A Brief History of the Private Securities Litigation Reform Act of 1995

Since the Depression, American capital markets have operated under the provisions of the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). The purpose of those bills was . . . to protect the investing public and honest business; . . . to prevent further exploitation of the public; . . . to place adequate and true information before the investor; to protect honest enterprise; . . . [and] to restore the confidence of the investor . . .

S. Rep. No. 47, 73rd Cong., 1st Sess., at 1 (1933). In particular, Section 10-b of the Exchange Act and its Rule 10b-5, 17 C.F.R. § 240.10b-5, deterred fraudulent conduct by insuring that companies were punished when they misrepresented or exaggerated information to affect the price of their stock.

The Securities Exchange Commission (“SEC”) does not collect investment losses for defrauded investors; therefore, private causes of action under the Securities Act and the Exchange Act have played an important role in supplementing the enforcement powers of the SEC. Private enforcement of the federal securities laws provides a necessary supplement to SEC action by affording relief to those injured by violations of the securities laws and by serving as a deterrent to future wrongdoing. In re M.D.C. Holdings Sec. Litig., No. CV 89-0090 E (M), 1990 WL 454747, at *5 (S.D. Cal. 1990) (citing J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964)).

The longstanding protection afforded by the Securities Act and the Exchange Act has convinced Americans of the safety and soundness of American capital markets, as evidenced by the enormous amount of private capital infused into the American capital markets each year. Indeed, more capital was raised in initial public offerings by emerging high-tech firms in 1995 than ever before — $8.4 billion. High Stakes Winners Meet the Get-Incredibly-Rich-Quick Crowd, Time, February 19, 1996, at 42. Nonetheless, in December, 1995, over the veto of President Clinton, Congress passed the most sweeping revision of the federal securities laws since the New Deal, the Private Securities Litigation Reform Act of 1995, 15 U.S.C.A. § 77z, 78u-4 (West Supp. 1996) (the “PSLRA”). William S. Lerach, et al., Changes in Private Litigation: Securities Class Action Litigation Under the Private Securities Litigation Reform Act of 1995, (the “ALI-ABA Presentation”) SC09 ALI-ABA 439, 443 (1997). Congress acknowledged that Private securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help to deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers and others properly perform their jobs.

Statement of Managers, The “Private Securities Litigation Reform Act of 1995,” (the “Statement of Managers”), p. 1. The stated purpose of the PSLRA was to “return the securities litigation system to that high standard.” Id.

The passage of the PSLRA was fraught with controversy, representing one of the most contentious lobbying efforts in history. Proponents of the PSLRA, consisting primarily of venture capitalists, corporate interests, and accounting firms, argued that these drastic departures from traditional securities law were necessary to impede “meritless” private lawsuits and to encourage officials of public companies to publish statements about their companies’ prospects without fear of shareholder lawsuits. Opponents of the PSLRA, including numerous consumer protection groups, argued that those who lobbied for the legislation were motivated solely by their desire to protect themselves from meritorious lawsuits. For example, in comments submitted to the Securities Exchange Commission on May 1, 1996, the American Association of Retired Persons, the Consumer Federation of America and the National Council of Individual Investors observed that “[w]hile the Act was touted as a way to eliminate frivolous lawsuits, its practical repercussion is that many investors with meritorious claims will be denied access to the courts.” Letter from Martin Corry, Director, Federal Affairs, American Association of Retired Persons, et al., to Jonathan G. Katz, Secretary, Securities and Exchange Commission (May 1, 1996). In his veto message, President Clinton observed that the bill would “have the effect of closing the courthouse door on investors who have legitimate claims.” 141 Cong. Rec. H15214 (daily ed. December 20, 1995). Despite these concerns, Congress overrode President Clinton’s veto of the PSLRA on December 22, 1995, the Senate voting to do so with only one member present. 141 Cong. Rec. S19180 (daily ed. December 22, 1995).

The PSLRA includes several provisions that represent significant departures from traditional securities law, including a heightened pleading requirement, a statutory “safe harbor” for certain “forward-looking” statements, a proportionate liability provision, and mandatory sanctions under Rule 11 under certain circumstances. Each of these provisions makes it more difficult for lost investments to be recovered by investors. In addition, the PSLRA also contains substantial procedural provisions, such as the “lead plaintiff” provisions and the automatic discovery stay provisions. This paper which Martin Chitwood delivered at a CLE program several years ago discusses the key provisions of the PSLRA, focusing on the legislative history of the PSLRA and judicial interpretation of the PSLRA.

