In the W$J, Ted explains why this securities fraud case pending before the US Supreme Court is of momentous import:
Treasury Secretary Henry Paulson called securities litigation the "Achilles heel for our economy," endangering the global competitiveness of American financial markets. Last January a report released by Sen. Charles Schumer (D., N.Y.) and New York City's Republican Mayor Michael Bloomberg concluded that investors were being driven away from American shores because "the highly complex and fragmented nature of our legal system has led to a perception that penalties are arbitrary and unfair."
The proposed solution to the legal mess offered by the so-called Paulson Committee Report was modest enough: "Greater clarity for private litigation." Yet even this small step could suffer a big setback. The plaintiffs' bar is heavily lobbying the SEC to intervene in a pending Supreme Court case, Stoneridge v. Scientific-Atlanta, on the side of a gigantic expansion of private litigation.
The case's facts are straightforward: Charter Communications purchased set-top cable boxes but got back some of the money in the form of advertising bought by the vendors. Charter executives recorded the outgoing money as a "capital expenditure" (to be depreciated over several years) but the incoming money as revenue recorded within a single year, thus falsely inflating operating cash flow. Three Charter executives went to prison over the shenanigans. Plaintiffs' attorneys sued Charter and the executives, of course, but named as codefendants two of the vendors, Motorola and Scientific-Atlanta.
The suit makes little sense. The vendors had no say in how Charter accounted for or reported its transactions. Worse is the precedent it represents: How can a business function if it is potentially liable for hundreds of millions because those whom they trade with misreport a day-to-day transaction? The Supreme Court stopped such private "secondary liability" suits in Central Bank v. First Interstate Bank, a 1994 decision that Congress ratified the next year, explicitly rejecting private suits for "aiding and abetting" in the Private Securities Litigation Reform Act (repeating the rejection in the 2002 Sarbanes-Oxley Act.)
A federal court in Missouri dismissed the case against the equipment vendors and the Eighth Circuit Court of Appeals affirmed that decision: Such liability would, the court said, create far-reaching "uncertainties for those engaged in day-to-day business dealings." Nevertheless, the Supreme Court has agreed to hear an appeal.
... Unfortunately, we cannot be certain why the Supreme Court has taken the case, or if it will do the right thing. While Chief Justice John Roberts and Justice Stephen Breyer have spoken of the need for judicial modesty, both have recused themselves from the case. All the more reason for Treasury and the SEC to stand firm and ask the solicitor general to urge the Supreme Court to keep liability circumscribed. And for Sen. Schumer to explain to his Democratic colleagues why that would be a wise choice -- before they criticize the Bush administration for making the wrong decision.
But here's a prediction that has nothing to do with the merits. As Gordon Smith observes, the Circuits are split on this issue. The 5th and 8th have come down on the no liability side. The Ninth came down on the side of imposing vendor liability. The SCOTUS doubtless took the case to resolve the split. Given that the SCOTUS seems to take special delight in reversing the 9th Circuit, my guess is that the Court will come down on the no liability side. OTOH, the excusal of Roberts and Breyer (who is usually sensible on securities issues) is somewhat worrisome for the reasons Ted blogged a while back.