Lifting the Lid-Top US court weighs scope of fraud suits

WASHINGTON, Oct 5 (Reuters) - The U.S. Supreme Court hears a case next week that could clear the way for investor lawsuits against banks and other third parties, including one from shareholders that lost billions when Enron imploded in 2001.

The outcome of the case, known as Stoneridge versus Scientific Atlanta, could determine whether banks, auditors and others can be held liable for fraud even when they are not directly involved in it.

In the Stoneridge case, and a pending suit involving Enron, plaintiffs are seeking money from outside entities rather than the companies in which they invested. The plaintiffs argue that those other entities’ actions helped the companies defraud them.

Often the company at the center of a scandal goes bankrupt, leaving shareholders with few options. One way to recover money is to go after deep-pocketed “third parties” such as banks and other entities that worked with the company.

“This is a critical case to see whether shareholders who are victims of the most complicated fraud can recover their money,” said Pamela Gilbert, a lawyer with Cuneo, Gilbert & LaDuca who is working on the Enron case.

Stoneridge Inc SRI.N, on behalf of Charter Communications CHTR.O shareholders, sued Scientific Atlanta, a unit of Cisco Systems CSCO.O, and Motorola MOT.N, saying the companies participated in a scheme to inflate Charter's revenues in 2000.

But a lower court ruled in Scientific’s favor, saying the law only prohibits the making of material misstatements and to rule otherwise would introduce potentially far-reaching uncertainties for day-to-day business dealings. The court also said decisions of this magnitude should be made by Congress.

An appeals court upheld the ruling and now the case is before the Supreme Court, which will hear one hour of arguments on Tuesday. It is not known when the court will rule.


The case has divided the U.S. Securities and Exchange Commission and the Bush administration. The SEC came out in support of the plaintiffs in the Stoneridge case. But Solicitor General Paul Clement, representing the federal government before the Supreme Court, took his cue from the Federal Reserve and the Treasury Department, who oppose third-party suits.

Opponents of such suits say they would harm the U.S. economy by introducing new liability risks to every aspect of doing business with public companies.

Others say it would serve as a deterrent and allow investors to seek recourse from parties that knowingly engaged in fraudulent activity.

Complicating matters is the fact that one of the nine high court justices has recused himself, opening the possibility of a split decision.

Jeff McFadden, a securities lawyer who has been following the Stoneridge case, predicted the court will uphold the lower courts’ findings.

“Just based on their past rulings on securities issues, I think they will stick to the text of the securities laws and their prior ruling and considerations,” said McFadden, a partner at Steptoe & Johnson LLP.


If the Supreme Court affirms the appellate court’s decision, Congress could amend federal securities laws to allow investors to sue third parties.

“If the court is too restrictive Congress may act,” said Patrick Coughlin, the lead trial attorney for the Enron case.

So far, senior Democratic lawmakers have sided with investors, but have not said if they will offer legislation.

Rep. Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee and House Judiciary Committee Chairman John Conyers, a Michigan Democrat, have said if the Supreme Court rules against investors, third parties will be effectively immune from suit no matter how reprehensible their conduct.

The SEC can sue third parties and make them repay ill-gotten gains, but it cannot sue for damages.

The agency pursued the various parties involved with Enron and collected about $500 million -- a fraction of the some $40 billion that Enron plaintiffs are seeking.

Citigroup C.N, Lehman Brothers LEH.N, Bank of America BAC.N, JPMorgan Chase JPM.N and CIBC CM.TO have settled with Enron plaintiffs and have paid a total of about $7.3 billion.

Plaintiffs have also filed suit against Merrill Lynch MER.N, Credit Suisse First Boston CSGN.VX and Barclays BARC.L in the Enron case pending before the Supreme Court. (Reporting by Rachelle Younglai)