Chapter 14 - § 14.7 • THE PRIVATE SECURITIES LITIGATION REFORM ACT
| Jurisdiction | Colorado |
The Private Securities Litigation Reform Act (PSLRA),83 passed by Congress in December 1995 over President Clinton's veto, was adopted with the express purpose of combating abuses in securities lawsuits by altering control of investors' cases, encouraging voluntary disclosures, and providing sanctions if claims are unsupported. At the same time, it intended to protect investors' rights to pursue valid claims for securities fraud.84
Because of forum shopping, state court acceptance of class actions, and other factors, Congress adopted the Securities Litigation Uniform Standards Act of 1998 (SLUSA)85 to eliminate state court venue for most class action claims involving securities fraud. SLUSA requires removal and then dismissal of covered class actions based on state law alleging a material misrepresentation or omission or use of a manipulative device in connection with the purchase or sale of a covered security. SLUSA not only applies to cases when purchasers or sellers of securities acted on the basis of misleading or incomplete information, but also applies to class actions where persons were induced to hold covered securities because of allegedly fraudulent information.86 SLUSA does not require federal jurisdiction for all class actions, however. In several 2006 decisions by the U.S. Supreme Court, the Court held that claims under state law brought by investors could not be removed to federal courts where the federal court did not otherwise have jurisdiction, and the district court's determination to remand the securities class action to the state court was not appealable.87 A 2016 Supreme Court case found that federal courts do not have jurisdiction to hear an investor lawsuit alleging only state law claims, even where the complaint contains allegations that the misconduct at issue violated an SEC regulation promulgated under the 1934 Act. Merrill Lynch, Pierce, Penner & Smith, Inc. v. Manning, 136 S. Ct. 1562 (2016). Similarly, a case alleging only 1933 Act violations is not removable to federal court under SLUSA.88
In Chadbourne & Parke LLP v. Troice,89 the Supreme Court further interpreted SLUSA in connection with a state court class action brought against insurance brokers, two law firms, and associated persons to recover from the multi-billion dollar Allen R. Stanford Ponzi scheme.90 Justice Breyer noted that SLUSA provides that plaintiffs may not maintain a class action involving 50 or more members based on statutes or common law of any state (with exceptions) that alleges misrepresentations or omissions of a material fact "in connection with the purchase or sale of a covered security."91 In this case, plaintiffs bought certificates of deposit from Stanford entities, including Stanford International Bank. These certificates of deposit were not traded and did not fit the SLUSA definition of "covered securities." In moving to dismiss the case, the defendants alleged that since the purpose of the offering was to purchase covered securities with the proceeds of the CDs, SLUSA should be applied. Notwithstanding arguably inconsistent precedent,92 the Court's opinion said that a "fraudulent misrepresentation or omission is not made 'in connection with' such a 'purchase or sale of a covered security' unless it is material to a decision by one or more individuals (other than the fraudster) to buy or sell a 'covered security'"93 and there must be a "material connection with a transaction in a covered security"94 for a defendant to obtain SLUSA protections. The dissent argued that the 7-2 majority's "narrow reading" of SLUSA "will permit a proliferation of state-law class actions, forcing defendants to defend against multiple suits in various state[s]" — the result SLUSA attempted to avoid.95
In March 1997, the Northern District of California became the first federal court to adopt Rule 23-2, which requires Internet posting of all filings in major securities fraud litigation, except sealed documents. The conference committee report for SLUSA urged other districts to adopt similar rules and procedures.96 The SEC includes information on its website that lists "Designated Internet Sites" at which members of the public can find information regarding class action securities fraud litigation.
§ 14.7.1—Lead Plaintiffs And The "Most Adequate Plaintiff"
The 1933 Act and the 1934 Act were amended to limit the use of "professional plaintiffs," i.e., people who own a nominal number of shares in a large number of companies. Now, named plaintiffs in any class action must identify to the court any other class actions in which they have served or sought to serve as a class representative during the past three years.97 "Except as the court may otherwise permit," no person may serve as a lead plaintiff or officer or director of a lead plaintiff more than five times in three years.98
• In Tumolo v. Cymer, Inc.,99 a group of 339 unrelated investors sought to become lead plaintiff for a class action. The court said that the large number of individuals would be inconsistent with the lead plaintiff provisions of the PSLRA.
