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Stock Fraud: Spread the Blame

Via the Stoneridge vs. Scientific suit, the Supreme Court should allow shareholders of companies found guilty of fraud to sue third parties such as lawyers and investment banks. Pro or con?

Pro: Sometimes It Takes Two

After the 1929 stock market crash, the government enacted federal securities laws to prohibit anyone from employing “any device, scheme, or artifice to defraud” or engaging in “any act [or] practice” that operates “as a fraud or deceit.” While those who commit securities fraud are infinitely—and perhaps wickedly—clever, the laws were drafted broadly enough to reach fraud in whatever guise it took. In the ensuing seven decades, as our country’s financial marketplaces experienced unprecedented growth and success, defrauded investors used these laws to recover billions of dollars and encourage honest corporate disclosure.

Now, only a few seasons removed from the largest wave of U.S. corporate scams in history, many of which required the knowing participation of investment banks, lawyers, and other third parties, the Stoneridge vs. Scientific Atlanta case will oblige the Supreme Court to decide whether these laws apply to everyone who participates in a fraud or will be narrowly circumscribed at the behest of corporate interest groups.

The case revolves around Stoneridge Investment Partners, an institutional investor that suffered losses when Charter Communications allegedly aided Scientific Atlanta—now owned by Cisco (CSCO)—in a fraudulent arrangement in 2000 and 2001 that caused Charter’s stock to inflate to $26.31, then drop to 76 cents. (The Eighth Circuit Court of Appeals ruled for the defendants.)

Parties such as Scientific Atlanta argue that those who intentionally commit fraud are immune from private lawsuits as long as they do not make a public statement. Thus, investment banks or law firms could willfully participate in a fraud for their corporate clients, but remain safely beyond the reach of the securities laws because they have not signed the company’s SEC filings.

This argument stands contrary to the plain language of the law, which states that anyone who commits securities fraud can face a lawsuit. In addition, the defendants ignore history when they argue that allowing investors to sue those who remain silent while committing fraud would destroy America’s “competitiveness.” Our capital markets rank as the world’s best because investors can defend themselves against wrongdoers, not despite it.

Indeed, even the SEC has rejected the defendants’ position, concluding that silence is not a defense and urging the Solicitor General to support investors in Stoneridge—advice the Bush Administration simply ignored in favor of siding with defendants.

Stoneridge provides a unique opportunity for the Supreme Court to protect the small investor against corporate interests. Let’s hope it is up to the challenge.

Con: Too Much Suing

Allowing private securities fraud suits against third parties is only a good idea if you think our economy is suffering from a shortage of litigation. The media tend to portray this issue as one that pits Big Business against shareholders. But turning third parties into potential defendants will hurt business, shareholders, and the economy as a whole, and help only lawyers.

There’s nothing wrong, in principle, with making wrongdoers pay for causing harm. In the real world, though, plaintiffs’ lawyers (who get a percentage of any settlement) don’t have much incentive to sue only the guilty, as opposed to any potential deep pocket—banks, lawyers, even vendors—connected with a company whose stock has declined. Imposing the costs and risks of securities fraud suits on this much broader group of potential defendants would translate into higher interest rates, higher professional fees, and more expensive products throughout the economy.

This might be justified if it were necessary to compensate injured victims. But it isn’t, because for every investor hurt by buying a stock at a price inflated by fraud, another is helped by selling at the higher price—and studies show that in the long run diversified investors break even. Settlements are little more than transfers from one group of shareholders (the defendants’ current shareholders) to another, with a massive deduction for legal costs and fees.

Even without third-party liability, securities fraud claims caused nearly $25 billion in shareholder wealth to be “wiped out just due to litigation,” according to an Institute for Legal Reform study. Allowing third-party suits would exponentially increase the number of potential defendants and take an even bigger bite out of the economy, while accomplishing nothing other than feeding the legal beast.

Congress made the right decision when it authorized “aiding and abetting” securities fraud suits against third parties by the SEC but not by private plaintiffs. The decision to bring such cases should rest with a responsible government agency, not with lawyers who have a financial interest in suing as many defendants as possible.

Opinions and conclusions expressed in the BusinessWeek Debate Room do not necessarily reflect the views of BusinessWeek,, or The McGraw-Hill Companies.

Reader Comments

Randy Hart

I believe the point here should not be that in the long run the good and bad of a fraud offset each other. Fraud is a mind set, and the idea should be to put the perpetrator in such a position as to make future fraudulent endeavors less profitable than past endeavors.

The rationale for entering into fraud is that the expected value of the gain outweighs the risk of exposure. Gains happen and the fees associated with the gains--like lawyers--are based on the monetary size of the transactions involved in the fraudulent activity. I see no difference between investment advisors and investment lawyers on the one side and plaintiff's bar on the other relative to the litigation argument. The only exception is that one sells his position to a jury and the other to a management group who has a lot to gain as well. The latter has a much easier time of it than the former.

It is just possible that our ethics need to be examined when we argue that fraud is OK so long as some people gain while others lose. The premise for a market to work in the "invisible hand" world is that information should be equally accessible to all. Fraud precludes that operation that causes harm to pricing mechanisms, job creation or lack there of, and cost of consumer and capital goods. One only has to look at WorldCom, whose fraud made the market believe that communications costs were much less than they really were. It crippled otherwise profitable companies, cost thousands their jobs (which were not replaced), and increased costs to the consumer as well. Competition was hurt as well as innovation.