Understanding the Standards for Class Certification Under Rule 23

Rules 23(a) and (b) contain the substantive requirements for certifying a class.  In order to maintain a class action, the plaintiff bears the burden of establishing the four class requirements of Rule 23(a) — numerosity, commonality, typicality and adequacy — and must also demonstrate that one of the three bases in Rule 23(b) has been met.  Rule 23(b)(3) permits a class action to be certified when common questions of law and fact predominate as to all members of the class and a class action is superior to alternative methods for the fair and efficient adjudication of the controversy.  Rule 23(b)(2) authorizes a class action when the party opposing the class has acted on grounds generally applicable to the class, making final injunctive or declaratory relief appropriate with respect to the class as a whole.  Rules 23(b)(3) and 23(b)(2) are the two bases most frequently used in antitrust actions.[1]

In determining the propriety of a class action, “the question is not whether the . . . plaintiffs have stated a cause of action or will prevail on the merits, but rather whether the requirements of Rule 23 are met.”  Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177-78 (1974) (quoting with approval Miller v. Mackey Int’l Inc., 452 F.2d 424, 429 (5th Cir. 1971)).  See also Cox v. American Cast Iron Pipe Co., 784 F.2d 1546, 1557 (11th Cir), cert. denied, 479 U.S. 883 (1986).  The most pertinent considerations in a court’s ruling on a motion pursuant to Rule 23 are the requirements of the rule itself and the allegations in the complaint, which must be accepted as true for the purpose of deciding whether a class should be certified.  E.g., Shelter Realty Corp. v. Allied Maintenance Corp., 574 F.2d 656, 661 n.15 (2d Cir. 1978); Westlake v. Abrams, 565 F. Supp. 1330, 1337 (N.D. Ga. 1983).  In making the necessary Rule 23 determination, “it is generally inappropriate for the Court to consider whether plaintiffs will prevail on the merits of their claim.”  In re Domestic Air, 137 F.R.D. at 684.  Furthermore, the policies underlying the need for class action litigation in general necessarily require that Rule 23 be interpreted liberally.  “[For] the interests of justice require that in a doubtful case . . . any error, if there is to be one, should be committed in favor of allowing a class action.”  Eisenberg v. Gagnon, 766 F.2d 770, 785 (3d Cir.), cert. denied, 474 U.S. 946 (1985) (quoting Esplin v. Hirschi, 402 F.2d 94, 101 (10th Cir. 1968), cert. denied, 394 U.S. 928 (1969)).  See also  Giles v. Ireland, 742 F.2d 1366, 1372 (11th Cir. 1984); Freeman v. Motor Convoy, Inc., 700 F.2d 1339, 1347 (11th Cir. 1983).

Each of the elements of Rule 23 is discussed more fully below.

  1. The Class Requirements of Rule 23(a)

Rule 23(a) provides:

One or more members of a class may sue or be sued as representative parties on behalf of all only if (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class, and (4) the representative parties will fairly and adequately protect the interests of the class.

Fed. R. Civ. P. 23(a).  All four of these class requirements must be met before a class may be certified under Rule 23.

  1. Numerosity

Rule 23 does not define what a class is or how its members should be determined.  In general, however, to satisfy the numerosity requirement, although a plaintiff need not prove the exact number or identity of class members, he must show that the number is exceedingly large and that joinder is impracticable.  See Evans v. United States Pipe & Foundry Co., 696 F.2d 925, 930 (11th Cir. 1983); In re Carbon Dioxide Antitrust Litig., 149 F.R.D. at  232.  Class actions consisting of fewer than 150 members have been held to satisfy the numerosity requirement, e.g., Kreuzfeld, A.G. v. Carnehammar, 138 F.R.D. 594, 599 (S.D. Fla. 1991) (certifying a class of approximately 130 members and noting that the numerosity requirement has been satisfied with as few as 25 or 30 class members) as have class actions involving millions of class members, e.g., In re NASDAQ Market-Makers Antitrust Litig., 169 F.R.D. 493 (S.D.N.Y. 1996) (class of at least a million securities investors certified); In re Disposable Contact Lens Antitrust Litig., 170 F.R.D. 524 (M.D. Fla. 1996) (class of 15 to 18 million members certified); In re Domestic Air Transp. Antitrust Litig., 137 F.R.D. 677 (N.D. Ga. 1991) (certifying class of approximately 12.5 million airline ticket purchasers).  Furthermore, where the putative class is geographically dispersed across the United States, as is the case in many antitrust actions, joinder of all class members is almost always considered impracticable.  E.g., Walco Invs., Inc. v. Thenen, 168 F.R.D. 315, 338 (S.D. Fla. 1996).

