The big news on Tuesday was the amicus brief filed on behalf of 27 luminaries (assorted SEC commissioners, professors, etc) supporting Respondents in Stoneridge. The big news from Wednesday was that the Solicitor General filed a brief supporting Respondents after having refused to file one on behalf of the SEC favoring Petitioner.  A copy of the brief can be found at the DU Corporate Governance web site. 

This brief will no doubt be viewed as an anti-investor move on the part of the Administration. In fact, if the Petitioner wins this case it will be in part because of the helping hand provided by the Solicitor General. How can that be?

The most difficult issue in the case concerns the type of behavior that can result in a finding of primary liability. This is particularly difficult where the ancillary actor did not speak, did not have a duty to speak, and did not participate in the disclosure process. On this issue, the Solicitor General comes down squarely on the side of Petitioner. Don't believe me? Let the brief speak for itself.

• The court of appeals in this case erred to the extent it held that Section 10(b) of the 1934 Act, 15 U.S.C. 78j(b), reaches only misstatements, omissions made while under a duty to disclose, or manipulative trading practices. The plain language of Section 10(b) demonstrates that it potentially reaches all conduct that is “manipulative” or “deceptive.” That interpretation is consistent both with the legislative history of the 1934 Act and with the contemporaneous understanding of the term “deceptive.” This Court’s cases provide no support for the conclusion that non-verbal deceptive conduct is somehow beyond the reach of Section 10(b). Properly understood, a person engages in “deceptive” conduct for purposes of Section 10(b) when the conduct by its nature is objectively likely to mislead another person, e.g. , when it has the effect of conveying a false appearance of material fact to an observer (assuming, of course, that the defendant possessed the requisite mental state in engaging in the conduct). Respondents’ alleged conduct constituted a “deceptive device or contrivance” because it not only was likely to, but allegedly did, mislead Charter’s outside accountant, Arthur Andersen, about the nature of the transactions into which respondents had entered. Such a reading of Section 10(b) does not nullify this Court’s holding in Central Bank that aiding and abetting liability is not available in a private Section 10(b) action, because a person cannot be liable as a primary violator unless it itself engages in deceptive conduct— and, critically, unless the other elements of primary liability under Section 10(b) are also established.

In other words, based upon the allegations in the complaint, Petitioner has alleged sufficient facts to establish that Motorola and Scientific-Atlanta fall within the definition of primary violator. 

Despite supporting Petitioner on this point, the brief was nonetheless filed in favor of Respondents. Here the Solicitor General repeated that, in addition to meeting the test for primary violator, a plaintiff also had to successfully plead all other elements of Section 10(b) and Rule 10b-5. No argument there. 

In this case, however, the Solicitor General takes the position that plaintiffs failed to establish reliance. As the brief noted: "Petitioner does not allege that it was even aware of the transactions that respondents executed with Charter; at most, petitioner relied on Charter’s misstatements in purchasing Charter stock." In other words, "the causal connection between respondents’ conduct and petitioner’s stock transactions is simply too attenuated to satisfy the reliance requirement."

Fortunately for Petitioners, this is an exceptionally thin reed to rest the case.  The Solicitor General is taking the position that shareholders must rely on the actual deceptive behavior, irrespective of its materiality or impact on the financial statements.  See Brief, at 21 ("In this case, petitioner does not contend that it relied upon respondents’ allegedly deceptive conduct ( i.e. , the backdating of the contracts increasing the price of the set-top boxes) in engaging in the relevant transactions ( i.e. , the purchase of Charter shares). In fact, petitioner does not contend that it (or the investing public) was even aware of the transactions that respondents executed with Charter.").  In this case, "it was Charter's misrepresentation of its cash flow, not respondents' conduct, on which petitioner allegedly relied."

The truth is that shareholders did not directly rely on either one.  Instead, under the fraud on the market theory of reliance, shareholders relied upon the integrity of the share price.  Even with respect to Charter's behavior, shareholders did not have to show actual reliance on any particular behavior or act.  It was enough to show that the misbehavior had a material effect on share prices.  The same is true of the behavior by Motorola and Scientific-Atlanta.

The brief does address the fraud on the market theory, merely noting that the "presumption applies only to publicly disseminated misrepresentations".  But wait.  Charter made false statements because of the allegedly deceptive practices of Motorola and Scientific-Atlanta.  Isn't that a public misstatement?  For the Solicitor General, apparently not.  See Brief, at p. 25 ("Petitioner's complaint does not identify any public statements or actions by respondents.").  In other words, liability may only be established if the actual deceptive behavior is disclosed.    

This is tantamount to the imposition of an actual reliance requirement in the case of actors who do not actually make the false statement.  See Brief at p. 22 ("Words or actions by a secondary actor that facilitate an issuer's misstatement, but are not themselves communicated to investors, simply cannot give rise to reliance (and thus primary liability in a private action).  That principal is at the heart of the distinction between primary liability and secondary liability of the kind rejected in Central Bank.").  That is strictly a policy decision, not one compelled by the language of Section 10(b) and the brief does not contain a compelling justification for the distinction.

We shall see if the Supreme Court uses Stoneridge as a case not cut back on primary liability but to erode the reliance element of Section 10(b) and Rule 10b-5.  Anything is possible but this is not likely.