October 29, 2007
On Stoneridge.
Posted by Julian Velasco

I realize that a post on Stoneridge isn't exactly timely, but I'm not a regular blogger.  Anyway, it seems that the Supreme Court is likely to affirm the judgment of the Eighth Circuit in the Stoneridge case.  I think that would be the right outcome.  However, the reasoning of the opinion may be more important than the outcome.  I would like the Supreme Court to use this case to take up the meaning of either "in connection with a purchase or sale of securities," or the scienter requirement.

"In connection with" has been interpreted extremely broadly over the years, and that probably is for the best.  But its limits should be better defined than they are.  Even assuming a "sham" transaction is fraudulent, that fraud is not necessarily in connection with a purchase or sale of securities.  Perhaps it is with respect to the company that intends to account for it improperly (although I would argue that it is the improper accounting, rather than the transaction itself, that satisfies the requirement).  But it is quite a stretch to say that a third party vendor engaging in a sham transaction is doing so "in connection with a purchase or sale of securities."  From the respondents' perspective, any fraud would have been in connection with the purchase and sale of set-top boxes and advertising, not securities.

Alternatively, the court could focus on scienter.  Scienter has been defined by the Supreme Court as an "intent to deceive," although most (all?) lower courts have held that recklessness will suffice.  I doubt that the respondents truly had an intent to deceive the securities markets.  At most, you could say that they were reckless with respect to the truth: they didn't care whether their actions would deceive the markets.  I would like the Supreme Court to hold that while recklessness may suffice with respect to participants in securities transactions (and their fiduciaries, including insiders), actual intent to deceive is necessary with respect to third parties.  If a person who is not involved in a securities transaction nevertheless intends to deceive others who are, then it may be reasonable to hold that person liable; but not if they're simply doing their own thing in disregard of securities markets.

Both of these analyses get at the same point: a person who has nothing to do with a securities transaction should not easily be held liable as a primary actor in securities fraud.  Liability, if any, should be based on aiding and abetting.  And Stoneridge seems a particularly good example of the difference between the two.  The respondents were not themselves engaging in securities fraud, but their actions may have aided and abetted securities fraud.

One of the worst possible outcomes would be for Supreme Court to limit itself to the question presented and decide that respondents cannot be held liable solely because they "made no public statements concerning those transactions."  A statement is expressly required by neither Rule 10b-5 nor § 10(b).  Section 10(b) speaks of "any deceptive device or contrivance," which is clearly broader than only statements; Rule 10b-5 is broader still (but limited by the statutory language, of course).  This issue is really about reliance, and since reliance is a separate requirement, you don't need to demand a statement.  With the availability of other statutory (and common law) bases for limiting Rule 10b-5, it would be imprudent for the Court to disregard the plain meaning of the statute.

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