  1. Commonality

Rule 23(a)(2) requires that in order for an action to be certified as a class action, the claims of the class members must involve common questions of law and fact.  This “commonality” requirement of Rule 23(a)(2) is satisfied if the “named representatives’ claims have the same essential characteristics as the claims of the class at large.” Appleyard v. Wallace, 754 F.2d 955, 958 (11th Cir. 1985) (quoting De La Fuente v. Stokely-Van Camp, Inc., 713 F.2d 225, 232 (7th Cir. 1983)).  The rule does not require that every question of law or fact be common to each class member, Cox v. American Cast Iron Pipe Co., 784 F.2d at 1557, but rather that all class members share a “substantially identical factual situation” and that the “questions of law raised by the plaintiff are applicable to each class member.”  In re Amerifirst Sec. Litig., 139 F.R.D. 423, 428 (S.D. Fla. 1991) (quoting Weiss v. York Hospital, 745 F.2d 786, 808 (3d Cir. 1984), cert. denied, 470 U.S. 1060 (1985)).  See also Powers v. Stuart-James Co., 707 F. Supp. 499, 502 (M.D. Fla. 1989).

In most antitrust actions, particularly price-fixing cases that allege a conspiracy among the defendants, the commonality requirement is easily satisfied.  In fact, numerous courts have held “that allegations concerning the existence, scope, and efficacy of an alleged antitrust conspiracy present important common questions sufficient to satisfy the commonality requirement of Rule 23(a)(2).” In re NASDAQ Market-Makers Antitrust Litig., 169 F.R.D. at 509 (finding common issues in price-fixing case against NASDAQ market-makers).  See e.g. In re Catfish Antitrust Litig., 826 F. Supp. at 1034 (all class members “share a unity of interest” in how the facts illustrate the misconduct and violations of law alleged); In re Potash Antitrust Litig., 159 F.R.D. at 689; In re Workers’ Compensation, 130 F.R.D. at 105 (“[a]ntitrust, price-fixing conspiracy cases, by their nature, deal with common legal and factual questions about the existence, scope and effect of the alleged conspiracy”); Town of New Castle v. Yonkers Contracting Co., 131 F.R.D. 38, 41 n.4 (S.D.N.Y. 1990) (“We agree with plaintiffs that the issue of the existence and effect of an antitrust conspiracy involves common questions of law and fact.”); Thillens, Inc. v. Community Currency Exch. Ass’n., 97 F.R.D. 668, 677 (N.D. Ill. 1983) (“The overriding common issue of law is to determine the existence of a conspiracy.”); Jennings Oil Co. v. Mobil Oil Corp., 80 F.R.D. 124, 128 (S.D.N.Y. 1978) (commonality requirement satisfied when plaintiff raises “common questions of the existence, scope and effect of the alleged conspiracy”).  See also 4 H. Newberg & A. Conte, Newberg on Class Actions, §18.05 (3d ed. 1992).

  1. Typicality

The “typicality” element of Rule 23(a)(3) requires “a nexus between the class representative’s claims or defenses and the common questions of fact or law which unite the class.”  Kornberg v. Carnival Cruise Lines, Inc., 741 F.2d 1332, 1337 (11th Cir. 1984), cert. denied, 470 U.S. 1004 (1985).  “A plaintiff’s claim is typical if ‘it arises from the same event or practice or course of conduct that gives rise to the claims of the other class members, and her or his claims are based on the same legal theory.’”  In re Domestic Air, 137 F.R.D. at 698 (quoting 3 Newberg on Class Actions, §18.09 at 464).  Obviously, in order to satisfy this requirement, the named plaintiff must be an actual member of the class, but typicality does not require that all claims or defenses be identical, and where a strong similarity of legal theories is present, the typicality requirement will be satisfied despite the existence of substantial factual differences.  Appleyard v. Wallace, 754 F.2d at 958.  However, the presence or absence of an adverse interest between the representative party and other class members is an additional factor affecting “typicality.”  Tidwell v. Schweiker, 677 F.2d 560, 566 (7th Cir. 1982), cert. denied, 461 U.S. 905 (1983).  See also In re Catfish Antitrust Litig., 826 F. Supp. 1019 (N.D. Miss. 1993).