• In Seamans v. Aid Auto Stores, Inc.,100 the court found that a group seeking to be the lead plaintiff that included a market maker of the securities was atypical and therefore should not serve as lead plaintiff in the litigation.
• A court appointed a pension fund as lead plaintiff in a class action over a group of plaintiffs "recruited by a law firm." The court found that the group was solicited and created by a law firm solely for the purpose of obtaining appointment as lead plaintiff and the members had no prior relationships.101
• In Naiditch v. Applied Micro Circuits Corp.,102 the court approved the appointment of an institutional investor as lead plaintiff despite the fact that he had been a lead plaintiff in class actions more than five times in three years.
The PSLRA and SLUSA attempt to minimize the "race to the courthouse," when the first plaintiff with an action filed generally becomes the lead plaintiff in a purported class action, and his or her lawyer is plaintiffs' counsel, even though a later complaint may be more thoroughly researched.
Under 1933 Act § 27(a)(3)(A) and 1934 Act § 21D(a)(3)(A), each plaintiff must notify all prospective plaintiffs within 20 days of filing the action by publication "in a widely circulated national business-oriented publication or wire service." This notice must include a description of the causes of action and inform class members that within 60 days the complainant may move to serve as lead plaintiff. Within 90 days of publication, the court must consider motions made and appoint the lead plaintiff.103
The PSLRA also provides that institutional investors may serve as lead plaintiff and requires courts to presume that the member of the purported class with the largest financial stake is the "most adequate plaintiff."104 This presumption is rebuttable, however, if it can be shown that the institutional investor will not be able to represent the class fairly and adequately or if the institutional investor is subject to unique defenses not generally applicable to the class.105 The conference committee specifically stated that the "most adequate plaintiff" provisions are not intended to impose any additional fiduciary duties on lead plaintiff and are intended to encourage institutional investors to take a more active role in class litigation.
Subject to court approval, the "most adequate plaintiff" retains class counsel.106 However, attorneys who directly or indirectly own a beneficial interest in securities subject to the litigation must disclose this ownership to the court, and the court must determine whether this is sufficient to disqualify the attorney.107
Costs of discovery, even in frivolous actions, can be extensive. Under the PSLRA, when the defendants have filed a motion to dismiss or for summary judgment, discovery is stayed until the court rules on the motion.108
The PSLRA added § 27(b)(2) to the 1933 Act and § 21D(b)(3) to the 1934 Act to make it unlawful for any person, upon receiving actual notice that names him or her as a defendant, to willfully destroy or otherwise alter potentially relevant evidence.
§ 14.7.2—Proportionate Liability And Joint And Several Liability
Before the enactment of the PSLRA, a defendant found to be 1 percent responsible could be liable for 100 percent of the damages, which Congress believed to create a coercive pressure for innocent parties to settle. The PSLRA amended the 1934 Act to provide for a "fair share" system of proportionate liability. 1933 Act liability under § 11 was also modified significantly for outside directors.
1933 Act § 11(f) provides that outside directors who sign a registration statement without knowing of a material misstatement or omission will have their liability apportioned by the court or jury. In addition, 1934 Act § 21D(f) now provides for "fair share" liability rather than joint and several liability for all 1934 Act cases in which liability can be predicated on non-knowing conduct. In an action to recover money damages, the PSLRA requires that the court submit written interrogatories to the jury on the issue of defendants' state of mind at the time of the violation. This forms part of the basis for determining proportionate liability of each defendant.
Both the 1933 Act and the 1934 Act amendments continue to provide for joint and several liability on defendants:
• Who knowingly participate in the securities law violations (1934 Act § 210(f)(2)(A)); or
• Who are liable to any plaintiff when the damages exceed 10 percent of that plaintiff's net worth and a portion of the judgment as to such defendant is uncollectible and when that plaintiffs net worth is less than $200,000 (whether or not the defendant acted knowingly) (1934 Act § 21D(f)(4)(A)(i)).
Control persons, potentially liable under 1934 Act § 20(a), are liable to the same...
To continue reading
Request your trial