem is that, instead of focusing on the type of conduct that should get a defendant into trouble under the securities laws, the Court focused on reliance. This is a weak theory once you accept, as the Court does, that 10b-5 liability can be based on conduct rather than misstatements.  Given the fraud-on-the-market presumption of reliance, it's far from clear why reliance was missing here, as the dissent pointed out. 

But the Court at least did have the right idea about where it was going. It says:

The determination of who can seek a remedy has significant consequences for the reach of federal power. . . . Concerns with the judicial creation of a private cause of action caution against its expansion. The decision to extend the cause of action is for Congress, not for us. Though it remains the law, the §10(b) private right should not be extended beyond its present boundaries.

Compare that with the advice I gave the Court on how to decide this case:

[T]here's a simpler argument against the Court's buying the scheme theory: any extension of liability . . . . is a job for Congress. Only Congress can weigh the policy arguments, informed by witnesses representing all of the various interest groups. Only Congress is in a position to be alerted to potential costs and risks of extending scheme liability, examining additional liability in the light of existing checks on securities fraud, and determining whether the costs of this liability outweigh the benefits. * * *

[L]iability in Stoneridge would give the go-ahead to trial lawyers to continue to push the envelope in ways that create additional costs and risks, with uncertain benefits. The basic problem in Stoneridge, then, is that liability in this situation would be legislation by litigation – indeed, a judicial expansion of the judicial legislation involved in the creation of the 10(b) cause of action. Whatever we think about the underlying policies, this is an issue that should be decided by Congress, not by the Court.

Moreover, as I’ve repeated argued in many forms and venues (e.g., my article on Dabit), the specific problem here is the encroachment on state remedies. As the Court said:

Were the implied cause of action to be extended to the practices described here, however, there would be a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees. Our precedents counsel against this extension.

Unfortunately, the Court seems to have gotten its conclusion from politics rather than jurisprudence. The majority says:

Overseas firms with no other exposure to our securities laws could be deterred from doing business here. . . . This, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings awayfrom domestic capital markets.

I agree with Elizabeth Nowicki when she says "I will bet you $12 that that line becomes one of the most-quoted Stoneridge lines within the next two years."

While I’m sympathetic with these concerns, and indeed have written extensively about them, I question their role in this opinion. It's not the Court's business to decide the appropriate level of liability under the securities laws, and whether this does or doesn't deter foreign issuers from listing here -- a matter on which there is considerable empirical and theoretical disagreement. Instead, the Court should be delineating the fact situations that would unduly extend whatever level of liability Congress has defined, and leave any such extensions to Congress.

More specifically, the Court should consider, more carefully than it has done in its opinion, precisely what conduct gives rise to a 10b-5 cause of action, and how that conduct must be connected to the deception of investors. The Court unfortunately has given little guidance on that critical issue. All it says is “nothing respondents did made it necessary or inevitable for Charter to record the transactions as it did.” It’s not clear how this “necessary or inevitable” standard will be applied in subsequent cases.

While I disagree with the Court's reasoning, I'm not sure the reasoning has done much harm.  Legal niceties aside, the Court has managed to send the issue of secondary liability to Congress, which is where it belongs.

Comments

[Anders West]

I think the concern about applying the Court's reliance test is overstated. The majority opinion sets out a reasonably clear, bright-line test. Investors could not have relied on the respondents' phony contracts because they did not know about them. And the presumption of reliance potentially available in the case of an omission did not apply because there was no breach of a cognizable duty to disclose. The Court also declined to extend the fraud on the market presumption of reliance concept to individual transactions that are consolidated into another party's financial statements. One reason not to do so is that the other party controls how the individual transaction is characterized on its own books and records. That language, noting that "nothing respondents did made it necessary or inevitable for Charter to record the transactions as it did" merely explains why it would be inappropriate to extend a presumption of reliance beyond the statements that actually (or arguably) were incorporated into the market price on which investors are presumed to rely.
Thus, the language you cite is an explanation, not a test. The line should be fairly clear between one party's financial statements and its transactions with others that are reflected in those statements.