In a typical antitrust action, the named plaintiff is seeking to prove that defendants committed the same unlawful acts in the same method against an entire class.  Thus, in those situations, most courts have found that all members of the class have identical claims, and therefore, the typicality requirement of Rule 23(a)(3) is usually satisfied.  See, e.g.Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718, 722-25 (11th Cir. 1987), cert. denied, 485 U.S. 959 (1988); Kennedy v. Tallant, 710 F.2d 711, 717 (11th Cir. 1983).

  1. Adequacy

Rule 23(a)(4) requires that the named plaintiffs fairly and adequately protect the interests of the class.  This “adequacy” requirement is met if it appears that (1) the named plaintiffs have interests in common with, and not antagonistic to, the interests of the other class members, and (2) the plaintiffs’ attorneys are qualified, experienced, and generally able to conduct the litigation.  Kirkpatrick v. J.C. Bradford & Co., 827 F.2d at 726; In re Carbon Dioxide Antitrust Litig., 149 F.R.D. at 233; Powers v. Stuart-James Co., 707 F. Supp. at 503.  The first aspect of the adequacy  requirement is usually satisfied unless the named plaintiff has an interest that might be in some way adverse to other class members.  In typical antitrust actions, however, the representative plaintiff’s interests are in common with the interests of the class, and have no interests adverse or antagonistic to any class member.

With respect to the second prong of the “adequacy” inquiry  — the qualifications of counsel — the named plaintiff’s attorneys must exhibit that they are qualified and experienced in antitrust class action litigation, and “will pursue with vigor the legal claims of the class.”  Kirkpatrick v. J.C. Bradford & Co., 827 F.2d at 727.

     [1]/  Rule 23(b)(1) authorizes class action treatment where separate actions would “create a risk of inconsistent or varying adjudications” that would “establish incompatible standards of conduct” for the party opposing the class, or where separate adjudications would “as a practical matter be dispositive of the interests of the others” in the class who are not parties to that adjudication.  Antitrust class action plaintiffs rarely rely on this third basis.

Procedural Issues in Antitrust Class Actions

Rule 23 of the Federal Rules of Civil Procedure (hereinafter “Rule 23″) governs federal class actions; however, the Local Rules of the Northern District of Georgia also contain important provisions specific to class actions.  Both should be thoroughly reviewed before filing a class action complaint.

Local Rule 23.1A requires that each class action complaint contain the designation “Complaint—Class Action” in the style of the case.   L.R. 23.1A, N.D. Ga.  The complaint must also contain a section entitled “Class Action Allegations” that states the following:

(1) The section of Rule 23 of the Federal Rules of Civil Procedure which is claimed to authorize maintenance of suit by class action.

 

(2) The size (or approximate size) and definition of the alleged class.

 

(3) The basis of the named plaintiff’s or plaintiffs’ claim to be an adequate representative of the class, or, if defendants, the basis of the named defendant’s or defendants’ claim to be an adequate representative of the class.

 

(4) The alleged questions of law and fact which are common among members of the class.

(5) The allegations necessary to satisfy the criteria of section (b)(1) or (b)(2) of Rule 23 or to support the findings required by section (b)(3) of Rule 23.

 

(6) For actions requiring a jurisdictional amount, basis for determination of that amount.

 

L.R. 23.1A, N.D. Ga.  The complaint must also define the class in a manner that is precise, clear, and presently ascertainable.  The definition of the class is of critical importance because it identifies both the persons entitled to relief and those to be bound by a final judgment.  The appropriate class definition may also be affected by other factors, such as the applicable law and choice-of-law considerations, which may sometimes necessitate the use of sub-classes.  See generally Manual for Complex Litigation, Third, § 30.14, at 217-218 (1995).

Before a case may proceed as a class action, the plaintiff must move for, and receive, certification of the class by the court.  Although Rule 23(c) provides only that the court should determine “as soon as practicable” whether a class will be certified, Local Rule 23.1B requires a plaintiff to move for class certification within ninety days after filing the complaint.  Whether and when a class is certified and how it is ultimately defined significantly impacts the management and outcome of the litigation.  Early certification of a class is crucial, because it can affect who the parties are, the timing and scope of discovery and motion practice, and the approach to settlement negotiations.  See generally Manual for Complex Litigation, Third, § 30.14, at 217-218 (1995).

