Writing for the Court, Justice Kennedy stated that because investors in a corporation do not rely on or even know about these sham transactions, they cannot be the basis for liability under § 10(b) of the Securities Exchange Act of 1934; at most, the Court said, this is “aiding and abetting,” which can be prosecuted by the Securities and Exchange Commission (SEC) but is not subject to private suit. The majority opinion was joined by Justices Alito, Scalia and Thomas and Chief Justice Roberts. In dissent, Justice Stevens – joined by Justices Souter and Ginsburg – argued that sham transactions are an actionable proximate cause of fraud on investors, and criticized the Court’s hostility to the 10(b) right of action and to implied rights of action generally. Justice Breyer was recused. 

Stoneridge filed a class-action securities fraud suit against Charter Communications, Inc., in which Stoneridge invested, and respondents Scientific-Atlanta and Motorola. The complaint alleged that Scientific-Atlanta and Motorola agreed with Charter to be overpaid for digital cable converter boxes and shortly return that overpayment by buying advertising from Charter. These sham transactions would be recorded by Charter in an unorthodox fashion “to fool its auditor into approving a financial statement showing it met projected revenue and operating cash flow numbers.” The respondents had no role in the financial statement itself. The Eighth Circuit held that the respondents were not subject to suit under § 10(b). AARP, consumer groups, and state retirement systems argued as amici that narrowing the scope of federal protections and remedies for securities fraud would endanger the investments of ordinary consumers, and especially retirees.

The Court began by noting that the private right of action under § 10(b) does not include aiding and abetting, and that “[r]eliance by the plaintiff upon the defendant’s deceptive acts is an essential element of the § 10(b) private cause of action.” It then stated that because the respondents owed no duty to Stoneridge and did not communicate their deceptive acts to the public, Stoneridge “cannot show reliance upon any of respondents’ actions except in an indirect chain that we find too remote for liability.” The Court continued: 

In effect petitioner contends that in an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect. Were this concept of reliance to be adopted, the implied cause of action would reach the whole marketplace in which the issuing company does business; and there is no authority for this rule.

In this case, the Court said, “[it] was Charter, not respondents, that misled its auditor and filed fraudulent financial statements; nothing respondents did made it necessary or inevitable for Charter to record the transactions as it did.” The Court dismissed the dissent’s complaint that its holding was contrary to common-law fraud principles, saying simply that “Section 10(b) does not incorporate common-law fraud into federal law.”

            To justifying its holding the Court invoked several broader considerations. First, the Court invoked federalism: if Stoneridge’s “scheme liability” theory were accepted, “there would be a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees.”

            Second, the Court interpreted Congress’s response to an earlier decision of the Court as supporting its narrow view of § 10(b). After the Court rejected aiding and abetting liability in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), Congress amend the securities law to allow the SEC to prosecute aiding and abetting, but did not allow for private suits. Justice Stevens attacked this as a non-sequitir, since Stoneridge alleged not aiding and abetting but acts of securities fraud by the respondents themselves.

            The Court also stressed what it saw as the practical dangers of scheme liability, which, it said, would raise the cost of doing business and deter foreign investors. Stevens also attacked this justification, arguing that America’s markets are desirable to investors precisely because they are secure against fraud.

            Critically, the Court also based its holding on general “[c]oncerns with the judicial creation of a private cause of action”: “The decision to extend the cause of action is for Congress.”

            Finally, the Court’s opinion stressed that the sham transactions at issue in the case “took place in the marketplace for goods and services, not in the investment sphere.” This language prompted Linda Greenhouse of the New York Times to speculate that the Court might permit “lawsuits with allegations that went closer to the heart of the integrity of the financial markets.”

            Justice Stevens’s dissent argued that the “Court’s view of reliance is unduly stringent and unmoored from authority,” including the common law of fraud. He dismissed as overblown the Court’s statements that “scheme liability” would reach “the whole marketplace.” Transactions like the ones here, he argued, are highly irregular, and scheme liability would exist only where a corporation like Charter committed fraud itself.

            Significantly, Stevens not only castigated “the Court's continuing campaign to render the private cause of action under § 10(b) toothless,” but criticized at length the Court’s general “mistaken hostility” to implied rights of action. He explained at length that it had been a founding principle of American law (later incorporated in most states constitutions) that “every wrong shall have a remedy.” The Supreme Court, Stevens noted, regularly employed this principle in construing federal statutes throughout the twentieth century, including the period when the Securities Exchange Act was enacted. Not until the “law-changing opinion” in Cort v. Ash, 422 U.S. 66 (1975), did the Court begin to restrict this approach, and only in 1994 in Central Bank did it apply its new parsimonious approach to securities fraud. “In light of the history of court-created remedies and specifically the history of implied causes of action under § 10(b),” he concluded, “the Court is simply wrong when it states that Congress did not impliedly authorize this private cause of action ‘when it first enacted the statute.’”