Risk Management

Shareholder Lawsuit Ruling a Boon?

Reports that today's Supreme Court decision is a major victory for corporations may be exaggerated.
Marie LeoneJune 21, 2007

The U.S. Supreme Court has upheld a 1995 law that established strict standards for proving corporate fraud in shareholder lawsuits. In an 8-to-1 decision handed down on Thursday, the high court said that to successfully prove that a company intentionally misled investors — and thus committed fraud — shareholders must present the court with “a cogent and compelling” set of facts.

In addition, the court acknowledged that the facts that give rise to the alleged fraud must be considered in total — that is, in the context of other facts presented in the suit — rather than in isolation. Further, the justices recognized that personal economic gain is part of a compelling story to prove that the company and its officers had an intent to defraud investors.

The ruling was based on the Private Securities Litigation Reform Act (PSLRA) of 1995, a bill that was vetoed by President Clinton, but passed into law by the Republican congress. At the time, the legislation was hailed as a victory for corporations over plaintiff’s lawyers by company officials who regarded such lawsuits as frivolous.

But the PSLRA didn’t stop the flood of shareholder lawsuits that poured in over the next few years. Indeed, not until 2005, when only 168 shareholder litigation cases were filed, did the country experience a dramatic drop in the number of investor-led complaints.

The new ruling may not stem the tide of future shareholder lawsuits either. Plaintiff’s attorney Barbara Hart of Labaton Sucharow & Rudoff says that the Supreme Court decision “is a finding for investors because the court articulated what [investors] need to bring a case —a ‘cogent set of facts that give rise to an inference of intent.’” Hart asserts that class-action shareholder suits are “long, high-risk, and costly,” so they should not be entered into without a full set of convincing facts. “Justice Ginsberg and the majority articulated a standard that I am comfortable with,” she added, referring to Justice Ruth Bader Ginsberg, who wrote the Supreme Court opinion.

Specifically, Ginsberg wrote that to meet the PSLRA fraud standards, intent must be “more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” The case heard by the Supreme Court was an appeal of Tellabs v. Makor Issues & Rights, a class-action suit in which the shareholders of Tellabs Inc. sued the telecom company and its chief executive, Richard Notebaert (now chairman and CEO of Qwest), for allegedly misleading investors about the financial health of the company.

According to the plaintiff’s suit, in March of 2001, Notebaert assured shareholders that the prospects for the company’s top-selling product — the Titan 5500, a telecom switching device — were positive. But in April, Tellabs revised annual sales projects, decreasing its annual revenue number by about $800 million. Then in June, Notebaert blamed the slump on declining demand for the Titan 5500. Consequently, Tellabs stock price fell from $67 to $16 during that period, taking millions of dollars in shareholder value with it.

Hart, who represents Connecticut’s Office of the Treasurer in a class-action shareholder suit against JDS Uniphase, thinks her case — which is slated for trial in October — “clearly meets the [PSLRA] standards,” and as a result is “satisfied” with the high court’s latest decision.

4 Powerful Communication Strategies for Your Next Board Meeting