Yesterday, the Supreme Court granted certiorari to consider whether secondary actors can be held liable to shareholders under a "scheme" liability theory. Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 549 U.S. ___ (U.S. 06-43 Mar. 26, 2007).

The Supreme Court's decision comes hard on the heels of the Fifth Circuit's decision in the Enron litigation last week, which highlighted the growing Circuit split on the issue. The Fifth and Eighth Circuit Courts of Appeal have rejected scheme liability, and the Ninth Circuit has indicated that liability may be found under the theory.

The Eighth Circuit had ruled that a party cannot be liable under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(a) and (c) for engaging in “schemes” to defraud. The Eighth Circuit held that liability under Section 10(b) is limited to those who (1) “make or affirmatively cause to be made a fraudulent misstatement or omission,” or (2) “directly engage in manipulative securities trading practices.” Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 443 F. 3d 987 (8th Cir. 2006).

The Eighth Circuit affirmed dismissal of securities fraud claims asserted by shareholders of Charter Communications (NASDAQ: CHTR) against two of Charter’s vendors, Scientific-Atlanta, Inc. and Motorola, Inc. (NYSE: MOT). Charter’s shareholders alleged that the two vendors had entered into sham transactions while knowing that Charter intended to account for the transactions improperly. Neither Scientific-Atlanta nor Motorola made or affirmatively caused to be made any allegedly misleading statements directly to Charter’s shareholders about those transactions. Charter’s shareholders had alleged that the two vendors could be liable for participating with Charter in a “scheme” to defraud Charter’s shareholders. The vendors allegedly deceived Charter’s shareholders because the “sham” transactions artificially inflated Charter’s cash flow by about $17 million in one quarter, which thereby inflated revenue forecasts and Charter’s stock price.

In rejecting scheme liability, the Eighth Circuit relied on the Supreme Court’s earlier decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994). In Central Bank, the Court held that there was no aiding and abetting liability for claims brought under Section 10(b) and Rule 10b-5. The Court in Central Bank did not foreclose all liability for secondary actors, noting that the absence of aiding and abetting liability “does not mean that secondary actors in the securities markets are always free from liability.”

A dozen years after Central Bank, the federal courts are increasingly divided on whether “scheme” claims against secondary actors are different from claims for aiding and abetting against those same actors. Although the Eighth Circuit ruled that “scheme” liability cannot be squared with Central Bank’s prohibition on aiding and abetting liability, the Ninth Circuit has ruled that it can under limited circumstances. Last year, the Ninth Circuit held that secondary actors can be liable for participating in a scheme to deceive investors if they engaged in conduct that had the “principal purpose and effect of [creating] a false appearance of revenues” even if they did not make misleading statements. Simpson v. AOL Time Warner, Inc., 452 F.3d 1040, 1048 (9th Cir. 2006). And last week, the Fifth Circuit expressly rejected the Ninth Circuit’s standard and joined the Eighth Circuit in rejecting “scheme” liability for secondary actors. Regents of The University of California v. Credit Suisse First Boston (USA), Inc., et al., No. 06-20856 (5th Cir. Mar. 19, 2007).

The actual question presented for review:

Whether this Court’s decision in Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994), forecloses claims for deceptive conduct under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5(a) and (c), 17 C.F.R. 240.l0b-5(a) and (c), where Respondents engaged in transactions with a public corporation with no legitimate business or economic purpose except to inflate artificially the public corporation’s financial statements, but where Respondents themselves made no public statements concerning those transactions.