When Justice Kennedy announced that he is stepping down from the US Supreme Court, the profiles of his time on that bench said a good deal about abortion, homosexual rights, and other hot-button issues, but relatively little about Kennedy’s contribution to securities law. Yet it is worth remembering that he has had an impact on this subject, one of which many alpha seekers (and their counsel) are presumably aware.
Kennedy was the author both of the court’s Central Bank of Denver decision (1994) and of an important follow-up to and expansion of that decision fourteen years later, Stoneridge v. Scientific-Atlanta (2008).
The question both cases address is, in broad terms, this: when does a corporation that issues securities have to factor into its calculations the possibility of a shareholder (civil) lawsuit, and the probability of plaintiff recovery, in addition to whatever worries it may have about the public regulatory authorities? When and to whom will courts extend compensation for securities fraud under an implied right of action found in section 10(b) of the Securities Exchange Act of 1934?
Justice Kennedy sided with the defendant/issuer in each case. He wrote the decision in the 1994 case holding that 10(b) does not create a right for a plaintiff shareholder against the aider or abetter of stock fraud, but only to those with primary liability, those who engage in a manipulative or deceptive practice. He also write the decision in the 2008 case that said, in effect, “and we meant that.” It held that third parties, such as accounting firms and investment banks, cannot be graduated from aiders and abetters into principals simply by the claim that there was a scheme and that the third parties were partners with the issuer in that scheme. They are still, from the point of view of the purchasers of stock … third parties.
Central Bank
The Central Bank decision was a 5 to 4 vote. Kennedy was writing for himself, Chief Justice Rehnquist, and Justices Thomas, Scalia, and O’Connor. Of these five, Kennedy and O'Connor had a reputation at the time as jurisprudential "centrists," while the other three were firmly regarded as of the right. John Paul Stevens wrote a dissenting opinion, joined by Blackmun, Souter, and Ginsburg. This was the usual "left wing," except for centrist Souter.
The nub of Kennedy’s decision was: “Congress has not enacted a general civil aiding and abetting statute -- either for suits by the Government (when the Government sues for civil penalties or injunctive relief) or for suits by private parties. Thus, when Congress enacts a statute under which a person may sue and recover damages from a private defendant for the defendant’s violation of some statutory norm, there is no general presumption that the plaintiff may also sue aiders and abettors.”
Stevens’ dissent argued that the courts had by then accepted the implied right of action against aiders and abetters as settled law for decades. He complained that the majority had reached into the bowels of a case that had originally been appealed their way on a very different basis, in order to find here a pretext for unsettling that formerly settled point.
Stoneridge
Stoneridge (2008) was a 5-3 decision, because Justice Breyer took no part in these deliberations. Kennedy again wrote for the majority, joined now by Chief Justice Roberts as well as by Justices Scalia, Thomas, and Alito. It is fair to say Kennedy was now the only jurisprudential "centrist" in this line-up. Stevens again wrote a dissenting opinion, joined again by Souter and Ginsburg.
Plaintiffs had sought to evade the effect of Central Bank by arguing for "scheme liability." The third parties involved weren’t mere aiders and abetters, they were equals with the issuer (Charter) in a scheme to defraud. The nub of Kennedy’s opinion was the rejection of this argument. Petitioners relied upon Charter’s financial statements and they were not in the same sense in reliance upon anything coming from Scientific-Atlanta. Thus, the two were not on the same footing with regard to liability.
In effect Kennedy was saying here, “Sorry plaintiffs, but you cannot turn an abetter into a principal just by calling it such.” What does all this have to do with the hunt for alpha? These two cases indicate that we still live in a legal world in which the principle of caveat emptor applies to the buyers of issued securities. It is not the only principle to be applied but it is not one that can be thoroughly forgotten either. Confirming that point is part of the retiring Justice Kennedy’s legacy.