Citation. _U.S_, 128 S. Ct. 761 (2008)
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By agreeing to arrangements that permitted Charter to mislead its auditor and issue a deceiving financial statement affecting its stock price, investors (Plaintiff) in Charter argued that Charter's customers/suppliers (Defendant) violated § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
Synopsis of Rule of Law.
A third-party customer/supplier of a company is not a prime participant, even though its misleading acts are part of a scheme to defraud investors, where investors wishing to bring the action have not relied on the third-party customer/supplier's acts, for purposes of a private cause of action under§ 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
Facts.
Charter participated in a multitude of fraudulent practices in order for its quarterly reports to meet Wall Street expectations. It was soon realized by Charter executives that even with the fraudulent efforts certain financial predictions still would not be realized by the company. Charter elected to change its current arrangements with its customers/suppliers, Scientific-Atlanta and Motorola, who agreed to the altered arrangements in order to help with the shortfall. Charter was allowed to trick its auditor into authorizing a financial statement demonstrating that the predicted revenue and operating cash flow numbers were met even though the transactions they entered into has no economic substance. Alternatively, preparation or dissemination of the financial statement was not performed by the customers/suppliers. A securities fraud class action was filed by investors claiming that by participating in the transactions, § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5was violated by the customers/suppliers. The investors claimed that the customers/suppliers were in reckless disregard of or aware of Charter’s intention to utilize the transactions to exaggerate its revenues and were aware that the resulting financial statements issued by Charter would be relied on by investors and research analysts. It was also claimed by investors that they had relied upon the customers/suppliers misleading acts. It was dismissed by the district court, and the court appeals affirmed. Certiorari was granted by the Supreme Court.
Issue.
Is a third-party customer/supplier of a company considered a prime participant where investors wishing to bring the action have not relied on the third-party customer/supplier's acts, for purposes of a private cause of action under § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5?
Held.
(Kennedy, J.) No.A third-party customer/supplier of a company is not a prime participant, even though its misleading acts are part of a scheme to defraud investors, where investors wishing to bring the action have not relied on the third-party customer/supplier's acts, for purposes of a private cause of action under § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.It was established byCentral Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994)that § 10(b) liability fails to extend to aiders and abettors. So, the investors must demonstrate reliance on the customer/suppliers’ misleading exploits, seeing as an element of a § 10(b) cause of action is reliance. In two circumstances, a rebuttable presumption of reliance has been found. Firstly, when a material fact is omitted by one with a duty to disclose, the investor to whom the duty was owed does not need to offer explicit proof of reliance. Secondly,reliance is presumed when the statements at issue become public, under the fraud-on-the-market doctrine. Seeing as the customer/suppliers misleading exploits were not communicated to the investing public during pertinent times and had no duty to disclose, neither presumption applies here. As a result, the investors are not to demonstrate reliance upon any of the customer/ suppliers' actswith the exception of an indirect chain that is too remote for liability. Absent a public statement, the investors' reference to so-called "scheme liability" does not,answer the objection that they did not in fact rely upon the customer/suppliers' deceptive conduct. In other words, if this perception of reliance was to be implemented investors would rely not only upon the public statements concerning a security but upon the transactions those statements reflect, the implied cause of action would extent the marketplace as a whole in which the issuing company does business. For this rule, there is no authority. The deceptive acts of the customer/suppliers' are too remote to satisfy the reliance requirement and were not disclosed to the investing public.The customer/suppliers did not mislead Charters auditor and file fraudulent financial statements, Charters did, and the customer/suppliers failed to make it necessary or inevitable for Charter to record the transactions the way it did. The Court's precedents advise against investors' attempt to extend the § 10(b) private cause of action past the securities markets into the territory of ordinary business operations, which are mostly overseen by state law. For example, seeMarine Bank v. Weaver, 455 U.S. 551 (1982). The contention that there may be a reliance finding had this been a common-law fraud action is answered by the fact that § 10(b) fails to include common-law fraud into federal law, and should not be interpreted to give a private cause of action against the whole marketplace where the issuing company functions. Moreover, the investors’ theory would place an unsupportable interpretation on Congress’ explicit answer to Central Bank in PSLRA § 104 by enlivening the implied cause of action against many aiders and abettors, in turn discouraging Congress’s resolve that only the SEC should pursue this class of defendants. The realistic outcomes of an expansion like this offer another reason to refute the investors’ method. The comprehensive discovery and the probability of doubt and disturbance in a lawsuit could permit plaintiffs with feeble allegations to extort settlements from guiltless companies. A new class of defendants would be exposed to risks like firms residing overseas with no additional exposure to U.S. securities laws, which steer them from doing business here, inflating the cost of operating as a publicly traded company under U.S. law and turning securities offerings away from domestic capital markets. Also, the cautious approach the Court has taken prior to moving forward lacking congressional direction and the history behind the § 10(b) private right of action offer further reasons to find no liability here. The § 10(b) private cause of action is a judicial construct that Congress failed to instruct in the text of the pertinent statutes and so caution needs to be used against judicial expansion, with extension only being performed by Congress. Judicial restraint like this is suitable in light of the PSLRA, where Congress, after the Court moved away from an extensive inclination to imply such private rights, enacted the implied right of action. Once the PSLRA § 104 was passed, it is suitable for the Court to assume that Congress accepted the § 10(b) private right as defined but without opting for further extension. In this case, the customers/suppliers, or secondary actors, are subject to civil enforcement by the SEC and criminal penalties. Affirmed and remanded.