The defendants in a purported class action often seek a court order early in the litigation limiting precertification discovery to specific class-related issues and staying any discovery on the merits of the action until after the court rules on the plaintiff’s motion for class certification.  However, this type of bifurcated discovery procedure is problematic because discovery relating to class issues usually overlaps substantially with merits discovery.  For example, an important factor in determining whether a class should be certified is the similarity between the claims of the class representatives and those of the other class members — an inquiry that often requires discovery on the merits of the action.  Id. at 215-216 (citing Chateau de Ville Prod., Inc., v. Tams-Witmark Music Library, 586 F.2d 962 (2d Cir. 1978).  As a result, bifurcating class and merits discovery leads to unnecessary duplication of discovery and disputes among counsel over whether discovery sought by the plaintiffs is necessary at the class discovery stage.  See Manual for Complex Litigation, Third, § 30.12, at 215.

Introduction to Class Actions and Antitrust Enforcement

Private citizens have the right under federal antitrust laws to “injunctive relief and damages for antitrust violations without regard to the amount in controversy.”  Hawaii v. Standard Oil Co., 405 U.S. 251, 266 (1972).  Class actions enable private citizens to seek relief for these violations without regard to the amount in controversy for each individual claim.  This article discusses the fundamentals of certifying an antitrust class and gives particular attention to three current issues in antitrust class action litigation.  In addition to discussing these class certification fundamentals in general terms, the  article also focuses on one of the more prevalent types of antitrust class action claims – horizontal price-fixing conspiracies.

The Benefits of Class Actions.

By their very nature, class action lawsuits can benefit society.  In a class action lawsuit, a “class representative” sues on behalf of himself and all other persons who were similarly harmed by the same wrongdoer or wrongdoers.  This process enables potential plaintiffs to pool claims for litigation which would be uneconomical to litigate individually.  Such potential plaintiffs “would have no realistic day in court if a class action were not available.”  Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 809 (1985).  Therefore, a practitioner should consider filing an antitrust claim as a class action whenever a large number of persons have been similarly harmed by an alleged wrongdoer or wrongdoers and the individual amount of damages suffered by each potential plaintiff is too small to justify litigating on an individual basis.

Antitrust class actions also further the important public policy of enforcing the antitrust laws.  As one court noted in Town of New Castle v. Yonkers Contracting Co., 131 F.R.D. 38, 41 (S.D.N.Y. 1990): “Since private enforcement of antitrust laws provides a supplement to governmental enforcement, it is our view that class action treatment of alleged antitrust violations is appropriate and desirable.”  The courts, including those in the Eleventh Circuit, have been vigilant in the protection of consumers who have asserted class action claims on behalf of large classes of like consumers who have been victimized by violations of the antitrust laws.  In re Domestic Air Transp. Antitrust Litig.,137 F.R.D. 677 (N.D. Ga. 1991); In re Disposable Contact Lens Antitrust Litig., 170 F.R.D. 524 (M.D. Fla. 1996); Coleman v. Cannon Oil Co., 141 F.R.D. 516, 520 (M.D. Ala. 1992) (“It may be that a class-action lawsuit is the most fair and efficient means of enforcing the law where antitrust violations have been continuous, widespread and detrimental to as yet unidentified consumers.”).  Moreover, class actions enforce the antitrust laws in a cost effective and efficient manner by combining a multitude of the same or similar claims into a single action.

