#10. No Tolling of the Statute of Repose
#9. The Elimination of Transnational Jurisdiction
#8. The Narrowing of What Constitutes Materiality
#7. The SEC’s Failure to Adequately Patrol Public Markets
#6. Heightened Pleading under Rules 8 and 9 of the Federal Rules of Civil Procedure
Now, on with the countdown.
#5. Pleading Scienter under the Private Securities Litigation Reform Act of 1995 (PSLRA) and the Potential Danger of Relying on Confidential Informants
Rule 9(b) of the Federal Rules of Civil Procedure states that “[m]alice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” In contrast, the PSLRA provides that in private actions under the Exchange Act, where “the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall . . . state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). President Clinton vetoed the PSLRA, stating that the heightened standard for pleading scienter “impose[d] an unacceptable procedural hurdle to meritorious claims being heard in Federal courts.” The PSLRA passed both houses of Congress over the president’s veto.
In Tellabs, Inc. v. Makor Issues & Rights, Ltd., the Supreme Court noted that “[t]he strong inference standard unequivocally raised the bar for pleading scienter.” The Court held that “in determining whether the pleaded facts give rise to a ‘strong’ inference of scienter,” the court must not only assume the truth of the facts alleged and all reasonable inferences but also “take into account plausible opposing inferences.” The Court explained that “the inference of scienter must be more than merely ‘reasonable’ or ‘permissible’—it must be cogent and compelling, thus strong in light of other explanations.” The Court concluded:
A complaint will survive . . . only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged. Therefore, a court may sustain a complaint only if a reasonable person would deem the inference of scienter at least as compelling as any opposing inference.
In addition, the PSLRA requires that “if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts upon which that belief is formed.” 15 U.S.C. 78u-4(b)(1). Some appellate courts have ruled that, although plaintiffs are not required to name sources, they must provide a detailed description of the source. See, e.g., Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242, 263 (3d Cir. 2009); Ind. Elec. Workers’ Pension Trust Fund IBEW v. Shaw Grp., Inc., 537 F.3d 527, 535 (5th Cir. 2008); Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 712 (7th Cir. 2008). Moreover, courts may order sanctions where a confidential informant later disavows statements attributed to the informant in a complaint. See City of Livonia Emps.’ Ret. Sys. v. Boeing Co., No. 09 C 7143 (N.D. Ill. Aug. 21, 2014). Thus, the PSLRA and this line of cases have clearly raised the bar for plaintiffs in pleading and surviving a motion to dismiss a private securities fraud case.
#4. No Private Cause of Action for Aiding and Abetting a Violation of Section 10 of the Exchange Act and the Potential Elimination of the Group Pleading Doctrine
The Supreme Court has made a number of decisions that have limited whom a plaintiff can sue. First, the Court has made clear there is no private right of action for aiding and abetting under section 10(b). See Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver N.A., 511 U.S. 164 (1994). The Supreme Court has also held that there is no “scheme liability” under the Exchange Act. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008). Further, in Janus Capital Group v. First Derivative Traders, 131 S. Ct. 2296, 2302 (2011), the Court held that a defendant “makes” a statement only if that person “is the person or entity with ultimate authority over that statement, including its content and whether and how to communicate it” (emphasis added).
In addition, the PSLRA and some courts’ interpretations thereof have essentially eliminated the group pleading presumption in private actions (though the PSLRA did grant the Securities and Exchange Commission (SEC) authority to bring actions under the Exchange Act against “any person that knowingly or recklessly provides substantial assistance to another person” who violates the Exchange Act or SEC regulations). 15 U.S.C. § 78t(e). Discussing the group pleading doctrine, the First Circuit stated that “[u]nder the group pleading presumption, a court may attribute all statements to the defendants as collective actions without considering the liability of each individual defendant.” Miss. Pub. Emps.’ Ret. Sys. v. Boston Scientific Corp., 523 F.3d 75, 93 (1st Cir. 2008). However, because the PSLRA refers to pleading “with particularity facts giving rise to a strong inference that the defendant” acted with requisite scienter, at least two other circuit courts and many district courts have held that the PSLRA’s “strong inference” requirement eliminated the group pleading doctrine. See, e.g., Winer Family Trust v. Queen, 503 F.3d 319, 337 (3d Cir. 2007); Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353, 364 (5th Cir. 2004) (collecting cases). See also Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1018 (11th Cir. 2004) (not ruling on remaining viability of group pleading, but stating “we believe that the most plausible reading in light of congressional intent is that a plaintiff, to proceed beyond the pleading stage, must allege facts sufficiently demonstrating each defendant’s state of mind regarding his or her alleged violations”). Thus, at least in these jurisdictions, plaintiffs must specifically plead each individual defendant’s culpable acts.
