Bill Would Restore Accountability To Companies Who Enable Fraud

specterFor the second time in as many weeks, Senator Arlen Specter (D-PA) has introduced legislation to overturn a Supreme Court decision that immunized corporations from accountability for their illegal acts.  Specter’s bill would strike down Stoneridge Investment Partners v. Scientific-Atlanta, which held that companies who enable other corporations to cook their books are immune from federal law banning securities fraud.

Stoneridge involved an elaborate scheme which a cable company called Charter Communications allegedly set up to trick investors into believing that its cash flow was much higher than it actually was.  As the Supreme Court explained the scheme:

Respondents [Scientific-Atlanta and Motorola] supplied Charter with the digital cable converter (set top) boxes that Charter furnished to its customers. Charter arranged to overpay respondents $20 for each set top box it purchased until the end of the year, with the understanding that respondents would return the overpayment by purchasing advertising from Charter. The transactions, it is alleged, had no economic substance; but, because Charter would then record the advertising purchases as revenue and capitalize its purchase of the set top boxes, in violation of generally accepted accounting principles, the transactions would enable Charter to fool its auditor into approving a financial statement showing it met projected revenue and operating cash flow numbers.Respondents agreed to the arrangement.

So Scientific-Atlanta and Motorola, agreed to overcharge Charter for an asset that Charter’s books would value at the inflated price, and also to overpay for advertising with revenues that Charter could account for as sales.  The result was a ledger which inflated Charter’s paper value without actually requiring Charter to earn any more money.

This kind of deception is illegal under federal securities law because it fools investors into investing in a company which is far less sound than its books suggest.  Stoneridge, however, held that companies which assist other companies in defrauding their investors are immune from private suits.  Considering that many companies who engage in Enron-style tricks do so because they are trying to hide their impending collapse, if more solvent companies who enable fraud are not accountable under the law investors are left with no one to seek compensation from when their stock becomes worthless.

Specter’s bill would fix this problem by allowing suits against anyone who provides “substantial assistance” to a company which defrauds its investors.  Hopefully, bills like this one will not only become law, but they will send a clear message to the Supreme Court to stop holding that corporate interests are immune from the law.