Antitrust violations are often ideal for class action treatment because they frequently involve a large number of persons who have suffered damages in amounts that are small enough to make  litigating them individually cost prohibitive, but that when pooled together are quite large.  Price-fixing cases typically fit this description.  Thus, courts frequently certify classes in cases involving claims of price-fixing.  E.g. In re Polypropylene Carpet Antitrust Litigation, MDL Docket No. 1075 (N.D. Ga. Sept. 5, 1997) (order granting plaintiffs’ motion for class certification) (hereinafter “In re Carpets Sept. 5, 1997 Order”).  In re NASDAQ Market-Makers Antitrust Litig., 169 F.R.D. 493 (S.D.N.Y. 1996); In re Potash Antitrust Litig., 159 F.R.D. at 688-9; In re Catfish Antitrust Litig., 826 F. Supp. 1019 (N.D. Miss. 1993); In re Carbon Dioxide Antitrust Litig., 149 F.R.D. 229, 232 (M.D. Fla. 1993); In re Domestic Air, 137 F.R.D. at 677; Coleman, 141 F.R.D. at 520; In re Workers Compensation Antitrust Litig., 130 F.R.D. 99, 105 (D. Minn. 1990); Cumberland Farms, Inc. v. Browning-Ferris Industries, Inc., 120 F.R.D. 642, 645 (E.D. Pa. 1988); In re Fine Paper Antitrust Litig., 82 F.R.D. 143 (E.D. Pa. 1979), aff’d, 685 F.2d 810 (3d Cir. 1982); In re Corrugated Container Antitrust Litig., 80 F.R.D. 244 (S.D. Tex. 1978); In re Sugar Indus. Antitrust Litig., 1977-1 (CCH) Trade Cas. ¶61,373 (N.D. Cal., May 21, 1976); In re Antibiotic Antitrust Actions, 333 F. Supp. 278 (S.D.N.Y.), amended, 333 F. Supp. 291 (S.D.N.Y.), mandamus denied, 449 F.2d 119 (2d Cir. 1971).  See also  4 H. Newberg & A. Conte, Newberg on Class Actions §18.05 (3d ed. 1992).

SECURITIES CLASS ACTIONS: THE PLAINTIFFS’ PERSPECTIVE – Part IV

This is Part 4 in a 4 part series on Securities Class Actions by Martin Chitwood.

The Private Securities Litigation Reform Act

In 1995, Congress passed the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) to “enact reforms to protect investors and maintain confidence in our capital markets.”  H.R. Conf. Rep.  No.  1058, 104th Cong., 1st sess., at 27 (1995).  Proponents of the PSLRA argued that the legislation was necessary to make it more difficult for investors to file “meritless” class action law suits in federal court against companies they claimed had misled them with overly optimistic forecasts of future profits, claiming that the PSLRA would allow officials of public companies to publish statements about their companies’ prospects without fear of shareholder lawsuits. Opponents of the PSLRA, including numerous consumer protection groups, argued that those who lobbied for the legislation were motivated only by their desire to protect themselves from meritorious lawsuits.  In reality, they argued, the legislation could go “far beyond curbing meritless lawsuits to all but legalizing securities fraud.”[1]

  1. Key Provisions of the PSLRA

The PSLRA goes well beyond reform to stifle an individual’s chances of recouping an investment loss.  The Act is fraught with potential obstacles for plaintiffs, including several provisions that represent significant departures from traditional securities law, including a statutory “safe harbor” for certain “forward-looking” statements, which includes a heightened pleading requirement, and a proportionate liability provision.  Each of these provisions may potentially damage an investor’s ability to recover his lost investment.  In addition to the substantive provisions, the PSLRA also provides two key provisions regarding procedural matters: the appointment of a “lead plaintiff” and the automatic stay of discovery pending resolution of a dispositive motion to dismiss.

  1. Statutory Safe Harbor and Heightened Pleading Requirement

The PSLRA contains a “safe harbor” provision that allows a company or its principals to release statements predicting the company’s future economic performance and describing the assumptions underlying such statements.  Securities Act § 27A; Exchange Act § 21E.[2]  The safe harbor provision has two prongs that operate in the disjunctive:

*          Under the “actual knowledge” prong, the issuer is protected with respect to the forward-looking statement if the plaintiff fails to prove that the statement was made with actual knowledge that the statement was false or misleading.  Securities Act § 27A(c)(1)(B); Exchange Act § 21E(c)(1)(B).

*          Under the “bespeaks caution” prong, the person making the forward-looking statement is protected if the statement is identified as a forward-looking statement and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.  Securities Act § 27A(c)(1)(A); Exchange Act § 21E(c)(1)(A).

The “actual knowledge” prong raises several obstacles to recouping investor losses.  The first obstacle is encountered in the pleading stage.  The PSLRA includes several heightened pleading standards for private actions, including codification of a state of mind requirement that is based on the Second Circuit’s former standard, which is generally regarded as the most stringent standard that had been applied before the passage of the PSLRA.  Exchange Act § 21D(b)(2); see also In re Glenfed, Inc., 42 F.3d 1541, 1547 (9th Cir. 1994) (en banc); Phelps v. Wichita EagleBeacon, 886 F.2d 1262, 1270 n.5 (10th Cir. 1989); Auslender v. Energy Management Corp., 832 F.2d 354, 356 (6th Cir. 1987).  Under the terms of the PSLRA, a plaintiff must state with particularity facts giving rise to a “strong inference” that the defendant acted with the required state of mind.  Exchange Act § 21D(b)(2).

