Vol. 9, No. 4, Pg. 41. The Private Securities Litigation Reform Act of 1995: Reform or Fiction.

• Author: By Pamela J. Roberts and Patrick L. Ridinger

South Carolina Lawyer

1998.

Vol. 9, No. 4, Pg. 41.

The Private Securities Litigation Reform Act of 1995: Reform or Fiction

41THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: REFORM OR FICTIONBy Pamela J. Roberts and Patrick L. RidingerAfter many years of intense lobbying efforts on the part of underwriters, issuers of securities and other interested parties in the securities field, Congress, on December 22, 1995, overrode a presidential veto and enacted into law the Private Securities Litigation Reform Act of 1995 (Reform Act).

This legislation amended the Securities Exchange Act of 1934 (1934 Act) and the Securities Act of 1933 (1933 Act) in an effort to provide public corporations with ammunition to combat the abuses inherent in class action securities suits. These suits, referred to as "strike suits," are typically initiated by a corporation's shareholders and involve securities class action complaints often supported only by the hope that broad-ranging discovery will provide sufficient evidence to survive a motion to dismiss or that the enormous costs of defending such suits will coerce a quick settlement.

The statistics support Congress's concerns. In the early 1990s, the number of class action securities suits filed in federal and state courts was approaching 300 per year. A staggering number of these suits, around 87.6 percent, were settling out of court, with the average settlement approaching $8.6 million. The average settlement was effectuated within 22 months. These suits were costing American businesses around $2.4 billion per year and resulted in some D&O insurers refusing to underwrite policies in certain industries or making such coverage prohibitively expensive.

The Reform Act attempted to reduce "strike suits" by implementing strict new pleading requirements, calling for mandatory stays of discovery, reducing the amount lawyers can recover in fees, allowing for mandatory Rule 11 sanctions and placing more control of the litigation in the hands of the parties most likely to represent the interests of putative shareholders.

This article focuses on how courts have interpreted certain provisions of the Reform Act and the effects the Reform Act has had in its first year and a half of implementation.

KEY PROVISIONS OF THE REFORM ACT

The "Strong Inference of Fraud" Pleading Standard. The pleading standard set forth in § 21D(b)(2) of the Reform Act requires, among other things, that plaintiffs "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." This language was taken from a body of case law in the Second Circuit interpreting the pleading requirements of Rules 8 and 9 (b) of the Federal Rules of Civil Procedure in cases involving securities fraud. Determining whether Congress's use of this language was an endorsement or an abrogation of the pleading standard then used by the Second Circuit has been the subject of constant debate in the courts.

The courts that have addressed this issue thus far have struggled with why Congress

42failed, in the Reform Act, to specifically approve or disapprove the Second Circuit's standard. In Marks-man Partners, L.P. v. Chantal Pharmaceutical Corp., 927 F. Supp. 1297 (C.D. Cal. 1996), the court opined that Congress's failure to abrogate the Second Circuit's "motive and opportunity" test and "strong circumstantial evidence" test meant that both tests survived passage of the Reform Act.

In support of this proposition, the Marksman court relied heavily on the Conference Committee's recognition of the Second Circuit's test as the most stringent in existence prior to the Reform Act. Id. at 1310. A review of the legislative history also led the court in In re Health Management, Inc. Securities Litigation, 970 F. Supp. 192 (E.D.N.Y. 1997), to conclude that "motive and opportunity" was sufficient to establish "a strong inference of fraud" under the Reform Act. Id. at 7.

Conversely, in Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42 (D. Mass. 1997), the Conference Committee's decision not to include in its pleading standard "language derived from Second Circuit case law relating to motive, opportunity or recklessness" was cited as authority for rejecting "motive and opportunity" as a sufficient pleading standard. Id. at 48. An analysis of the same legislative history also resulted in imposition of a stricter pleading standard in In re Silicon Graphics, Inc. Securities Litigation, 1996 WL 664639 (N.D. Cal...