Dissent.
(Stevens, J.) Seeing as Charter’s revenue statements were relied upon by the investors,they were also reliant upon the customer/supplier’s fraud, a “deceptive device” which § 10(b) prohibits. This is ample to differentiate this case from Central Bank, where the majority significantly departs. The lack of violation of § 10(b) in that case rests on two failed premises: that reliance needs super-causation and a too broad reading of Central Bank. It is recognized that verbal and nonverbal deceptive conduct are covered under § 10(b), so the production of misleading documents by the customer/suppliers falls under that statute, however, in Central Bank, the bank failed to engage in any deceptive acts. This made the bank, at most, an aider and abettor, so the holding in that case that a private cause of action under § 10(b) fails to extend to aiders and abettors is not applicable here or in any case where the participant in deceptive acts is the actor itself and so the majority failed to recognize that these cases are different. Also, the majority’s outlook on causation is unprecedented and unwarranted. The fraud-on-the-market presumption of shareholder reliance on public material misrepresentations, combined with a proper view of causation, would allow the investors to plead reliance, because investors do not have to be cognizant of deceptive acts in particular. What individuals or corporations need to do in order to “cause” the deceiving information to reach the market is not stated in the presumption. Reliance is properly related to “transaction causation” by lower courts, which is often defined as but-for causation, so the majority has it reversed when it initially mentions the fraud-on-market presumption as opposed to the causation needed. Seeing as investors have claimed thatcustomer/suppliers acknowledged that their deceptive acts were the foundation for statements that influenced Charter stock’s market price on which shareholders would rely, even without but-for causation, proximate cause would be satisfactory. So, a foreseeable effect of making the investors buy Charter securities was established by their acts. The majority had an unfounded fear that adopting more lenient standard of reliance would allow the implied cause of action to blanket the entire marketplace where the issuing company does business, however, liability is only attached when the company doing business with the issuing company has violated § 10(b). The majority is erroneous in stating that the legislative history of the PSLRA proves congressional intent that fails to support the investors'stance. Although the PSLRA was passedin response to Central Bank, itsignified a compromise on aiding and abetting private causes of action, with the ultimate compromise not in support of a Central Bank extension to immunize from liability in private litigation, an undefined class of actual violators of § 10(b). Rather, Congress proposed that private litigation under § 10(b) would still be an integral part of protecting the integrity of the securities markets. Seeing as it is the integrity and safety of the U.S. markets, promoted by liability like that, that attracts foreign participation in our markets, so the majority's concern that liability for such conduct would deter overseas firms from doing business in the U.S. is misplaced.
The private cause of action was impliedly authorized by Congress once it passed the Securities Exchange Act, and it was the practice of the judiciary to offer a remedy for every wrong at that time, and Congress passed the Act with the comprehension that the federal courts respected the principle that every wrong would have a remedy, contrary to the majority’s view.
Discussion.
The SEC's enforcement powers against aiders and abettors "is not toothless," as proven by the majority, by observing that, since 2002, SEC enforcement actions have amassed over $10 billion in disgorgement and penalties.
