Rogue Missives Friday, June 20, 1997

The In-Securities Act
Part 2: Closing Loopholes
-- Louis Corrigan  (RgeSeymour)

Advocates of the proposed changes say the new legislation will close loopholes left open by the 1995 Act and which are now being exploited by those cagey plaintiffs' attorneys who will do anything to protect their business. So far, few investors seem overly concerned by or even aware of the possibility that the federal government might effectively curtail shareholder rights afforded by state securities laws. Even so, a study conducted by the Securities and Exchange Commission (SEC) recently determined that it was too early to draw conclusions about the 1995 Act and that amendments at this point would be premature. Meanwhile, at least one recent court decision has raised concerns about whether the 1995 Act is already creating unjustifiably high hurdles for investors seeking restitution from companies that may have defrauded them.

At the center of this re-opened can of worms is a study conducted by two Stanford law professors, former SEC commissioner Joseph A. Grundfest and Michael A. Perino. Made public on February 17, the study analyzes class action securities fraud litigation since passage of the Reform Act. The professors caution that their conclusions are preliminary, in part because few complaints have proceeded very far given that some of the novel provisions of the Act, such as changes in how lead plaintiffs are selected, effectively slow down the preliminary stages of litigation. Still, their findings offer important insights into what the 1995 Act has wrought.

For starters, the overall number of complaints is down, but only slightly. On an annualized basis, there are about 148 to 163 distinct state and federal class action securities suits being filed. That's down 7% to 16% from 176 in 1995, but comparable to previous years, particularly since stocks generally did quite well last year and so fewer companies turned in results that would make them likely litigation targets. Still, these statistics alone don't say much. Do they bear out opponents of the new law, who insist there were few frivolous lawsuits to begin with? Is the Reform Act in some way not tough enough to cut down on such meritless suits? Or given time for the courts to establish necessary precedents interpreting the law, will the new securities regulations eventually cut down on the litigation, meritless or otherwise?

What's clear, however, is that plaintiffs' attorneys have moved a significant number of cases to state courts, which have in the past seen relatively few class-action securities lawsuits. About a quarter of the suits last year were filed in state courts with no parallel filing in federal court, perhaps because the underlying facts of the case didn't seem sufficient to satisfy the more stringent new federal pleading requirements.

But even as state courts may offer more attractive alternative forums, plaintiffs' attorneys also appear to be using them to bypass new restrictions imposed by the Reform Act. While parallel filings of identical suits in state and federal court were rare prior to passage of the new law, 28% of federal filings last year had a companion state complaint. Backers of the 1995 Act had argued that plaintiffs' attorneys were filing meritless complaints but using the right of discovery to go on fishing expeditions that then allowed them to build a more substantive case. The Act allowed for a stay of discovery that essentially requires plaintiffs themselves to piece together sufficiently incriminating materials to convince a judge that a case has merit before forcing a company to hand over internal memos and the like.

State securities laws don't impose this roadblock, so parallel filings potentially allow plaintiffs to avoid the Reform Act's new constraints on discovery. As Grundfest and Perino suggest, an increase in state filings not only has the potential to undermine the intent of the Act; it will also increase the overall cost of litigation, as companies may find themselves defending themselves in state and federal court.

Part 3: Grounds for Litigation

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