Unclassy action

This week, the Supreme Court hears what some call “the most important securities case in a generation.” Stoneridge v. Scientific-Atlanta determines whether the business partners, banks or law firms of companies that violate U.S. securities law can be sued for damages even without knowledge of, or participation in, the transgression. Charter Communications, a cable-television firm, bought set-top boxes from Scientific-Atlanta and Motorola. In a joint deal, the latter two companies put the money into an advertising fund run by Charter. Charter executives used this arrangement to inflate their earnings. Three of them ended up in jail. Under current law, that’s where thing would end. But in Stoneridge, the trial lawyers want a piece of Scientific-Atlanta and Motorola.

“Scheme liability,” as it is called, opens a whole new universe of targets to sue. Presently, the distinction between “primary liability and “secondary” is a bright, uncrossed line. Only those who actually broke the law can be sued. Here, in Stoneridge, tort lawyers contend that the two partner companies should have known that their partners were crooks.

It is a massive change, and has many securities experts fearing the consequences. In a contentious 3-2 split, the Securities and Exchange Commission recently voted in favor of this new interpretation. What a trial-lawyer bonanza it will be if this becomes the new standard. SEC Commissioner Paul S. Atkins prefers the status quo, despite his agency’s ruling. As Mr. Atkins put it last month: “[T]he lure of potentially enormous payouts for successfully settled class-action lawsuits has encouraged creativity by the class action plaintiff’s bar, including the development of new and expansive theories of liability… Under the ‘scheme liability’ concept that the SEC majority advocated, plaintiffs would be able to reach into the deep pockets of customers, vendors and other firms that simply do business with issuers.”

This would be staggeringly expensive for U.S. corporations. Most securities lawsuits never reach a test in court; they are settled outside. With the voluminous new documentation and heightened liability this “scheme liability” would involve, it is certain that on the margin, American and foreign businesses will simply opt out of a transaction rather than withstand the risk. As the Economist magazine put it recently: “Many foreign firms that choose to list their shares elsewhere point to America’s ‘litigation lottery’ as the principal reason.” Also: “Any firm, anywhere, doing business with American companies would have to live with the risk that the transaction could later be portrayed as fraudulent and deceptive.”

Trial lawyers have an obvious financial incentive and demonstrate proclivity to fleece anyone they can. The best recourse continues to be the Securities and Exchange Commission, which for all its flaws handles this matter much better than courtrooms ever could.