Caveat Plaintiff Congress Has Defederalized Private Securities Litigation

Publication year1998
Kansas Bar Journals
Volume 67.


Journal of the Kansas Bar Association
November, 1998


Congress has Defederalized Private Securities Litigation

Steven A. Ramirez [FNa1]

Copyright (c) 1998 by the Kansas Bar Association; Steven A. Ramirez

In the depths of the Great Depression, an economic catastrophe that slashed gross domestic product in the United States by 33 percent, Franklin Delano Roosevelt sent Congress historic financial market regulatory initiatives as part of his New Deal. Among these initiatives were the Securities Act of 1933 (the "33 Act") [FN1] and the Securities Exchange Act of 1934 (the "34 Act"). [FN2] Roosevelt intended these acts to heighten the fiduciary obligations of those selling investments and to thereby restore confidence in the nation's financial markets, which had recently degenerated into an historic panic. [FN3] In this regard, the federal government was following the lead of a number of progressive states such as Kansas, which had enacted similar securities regulatory schemes as early as 1911. [FN4] All of this legislative activity, at both the state and federal level, was designed to remedy common law deficiencies in dealing with inappropriate conduct in connection with the sale and purchase of securities. [FN5]

Page 17

Shortly after the enactment of the federal securities laws, [FN6] federal law became the primary source of remedies for plaintiffs suffering damages from the sale or purchase of securities. [FN7] The U.S. Supreme Court (initially at least), along with the lower federal courts, broadly interpreted the federal securities laws to effectuate their fundamental remedial purposes. The courts held that the federal securities laws extended remedies to victims of: fraudulent proxies, [FN8] misrepresentations made in the purchase or sale of small businesses, [FN9] insider trading [FN10] and even mere negligent misrepresentations in connection with the sale of securities. [FN11]

During the 1970s and 1980s most plaintiffs viewed federal law as the best means for pursuing securities-related claims of misconduct unless significant reasons to the contrary existed. In particular, most damaged securities investors rightfully viewed Rule 10b-5 [FN12] (promulgated by the Securities and Exchange Commission under rulemaking authority granted by Congress in Section 10(b) of the 34 Act) as the most beneficial and most broadly available remedy. In addition to the antifraud provisions of Rule 10b-5, the federal securities laws extended generous remedies for misconduct in connection with the sale or distribution of securities, misconduct in connection with proxy solicitations, and misconduct in connection with other securities-related activities. [FN13]

More recently, the judiciary and Congress have dramatically restricted the remedies available under the federal securities laws. [FN14] Now it appears the law has come full circle: Kansas law generally provides superior remedies to those that exist under federal law. This article will demonstrate that ordinarily practitioners are well-advised to pursue claims on behalf of injured investors under Kansas law rather than under federal law. Further, securities industry sponsored arbitration forums, available with respect to certain claims against those who agree to arbitrate (most notably registered broker-dealers), also provide a superior remedy to that available under federal law. The article concludes that unless there are compelling reasons to the contrary, practitioners should carefully consider the remedies available under state law and arbitration rules rather than assume the federal courts and the federal securities laws provide the best means of protecting investors damaged because of the purchase or sale of securities. Simply stated investors are usually well-advised to forgo federal remedies and seek state remedies. [FN15]

I. Introduction to securities litigation

Securities transactions often can be quite complex, but fundamentally they involve a buyer, a seller and information. [FN16] Information is key to assessing the ability of a given security to yield profits. Information suppliers in the context of securities transactions may include the seller, a broker or investment adviser, an attorney, an accountant or other professionals. Depending upon the specific type of securities transaction at issue and the specific nature of the professional relationship at issue, a number of federal and state claims may be triggered. For example, those in the business of providing information for the guidance of others involved in business transactions may be held liable for negligent misrepresentation. Those who stand in a fiduciary relationship with a party to securities transaction may be held to answer for breach of fiduciary duty. Similarly, the type of securities transaction also determines which claims are available. For example, sellers of securities in public offerings may be "strictly liable" under federal or state law for material misrepresentations made in connection with the public distribution of securities. [FN17] And, insiders who trade

Page 18

based upon non-public information may be held liable under the misappropriation theory recently adopted under federal law. Basically, securities litigation arises in three general contexts: [FN18] first, a customer may pursue claims against a broker, investment adviser or some other professional regarding management of an investment account or advice given with respect to a specific securities transaction; [FN19] second, investors who hold stock in a publicly held corporation may complain that material information was denied to them or misstated in connection with an investment decision; [FN20] and third, a dispute may center upon private securities transactions such as in a sale of a privately held business. [FN21]

The federal securities laws have traditionally had no pre-emptive effect on state law remedies. [FN22] Therefore, state common law remedies and state statutory remedies (frequently codified as a state "blue sky law") are cumulatively available along with any remedies available under federal law. Ordinarily, these cumulative state claims may be brought in federal court, pursuant to the court's supplemental jurisdiction. [FN23] For the most part, however, federal claims must be brought in federal court. [FN24] Nevertheless, a plaintiff may always forgo federal claims and seek relief under state law; thus, a plaintiff has wide discretion over which claims to pursue. [FN25]

The thesis of this article is that generally state law, or arbitration, provides a more generous substantive basis for recovery than federal law, for most relationships and types of transactions giving rise to securities litigation. Under certain circumstances certain federal claims may continue to be the best available. This article argues that those circumstances are now far more narrow than was traditionally the case.

II. An overview of private federal securities litigation: 1998

This article first illustrates the legislative and judicial retrenchment of federal remedies for misconduct in connection with the purchase or sale of securities. Next this article examines what is left of federal remedies for injured investors under the federal securities laws.

A. The incredible shrinking private federal securities remedies

In the past 10 years the courts and Congress have hacked away at traditional federal remedies available under the federal securities law for injured investors. Most recently, Congress enacted the Private Securities Litigation Reform Act of 1995 (the "95 Act"). [FN26] This act had far reaching consequences on the private remedies available under the federal securities laws. Even before the 95 Act the judiciary had already dramatically reduced the scope of federal remedies available to injured investors. In a series of decisions beginning in 1990, for example, the Supreme Court greatly restricted the availability of private remedies.

1. Statute of limitations

In 1991, the Supreme Court determined that the appropriate limitations period for claims brought under Rule 10b-5 is one year "after the discovery of the facts constituting the violation" and in no event more than three years from the date of the violation. [FN27] This is far more restrictive than prior federal law. [FN28] Before the Court's decision in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, the circuit courts had looked to state law to define the statute of limitations for claims under Rule 10b-5 for nearly 40 years. [FN29] Invariably these statutes of limitations were more generous to injured investors in terms of the statutory periods in which claims must be brought. [FN30] This is because the Supreme Court in Gilbertson basically ingrafted a strict liability, recision-based statute of limitations upon a fraud-based remedy. [FN31]

Page 19

Additionally lower courts, such as the U.S. 10th Circuit Court of Appeals, have interpreted this limitations period in a restrictive fashion, by starting the statutory period based upon constructive discovery. [FN32] Because of the great divergence between state and federal statutes of limitations, the Gilbertson decision had the effect of shifting many claims out of federal court and into state court. For example, as discussed later, Kansas has a far more generous statute of limitations for securities-related claims than that which is provided for Rule 10b-5 claims under Gilbertson.

In any event, because Rule 10b-5 is the broadest private remedy available under the federal securities laws, the Court in Gilbertson struck a hard blow for the defederalization of private securities actions.

2. Limitation of recision remedies

Section 12(a)(2) of the 33 Act provides a...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT