The Supreme Court's decision in Stoneridge Investment Partners LLC v. Scientific Atlanta will mean that mutual fund companies, could be better protected from class-action investor suits involving third parties that support the administration and running of a fund's trading floor and back office.

Some legal actions that target mutual fund service providers, such as suppliers, lawyers, bankers and auditors and any other "third parties," as long as investors weren't directly misled, will be non-starters as a result of the decision.

The case upheld the dismissal of a lawsuit against cable television set-top provider Scientific Atlanta and Motorola. The Supreme Court affirmed the lower court's decision by a 5:3 vote.

Stoneridge, an investment company, claimed in its original suit that Scientific Atlanta and Motorola helped fraudulently inflate revenue and cash flow in 2000 by implementing marketing support deals. Cisco Systems bought Scientific Atlantic in 2005 for $5.9 billion.

In their dissent, Justices John Paul Stevens, David Souter and Ruth Bader Ginsberg wrote that the majority decision was part of a continuing campaign by the Court to weaken private shareholders' rights to sue.

The closely followed case presents a double-edged sword to the managed funds industry, according to Roger Joseph, a partner at Bingham McCutchen.

"The decision stands for the principle that the courts won't expand individual private rights of action in lawsuits," he said. On the downside, it could limit mutual funds' ability to seek redress as institutional investor plaintiffs in, say, another Enron debacle.

And the impact on the mutual fund industry won't be dramatic, Joseph added. It will tend to reduce the number of lawsuits against fund companies but be of the greatest interest to parties who provide services to fund companies, such as annual report preparation, prospectus preparation and distribution and NAV calculations. Joseph said the decision will foreclose avenues of attack against these third parties.

"Anybody who provides a service to mutual funds may be better off as a result of this decision," he said.

For example, an investment bank that does a swap for a fund will be less likely to be brought into a case if the investment tanks in light of the Stoneridge decision.

Joseph said most fund managers will look at Stoneridge as a positive both for their industry in particular and for the entire securities industry since the litigiousness of the American system is often seen as drag on its competitiveness.

Indeed, the effect on U.S. competitiveness may have been a primary motivation for the Supreme Court. It said that a reversal of the lower court's decision protecting the rights of industry third-parties would hurt overseas funds with no other exposure to U.S securities laws. This would, in turn, raise the cost of being a public company or investing in listed companies under U.S. laws, and might discourage potential foreign investors.

For Robert Kurucza, a partner with Morrison & Forester, the imporantce of the Stonebridge decision is that it represents a return to the intent of Congress to narrowly interpret the rights of private actions in securities litigation.

"The pendulum had swung way too far in support of the rights of private actors," Kurucza agreed. "Any result other than upholding the lower court would have set the law about 17 steps beyond what I believe to be Congress' intent."

Kurucza added that nothing in the decision limits the SEC's ability to prosecute any companies where it suspects misbehavior.

Another fund industry attorney, Mike Wolensky, a partner at Schiff Harden, said that despite the initial positive reaction to the decision, fund managers would do well to not exaggerate any leniency they might expect from the decision.

"The euphoria will be short-lived once people read the decision. It is important that they listen to the music and read the words," he said.

Wolensky said that because the court found that Scientific Atlanta and Motorola were customer suppliers for the cable television firm, rather than advisers in the way that lawyers and bankers would be, there is less blanket protection for third parties than the case might indicate at first glance.

While the decision will likely reduce suits from individual shareholders, it doesn't change anything in the SEC's mandate to investigate potential wrongdoing.

As a result, Wolensky said fund executives should continue to look very hard at their compliance processes.

A number of legal experts who work with the mutual fund and managed funds industry said this month's Stoneridge decision may also have a secondary effect of making it harder for mutual funds to bring cases as plaintiffs in securities fraud situations.

"This case may make it harder for mutual fund companies to join classes of plaintiffs or to lead the actions in class action cases," Joseph said.

His colleague Kurucza concurred, noting that the new Supreme Court decision may make it more difficult for mutual funds to participate in suits as investors. He cited the example of an investment that went wrong as a situation in which a mutual fund could no longer sue.

But Kurucza added that this was a small tradeoff for the increase in rationality the decision as a whole brings to the market.

Another outgrowth of Stoneridge could be increased activity by state attorneys general if they choose to compensate for the increased difficulty individual investors have in bringing suits against members of the securities industry community. Joseph said that attorneys general may assume that since they can't rely on private civil litigants, they will have to find state law theory to bring the cases. So, while the asset management industry may have dodged some bullets with the decision, both the continuing threat of regulators' ire and a dedication to good business practices means that compliance will still matter.

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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