The Wall Street Journal-20080116-High Court Curbs Suits Of Defrauded Holders

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High Court Curbs Suits Of Defrauded Holders

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WASHINGTON -- In the latest of a series of victories for Wall Street, the Supreme Court sharply limited the ability of shareholders defrauded by a company to sue other parties, including advisers, lawyers and accountants.

If the ruling had gone the other way, it could have expanded the power of defrauded shareholders to sue, invigorating the multibillion- dollar field of securities class-action lawsuits.

Instead, the court's opinion maintains a status quo and extends Wall Street's winning streak on securities cases. This is the fifth securities matter to come out in favor of business since 2004. Wall Street has successfully argued that Congress intended only the Securities and Exchange Commission to police fraud, not to open the door to lawsuits by private shareholders.

In particular, the ruling dims the hopes for shareholders in big accounting frauds, such as Enron Corp., where the perpetrator is bankrupt but firms that allegedly contributed to the fraud remain in business.

Yesterday's 5-3 vote illustrated a close division not only among the justices but within the Bush administration. The SEC took the position that federal law permits private lawsuits against third parties. But the White House, responding in part to concerns from Wall Street, overruled the SEC and directed the Justice Department to argue against allowing the shareholders suits.

There has been an intense public-relations battle over the case between two deep-pocketed enemies: the trial bar and big business, both of which mustered an array of supporters to file briefs in the case.

The spotlight now shifts to the SEC, which the court found has exclusive authority to pursue actions against third parties. With control of the SEC up for grabs in this year's presidential election, it raises November's stakes.

In light of the decision, "one of the most important questions that will be decided by the 2008 [election] is the SEC," said Rep. Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee. While praising the current Republican chairman, Christopher Cox, Mr. Frank said the "big issue is who fills the SEC vacancies."

The Stoneridge case, as it is known, revolved around an episode near the end of the 1990s dot-com bubble. Charter Communications Inc., a St. Louis cable provider, engaged in accounting fraud to meet analyst expectations. Four former Charter employees were indicted and pleaded guilty to conspiracy. The company also agreed to pay $144 million to settle a class-action suit led by one of its shareholders, Stoneridge Investment Partners of Malvern, Pa.

Stoneridge also sued Motorola Inc. and Scientific-Atlanta, now a unit of Cisco Systems Inc. Both vendors agreed to charge artificially high prices for cable boxes they sold to Charter. They used the extra money to "buy" advertising from Charter, money Charter used to inflate its bottom line.

At issue was what role third parties must play in order for them to face liability. Companies contend that private lawsuits are limited to cases in which investors rely on fraudulent statements. They also say suits can be brought only against those who control the fraud. The court agreed.

"We conclude the private right of action does not reach the customer/supplier companies because the investors did not rely upon their statements or representations," Justice Anthony Kennedy wrote in the majority's opinion. He said investors must rely on deceptive acts in order for a civil lawsuit to succeed.

He was joined in the majority by Chief Justice John Roberts and Justices Antonin Scalia, Clarence Thomas and Samuel Alito. In dissent, Justice John Paul Stevens, joined by Justices David Souter and Ruth Bader Ginsburg, complained that the court was on a "continuing campaign to render" private shareholders' right to sue "toothless." Justice Stephen Breyer recused himself. He owns Cisco Systems shares.

Still, the complexity of securities law means the potential for certain third-party suits -- and the exact implications for the Enron cases -- may be unclear. The University of California lost in the lower courts when it sued Wall Street banks, including Merrill Lynch & Co., which worked with Enron. It has its own appeal pending at the Supreme Court.

Spokesmen for Merrill Lynch and the SEC declined to comment.

(Stoneridge Investment Partners v. Scientific-Atlanta Inc. and Motorola Inc.)

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Mark H. Anderson contributed to this article.

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