(The news featured below is a selection from the news covered in SEC Today, which is distributed to subscribers of SEC Today.)

International Businesses Urge Supreme Court to Reject Scheme Liability

A consortium of international business organizations has urged the U.S. Supreme Court to reject scheme liability for non-speaking secondary actors in private securities fraud actions. From the perspective of foreign companies in particular, scheme liability is unworkable and would convert foreign companies in overseas transactions with U.S. entities into de facto auditors of their U.S.-listed counterparty's financial statements, according to the brief. In turn, the imposition of scheme liability would have a material chilling effect on the willingness of foreign companies to engage in general commercial transactions with U.S. public companies (Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., Doc. No. 06-43).

The brief, citing the German press, notes that scheme liability endangers transatlantic economic relations because it could be at odds with the spirit of the April 2007 U.S.-E.U. Economic Summit at which the parties agreed to work toward the harmonization of the regulatory environment for financial markets. The brief was filed by the International Chamber of Commerce and the Confederation of German Industries, among others.

In Stoneridge, the Court is slated to determine whether non-speaking actors, such as investment banks and auditors, that knowingly commit securities fraud can be held liable for their actions. The brief addressing this question, a concept known as scheme liability, was filed in support of the defendants in the Stoneridge case.

The battle over scheme liability is joined when investors argue that an investment bank or auditor need not have made misleading statements or omissions to be liable for securities fraud since participating with scienter in a sham transaction with no legitimate business or economic purpose should suffice. The countervailing argument is that the actors must make a misleading statement to be held liable under rule 10b-5. Scheme defendants who remain silent and owe no duty of candor to investors are categorically exempt under this argument.

According to the international group, scheme liability would inject into the U.S.'s carefully considered securities law enforcement system an unpredictable and potentially arbitrary mechanism for determining liability. That mechanism would be placed in the hands of the class action bar, not the SEC. In the consortium's view, that combination creates precisely the litigation risk that discourages foreign companies from doing business in the U.S.

The introduction of scheme liability to the legal landscape exposes those who engage in commercial transactions with U.S. issuers to liability for the issuer's misrepresentations and increases the likelihood that the silent counterparty could be held liable for scheme-wide damages in excess of those that can be traced to its conduct.

Confronted with such unpalatable realities, both foreign and domestic counterparties will either decline to engage in transactions with U.S. issuers or will do so only after engaging in a de facto audit of their counterparties' intended accounting and reporting, according to the brief. The group notes that foreign companies are particularly ill-suited to this gatekeeper role. The legal structures in the world's other major financial centers do not impose such illogical burdens.

For example, the U.K. Financial Services and Markets Act contains provisions similar to section 10(b) that impose civil liability for misleading statements made in financial statements. Under these provisions, issuers, as well as directors or other persons discharging managerial duties in relation to such issuers, may be liable for any false or misleading statements. However, liability is not imposed by statute or regulation on third parties that enter into transactions with the issuer which the issuer then misreports.

Similarly, the German Securities Trading Act limits liability for misstatements to the issuer and, potentially, to its directors and officers. The Act does not provide for claims against silent third-parties to commercial transactions that the issuer misreports.

Looking at the German and U.K. experiences, the international group said there is no reason to believe that the U.S. Congress, when it refused to restore a private right of action for aiding and abetting under section 10(b), intended that the U.S. be an exception among its peers. 

The group observed that international commentators view the scheme liability issue as a bellwether of the U.S. litigation environment. The group cites German press reports that the imposition of scheme liability would mean that businesses dealing with U.S. listed companies would have to examine the possibility of a false booking in every transaction, which is practically impossible.