Supreme Court’s LaRue and Stoneridge opinions are both pro-investor
A few weeks ago, the Supreme Court’s decision in Stoneridge v. Scientific-Atlanta was denounced by shareholder activists and much of the media as “anti-investor.” Why? Because the 5-3 opinion had limited the rights to sue “secondary actors” in securities fraud cases.
But today, those same five justices who put together the Stoneridge opinion — Anthony Kennedy, Clarence Thomas, Antonin Scalia, Samuel Alito and Chief Justice John Roberts — joined in the Court’s unanimous decision granting individuals in 401(k) plans the right to sue plan administrators. This case, LaRue v. DeWoolf will no doubt be hailed as “pro-investor.”
In my view, both cases were decided correctly. And the results of both cases should be characterized as pro-investor.
Today’s case, from the facts as stated in the decision, involved a clear breach of fiduciary duty. The plaintiff, LaRue, directed the administrator of his 401(k) to change the investment options in his plan. Those directions, however, were never acted upon, costing LaRue thousands in potential gains to his portfolio.
The issue at hand was the appeals court’s ruling that the federal law governing pensions — the Employee Retirement Income Security Act of 1974 (ERISA) — barred LaRue from suing because the administrator’s action didn’t affect the plan as a whole for all pension holders. ERISA was written when most workers were in the same defined benefit pensions, and didn’t have 401 (k) defined contribution plans with customized investments they could choose from.
Five justices, including Alito, joined in the majority opinion overturning the appeals court, saying ERISA allows lawsuits covering individual portfolios as well as plans as a whole. The four other justices concurred that LaRue’s lawsuit could go forward. Roberts and Kennedy wrote that the lawsuit was allowed under a different section of the law than that permitted by the majority opinion. And Thomas and Scalia opined that individual portfolios were encompassed by the word “plan,” thus the law made no distinctions between a defined and benefit and defined contribution plans; lawsuits can occur for breaches of either.
Stoneridge, by contrast, involved no breach of fiduciary duty, but “secondary actors” who participated in a transaction that defrauded investors. In this case, the defendants were suppliers of TV set-top boxes to a company that was manipulating its official costs and earnings. Thus, if this suit were allowed to proceed, lawsuits in similar cases could involve anyone who has a remote and unknowing connection to a company committing fraud. The Court wisely refused to read into the law such a broad standard for lawsuits, which would have had a devastating effect on U.S. capital markets and competitiveness.
As I stated when the Stoneridge case was being argued: “A ruling in this case that allowed broad “scheme liability” would hurt businesses and investors alike. Investors are harmed as excessive litigation hurts legitimate companies, and liability costs deprive shareholders of greater returns.
“Companies should be punished for participating in fraud, whether alone or with other businesses. But firms cannot be expected to know if every firm they do business with is committing fraud at a given time.”
I’m pleased that in both LaRue and Stoneridge the Court correctly interpreted federal law correctly to allow legitimate lawsuit for clear breaches of fiduciary duties but discourage frivolous suits that would drive up costs for the majority of investors.