Class action certification in private securities litigation: endangered species?

Author:Caulfield, Margaret Anne

"Once, long ago and far away--say, before mid-2006--securities class actions were almost automatically certified." (1)


In the late 1990's and in 2000, an exceptionally large number of initial public offerings ("IPOs") traded at "extraordinary and immediate aftermarket premiums." (2) During this bubble period, a select few investors received these "hot" allocations. (3) Regulatory agencies probed into the impropriety of the distributions and investor confidence in the integrity of the pricing process plummeted. (4) Furthermore, corporate accounting scandals, most notably with Enron and WorldCom, ran rampant. (5)

In an attempt to reform the underwriters' improper IPO practices, the New York Attorney General's Office and other regulatory agencies entered into a $1.4 billion "Global Settlement" with the nation's top ten investment banking firms. (6) The goal of this historic agreement was to "balance[] reform in the industry and bolster confidence in the integrity of equity research" along with resolving the existing conflict of interest schemes. (7) Additionally, enforcement actions by these agencies addressed improper IPO arrangements. (8) For example, the National Association of Securities Dealers, Inc. ("NASD") and the Securities and Exchange Commission ("SEC") filed a set of IPO rules aimed at promoting fair IPO allocations. (9) Also, at the SEC's request, the NASD and the New York Stock Exchange ("NYSE") formed an IPO Advisory Committee that issued a report recommending changes in regulations applicable to IPO underwritings. (10) These regulatory agencies also brought actions against corporate officers at Credit Suisse First Boston ("CSFB") and Salomon Smith Barney ("SSB"). (11)

In the aftermath of the high tech bubble burst and resulting corporate scandals, individuals sought redress against underwriters. (12) Specifically, many shareholders brought private class actions to seek justice for their securities fraud claims. (13) Today, despite the scandals and reforms, "[o]nce-thriving securities-fraud lawsuits, hailed by shareholders and bashed by businesses, are facing an onslaught of legal challenges that could cripple the controversial class actions." (14) Class action lawsuits are decreasing in frequency and "[b]usinesses are stepping up their assault on what they call frivolous litigation." (15)

This Note, guided by Rule Twenty-Three of the Federal Rules of Civil Procedure ("Rule 23") and appellate case law, explores a major procedural hurdle that plaintiffs face during securities class action certification. (16) Part II examines the history of securities fraud class action claims. (17) Sections A and B of Part II observe the role of Rule 23 in securities class actions by outlining the certification requirements and the Rule's 1998 amendment that impacts these actions. (18) In addition, Section C takes a close look at the current circuit split over the extent to which courts may inquire into the merits of a case in evaluating class certification. (19) Specifically, this section compares the "some showing" standard with the "rigorous analysis" standard behind this inter and intra circuit conflict. (20)

Part III explores the potential impact of the In re Initial Public Offerings Securities Litigation (21) [hereinafter In re IPO] decision. (22) Specifically, issues considered in this section include: forum shopping by the plaintiffs, extension of discovery for counsel, small investors' prospects of going solo, and whether other federal class action suits will be affected. (23) Finally, Part IV concludes with a suggestion that at the class certification stage, judges must allow the parties to develop and present a full record of Rule 23 issues. (24) These tough standards will likely result in the contraction of class action certification for securities litigation. (25)


Class Action Development and Procedures

In the aftermath of the stock market crash of 1929 and during the New Deal, Congress enacted the nation's first two pieces of federal securities legislation: the Securities Act of 1933 ("Securities Act") and the Securities Exchange Act of 1934 ("Exchange Act"). (26) Both Acts only provided for government enforcement of securities laws violations. (27) In 1971 the United States Supreme Court held that section 10(b) of the Securities Act allowed for a private right of action. (28) Once the private right of action was allowed, a litigation explosion ensued and securities suits began to be filed as class actions under Rule 23. (29) Securities class action abuse followed, prompting Congress to enact litigation reform. (30)

