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October Term, 2007 

January 22, 2008

The Supreme Court Denies Review in Enron Despite Plaintiffs' Assertion That There Is a "Financial Services" Exception to Stoneridge's Limit on Third Party Liability.

Last week, in Stoneridge Investment Partners v. Scientific-Atlanta, Inc. & Motorola, Inc., No. 06-43 (discussed in our Jan. 15, 2008 Decision Alert), the Supreme Court by a 5-3 vote affirmed the Eighth Circuit's dismissal of a private Section 10(b) securities fraud suit against vendors alleged to have engaged in transactions with a public company, Charter Communications, that enabled Charter to inflate its revenues. Allegedly, Charter agreed to pay the vendors $20 more for each product purchased and the vendors agreed to pay Charter the same amount for joint advertising. The vendors properly accounted for these transactions as a wash, but Charter did not, resulting in an overstatement of its revenue. The Court rejected plaintiffs' contention that third parties involved in a public company's "scheme" to defraud investors may be held liable for damages as primary violators of Section 10(b) where the third party has not itself misled investors. In those circumstances, the Court held, investors cannot be said to have relied on the third party's conduct or statements. The Court cited, among other considerations, Congress's determination in the Private Securities Litigation Reform Act that "aiding and abetting" securities fraud is a matter for SEC enforcement but is not subject to private damages actions, which Congress recognized are prone to considerable abuse.

Today the Supreme Court denied certiorari in Regents of the University of California v. Merrill Lynch Pierce Fenner & Smith, Inc., No 06-1341-a petition arising out of the collapse of Enron that had been held in abeyance pending the Court's ruling in Stoneridge. Although we do not normally alert readers to denials of certiorari, the Court's action is significant because the plaintiff Enron shareholders vigorously argued in a post-Stoneridge brief that the Court should grant their petition to explain that there is a "financial services" exception to the principle that third parties who do not communicate with investors are at most aiders and abetters, not primary violators subject to private securities fraud suits. Of further interest, Justice Kennedy, who provided the fifth vote to affirm in Stoneridge and who wrote the opinion for the Court, was recused in Regents, while Justice Breyer, who was recused in Stoneridge, participated in Regents. Despite this change in the Court's lineup, plaintiffs could not garner the four votes necessary to grant certiorari in Regents, nor the five votes necessary to remand the case to the Fifth Circuit for consideration of Stoneridge's application to financial services providers.

The Supreme Court in Stoneridge rejected plaintiffs' theory of scheme liability in part because it would "provide a private cause of action against the entire marketplace in which the issuing company operates" and thereby extend Section 10(b) into "the realm of ordinary business operations." Slip op. 10-11. Focusing on the fact that the defendants in Stoneridge were product manufacturers, plaintiffs contended in Regents that the Court should grant review to establish that different rules apply to "financial professionals engaged in fraudulent dealings in our securities markets."

The Enron plaintiffs alleged that the defendant banks "structur[ed] and support[ed] off-the-books special-purposes entities and related-party transactions" that "hid debt and provided false positive cash flow from operations." Although, like the vendors in Stoneridge, the banks in Regents did not deal directly with the public company's investors with regard to these transactions, plaintiffs urged the Court nevertheless to label them "primary violators" for allegedly having "conceptualized, designed, and structured" the transactions that Enron misrepresented to its investors. Plaintiffs argued that the transactions were deliberately structured by the banks so as to inflate Enron's revenues. In support of their contention that the banks should be treated as primary violators, plaintiffs noted that the banks had made statements to Enron investors in other contexts (i.e., when underwriting Enron stock and debt offerings and when issuing analyst reports, including 'buy' recommendations on Enron stock) in which, plaintiffs asserted, the banks had a duty to disclose the facts with regard to Enron's special purpose entities. The Supreme Court's summary rejection of plaintiffs' certiorari petition in Regents and refusal even to remand the case to the Fifth Circuit to reconsider its dismissal of the suit suggests that a majority of the Court believes that the reasoning in Stoneridge applies equally to transactions involving financial services providers.

Mayer Brown's Supreme Court and Appellate Practice group represented the successful Stoneridge defendants in the Supreme Court, with Steve Shapiro arguing the case. If you are interested knowing more about Stoneridge or Regents, please contact Tim Bishop at 312-701-7829 or tbishop@mayerbrown.com.


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