Within hours after the Supreme Court's decision in Stoneridge, news reports and law firm advisories were buzzing that the Court had sounded the death knell for "scheme liability" claims against "secondary actors" under the securities laws. In fact, though, and with apologies to Mark Twain, reports of the death of scheme liability have been greatly exaggerated.
Two important holdings in the case strengthen the position of investors. First, the Court held that the law's prohibition of "deceptive conduct" was not limited to misstatements or omissions; all deceptive conduct is prohibited. The Supreme Court took the case to decide whether an injured investor may recover from a "party that neither makes a public misstatement nor violates a duty to disclose but does participate in a scheme to violate §10(b)." In holding that investors can recover in such cases, the Supreme Court delivered a win for investors.
But how big a win? What the Court found lacking in Stoneridge was reliance by investors on the conduct of the defendants. Their deceptive conduct -- the allegedly phony advertising contracts, the backdating of contracts, and the rest – was never publicly disclosed. Therefore, the Court held, we could not show reliance "except in an indirect chain that we find too remote for liability." The Court was worried that if this "indirect chain" of reliance were accepted – deceptive behavior gets reflected in financial statements that, in turn, investors rely upon – every commercial transaction could turn into a securities fraud claim. Indeed, the majority opinion emphasizes that the deceptive transactions "took place in the marketplace for goods and services, not in the investment sphere."
Although the reliance requirement is the argument that secondary actors will try to hide behind in the future, there are many situations in which it will not work. For example, financial transactions are often the subject of public announcements. Almost daily we read of equity infusions into ailing public companies. But what if the transaction is in reality a loan dressed up deceptively to appear as equity? The public disclosure of such a transaction should satisfy the reliance requirement, because the market is aware of the transaction. Even if the investor/lender itself said nothing publicly, and even if its identity is never disclosed, its deceptive conduct was disclosed to the market and that should be enough.
Lawyers who structure misleading transactions, or who create misleading descriptions of them to be released to the market, should also be concerned about the Stoneridge decision. The fact that the lawyers do not put their own names on these deceptions should be irrelevant: their deceptive conduct was disclosed to the market, and the reliance element would be satisfied in that case as well.
In fact, even business transactions in the "commercial sphere" can satisfy the reliance requirement under the right circumstances. Suppose, for example, the false revenue contracts at issue in Stoneridge had actually been disclosed to the market, and suppose the defendants had known they would be? In that circumstance it seems clear that the reliance element would be satisfied.
In short, once the commentariat gets past its knee-jerk reaction to the dismissal of the Stoneridge case, awareness will sink in that investors have made some significant gains as a result of that decision.
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