Federal Rules of Civil Procedure Issue in Securities Class Actions

The Private Securities Litigation Reform Act ("PSLRA") heightened pleading standards for securities class actions and made class certification the critical litigation decision. (31) Historically, Rule 23 was interpreted liberally and courts generally found class certification appropriate for securities litigation. (32) Further, "for many years, effective, timely and meaningful appellate review of class certification order in securities class actions was lacking." (33) In 1998, Rule 23 was amended to include 23(f), which allows parties to request an immediate appeal by the circuit courts of any order granting or denying class certification without having to first obtain consent from the lower court. (34)

This Rule, however, does not state the standard of review to determine whether such appeal is warranted. (35) Each circuit court of appeals articulated a standard for its jurisdiction. (36) The "reverse death knell doctrine" weighs heavily on all jurisdictions and "applies where the order granting class certification so raises the stakes for the defendant that it will be forced to settle rather than proceeding with a 'bet the company' trial." (37)

Rule 23(f) impacted securities class actions in numerous ways by allowing interlocutory appeals. (38) These appeals involve: (1) the basic requirements of Rule 23 and the standard used to determine if met; (2) the proper standard for district courts in ruling on motions for class certification; (3) the important underlying substantive law; and (4) the application of the "fraud-on-the-market doctrine." (39) Recent decisions emphasize that trial courts should conduct a rigorous analysis of class certification requirements and carefully analyze the evidence supporting certification because of the impact of class certification on defendants. (40)

Class Certification Standards Under Fed R. Civ. P. 23: In re IPO

Securities class actions were almost automatically certified before mid-2006 because of: "(1) the 'fraud on the market doctrine' which eliminated the need to show individual reliance[;] (2) a minimal loss causation standard; and (3) the rule in Eisen v. Carlisle & Jacquelin, (41) that the district court could not, at the certification stage, 'conduct a preliminary inquiry into the merits of a suit.'" (42) Classes were filed, certified, and then generally settled. (43) Recently, the circuit courts have issued conflicting opinions addressing the way trial courts should certify a class in securities cases. (44) Particularly, the "merits" inquiry and the "fraud-on-the-market" doctrine received attention. (45)

  1. Circuit Split Over the Extent of the "Merits" Inquiry When Evaluating Class Certification

    The source of the appellate court conflict is the appropriate evidentiary standard--the extent of inquiry into the merits of a case--necessary to satisfy class certification requirements. (46) Courts take two very different approaches to class certification. (47) The minority stance is that the class certification decision should be made "as soon as practicable after the commencement of the action" and be "tailored to facts emerging in discovery." (48) The minority courts, using the "some showing" standard, find that class certification is "divorced from the merits of the claim." (49) The majority of circuit courts disavow that certification is always divorced from any inquiry into the merits of the case. 50 These courts adopt a "rigorous analysis" standard in deciding class certification. (51) The district court must make sure that every Rule 23 requirement is met before certifying a class. (52) Confusion arises when a Rule 23 requirement overlaps with the merits of the case. (53) When an overlap occurs, the conflict becomes whether the trial court has the authority to conduct an inquiry into the merits during the class certification stage. (54)

  2. The Second Circuit's "Rigorous Analysis" Determination

    The Second Circuit acknowledged Rule 23's uncertainty and clarified the standards governing class certification motions in its recent decision in In re IPO. (55) The court determined the appropriate standards that govern a district judge in adjudicating a motion for class certification under Rule 23. (56) Specifically, the court addressed whether the 2003 amendments to Rule 23 are consistent with the "some showing" standard that the Second Circuit utilized in previous decisions. (57) The Second Circuit dealt the plaintiff's bar a significant blow by rejecting the lenient "some showing standard" and insisting on a more stringent standard. (58)

    In addition, the court acknowledged the troublesome issue that arises when a Rule 23 requirement overlaps with a merits issue. (59) In examining this dilemma, the court evaluated Eisen and concluded that there was no basis for finding that a specific Rule 23 requirement was not established just because it overlapped with the merits of the case. (60) The court held that the statement in Eisen that courts considering certification may not look into the merits of a case was "made in a case in which the district judge's merits inquiry had nothing to do with determining the requirements for class certification." (61) Thus, the Second Circuit in In re IPO mandates trial courts to use the rigorous analysis standard when...

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