After Federal Securities Reform: Blue Sky Ahead for Colorado Class Actions-part I

• Publication year: 1996
• Pages: 37
• Citation: Vol. 25 No. 7 Pg. 37

25 Colo.Law. 37 Colorado Lawyer 1996.

1996, July, Pg. 37. After Federal Securities Reform: Blue Sky Ahead for Colorado Class Actions-Part I

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Vol. 25, No. 7, Pg. 37

After Federal Securities Reform: Blue Sky Ahead for Colorado Class Actions---Part I

by Lisa S. Kahn and Laura M. Metcalfe

In December 1995, Congress enacted the Private Securities Litigation Reform Act of 1995 ("Reform Act"),(fn1) elevating the standards plaintiff investors must meet to plead and prove securities fraud under federal law. As reflected in the legislative history of the Reform Act, Congress intended to discourage perceived abuses in the filing of class action lawsuits against issuers of securities and their officers, directors and professional advisors.(fn2) This legislative reform followed significant judicial reform. Indeed, in the several years just prior to passage of the Reform Act, the U.S. Supreme Court issued landmark decisions eliminating and restricting claims available to investors under the federal securities laws.(fn3)

To date, however, neither the Colorado General Assembly nor the Colorado appellate courts have followed these federal leads. In fact, the same week Congress passed the Reform Act, the Colorado Supreme Court in Rosenthal v. Dean Witter Reynolds, Inc.(fn4) declined to follow federal law and liberalized the pleading required to state a claim for damages under Colorado's "blue sky" statute, the Colorado Securities Act ("Colorado Act").(fn5) The Rosenthal decision, coupled with the legislative and judicial reforms of the federal securities statutes, suggest that Colorado courts increasingly may depart from federal precedent once considered virtually determinative.(fn6)

Because of these recent counter-developments in state and federal law, defendants sued under the Colorado Act arguably face greater exposure to liability than defendants fighting federal claims. Among the advantages available to plaintiffs who sue under the Colorado Act are less stringent pleading requirements, statutorily authorized claims against aiders and abettors, a longer statute of limitation and no statutory safe harbors for forward-looking statements. In addition, investors suing under the blue sky statute may recover their attorney fees and possibly even punitive damages in appropriate cases. As a result, an increasing number of investors may choose to file their putative class actions in Colorado state court, premising their claims on purported violations of the Colorado Act rather than federal law.

This two-part article discusses some of the most important differences between litigating fraud claims under the federal Securities Exchange Act of 1934 ("1934 Act"), § 10(b) and Rule 10b-5, and litigating claims alleging violations of the Colorado Act analog, CRS §§ 11-51-501 and 604. Part I describes the primary substantive differences between the federal and state antifraud statutes, both as drafted and as interpreted by the courts. Part II will address strategic questions and procedural hurdles confronting parties litigating statutory antifraud claims in federal and state court, as well as the recovery rules under federal and state law.

Elements of Claims

Because CRS § 11-51-501 is virtually a verbatim recital of Rule 10b-5,(fn7) courts, practitioners and commentators had assumed before Rosenthal that the elements of the two claims were identical.(fn8) The elements of a claim under Rule 10b-5 are well established. In the Tenth Circuit, as elsewhere, a plaintiff must plead and prove that (1) the defendant made a false representation or failed to state, (2) a material fact, (3) with the requisite intent to deceive or defraud, (4) on which the plaintiff relied and (5) which misrepresentation or omission was the proximate cause of the plaintiff's damages, (6) in connection with the purchase or sale of a security.(fn9)

Even before Congress passed the Reform Act, federal law required plaintiff investors to plead and prove both that they relied on the defendant's misrepresentations or omissions and that those misrepresentations or omissions caused their losses.(fn10) The U.S. Supreme Court and the Tenth Circuit have recognized repeatedly that reliance is an element of a cause of action under Rule 10b-5,(fn11) and Congress now has codified the well-established judicial requirement(fn12) that plaintiffs also plead and prove "loss causation"---that the misrepresentation or omission was related to the market factor causing the decline in the price of the security.(fn13)

In December 1995, however, the Colorado Supreme Court declined to follow federal precedent requiring the pleading of both reliance and causation. In Rosenthal, the court looked to the "plain language" of the Colorado Act(fn14) rather than federal case law describing the elements of a Rule 10b-5 claim.(fn15) Listing the elements of a claim under Colorado's analog to Rule 10b-5, the court held that a plaintiff must plead and prove:

(1) that the plaintiff is a purchaser or seller of a security; (2) that the security is a "security"; (3) that the defendant

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acted with the requisite scienter; (4) that the defendant's conduct was in connection with a purchase or sale of securities; (5) that the defendant's conduct was in violation of section 11-51-123; and (6) that plaintiff relied upon defendant's conduct to his or her detriment, or that defendant's conduct caused plaintiff's injury.(fn16) [Emphasis added.]

The Rosenthal majority, reasoning that reliance is merely a means to prove causation, held that a plaintiff's complaint "need only allege reliance or causation."(fn17) Seizing upon this language, plaintiffs undoubtedly will attempt to argue that they need only prove causation generally (for example, that investing in the security caused them to lose money) in order to recover damages under the Colorado Act. However, the Colorado Supreme Court's opinion does not support this interpretation. As the majority explained:

At trial, when required to prove reliance or causation, a plaintiff must establish that a defendant's omission or misstatement was a substantial factor in determining the course of conduct that resulted in the plaintiff's loss.(fn18)

The court also noted that proof of causation will center on materiality, which in turn depends on whether a reasonable investor would consider the defendant's statement or omission important when making the investment decision.(fn19)

Thus, Rosenthal makes clear that although plaintiffs need not specifically plead reliance and causation as separate elements in their complaint, they still must prove adequate causation to recover damages at trial. Future debates may center on the precise proof necessary to satisfy the Rosenthal causation requirement. Plaintiffs will argue that they need only prove that, if they had not invested, they would not have lost money. Defendants will contend that plaintiffs must present evidence that the fraud both caused them to buy or sell the security and was a substantial factor causing the loss in value of the security.

Fraud-on-the-Market Presumption

The federal courts, while...