GPSolo Magazine - March 2006
Can Congress Legislate Litigation?
Let’s roll back the clock to 1995. We are in the middle of what turns out to be the longest economic boom in national history. In those sunny days, people saw the prospect of shareholder securities class action litigation as a serious threat to corporate expansion in key, high-growth business sectors. Those companies knew that whenever their future performances deviated from their management’s public expectations, they would be accused of having fraudulently misled investors.
In 1995 Congress passed the Private Securities Litigation Reform Act (PSLRA). When Congress did so, the two most important of the perceived ills were that securities class actions were too lawyer-driven, with investors having little control over the process, and that notice pleading standards did not adequately allow judges to weed out frivolous cases at the motion-to-dismiss stage.
In enacting the PSLRA, Congress sought to reduce the role of plaintiffs’ lawyers in securities litigation by increasing the role of the injured investors, and to restructure standard pleading and discovery procedures for the benefit of corporate defendants. The PSLRA revamped the process by which lead plaintiffs are selected. Previously, the race to the courthouse generally determined who would become lead plaintiff.
The PSLRA ended the practice of rewarding with lead plaintiff status the lawyers who drew the lowest docket numbers at the clerk’s office. What Congress did instead was to make the plaintiff with the largest economic stake in the litigation the presumptive lead plaintiff. The goal was to align the interests of lead plaintiff’s counsel with the interests of the lead plaintiff and of the class itself.
What has a decade’s experience shown? Judicial selection of lead plaintiffs under the PSLRA has increased the role of institutional investors in securities litigation. Institutional investors have the greater economic stake in the outcome of the securities cases that they bring, and they command greater resources. This, in turn, should make them active clients who, compared to pre-PSLRA plaintiffs in name only, are better able to monitor their counsel.
Congress believed that institutional investors serve the interests of the class better than smaller shareholders with a lesser ability to monitor the action. And Congress thought that institutional investors’ counsel would far better serve those interests than plaintiffs’ lawyers, whose self-interest was blamed for the prevalence of so-called nuisance suits. But the question remains: Has the PSLRA really altered the balance between the interests of the lawyers and the interests of the shareholder litigants?
Consistent with the intent of the PSLRA, institutional investors now commonly serve as lead plaintiffs in securities litigation. The economists who have mined the historical data suggest that cases with an institutional investor plaintiff settle for approximately one-third higher value than those with an individual plaintiff.
These relatively higher settlement values may suggest institutional investors are more than clients in name only, actually supervising their counsel and, with greater insight, demanding better results. The securities cases also may be settling for relatively greater amounts because institutional investor plaintiffs are more discriminating and seek to “invest” in the cases in which either the claims are strong or the losses are large—or both. And not surprisingly, the cases that do not attract the interest of an institutional plaintiff tend to be viewed—and valued—differently.
Congress wanted to increase the role of larger investors in securities litigation, and it appears to have accomplished that. But they still do not control the majority of the litigation. Institutions are lead plaintiffs in only about 35 percent of all securities cases. And if Congress also wanted to disenfranchise what was perceived or portrayed as an entrenched plaintiffs’ securities bar, that certainly has not happened either. The law firms dominant before the PSLRA have been the overwhelming counsel of choice for institutional investors, too.
Before the PSLRA, companies faced the unappealing choice of paying money to settle cases making relatively weak claims or suffering the exorbitantly high costs of discovery. Congress did two things to end the practice of filing generalized securities complaints and using the discovery process to dig for evidence to find an alleged fraud. First, it heightened the standard for securities fraud cases. Instead of notice pleading, plaintiffs must plead with particularity both a defendant’s alleged misrepresentations and scienter. Second, Congress stayed all discovery, with limited exceptions, against a defendant until determination of the motion to dismiss. Through these PSLRA changes, Congress attempted to increase dismissals of “meritless” cases and to shut down the costly discovery process until a complaint passed muster under the new heightened pleading standards.
What, if anything, Congress spared the court system in volume may be offset by the duration of litigation under the new regime. The filed cases that survive dismissal seem to take longer to resolve. The heightened pleading provisions, which Congress designed to handicap the ability to bring securities claims in the first place, has become a plaintiff’s strategic weapon where the motion to dismiss is denied; any suit that survives a dismissal motion significantly increases in value.
Plaintiffs’ lawyers started to figure out ways to avoid the federal system entirely and go where the grass was greener and the pleading standard was lower: state court. There, they would be beyond the reach of PSLRA. This prompted a revival of state common and statutory law claims. Congress responded by passing the Securities Litigation Uniform Standards Act (SLUSA) to try to shut down these end runs. SLUSA generally mandates that, whether an action is styled as a common law fraud case or an action based on another tort theory, if there are more than 50 plaintiffs and the facts of the case involve misrepresentations or omissions regarding the purchase or sale of securities, the case can be removed to federal court, where it will be dismissed on preemption grounds.
Testing the boundaries of what Congress had done, plaintiffs’ lawyers began pleading new and different claims that could not be removed to federal court yet still looked and smelled like securities fraud claims.
Securities fraud claims were disguised as state law derivative suits. Because of the traditional role of derivative suits and their well-established province of the state courts, Congress had carved them out of SLUSA, and these cases could not be removed to federal court.
Another type of claim, virtually unheard of before the PSLRA began to emerge: the state law “holding” claim. In these suits, plaintiffs allege not that fraud induced investors to buy or sell a security but rather that fraud induced them to hold a security they otherwise would have sold. Because these claims do not plead a purchase or sale of securities, they do not fall under Rule 10b-5. Currently before the U.S. Supreme Court is the question of whether such claims are nonetheless preempted by SLUSA.
Institutional plaintiffs also have begun going it alone in the wake of the PSLRA and SLUSA. An unintended consequence of PSLRA was that institutional investors realized not only that it was good to be lead plaintiffs in federal class actions, but that it sometimes was even better to be opt-outs and pursue their separate claims in state court.
Bruce Angiolillo is a senior partner in the litigation department of Simpson Thacher & Bartlett LLP in New York City. He can be reached at firstname.lastname@example.org.
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