Rogue Missives Friday, June 20, 1997

The In-Securities Act
Part 4: Raising the Bar
-- Louis Corrigan  (RgeSeymour)

Much to the chagrin of the Act's supporters, few courts have opted to simply dismiss securities fraud suits under the new law. Judge Smith, for example, allowed Milberg Weiss to re-plead the case. And in a move that suggests the importance of the case, the SEC filed a friend-of-the-court brief supporting the plaintiffs and urging Judge Smith to reverse her initial ruling. The recklessness standard, the SEC noted, "is needed to protect investors and the securities markets from fraudulent conduct."

Nonetheless, late last month, Smith stuck to her guns in handing down her ruling on the new plea. She dismissed the complaint against Silicon Graphics on the grounds that the plaintiffs had failed to meet the higher standard of "a strong inference of knowing or intentional misconduct." If this decision really signals the death of the recklessness standard, investors will indeed find it far more difficult to sue companies for fraud.

But reaction has been mixed regarding whether Smith's decision actually creates a precedent-setting interpretation of the Reform Act's pleading standards. That's because in her second ruling, she ambiguously suggested that "intentional misconduct" included "deliberate recklessness." As The Wall Street Journal reported, John Coffee, a well-known securities law professor at Columbia University, believes the decision does raise the pleading requirements. However, the SEC's general counsel Richard Walker said the decision meant investors could still allege recklessness. According to the Journal, Walker said, "This reaffirms that the standard of liability has not been changed."

Attorneys for both sides, however, believe the decision will raise the bar on securities litigation unless it's overruled on appeal. In the view of many opponents of the Reform Act, the decision in this case raises fears that the Act will not just curtail frivolous suits but will have a chilling impact on even meritorious complaints. As Mern Horan, executive director of the National Association of Securities & Commercial Law Attorneys told Business Week, "There's nothing about this suit that is frivolous. It's exactly what we were afraid of."

Many individual investors celebrated passage of the Reform Act, cheered by the prospect that the high-tech companies that have been driving the nation's economy and pumping up individual stock portfolios would no longer be quite so vulnerable to costly and, arguably, meritless lawsuits filed by vultures disguised as securities attorneys. Still, it should be troubling to all investors that we may have entered a new era in which we no longer can rely on standards even the SEC considers necessary to protect investors from fraud. The idea of now curtailing investors' opportunities to take their cases to state courts should be further cause for concern if not alarm.

On the other hand, it's apparent from the SEC's April study that the Reform Act has so far been a spectacular failure in the one area in which all investors would like to see it succeed: increased public disclosure. According to the SEC report, "the staff believes that the quality and quantity of forward-looking disclosure has not significantly improved following enactment of the safe harbor for forward-looking statements. So far, it appears that companies have been reluctant to provide significantly more forward-looking disclosure than they provided prior to enactment of the safe harbor."

Clearly, it makes sense that corporate counsels would advise companies to be cautious in making forward-looking statements, as least until the courts had a chance to define the new law. And given the rise of state courts as an alternative venue for litigation (which in retrospect should have been predicted by Congress), it's unlikely that the safe harbor provision will be a boon to investors until the shortcomings of the Reform Act have been resolved.

Indeed, one has to agree with John Doerr, NETSCAPE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NSCP)") else Response.Write("(Nasdaq: NSCP)") end if %> director and well-known Silicon Valley venture capitalist, when he says that companies want broadly enforced, uniform guidelines. It only makes sense. Or as INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> legal affairs director Douglas B. Comer told Business Week, "Nationally traded companies shouldn't have to follow 50 sets of rules in 50 different states." As Grundfest and Perino suggest, the "boom in state class action securities fraud litigation raises issues regarding the optimal coordination of federal and state litigation regimes and suggests that a systematic review of the issue by Congress is in order."

Still, the prospect that the recently proposed federal legislation could curtail rights afforded shareholders by state securities laws raises broader questions about the proper role of government in organizing public companies and the rules under which they must operate. Does it make sense, for example, to allow companies to skirt 50 different state rules at the same time they can pick and choose which state to incorporate in based on tax advantages and the relative laxity of governance standards required of them? If we're going to federalize antifraud standards, why not also federalize the business of issuing corporate charters? If we're raising the barrier on class-action lawsuits, why not also raise the requirements under which boards and managers operate?

Shareholder lawsuits turn on the issue of accountability. If we agree that litigation is always the worst option for insuring that companies are accountable to shareholders, why not spend more time considering alternatives?

--Louis Corrigan ([email protected])

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