On first reading, the Supreme Court's decision in
Stoneridge Partners LLC v. Scientific-Atlanta Inc.(1) seems very predictable. The Court, well-known for its pro-business leanings, rejects the "scheme liability" claim plaintiffs made against the two vendors of cable TV set top boxes-Scientific-Atlanta and Motorola-who helped Charter Communications engage in financial fraud by entering into bogus transactions and backdating or otherwise falsifying the related documents. The opinion by Justice Anthony Kennedy treats the issue as an easy and natural extension of his earlier opinion in
Central Bank of Denver,(2) and is filled with
non sequiturs and overblown rhetoric about class action abuses, the virtues of federalism, and the need to keep U.S. capital markets globally competitive.
As a result, it is easy to read the opinion as no more than a blunt confinement of third-party liability via a stringent reliance requirement. That certainly is how most commentators have read it, whether or not they applaud the outcome. Likewise, by and large, lower courts have found nothing in Stoneridge to cause them to rethink how they decide third-party liability cases. Most continue to apply pre- Stoneridge precedent, finding some sound bite to take from the Court's opinion to justify staying the course. This is particularly noticeable among those courts that apply the so-called "bright-line" or "attribution" test for when a third party faces the risk of liability, which allows cases to proceed only when there is some kind of public attribution of the allegedly misleading disclosures to the third party.
Rhetoric and non sequiturs aside, however, Stoneridge does articulate a clear principle from which the Court determines that Scientific-Atlanta and Motorola do not face liability: that their behind-the-scenes deception was "too remote" or "too attenuated" from Charter's dissemination of false financial information to justify liability. And what is interesting about this choice of principle is that it is not a bright line-no causation inquiry ever is-and that it implicitly pushes aside other ways of explaining why investors could not show reliance in a case like this. Take the attribution test. Had the Court so wished, it would have been easy to say that investors cannot rely on something of which they are not aware. Many lower courts had said precisely that in justifying the bright-line approach, and many of the defense-side advocates urged the Court to follow along when Stoneridge was being argued. But it did not.
To me, the best explanation for why it did not-instead embracing a remoteness standard-is that it actually preferred the approach it chose to the alternatives put before it. If so, maybe we should take that approach more seriously, and read Stoneridge more carefully.
What is the remoteness approach? In a couple of places in the opinion, the Court suggests that it is something akin to a proximate cause analysis. But that can't be right, because a conventional proximate cause analysis simply asks whether the harm that befell the victims was reasonably foreseeable to the wrongdoer at the time of the wrong. Even the Court seems to admit that that analysis would make the two defendants liable, since the natural and foreseeable consequence of their deception was that Charter's accountants were fooled into certifying Charter's financials. Instead, it explicitly rejects that inquiry.
A better explanation of what the Court is doing turns to a related concept in tort law: duty-not duty as in "is there an affirmative duty to disclose?," but, rather, in its broader tort-law function of defining scope of liability. Until now, lower courts have largely assumed that all persons who speak in a manner reasonably calculated to influence investors have a duty to speak truthfully or face liability to the investment marketplace. The Court disagrees, and says that Scientific-Atlanta and Motorola did not owe an enforceable duty to the investing public, because of the remoteness of their actions from the subsequent fraud.
Why should there be no duty? After all, both duty and proximate cause are workhorses in the law of negligence, but have never been applied strictly with respect to intentional misconduct, which this surely was. What may have been bothering the Court was a sense of disproportion between the conduct of what it might well have assumed was no more than mid-level sales people at Scientific-Atlanta and Motorola in trying to please an important customer and the extraordinary damages that can follow from fraud-on-the-market liability-especially under a "scheme liability" theory that sought to hold the defendants liable for damages even beyond those caused by their own deceptions. A sliding scale of duty based on remoteness or attenuation is a way of saying that some kinds of conduct, even if deceptive, do not warrant that kind of liability.
This duty-based reading helps explain the otherwise puzzling discussion in the Court's opinion about the supposedly distinct spheres of "commerce" and "finance." The distinction is illusory and seems foolish: accounting, which is at the heart of finance, is the quantitative description of commercial activity. But if this is really about what kind of conduct should face the special liability risk that private securities class actions create, then there may be some intuitive justification for saying that those occupying the world of finance-aware, or at least on notice, of that world's intrusive regulatory demands and pervasive litigation-can fairly be asked to assume that risk, but those outside that world generally should not.I am not necessarily concurring in this account, but simply saying that it helps make more sense of what appears to be a pivotal point in Stoneridge.
If we read Stoneridge this way, then the obvious question is what kinds of behind-the-scenes deception would not be too remote or attenuated, and so can support a finding of reliance? For reasons noted earlier, I do not think that the answer is only that which is publicly visible or attributed to the actor. Once again, the Court could easily have drawn that line had it wanted, but drew a different one instead-making no reference whatsoever to either visibility or attribution. Moreover, the courts that devised the bright-line test after Central Bank did so because it was responsive to the Supreme Court's insistence on reliance to justify third-party liability. Now that the Court has created a different way of addressing reliance, such a construction is neither necessary nor appropriate. Put another way, if the attribution standard applies, then the Court's remoteness approach largely becomes surplussage: there will be few, if any, plausible instances where a third party's involvement is publicly identified but too remote.
A more reasonable answer can be found by again taking the Court seriously: those third parties who are an integral part of the world of finance, rather than the world of commerce, do owe a duty to investors that can be enforced via a fraud-on-the-market lawsuit.They are on notice of the risks, and bear special responsibilities because of their status as broker-dealers, investment advisers and the like. While no clear line separates the two domains, investment banks and accountants, at least, belong squarely in the world of finance. For this reason, I find considerable grounds for distinguishing Stoneridge from what was at issue in the Enron litigation.(3) On a duty-based reading, what the banks allegedly did in assisting Enron was by no means remote or attenuated. I am well aware of the denial of certiorari in the Enron case right after Stoneridge was handed down, and that many commentators have read that as the Court's endorsement of the Fifth Circuit's reasoning.That reads too much into a cert denial, however. If we focus instead on the Stoneridge analysis itself, which is of much greater precedential weight, the distinction between the two cases is compelling.
What I have offered is a very different reading of Stoneridge, then, more plausible to me by far (and a bit more plaintiff-friendly) than most of the prevailing ones. But I do not want to appear naïve by suggesting that I expect this to become the prevailing reading.While I hope that lower courts will be more imaginative and careful in their interpretations in future cases, the early reader reactions to any authoritative text are hard to dislodge, even when they are careless. Nor would I ever say that this reading is the best way of addressing third-party liability. For these reasons, we really do need a legislative solution to the problem, one that thoughtfully balances legitimate claims to investor compensation with the need for measured proportionality. Securities law policy simply is too important to be left to the Supreme Court.
1 128 S.Ct. 761 (2008).
2 Central Bank of Denver v. First Interstate Bank, 511 U.S. 164 (1994).
3 Trustees of the University of California v. Credit Suisse First Boston, 482 F.3d 372 (5th Cir. 2007).