Public Statement by SEC Commissioner:
Just Say 'No' to the Trial Lawyers
Commissioner Paul Atkins
"Op-Ed" for the Wall Street Journal
October 9, 2007
The U.S. Supreme Court will hear oral arguments today in one of the most important business cases to come up for judicial review in years. At issue is whether corporations can be held liable under private class-action lawsuits for alleged crimes committed by business partners.
The case, Stoneridge Investment Partners v. Scientific-Atlanta, is not just a lawyer's case. Its implications and potential liabilities have drawn the attention of U.S. and foreign business leaders, politicians and investors. What the Supreme Court decides will affect the economy. The Court should not follow the lead of the Securities and Exchange Commission, a 3-2 majority of which came out in support of expanding the reach of private class-action lawsuits. I hope that the Court makes a better decision for our economy and for fairness in the judicial process than the SEC did.
Stoneridge tests the definition of who is — and who is not — subject to private suits by class-action lawyers in securities fraud cases. At issue is the line between what lawyers call "primary" and "secondary" liability. At present, the SEC and the Justice Department can bring an aiding-and-abetting charge against a firm that knowingly and substantially assisted in a fraudulent transaction; but, the firm cannot be sued by a private plaintiff for that same charge. Private lawsuits are reserved for primary violators who are alleged to have actually deceived investors in a securities transaction.
In the past decade and a half, Congress has twice tightened the standards for private lawsuits to try to stop abuses by securities class-action lawyers, such as paying sham plaintiffs to bring cases with dubious claims of investor injury, filing suit based only on vaguely worded complaints copied from a previous suit, and shaking down companies for settlements.
Stoneridge involves a backdoor attempt to expand the realm of private suits through so-called scheme liability, by recasting secondary liability as primary liability. Through scheme liability, plaintiffs would be able to reach participants of whom the defrauded investors were unaware at the time of the fraud.
Consider, for example, how this newspaper might fare under scheme liability. What if it published an advertisement raving about a penny stock? Under scheme liability theory, if the ad includes statements that are false or misleading, this newspaper could be sued for participating in a "scheme" to defraud investors. A plaintiff might assert that the newspaper either knew or was reckless in not knowing that the statements in the ad were false, because the newspaper had reported in the past about SEC enforcement actions against stock manipulations involving similar ads. Under scheme liability, based on its publication of an ad that it should have known to be false, the newspaper could be exposed to liability for the entire fraud.
Perhaps the newspaper would prevail in litigation. But the prospects of success would be irrelevant if the litigation costs, and an understandable aversion to the inherent risk of a bad outcome, tilt the balance in favor of the newspaper's agreeing to pay a large settlement before trial.
Talk about a chilling effect on business. Imagine the measures (paying lawyers, turning down ads or passing up other opportunities) that this newspaper or other companies would have to take to protect themselves from potential misdeeds of customers, suppliers and clients. Any liability would be determined years later, by others' judging what "red flags" were missed.
The costs of these preventative measures would be a hidden tax on the American economy and would affect our global competitiveness. Ultimately, all of us would pay the price: investors with reduced shareholder returns, workers with fewer jobs and consumers with higher prices for goods and services.
Unfortunately, the SEC majority has endorsed the scheme liability concept in Stoneridge. And it did so in part because the SEC endorsed the theory once before, in an amicus brief in a 2004 case. But the SEC ought not to have allowed that prior advisory position to dictate its position in this case.
In the intervening years, the SEC has had the benefit of judicial decisions rejecting that prior position and has had the ability to see fact patterns that point out potential dangers of that position. It has also had the opportunity to hear criticisms from government officials who share the SEC's concerns with U.S. competitiveness and the welfare of consumers and investors.
Yet, a majority of my colleagues chose to ignore this experience and urged the solicitor general to advocate in favor of scheme liability. The solicitor general's office properly refused to do so, and expressly stated that the SEC's position is not the position of the U.S. government.
My hope is that the Supreme Court will likewise see the folly of scheme liability and reject this latest attempt to expose shareowners and their companies to massive and arbitrary litigation risk. If the Supreme Court instead embraces scheme liability, investors and consumers will bear the costs as their investments fall in value and the prices of their purchases rise.