The Supreme Court is set to take up the issue of investor rights Tuesday in what could be one of the most important securities cases the high court has considered in more than a decade.
At issue is whether third parties, such as vendors, accounting firms or banks, can be held primarily accountable when they knowingly contribute to a fraudulent scheme to inflate stock prices.
In the case before the court, investors in Charter Communications claim that the cable company used its vendors, Scientific-Atlanta and Motorola Inc., in a scheme to inflate stock prices.
The investors allege that Charter agreed to overpay its vendors for cable boxes, with the condition that the vendors would in turn use the extra funds to purchase advertising from Charter. The alleged scheme enabled Charter to report higher returns from advertising revenue.
Charter Communications' stock price collapsed when it was disclosed that it faced a criminal investigation for a multitude of alleged fraudulent activities.
In legal papers the investors say they want to be able to hold the vendors accountable for the fall in the stock price. "The sole purpose of their deceptive conduct was to further the scheme to overstate Charter's revenue and operating cash flow," attorneys for the investors claim.
Should the court rule that such vendors can be held accountable as "primary violators" in securities laws, the impact on the business community would be enormous.
Georgetown University law professor Donald Langevoort said that the case could have as large an impact on the business world as the landmark abortion case Roe v. Wade had in the arena of abortion rights.
"This is securities law Roe v. Wade," he said.
Langevoort said at issue is how deeply a secondary party has to be involved to cross from aiding and abetting to actual fraudulent behavior. According to Langevoort, the court will explore the question, "When do you cross the line as a behind the scenes player?"
Scientific-Atlanta and Motorola respond that they had no involvement in "the preparation or review of Charter's financial statements." The vendors also claim that they made "no statements to Charter's investors or accountants and had no duty to do so."
The vendors warn that if the court rules for the investors, anyone doing business with a public company would have to take on "legal responsibility" for that company's financial reporting.
John Engler, president and CEO of the National Association of Manufacturers, said, "The key issue in this case is primary liability. Without question, a company must give accurate information about its own stock. But the actions of third parties are not covered by this provision of the law. Plaintiffs' attorneys are not empowered to sally forth beyond the law in an indiscriminate search for deep pockets."
Investors across the country are carefully watching how the court will respond in the case.
For example, Enron shareholders, who lost billions of dollars when the company collapsed, believe that if the court rules in favor of the investors, then they will be able to go after the banks that they claim engaged in deceptive conduct to help falsify Enron's financial statements.
"The Supreme Court ruling will probably determine whether the Enron shareholders, victims of the largest corporate fraud in history, will be able to hold all the wrongdoers accountable for that fraud," Pamela Gilbert, a lawyer representing Enron shareholders, said.
Lawyers for the U.S. government have sided with the vendors in the case.
Solicitor General Paul D. Clement argues in court papers that if "secondary actors" could be held primarily liable whenever they engaged in allegedly deceptive conduct, then they could be exposed to "potentially billions of dollars in liability." The government argues "such a rule would thereby considerably widen the pool of deep-pocketed defendants that could be sued" and could also affect "foreign companies that trade with publicly listed companies."
The case is expected to be decided by early next summer.