A significant decision in the area of securities laws was handed two days ago by the US Supreme Court in the case of Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. In its judgment (available here), the court (by a 5:3 majority) held that private actions for securities fraud (under Section 10(b) of the Securities Exchange Act, 1934) are not allowed against third parties who did not directly mislead the investors, but were business partners of the issuer company involved.
A class-action suit was filed by the investors of Charter Communications, Inc. against two suppliers of Charter, being Scientific-Atlanta, Inc. and Motorola Inc. The investors alleged that in order to enable Charter’s quarterly reports meet Wall Street expectations, the respondents Scientific-Atlanta and Motorola entered into a scheme with Charter so as to artificially inflate Charter’s earnings. The respondents executed contracts that enabled Charter to book higher profits and capitalize certain expenses so as to boost its financial results. The auditors (who incidentally happened to be none other than Arthur Andersen) were misled by these transactions and audited the financial results of Charter on that basis. The question that arose for consideration by the Supreme Court was whether the respondents, who were only suppliers and customers of Charter, were liable for defrauding Charter’s investors.
The Supreme Court ruled against any liability on the part of the respondents, Scientific-Atlanta and Motorola. The court ruled that there was no right of action because Charter’s investors did not rely upon the respondents’ statements or representations, as they had no role in preparing or disseminating Charter’s financial statements. The court held that the plaintiff must prove reliance, as here relevant, reliance upon a material misrepresentation or omission by the respondents.
A rebuttable presumption of such reliance is found in two circumstances. First, if there is an omission of a material fact by one with a duty to disclose, the investor to whom the duty was owed need not provide specific proof of reliance. Second, under the fraud-on-the-market doctrine, reliance is presumed when the statements at issue become public. Neither presumption applies here: the respondents had no duty to disclose; and their deceptive acts were not communicated to the investing public during the relevant times.
The court also affirmed its previous ruling that the private right of action does not extend to aiders and abettors. Upon a full consideration, the court held that the respondents were not liable to private action by the investors of Charter for any alleged misrepresentation.
As this decision in a sense represents the victory of business and corporations over the investor community, it has naturally generated a heated debate. Blawgosphere is replete with discussions about the outcome of the case and the reasoning of the Supreme Court. Those of you who may be interested in reviewing the case in the light of US securities law and policies may wish to refer to following blawgs for reactions (both positive and negative) on the decision:
- Scotus Blog
- Law & Business Professor Bainbridge
- Truth on the Market
- The Race to the Bottom
What, if any, are the implications of the decision for Indian companies? The implications, are I think, both direct as well as oblique. Let us look at each one of them as follows:
- Indian companies listed in the US: Perhaps it is this set of companies who will be impacted directly by this decision. Investors in these companies would not have a private action against third parties that are not responsible for misrepresentation. For instance, customers and suppliers of US-listed Indian companies would have no liability under US securities laws.
An interesting question that this throws open is whether other third parties involved in relation to an issuer company such as investment bankers, accounts and lawyers would also be entitled to take the benefit of the Supreme Court decision in Stoneridge and thereby exonerate themselves from liability. Prudence indicates that that would not be the case because parties such as investment bankers, accountants and lawyers are more closely involved in the investment matters pertaining to issuers than are customers and suppliers and hence they are more proximate to acts of the issuer company in issuing statements of the company that cause misrepresentation among investors. However, this question is yet open and we may have to await a future ruling on this issue before it can be put to rest.
- Indian companies looking to list overseas: One of the important considerations for Indian companies that choose to list overseas also pertains to the stringency of regulatory regimes in the jurisdictions that they plan to list. A relevant criterion these days relates to the strict disclosure and internal control measures imposed on US-listed companies by the Sarbanes-Oxley Act of 2002 that significantly increases compliance costs on these companies. Owing to this, one also begins to witness the emergence of regulatory competition with other jurisdictions and stock exchange such as London, Singapore and Hong Kong vying to attract issuers from countries like India to list on their exchanges. Furthermore, the depth and robustness of the Indian capital markets themselves need not be reemphasized more – what with the Reliance Power IPO taking all of one minute to lap up its full offering size of US$ 3 billion.
It is in this overall context that we consider a policy statement made by the US Supreme Court in the Stoneridge decision:
“Overseas firms with no other exposure to our securities laws could be deterred from doing business here. … This, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets”
Clearly, this statement evidences the court’s concern about regulatory competition and flight of capital markets from the US to other countries where issuers play the game of regulatory arbitrage, and therefore that the US securities laws should be interpreted so as to prevent a dilution of domestic markets. In other words, this statement (by implication) is a recognition that not only should US companies be prevented from listing elsewhere but also that the liability regime should be conducive for foreign issuers (such as Indian companies) to be listed in the US markets.
- Indian companies doing business with US-listed companies: The policy statement of the court quoted above also seems to take into account other companies that are not listed in the US (or for that matter listed anywhere at all) that may be doing business with US-listed companies either as suppliers or customers or in any other capacity. If third parties were held liable for private actions by investors, then that would result in outside entities that are customers or suppliers having to submit to US securities law. For example, there are thousands of Indian companies that do business with US-listed entities, but are themselves not listed in the US. By its decision, the court avoided a perverse situation where such Indian companies may have had to comply with US securities laws by merely doing business with US-listed entities.
- Persuasive value under Indian law: Although the US Supreme Court decision is not binding when it comes to interpretation of Indian securities laws dealing with third party liability, either under the Companies Act, 1956 or the Securities and Exchange Board of India Act, 1992 and the various regulations and guidelines issued thereunder, Indian courts may be persuaded by the reasoning of the US Supreme Court. As issues of securities regulation are fairly at an evolutionary stage, courts and regulatory authorities in India often refer to the jurisprudence developed in the US for assistance. For example, it is not at all unusual for SEBI and the Securities Appellate Tribunal (SAT) to defer to US cases in areas like insider trading and securities fraud, all mainly pertaining to Section 10(b) of the US Securities Exchange Act, 1934.