Some legal experts expect the new Congress--with expanded Democratic majorities in both chambers and a new Democratic president--will take legislative action in 2009 to reverse U.S. Supreme Court rulings that sought to limit securities litigation.

Speaking at a Nov. 5 conference in San Francisco hosted by the Professional Liability Underwriting Society (PLUS), Stanford University Law Professor Joseph Grundfest said Christmas had come “early” for investor lawyers, and the only question is “what’s in the boxes and what’s under the tree,” according to The D&O Diary, a weblog written by insurance lawyer Kevin LaCroix. Grundfest, a former commissioner with the Securities and Exchange Commission (SEC), said that Congress may act legislatively to reverse the Stoneridge (2008) and Central Bank of Denver (1993) rulings, where the Supreme Court limited the liability of investment bankers, vendors, lawyers, and other “secondary” actors.

However, Keith Johnson, who heads the institutional investor services practice group at the Reinhart Boerner Van Deuren law firm in Wisconsin, cautions that Congress and the new president likely will address other pressing issues related to the global credit crisis before securities litigation. “I don’t see securities litigation reform at the top of Obama’s legislative agenda,” he told the SCAS Alert, noting that Congress may move first to enact reforms like “say on pay” advisory votes and proxy access, which “could have more impact” for investors.

Likewise, James Cox, a securities law professor at Duke University, told the SCAS Alert that he expects that Congress would address securities litigation reform after grappling with “the 800-pound gorilla in the room--the issue of regulatory reform.” He said he had heard that prominent plaintiffs' firms and Senate offices have been working on draft legislation to address Stoneridge.

The Stoneridge and Central Bank rulings address the scope of SEC Rule 10b-5, which was promulgated under Section 10(b) of the Securities Exchange Act of 1934. The rule, which is the legal basis for most securities class-action cases, makes it unlawful: “a) to employ any device, scheme, or artifice to defraud; b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.”

Though the law doesn’t explicitly authorize private shareholder suits, the Supreme Court held in 1971 that there was an implied right of action in Section 10(b) and its implementing regulations. However, in Central Bank, the justices ruled that this liability did not extend to “aiders and abettors.” In 1995, Congress passed the Private Securities Litigation Reform Act, which explicitly authorized the SEC to pursue “aiders and abettors,” while imposing new limits on private lawsuits. In response to Central Bank, plaintiffs’ lawyers argued that investors could still sue secondary actors if they directly participated in a scheme to defraud investors.

In Stoneridge, the Supreme Court upheld an appellate court ruling that barred Charter Communications shareholders from suing two vendors who allegedly helped the company mislead its auditor and investors but did not make any statements to Charter investors. “The determination of who can seek a remedy has significant consequences for the reach of federal power. . . . Concerns with the judicial creation of a private cause of action caution against its expansion,” Justice Anthony Kennedy wrote in the majority decision last January. “The decision to extend the cause of action is for Congress, not for us. Though it remains the law, the §10(b) private right should not be extended beyond its present boundaries.”

The Stoneridge decision was denounced by prominent Democratic lawmakers and investor advocates, while receiving praise from corporate groups. (For more details, please see the February 2008 edition of the SCAS Alert.) The case was decided by a 5-3 majority (with one justice not taking part). Johnson said one or two Obama-appointed justices might prompt the Supreme Court to revisit Stoneridge in a few years, but he said it would be simpler and quicker if Congress were to address the issue.

Adam Savett, head of RiskMetrics’ Securities Class Action Services unit, said he could see lawmakers acting to address the Stoneridge and Central Bank decisions. “If you read Rule 10b-5(a) and (c), it clearly anticipates liability for non-speaking defendants, as those two subsections do not even mention statements, like subsection b does,” he noted. “Thus, we have a disjunction between the actual rule and judicial interpretations of that rule. Congress may choose to resolve that and offer strengthened protections for shareholders.”

Cox said the accounting profession should support legislation to address Stoneridge. As the Duke professor explains, that decision provides little protection to audit firms, which certify financial statements and thus are deemed to make public statements to the investors of their corporate clients, while shielding other deep-pocket defendants (such as investment banks) that could contribute to securities settlements.