The sneaky plot to greatly expand corporate liability in securities laws class action suits looks like it might be in trouble
Thirteen years ago the Supreme Court ruled that companies could not be held liable for aiding and abetting fraud in private class action suits under securities laws. Regulators can bring actions for aiding and abetting, but private plaintiffs are restricted to suing the primary wrong-doer. Or, well, they were until trial lawyers invented a work-around called “scheme liability” for the restriction on their lawsuits.
The theory of scheme liability is that companies should be held liable for crimes committed by business partners if they played an integral part in the fraud. So if executives at a public company defraud shareholders by deceiving them, the shareholders would be able to sue not only the executives and the company but other companies who did business with them.
The Supreme Court today heard a case that will decide the fate of this clever ploy by trial lawyers to revive secondary liability. Apparently the advocates of scheme liability came in for some rough questioning. Unsurprisingly, Scalia didn’t like scheme liability. But Chief Justice John Roberts also reportedly had some harsh words for the theory, telling the lawyers that he believe the court should “get out of the business of expanding” shareholders rights.
If upheld, scheme liability could have a profound impact on the way Wall Street does business. Banks would be forced to regulate their corporate clients for compliance with securities laws. It would make the process of due diligence by Wall Street firms who lend money or put together deals for corporations far more time consuming and expensive. And, of course, when business deals go bad, it would inevitably open them up to lawsuits from the plaintiff’s bar and shakedowns for settlement payments.
For corporate America, scheme liability would create a duty to investigate the securities law compliance of potential business partners. “The costs of these preventative measures would be a hidden tax on the American economy and would affect our global competitiveness,” SEC commissioner Paul Atkins writes in today’s Wall Street Journal.
And, he might have added, it will ultimately harm the interests of shareholders by saddling companies with new legal costs at a time when they are already burdened by too much litigation. But, you know, scheme liability is advanced by advocates of “corporate investors” and in the name of “shareholders rights.” So your not supposed to notice that it damages shareholder’s interests.
Update: Peter Lattman at the WSJ's LawBlog has gone all "flood the zone" on the case. First, he comments on the PR spin of the plaintiff's bar. And files a report from a court observer who says that only two justices seemed sympathetic to the scheme liability theory. And, perhaps finally, delivers some interesting insights on who was asking the questions during the hearing.
Early Reports From Scheme Liability Scam Case [Associated Press]
Posted by Random Banker, Oct 09, 2007 3:55PM
Carney:
Of course the only problem is that the theory makes complete since.
First of all, the companies that commit these acts are usually so financially strapped that when they go bankrupt their will be little left for their shareholders.
Second, these companies are by definition committing fraud. You ever try to detect fraud by reading a 10k? I don't mean Enron style "creative accounting" but out and out fraud, Worldcom style like capitalizing operating expenses. There's is really no way for the average investor to detect this.
Thirdwise, Banks do not do due diligence. Trust me i'm the one responsible for doing it. We copy shit from one source and paste it into another. Seriously most of due diligence is literally formatting. No body actually verifies that any of the shit in the OM/Bank Book/ Prospectus or whatever information source you're actually using. I guess their were accountants looking at this shit at some point... I guess. As long as you can get the deal closed or syndicated then who cares, right?
If countreparties were actually held accountable when they perpetuate fraud its would nip a lot of this shit in the bud...yeah i just aid nip it in the bud. Maybe Qwest's bankers didn't know about their fraud but their PC suppliers did (i would explain this reference but if you really care look it up).
This is the same principal used for "down stream liability" in computer networks. If you have shitty security and leave your network unprotected and everyone connected to you gets hacked then YOU are liable.
Of course this shit (Scheme Liability) will never be upheld, it makes too much sense.