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The U.S. Supreme Court hears arguments today in a case built as do or die; that's for investors trying to recover losses in cases like Enron. At issue is whether third parties like banks, insurance, and accounting companies can be held liable for conspiring with other companies that deceived their stockholders.

Earlier this year, the Securities and Exchange Commission voted to side with the investors, but President Bush overruled the commission.

NPR's legal affairs correspondent Nina Totenberg reports.

NINA TOTENBERG: With the Enron case waiting in the wings and largely dependent on the outcome, the case before the court today involves a cable company named Charter Communications that's alleged to have deceived investors by conspiring with two of its vendors to make Charter's balance sheet look better than it was.

The Securities and Exchange Commission found that in August of 2000, Charter realized that its operating cash flow would not meet projections. So to keep up its rosy image for investors, the company offered to pay its set-top box vendors some $17 million more for their product than had been agreed to, and in exchange the vendors would plow the money back into Charter by buying advertising. The revenue to Charter from these arrangements was the same amount it needed to cover its shortfall.

When Charter's day of reckoning finally came, the investors sued both Charter and the vendors. The investors alleged that the vendors had backdated documents to facilitate the scheme and that they knew that these sham transactions would help Charter keep an inflated stock price. A federal appeals court, however, threw out the case against the vendors, ruling that the set-top box manufacturers had engaged in an arms-length transaction for which they could not be held liable.

The appeals court sighted a 1994 Supreme Court decision that said aiders and abettors could not be sued for damages under the securities law. And the lower court said that since the vendors themselves had not made statements on which the investors relied, the vendors were only aiders and abettors. The investors appealed to the U.S. Supreme Court, contending that the vendors were primary actors in the scheme. Among the 28 friend of the court briefs filed on the case are dueling briefs from former SEC commissioners.

NYU law professor Arthur Miller represents two former SEC chairmen who are siding with the investors. He sees the vendors as intimately involved in the scheme to defraud.

Professor ARTHUR MILLER (New York University): These are not marginal actors. If you look at the facts of this case, you have blatant, active participation in the creation of transactions that were absolutely phony, that had zero business justification, coupled with falsification of documents and blatant lying. The only objective was to create a completely false image of revenues and profits. And if that isn't the eye of the statute, which strikes out against manipulative and deceptive practices, then nothing is.

TOTENBERG: The securities law bars any device, scheme or artifice that operates as a fraud or deceit on investors, and it allows investors to sue for damages to recover their losses. But the business community backed by some former SEC commissioners argues that the law applies only to those business entities that actually make representations to investors. In this case that would be Charter and Charter only.

Former SEC commissioner Joseph Grundfest teaches at Stanford Law School. He says that nobody's arguing that what the vendors did here is legal.

Dr. JOSEPH GRUNDFEST (Stanford University): The question instead is whether in addition to the prosecutions by the SEC and in addition to the prosecutions that can be brought by the federal government criminally, there should also be the ability for private parties to seek money damages layered upon this. And to that question the answer is no.

TOTENBERG: Grundfest contends that if Congress wanted to give investors the right to sue third parties like the vendors for damages, it's had plenty of opportunity to do that in the aftermath of the Supreme Court's 1994 decision ruling aiders and abettors out of bounds for such lawsuits. But Congress didn't take any action even when asked, observes Grundfest. And the vendors here are just aiders and abettors.

Dr. GRUNDFEST: The plaintiffs are attempting to engage in a level of semantic prestidigitation that I just don't think is going to fool anybody here.

TOTENBERG: The Charter investors and their allies counter that there's a big distinction between passive aiders and abettors and the vendors in this case, or the banks in the Enron case.

Chris Patti represents the University of California Board of Regents, one of the many institutional investors in the Enron case.

Mr. CHRIS PATTI (University of California Board of Regents): If you engage in deceptive conduct, you are not merely an aider and abettor. You're an actual participant in the fraud.

TOTENBERG: The stakes in this case run in the billions. It's not just Charter and Enron, but other major stock frauds. Charter and its allies, including the Bush administration, argue that the entire economy could be affected if third parties get roped into being sued for damages.

Again, Professor Grundfest.

Prof. GRUNDFEST: The rules for calculating damages in these private class-action lawsuits are absolutely insane. You can have a company that was involved in a very small amount of alleged wrongdoing in one of these transactions then becoming exposed to billions and billions of dollars of damages in these private class-action lawsuits.

TOTENBERG: Chris Patti, who represents the University of California in its investor suit against Enron, counters that federal law limits recovery in proportion to the offender's role in a fraud. He acknowledges though that in some cases like Enron, where the investors are suing the banks that helped Enron, the only way to recover losses is to sue the co-conspirators who are still solvent.

Mr. PATTI: It's true that we're going after the deep pockets, but they are also the main offenders. The fraud could not have occurred if it weren't for the activity of these banks. And in many cases the banks actually designed the phony transactions that led to the fraud.

TOTENBERG: William Donaldson, who served as chairman of the Securities and Exchange Commission from 2003 to 2005, supports that notion. Without investor suits, he says, there will be little if any incentive to stay out of such frauds since SEC fines are far smaller than paying losses to injured investors, smaller in many cases by not just hundreds of millions of dollars but by the billions.

Mr. WILLIAM DONALDSON (Former SEC Chairman): In theory, somebody will be able to be a knowing and active participant and not have any liability for that, and I think that's just wrong in terms of investor protection.

TOTENBERG: Now it's up to the Supreme Court to determine whether there's a de facto immunity from investor lawsuits for some active participants in a fraud.

Nina Totenberg, NPR News, Washington.

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