You Can't Sue the Bean Counters

What the Supreme Court's recent ruling on corporate fraud means for companies and shareholders

That faint cheering sound you may have heard on Jan. 15 was Wall Street celebrating a rare piece of good news. The U.S. Supreme Court handed bankers, accountants, and lawyers a big win by holding that they are virtually immune to fraud lawsuits brought against companies by disgruntled shareholders.

Business groups hailed the court's decision in StoneRidge Investment Partners v. Scientific-Atlanta as a victory against baseless litigation. Investor advocates complained that it would encourage corporate fraud. In the post-decision crossfire, many people were left with questions about the meaning of the ruling. Here are some answers:

What did the case say?That investors who lose money because of corporate fraud can usually sue only the company, its officers, and the directors. Rejecting the idea that shareholders should also be able to target a company's advisers and business partners, the majority opinion, written by Justice Anthony Kennedy, said that giving investors this power would potentially allow lawsuits to "reach the whole marketplace in which the issuing company does business."

Is that a change in the law?Not really. A landmark 1994 Supreme Court decision already had limited the ability of shareholders to sue "aiders and abettors" for securities fraud.

So what's the big deal?In the wake of the Enron debacle, in which accountants, investment bankers, and lawyers all played key roles, pressure increased to hold professional gatekeepers and other key players responsible for corporate wrongdoing. Plaintiffs' lawyers advanced a new legal theory, known as "scheme liability," which increased financial liability for third parties that helped a company commit fraud. Some federal courts accepted this theory. Now the Supreme Court's StoneRidge ruling has shot it down.

How does this affect investors?That's a debatable question. Investor advocates argue that the decision is bad for shareholders because it removes a substantial deterrent to corporate fraud: the threat that accountants, lawyers, bankers, and others might be financially liable for it. Moreover, StoneRidge is likely to reduce the amount of money defrauded investors can recover in civil lawsuits. But business groups counter that shareholder fraud cases are so costly and inefficient that limiting their scope will benefit the economy and the market as a whole.

So do accountants, bankers, and lawyers go unscathed?Not completely. While plaintiffs' lawyers will find it harder to squeeze money out of them in private shareholder litigation, the Securities & Exchange Commission is still free to bring fraud cases against these so-called secondary actors.

Will this case have an impact on litigation over the subprime lending crisis?That is obviously a big concern for many on Wall Street. Currently the subprime litigation storm is still building. Some shareholder fraud lawsuits have been filed against lending institutions such as Countrywide Financial (CFC) and investment banks, including Merrill Lynch (MER). You can be certain the lawyers and accountants who advised them are breathing more easily today.

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