The Private Securities Reform Act of 1995 was intended to make it more difficult for investors to bring “frivolous” securities fraud class-action suits. Backed by a broad coalition of corporations, trade associations, and defense attorneys, the act was supposed to decrease the number of suits filed and make it easier to obtain pretrial dismissals of meritless cases.
Has the legislation accomplished these goals? The short answer is that it is too soon to tell. It has been only 20 months since passage of the legislation. Nonetheless, it is possible to make some preliminary observations about the effect of the reform act.
The total volume of litigation is little changed. While it is too early to draw any reliable conclusions about long-term effects on filing rates, analysis of litigation activity through June 30, 1997, reveals that the overall number of companies sued in securities class actions is roughly equivalent to the number sued prior to the reform act.
State court securities fraud class-action cases have substantially increased. State court class-action cases used to be rare. But in the first 18 months after passage of the reform act, a total of 92 issuers were sued in state court proceedings. We believe this shift has occurred for two reasons. First, there appears to be a substitution effect, where plaintiffs’ counsel file state court complaints when the underlying facts appear not to be sufficient to satisfy new, more stringent federal pleading requirements. Second, plaintiffs appear to be filing parallel state and federal actions in an effort to avoid stays of discovery, which under the reform act are imposed in federal court if a motion to dismiss the action is filed.
High-technology companies continue to be disproportionately frequent targets in securities fraud actions, while larger companies are being sued less frequently. High- technology companies represented 34 percent of all issuers sued in federal court in 1996–not statistically different from pre-reform numbers. On the other hand, very few companies with a market capitalization greater than $5 billion were sued in federal court in 1996. These companies represented about 8.4 percent of companies sued prior to the act.
Institutional investors are rarely stepping forward to become lead plaintiffs. The reform act provides that the person with the largest financial stake in the litigation is presumed to be the most adequate plaintiff. This provision was intended in part to lessen the use of so-called professional plaintiffs. So far, only a handful of institutional investors have stepped forward to serve as lead plaintiffs. Those institutions that have done so have faced significant opposition from the plaintiffs’ bar.
Although the long-term effects of the reform act are not yet known, the increase in state court filings of securities fraud class actions has already given rise to calls for a uniform federal standard that would govern securities fraud litigation affecting national markets. Two bills currently pending in Congress, H.R. 1653 and H.R. 1689, would both achieve that result. The objective of each bill is to eliminate the strategic use of state securities fraud litigation as a means to evade key provisions of federal law.
We believe the rationale behind these bills makes sense. National markets should be governed by national standards. If states are permitted to assert individual jurisdiction over transactions in national markets, the result will be chaos and mayhem.
Congress can eliminate this possibility by enacting legislation that makes it crystal clear that national markets are subject to uniform national standards. Flaws in our antifraud regime–of which there are many– should be worked out in Congress, not through a crazy-quilt pattern of state adjudication and legislation.