Supreme Court backs con men over honest investors

Supreme Court backs
con men over honest investors

It is interesting that a majority on the Supreme Court this week decided to protect schemers and thieves in security fraud cases because to do otherwise would have opened up too many investment companies to liability, which could raise the cost of doing business in the United States and drive securities markets overseas.

Two questions: Shouldn’t we want to discourage aiders and abettors from taking a more active role in fleecing American investors? And if the court is going to worry about someone, shouldn’t it worry more about the investors who were defrauded than the people who were part of the scheme to defraud?

The case in question was Stoneridge Investment Partners v. Scientific-Atlanta Inc. and involved a scheme hatched by Charter Communications, a St. Louis-based cable TV company. Charter was worried that auditors would find that it was losing money, which would cause its stock to plummet. So officials of the company approached two of its suppliers, Scientific-Atlanta Inc. and Motorola Inc., with a deal. The companies could increase the amount they charged Charter for cable boxes by $20 each. In exchange, Charter would credit the companies with purchasing $17 million in advertising from Charter, which would inflate the company’s bottom line, fooling the auditors and the investors.

After the fall

When Charter eventually collapsed, Stoneridge and its clients lost millions. Charter couldn’t make good, so Stoneridge turned its sites on Scientific-Atlanta and Motorola, arguing that without the complicity of those companies, Charter would not have been able to deceive its investors.

Writing for a majority of the court, Justice Anthony Kennedy said there was there was no evidence that investors relied on the deceptive acts of Charter’s suppliers when making investment decisions and Scientific-Atlanta and Motorola had no obligation under U.S. securities law to disclose that they were involved in a sham sale that inflated Charter’s assets.

Joining Kennedy for the majority were Chief Justice John Roberts and Justices Antonin Scalia, Clarence Thomas and Samuel Alito. It is worth noting that the Bush administration’s Justice Department joined this case on the side of the con men. President Bush and Solicitor General Paul Clement ignored the advice of Chris Cox, chairman of the Security and Exchange Commission, who recommended filing a brief in favor of the investors.

In his dissent, Justice John Paul Stevens noted that the court has been engaged in a continuing campaign to undercut investor lawsuits and that Charter could not have inflated its revenues without the “knowingly fraudulent actions” of the two suppliers. Stevens was joined by Justices David Souter and Ruth Bader Ginsburg.

Justice Stephen Breyer disqualified himself from the case because he owns stock in Cisco Systems Inc., which now owns Scientific-Atlanta.

Larger implications

We have to wonder if any of the justices have holdings in Merrill Lynch, Credit-Suisse First Boston and Barclays Bank. Why? Because they were among the defendants in a similar case filed on the West Coast after the collapse of Enron, the Texas-based energy conglomerate.

By ruling for the swindlers and against honest investors in the relatively small Stoneridge case, the Supreme Court has essentially protected investment bankers against billions of dollars in claims from ordinary people who lost their life savings when Enron’s house of cards collapsed.

And while the court expressed concern about protecting American investment markets as a good place for foreign investors to wheel and deal without fear of troublesome litigation, it sent a sobering message to average investors.

Caveat emptor has always been good advice for buyers, but it becomes difficult for investors to be wary when the Supreme Court has ruled that all cheaters have to do is get one level of separation between them and the victims of investment fraud.