Supreme court backs limits on securities fraud suits

WASHINGTON (Reuters) - The U.S. Supreme Court ruled on Tuesday that shareholders cannot sue third parties such as suppliers and banks in securities fraud cases unless investors directly relied on the parties' statements or representations when making investment decisions.

The 5-3 ruling drew praise from business groups and is widely seen as affecting a similar lawsuit by Enron Corp investors against investment banks over the energy trader's collapse in 2001.

The high court's ruling involved a lawsuit by Stoneridge Investment Partners, on behalf of Charter Communications (CHTR.O) shareholders. Stoneridge filed a suit against Scientific Atlanta, which later became a unit of Cisco Systems (CSCO.O), and Motorola Inc MOT.N, alleging that the companies schemed to inflate Charter's revenues in 2000.

The Supreme Court upheld a lower court's dismissal of the lawsuit. Justice Anthony Kennedy concluded for the court majority that federal securities law does not reach the companies because Charter investors did not rely on their statements or representations.

Kennedy said Scientific Atlanta and Motorola "had no duty to disclose; and their deceptive acts were not communicated to the public."

The shareholders cannot show reliance on any of the third parties' actions "except in an indirect chain that we find too remote for liability," he wrote.

He went further to say that allowing shareholders to pursue third parties "would expose a new class of defendants to these risks." "Overseas firms with no other exposure to our securities laws could be deterred from doing business here," he said.

Kennedy said third parties can still face criminal penalties and civil actions by the federal government's Securities and Exchange Commission.

Industry groups applauded the decision. The National Association of Manufacturers said it was a "tremendous relief."

The U.S. Chamber of Commerce, a business lobbying group, said the Supreme Court made clear that expanding the law would put American businesses at a severe competitive disadvantage.

The Securities Industry and Financial Markets Association said any other ruling would have "unnecessarily generated significant additional litigation."

The ruling was a defeat for investor advocates, who have said that all parties should be liable if they knowingly worked on a transaction that defrauded investors.

"It does not bode well for the Enron plaintiffs," said Eric Rieder, a partner with law firm Bryan Cave, who represents companies.

Christopher Dodd, a Democrat and chairman of the Senate Banking Committee, said the decision would "protect wrongdoers from the consequences of their actions."

Barney Frank, the chairman of the House Financial Services Committee, told Reuters that the ruling was something that should be overturned. But Frank, a Massachusetts Democrat, said he would not introduce any kind of legislation during George W. Bush's presidency as it would likely get vetoed.

The world's largest trial bar association, the American Association for Justice, said the court was careful to make the distinction between secondary actors in the goods and services industry and those in the financial sphere.

"We are hopeful that this means that the investors defrauded in the Enron case still have the opportunity to recover and rebuild their lives," the association said.

Justice John Paul Stevens, joined by Justices David Souter and Ruth Bader Ginsburg, dissented.

"Today's decision simply cuts back further on Congress' intended remedy" in enacting the securities laws, Stevens wrote.

Stevens objected to what he called the court's continuing campaign to render "toothless" private lawsuits under a section of federal securities law dealing with manipulative and deceptive practices.

(Reporting by James Vicini and Rachelle Younglai; Editing by Tim Dobbyn, Brian Moss)