The U.S. Supreme Court last week issued a decision upholdingprotections that shield secondary players from liability insecurities fraud cases--an action welcomed by insurers providingdirectors and officers liability coverage.

In Stoneridge Inv. Partners, LLC vs. Scientific-Atlanta Inc.(No. 06-43), the Supreme Court, in a 5-3 decision, affirmed lowercourt decisions throwing out a lawsuit by shareholders of CharterCommunications Inc. against two of the companies' suppliers.

The plaintiffs in the case had sued the two cable televisionequipment suppliers--Motorola and Scientific-Atlanta--that wereallegedly involved in deceptive transactions that helped Charter, acable television company, inflate its earnings and hide its failureto achieve its financial goals.

The Supreme Court majority opinion upheld a federal districtcourt in Missouri, which had dismissed the suit, and the 8th U.S.Circuit Court of Appeals, which had upheld the dismissal.

Supporting its decision, the Supreme Court majority said Chartershareholders didn't show they relied on the alleged deception bythe suppliers in making investment decisions.

"Reliance by the plaintiff upon the defendant's deceptive actsis an essential element of the...private cause of action" undersecurities laws, the majority said.

Motorola and Scientific-Atlanta "had no duty to disclose; andtheir deceptive acts were not communicated to the public," themajority continued, noting the investors "as a result cannot showreliance upon any of [those] actions except in an indirect chainthat we find too remote for liability."

In the underlying case, it was alleged that the cable companymade agreements with the two suppliers to pay inflated prices forcable boxes. The suppliers then turned around and used the excesscash to advertise on the Charter's cable system.

The inflated prices were listed as a capital expense, and theadvertising was added to revenues helping Charter meet securitiesanalysts' expectations.

The term of art involved in the case is "scheme liability,"according to lawyers active in securities litigation. That is theidea that third parties can be held liable for securities fraudcommitted by companies with which they do business.

A ruling allowing the Charter case to proceed not only wouldhave made suppliers liable for securities fraud committed by theirpublic company clients, but also could have made investmentbankers, accountants and law firms liable as well.

The D&O insurance industry had been awaiting the decisionwith bated breath.

Commenting on the ruling, Kevin M. LaCroix, an attorney and adirector of OakBridge Insurance Services, a Beachwood, Ohiobrokerage, noted that a different ruling by the Supreme Court--onesupporting the position that the investors urged--"would have had adramatic impact on the cost of liability insurance."

On his Web blog, "The D&O Diary" (athttp://dandodiary.blogspot.com), Mr. LaCroix said one notableaspect of the majority opinion was its reference to "extrajudicialconsiderations," which seem to have influenced the decision, suchas the potential impact that supporting the Charter investors'positions might have had on the relative competitiveness of U.S.financial markets.

In the ruling, for example, the majority noted that if theinvestors' position were recognized, "then contracting partiesmight find it necessary to protect against the threats, raising thecost of doing business."

Although Mr. LaCroix noted that while such considerations"arguably are irrelevant" to the central question in thecase--whether the claimants have a remedy under Section 10-b of theSecurities and Exchange Act of 1934, which imposes liability formanipulative devices and material misstatements made in connectionwith registered securities--the majority was correct about thebusiness costs.

In fact, Mr. LaCroix continued, if companies had been forced toget insurance to protect against not only the securities liabilityarising from their own conduct but also with respect to everycompany to which they are a customer or vendor, "the cost ofliability insurance would have soared."

Moreover, he added, "the burden of trying to underwrite thisexposure would have been enormous as well, not to mention extremelychallenging."

During the Professional Liability Underwriting SocietyInternational conference last November, insurer representativesoffered similar observations in advance of the Supreme Courtruling.

Heather Fox, senior vice president and chief underwritingofficer for AIG's National Union Fire Insurance Company ofPittsburgh, based in New York, said that if the Supreme Courtallowed suits against secondary actors, D&O and professionalliability underwriters could face "exponential exposure."

Insurers would have to look beyond the internal controls oftheir own clients to underwrite the coverage--forced to underwritethe internal controls of their clients' vendors and businesspartners as well, she said.

Following the decision, an AIG representative, Chris Winans,said that although the Supreme Court delivered "an importantdecision thwarting an attempt to broaden management liability, itis unlikely to have any impact on D&O claims trends."

"At AIG, our underwriting already assumed that the case would bedecided this way, so it doesn't affect our book of business," Mr.Winans said.

Mr. LaCroix also noted the unsurprising overall case outcome,writing that "more expansive possibilities may never really havebeen in the cards, given the lineup of the court."

"Yes, the decision could have changed things, but in the end, itdid not," he wrote. "In effect, Stoneridge represents a 5-3 votefor the status quo. While a decision for the investors could haveincreased the cost of insurance, the actual outcome on behalf ofthe vendors is unlikely to impact the cost."

Amy Goodman, a lawyer with Gibson, Dunn & Crutcher LLP, inWashington, D.C., said that before the case was decided, there wasconcern by D&O insurers "of additional liability beyond whichthey had contemplated." The Supreme Court decision "shoulddissipate that concern," she added.

Also reacting to the decision, Greg Flood, president of IronPro,the professional/management liability division of IronshoreHoldings U.S., told NU that "as a layman underwriter, I think thedecision gives us some certainty as to the potential liability ofsuppliers, consultants and vendors as contributors to securitiesfraud."

"It appears the court is saying that the SEC has to deal withsuch issues--not private securities lawyers," he continued.However, he added, "there is still the potential for the SEC toact, which would create more complexities."

Outside the insurance industry, the Supreme Court majority'sruling has detractors, including Democrats in Congress such as Sen.Chris Dodd, D-Conn., chair of the Senate Banking Committee.

"As the author of the Private Securities Litigation Reform Act,I stand second to none in my commitment to protect Americanbusinesses from frivolous litigation, but today's decision goesbeyond that common-sense law," Sen. Dodd said.

"Instead of protecting innocent businesses, it would protectwrongdoers from the consequences of their actions," he added. "Sucha misguided standard will do nothing to strengthen the competitiveposition of America's businesses and capital markets."