It is my contention that fraud should carry a heavy weight of punishment not only to the those executing the fraud but also to those who enabled it via their advice. In the end, they are the only ones who gain, and it would be repugnant to allow the advisors to continue to avoid their culpability.


Wow! Could it be that Mr. Browne is a trial lawyer? I've seldom seen such distortion of reality and blatant pandering as is present in his argument.

Here is hoping that John Q. Citizen, who may not be fully aware of the facts and what is at stake in this case, can see past Mr. Browne's hyperbole.

The trial bar and its sue-em-all approach to life have done real harm to our economy, our society, and our culture. Here is hoping sanity will prevail in the Stoneridge case.

John Schlicter

Meir Feder's comment looks like it was written by the Chamber of Commerce. It is also premised on the assumption that all shareholders are diversified shareholders. It also assumes responsible government agency will pursue action, which is so absurd I won't even comment.


Why shouldn't investors be protected from fraud no matter who commits it?

Do we really want our country to be bamboozled by bad guys?

Gregory David

Against the Con.

Perhaps Mr Feder places no stock in crime and punishment, that third parties may think twice about aiding the fleecing of investors if they, too, run the risk of a jail term and the loss of their money.

To argue against punishing crime of this magnitude because (in his opinion) it would only help the lawyers, is a vote for the type of neo-Darwinist, criminal rationalization that like a cancer is attacking the foundations of our society. The privileged must be held as accountable as a lowly employee found pinching from the corporate coffers. I say no more "get out of jail free" cards for the rich and powerful.


Meir Feder's statement seems to be an oversimplification of the facts. Stating that illegal activity is okay because "someone benefits" is absurd. As long as there is incentive for companies to take a short cut, there will be people doing it. Taking away accountability gives them a blank check to commit fraud. I would hope that Mr. Feder never has to teach an ethics course.


In a word, culpability.

If external entities such as lawyers and investment banks are culpable in the fraud, then to argue that they should not be defendants in a suit that seeks redress is not only illogical but also suggests the existence of an abundance of skeletons in someone's closet.

Freedom from accountability inevitably leads to abuse; consider Blackwater.


Is stock "bashing" fraud?

Freedom 1776

The main perpetrators of the fraud are like the robbers who enter a bank and hold the employees at gunpoint. Those who assist outside (the driver of the getaway car) are enablers who make the robbery possible. The enablers are held responsible; likewise those who make the crime possible should be held responsible as well. All should spend time behind bars, pay heavy fines, and be subject to private lawsuits.


Third party securities lawsuits seem to be a frivolous abuse of our legal system. It's simply another way for companies accused of securities fraud to claim that they're innocent because of bad information provided by their legal and accounting advisers. The companies should be held accountable. If they, in turn, want to sue their lawyers or accountants to prove their innocence, that's their prerogative. Arthur Andersen's conviction in the Enron accounting scandal was overturned, but it still destroyed its reputation. Former Enron CEO Jeff Skilling still contends that he was unaware of any financial problems at the company because his advisers told him otherwise. You can decide who is ultimately responsible, but I don't feel allowing investors, who should be aware of potential risks in stock investments, have anything to gain by engaging in third-party lawsuits.


Clearly, any person or entity who commits fraud should be subject to criminal penalties and monetary redress, if appropriate (seems strange that anyone would argue otherwise).

Very few would argue that unnecessary litigation and frivolous lawsuits are not problems that ultimately waste time and money. But this problem should be dealt with as a separate issue. Would it really be that difficult to pass legislation that?:

1) limits legal fees (not awards), especially for class action lawsuits
2) gives judges the ability to levy large fines against lawyers and firms for engaging in frivolous lawsuits.

For example, for lawsuits where the redress requested is above a certain value (e.g. $5 million), then give judges the power to fine lawyers and/or their firms up to 50% of the requested amount (maybe tied to the amount of time wasted by the courts and defendants).

Assuming we can create a good and generally accepted definition of a frivolous lawsuit and the judges can be counted on to apply the statute appropriately and without prejudice, then we may actually have a new monetary flow--from lawyers to government coffers. Maybe even driving a tax decrease (there's always hope).


Hello. For those of you who do not know, frivolous lawsuits do not survive very long, and subject the filing party to monetary sanctions. They are a non-issue in today's legal environment. How can anyone justify the argument that, while I have engaged in intentional fraudulent conduct, I should not be held liable because I did not sign an SEC filing? Give me a friggin' break. Since I do not possess a specialized expertise in rocket science, I make it a point not to comment on matters of rocket science.

Alexander Higgins

Look at our current stock market crash. It's been caused by insurance fraud schemes run by Wall Street insiders (Wall Street executives plus edge fund managers).

1) Take insurance policies to protect a rating cut and/or bankruptcy, also know as credit default swaps.

2) Greedy CEOs involved in schemes take on trillions of insurance policies; they can't pay to make the banks risky.

3) Hedge funds short the stock, drive down the stock price, and get the credit ratings cut.

Everyone in the scam billions are made 1) on the short selling and 2) by collecting on the insurance policy/credit default swap.

R. Potter

Does Mr. Feder need a reality check? The mortgage crisis, and ensuing market crash, were caused by intentional fraud. The greed of the few outweighed the need of many for this to happen. Fraudulent behavior must be punished for the world to have confidence in our markets. Otherwise, we have nothing more than medieval feudal lords holding dominion over the masses.

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