Scheme Liability -- look out!

I'm afraid the link in the title above requires you to have a NY Times Select subscription. You can read the story in print on the front page of the Business Day section of today's New York Times. The title is "Is Fraud OK If You Help Just a Little?" by Floyd Norris. The article discusses a case coming up through the federal courts, and due before the Supreme Court next fall.

This case involves Motorola, Scientific-Atlanta and Charter Communications, a cable television operator (In re Charter Communications, Inc., Securities Litigation, 443 F.3d 987, Fed. Sec. L. Rep. P 93,743 (8th Cir.(Mo.) Apr 11, 2006) (NO. 05-1974) and later Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., C.A.8, filed 2005, and with a slew of briefs dating up through June and July, 2007, with a writ for cert to Supreme Court July 7, 2007, granted at Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 127 S.Ct. 1873, 167 L.Ed.2d 363, 75 USLW 3034, 75 USLW 3508, 75 USLW 3511 (U.S. Mar 26, 2007) (NO. 06-43)
).

Motorola and Scientific-Atlanta allegedly colluded with Charter Comm to buy cable boxes from the first two at high prices, allowing Charter Comm to show the excess as profit on their books. Investors sued, and are asking to include Motorola and Scientific-Atlanta in "scheme liability" Here is a link to an accessible and excellent article in March, 2007 of International Business Times, "Court Considers 'Scheme Liability' Case," By Christopher S. Rugabe.

Wall Street and law firms around the country are closely watching the case, which won't be argued until the court's next term beginning in October. Federal appeals courts so far have split on whether such "secondary actors" can be held liable.

"This is probably the most important legal issue for the securities industry in a generation," said Robert Giuffra, an attorney at Sullivan & Cromwell who has defended corporations in securities cases.

Last week, the 5th U.S. Circuit Court of Appeals ruled against a class-action lawsuit brought by former Enron shareholders against several investment banks, including Merrill Lynch & Co. Inc. and Credit Suisse Group, over their alleged role in Enron's collapse [In re Enron Corp. Securities Slip Copy, 2006 WL 4381143, (S.D.Tex.,2006).June 05, 2006 (Approx. 109 pages)]. The Houston-based oil services firm went bankrupt in 2001 after a widespread accounting scandal was uncovered. Several executives pleaded guilty or were convicted of fraud, and investors and former employees lost millions in the debacle.

The 5th Circuit found that the banks may have knowingly "aided and abetted" Enron's fraud, but under a 1994 Supreme Court ruling, companies are generally protected from shareholder lawsuits even if they aid and abet fraud. However, the Securities and Exchange Commission can pursue civil actions in such cases.

The case the justices agreed to hear stems from an episode of alleged securities fraud by cable television provider Charter Communications Inc. in 2000. A Charter investor, StoneRidge Investment Partners LLC, sued Motorola Inc. and Scientific-Atlanta Inc., which is now owned by Cisco Systems Inc. StoneRidge alleged that the companies participated in sham transactions with Charter.

The NY Times column brings in another massive corporate fraud case with potentially long tentacles. The Refco company evidently was working a big fraud on buyers and investors, hiding massive debt. When a new hire tumbled to the deception, everything fell apart, bankruptcy ensued and stock prices dropped like a rock, hurting new investors of this company that had been acquired and then taken public.

In the aftermath, angry purchasers are suing everybody in sight, and looking for fraud prosecution. The interesting question become, how involved did a law firm, accountant or bank have to be in order to become liable? The law firm that did "due diligence" work on the purchase has been sued for assuring the purchaser that there was no problem when in fact there were huge problems. They are not suing for malpractice so much as looking for deep pockets in the fraud action to pick up after the bankrupt Refco.

Here is a link to a Boston Globe article from April, 2006 about the Refco case and mentioning the complaint filed against 3 banks and Grant Thornton as auditor for not alerting investors to the Refco fraud. Here is a link to an Aug. 9, 2007 MSNBC story about the initial Refco collapse and a pending class action by investors. Here is a brief article about Thomas H. Lee and partners (private equitry financiers) suing law firm Mayer Brown Rowe & Maw over the law firm’s role in the Refco fraud case. I am having trouble identifying the Refco cases in federal court. If readers can add info, it would be much appreciated!

I am guessing the law and accounting firms that do this sort of work are watching the outcome of these cases with 'bated breath. Scheme liability has a huge potential to implicate minor players in big liabilities! There seems to be a good article on the topic of Scheme Liability at 1571 PLI/Corp 991 , Practising Law Institute's THE EVOLUTION OF “SCHEME” LIABILITY UNDER SECTION 10(b), November, 2006 by Gregory A. Markel and Gregory G. Ballard of Cadwalader, Wickersham & Taft LLP.