Commercial Developments: Private Securities Litigation Reform Act of 1995

One of the most significant developments in securities litigation is the passage of the Private Securities Litigation Reform Act of 1995. This act was approved by Congress on December 22, 1995, over President Clinton's veto. A complete analysis of this lengthy and comprehensive bill is beyond the scope of this article. Rather, this article will serve to highlight some of the more significant aspects of this new legislation.

Purpose

Essentially, Congress recognized the increasing trend of filing frivolous lawsuits based on a company's announcement of bad news, rather than on evidence of fraud. Congress was concerned that this abusive litigation threatened to undermine Federal securities laws.

As a result, Congress crafted this legislation to strike a balance between protecting the rights of victims of securities fraud and the rights of public companies to avoid costly meritless litigation. This new legislation was designed to promote three goals:

1. To encourage the voluntary disclosure of information by issuers,
2. To empower investors so that they, not their lawyers, control securities litigation; and
3. To encourage plaintiff's lawyers to pursue valid claims for securities fraud and to encourage defendants to fight abusive claims.

History:

Major proponents of this legislative initiative include professional groups, such as the AICPA, and major financial and corporate interests, such as high-tech companies. Enactment of this legislation was one of the top ten (10) objectives of the Republicans' Contract With America. As might be expected, this legislation was vigorously opposed by consumer groups, plaintiffs' trial lawyers, many state pension funds and securities enforcement agencies.

This legislation was passed by both Houses of Congress in mid 1995 and sent to a conference committee which issued a report in late November 1995. Both Houses passed the conference legislation, which eventually reached President Clinton in mid-December. On the last day for him to act, President Clinton vetoed the legislation. However, both the House and Senate overrode the veto, causing the legislation to become law on December 22, 1995. From a practical standpoint, the law is prospective only and affects private plaintiff class actions brought in Federal Court under the Securities Act of 1993 and the Securities Exchange Act of 1934.

Significant Changes

A review of the new legislation as a whole reveals the clear intent of its proponents to curtail securities class actions as much as possible. Some of the most significant aspects of the legislation include:

1. Proportionate liability:
   The new legislation reverses traditional joint and several liability standards unless plaintiff can establish "knowing" conduct against outside directors under section 11 of the 1933 Act and against all persons or claims under the 1934 Act. Determination of "non-knowing conduct" is to be determined by the jury's answers to special interrogatories. Damages awarded against a "non-knowing" defendant that are not collectible, or from a fully liable "knowing" defendant, may be collected from other "non-knowing" defendants in two respects:
   1. Plaintiffs, with net worth under $200,000 and whose damages are more than ten percent (10%) of their net worth, may collect in full;
   2. All remaining plaintiffs may collect based on further assessments against "non-knowing" defendants in proportion to their liability, up to an additional fifty percent (50%) of their share of damages.
   If a defendant settles, the plaintiff's judgment is reduced by the greater of the amount of the settlement payment or the proportionate liability of the settling defendant. Further, the Act provides that contribution actions by defendants must be brought within six (6) months.
2. Stay of Discovery:
   The Act provides that discovery is automatically stayed upon the filing of a motion to dismiss, unless the court finds exceptional circumstances where particularized discovery is necessary to preserve evidence or to prevent undue prejudice. All parties with notice are obligated to preserve evidence during the pendency of this stay or face possible sanctions as a penalty.
3. Heightened Pleading Requirements:
   The Act provides for enhanced Rule 9(b) pleading standards as to the particularity of pleading fraud. The enhanced Rule 9(b) pleading requires that the plaintiff plead facts that give rise to a "strong inference" of defendant's fraudulent intent. The plaintiff must also specifically identify each statement alleged to have been misleading, the reason(s) why the statement is misleading, and if the allegation is made on information and belief, the plaintiff must set forth all information in plaintiff's possession on which the belief is formed. Additionally, plaintiff is required to show that the misstatement or loss alleged in the complaint caused the loss incurred by the plaintiff.
4. Attorneys Fees:
   To significantly reduce the filing of meritless securities lawsuits, this act strengthens the application of Rule 11 in private securities actions. This legislation requires the court to include in the record specific findings, at the conclusion of the action, as to whether all parties and all attorneys have complied with each Rule 11(b) requirement. There is a presumption that the appropriate sanction for filing a complaint that violates Rule 11(b) is an award to the prevailing party of all attorney's fees and costs incurred in the entire action. Courts will grant relief from the presumption where a de minimis violation of the Rule has occurred.

Conclusion:

This article outlines only a few of the significant changes created by the reform act. Other areas impacted by the Act include safe harbor for forward looking statements, provisions concerning appointment of lead plaintiff, and sanctions which appear to increase the risk for plaintiffs and their counsel. Perhaps the most significant impact of this Act will be felt by the accounting profession. With the heightened 9(b) pleading requirements and the automatic stay of discovery upon the filing of a motion to dismiss, this Act will create many obstacles to joining accounting firm in securities litigation. In fact, President Clinton expressed his displeasure with the heightened 9(b) requirements indicating that such a requirement would be "insurmountable" and extends beyond requirements in existing law.