#3. Circuit Split on Whether a Reckless State of Mind Is Sufficient to State a Claim
Prior to the enactment of the PSLRA, all circuit courts of appeals that had addressed the issue had held that reckless behavior was a sufficient basis for liability under section 10(b). For example, the Second Circuit held that a plaintiff could allege facts that “give rise to a strong inference of fraudulent intent” by, among other things, “alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.” Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994).
The PSLRA, however, did not explicitly adopt the Second Circuit’s rule that allegations constituting “strong circumstantial evidence” of recklessness are sufficient. As a result, a circuit split has developed regarding whether a reckless state of mind is sufficient to state a claim under the PSLRA. In the Ninth Circuit, a plaintiff must plead “facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct,” and the court has held that “facts showing mere recklessness or a motive to commit fraud and opportunity to do so . . . are not sufficient to establish a strong inference of deliberate recklessness.” In re Silicon Graphics Secs. Litig., 183 F.3d 970, 974 (9th Cir. 1999). Similarly, in the First Circuit, scienter requires either a “conscious intent to defraud” or “a high degree of recklessness.” Miss. Pub. Emps.’ Ret. Sys. v. Boston Scientific Corp., 649 F.3d 5, 20 (1st Cir. 2011) (quoting ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 58 (1st Cir. 2008)). In contrast, in the Third Circuit, “recklessness . . . remains a sufficient basis for liability.” In re Advanta Corp. Secs. Litig., 180 F.3d 525, 535 (3d Cir. 1999).
#2. The Automatic Stay of Discovery
The PSLRA established that in any action arising under the Securities Act or the Exchange Act, “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds, upon the motion of any party, that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” 15 U.S.C. § 78u-4(b)(3). Under this regime, courts decide motions to dismiss based on the facts alleged in the complaint and the inferences drawn from those facts. This can be problematic because a defendant’s assertions as to what inferences the court may draw come from the briefs filed by counsel, rather than from fact discovery.
#1. Recent Court Decisions Creating Obstacles to Class Certification
The Supreme Court has held that class certification is proper only if “the trial court is satisfied, after a rigorous analysis, that the prerequisites of Rule 23(a) have been satisfied” and that this rigorous analysis may require a court to “probe behind the pleadings” into the merits of the plaintiff’s case at the class certification stage. Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2551 (2011). Then, in Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013), the Supreme Court held that, when ruling on class certification, the trial court could not decline to evaluate the methodology of the plaintiff’s expert witness’s testimony about damages, even if that evaluation might ultimately affect the ability of the plaintiff to establish damages at trial. Further, the Court held that, at the class-certification stage, plaintiffs must provide a class-wide damages model that is consistent with their theory of liability. In Re BP p.l.c. Securities Litigation provides a good example of how these decisions have created obstacles to successful securities class action claims. In that case, the United States District Court for the Southern District of Texas refused to certify one of two proposed subclasses because the plaintiffs had not met their burden under Comcast Corp. v. Behrend of “showing that damages can be measured on a classwide basis consistent with their theories of liability.” In Re BP p.l.c. Sec. Litig., No. 4:10-md-02185 (S.D. Tex. May 20, 2014), ECF No. 857. Both sides are appealing the district court’s decision to certify one subclass and deny certification of the other. Ludlow et al. v. BP, P.L.C. et al., appeal docketed, No. 14-20420 (5th Cir. 2014).
Last year, the Supreme Court decided Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014). The degree to which Halliburton creates an obstacle to plaintiffs is still to be determined, and both the plaintiffs’ and defense bar have declared the decision to be a victory. In sum, the majority held that plaintiffs need not actually prove reliance at the class-certification stage; rather, plaintiffs can still satisfy the predominance requirement of Rule 23(b)(3) by proving the prerequisites for invoking the presumption—i.e., publicity, materiality, market efficiency, and market timing. The majority also held, however, that defendants may seek to defeat the presumption of reliance at the class-certification stage through direct, as well as indirect, price-impact evidence. Adding to the mix, Justice Ginsburg, joined by Justices Breyer and Sotomayor, wrote a one-paragraph concurrence noting that the Court’s judgment “should impose no heavy toll on securities-fraud plaintiffs with tenable claims” because “it is incumbent upon the defendants to show the absence of price impact.”
Some Closing Thoughts on Overcoming the Obstacles
Although these 10 obstacles, and more, potentially stand in the way of successfully bringing claims, the Acts still maintain some vitality. For example, institutional investors may decide to opt out of class actions in favor of pursuing private actions. In addition, many non-U.S. jurisdictions have securities law regimes that are more favorable to investors, such as the Australian Stock Exchange’s “continuous disclosure” regime. Last, a handful of new plaintiffs’ attorneys and firms have emerged to monitor potentially fraudulent conduct and protect investor interests.