Corporate Governance

Stoneridge and the Rule of Unintended Consequences

By J. Robert Brown

We don't often agree with Larry Ribstein but his criticisms of the Supreme Court's use of reliance to resolve the case in Stoneridge are sound (even if he would have affirmed the 8th Circuit on other grounds).  As he notes:

• 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.

Let us think about one of the consequences of the holding.  By relying on reliance, the Court did not exactly say that vendors were aiders and abettors.  In other words, Stoneridge doesn't really build on Central Bank.  It merely comes up with an independent basis for exonerating certain categories of secondary actors.

The odd and unsupported nature of the holding can be seen by looking at the impact on the Securities and Exchange Commission.  Everyone, even the Supreme Court, recognized that offending vendors can still be sanctioned as aiders and abettors by the Commission.  The Agency has the authority to bring actions for aiding and abetting, munificense granted in the PSLRA.  But why use aiding and abetting?  The Commission can charge vendors like Motorola and Scientific Atlanta as primary violators.  Why?  Because the Commission doesn't have to show reliance in order to bring an action under Rule 10b-5.  See SEC v. Rana Research, 8 F.3d 1358 (9th Cir. 1992)("One claim, however, raises an issue of first impression in this circuit and on that issue we hold that the SEC need not prove reliance as an element of its case in an action to enjoin future violations of section 10(b) and Rule 10b-5.").  

One could argue that it makes no difference, an entirely academic matter so to speak.  But it does matter.  To bring an action for aiding and abetting a Rule 10b-5 violation, reckless behavior will not suffice.  The Commission must show actual misconduct.  See SEC v. Cedric Kushner Promotions, Inc., 417 F. Supp. 2d 326  (SD NY 2006).  See also 15 USCS § 78t (Commission authorized to bring action for aiding and abetting against "any person that knowingly provides substantial assistance").  The Commission may, therefore, circumvent both the holding in Stoneridge and the limits on aiding and abetting by charging vendors as primary violators. 

This is what happens when the Supreme Court opts to interpret a statute based upon the dubious legal principal of no "expansion."  In other words, where the Court is determined to stop the "expansion" of antifraud liability, the language of the statute, prior decisions, the common law, and all other guiding principals go out the window.  Instead, the Court develops an expediency designed to do nothing more than prevent application to the expanded category of defendants.  This is sloppy legal reasoning and it all but makes legal argument on what Section 10(b) and what Congress intended in adopting it meaningless.

Full post as published by The Race to the Bottom on January 22, 2008 (boomark / email).