The PSLRA further elevates the plaintiff’s burden by providing that discovery in the case is stayed when the defendant files a motion to dismiss.  Securities Act § 27(b); Exchange Act § 21D(b)(3)(B). The effect of the combination of heightened pleading standards and the stay of discovery is that a plaintiff must plead facts that are uniquely within the defendant’s possession, but is precluded from exploring company records that would demonstrate the defendant’s knowledge of the falsity.  The PSLRA requires that, before any discovery can be transacted, a plaintiff must carry the often insurmountable burden of pleading, with exacting specificity, facts sufficient to show “actual knowledge.”

The “bespeaks caution” prong of the safe harbor provision is also problematic.  Read literally, it will protect forward-looking statements that were known to be false and misleading when made, so long as they were accompanied by meaningful cautionary statements.  The Statement of Managers accompanying the PSLRA confirms this reading by providing that “courts . . . examine only the cautionary statement accompanying the forward-looking statement.  Courts should not examine the state of mind of the person making the statement.”  Statement of Managers at H13703.

Additionally, the cautionary language that accompanies the forward-looking statement need only identify some important factors that could cause the company’s actual performance to differ materially.  See id.  “Failure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor.”  Id. (emphasis added).  Consequently, a company can release false or incomplete information and still fall within the PSLRA’s safe harbor provision, avoiding any liability.

  1. Proportionate Liability

In addition to the statutory safe harbor and heightened pleading requirements, the PSLRA also limits the application of joint and several liability to defendants who knowingly commit a violation of the securities laws.  Exchange Act § 21D(g).  All other defendants are proportionately liable based upon their percentage of responsibility for the damages.  See Exchange Act § 21D(g)(3)(C).

Knowledge, for purposes of proportionate liability, exists when the defendant (1) makes an untrue statement of a material fact with knowledge of its falsity, (2) omits to state a fact necessary to make a material statement true, with actual knowledge that without the omitted fact, the representation is false and people are likely to rely on that false representation, or (3) in cases not involving false representations, engages in conduct with actual knowledge of the facts and circumstances that make such conduct a violation of the securities laws.  Exchange Act § 21D(g)(10)(A).  As discussed above, proof of actual knowledge, particularly at the pleading stage, presents tremendous problems for plaintiffs.

The PSLRA’s departure from joint and several liability demonstrates the extreme nature of this legislation.  Joint and several liability is a well-established rule of law grounded in equitable principles that operate to protect investors.  See McDermott, Inc. v. Clyde, 114 S. Ct. 1461 (1994).  Under the PSLRA, defrauded investors may not be made whole if a defendant is insolvent.

  1. The Lead Plaintiff Provision

One of the purported purposes of the PSLRA was to discourage the “first come, first served” rule regarding who would be appointed lead plaintiff in a securities class action and to encourage the selection of institutional investors, which usually have the largest financial stakes, as lead plaintiffs.  The PSLRA requires courts to choose the “most adequate plaintiff” as the lead plaintiff and to presume that the most adequate plaintiff is the investor with the largest financial stake in the relief sought.  Securities Act §27(a)(3)(B)(iii); Exchange Act §21D(a)(3)(B)(iii); Conf. Rep. at 29.

In order to give potential lead plaintiffs with large financial interests the opportunity to serve as lead plaintiff in the action, the Act requires that a plaintiff filing a securities class action must, within 20 days of filing the complaint, provide notice to all potential class members in a “widely circulated national business-oriented publication or wire service.”  Securities Act §27(a)(3)(A)(i); Exchange Act §21D(a)(3)(A)(i). The notice must identify the claims alleged in the action and the class period, and it must inform potential class members of their right to move to serve as lead plaintiff within 60 days of the date of the filing the complaint.  Id.  As a practical matter, such notices also typically include the name, address, and phone number of the attorneys representing the class and direct any potential class members to contact such person for more information.

  1. Automatic Stay of Discovery

The PSLRA further elevates the plaintiff’s burden by providing that discovery in the case is automatically stayed when the defendant files a dispositive motion to dismiss.  Securities Act § 27(b); Exchange Act § 21D(b)(3)(B). The effect of the combination of heightened pleading standards and the stay of discovery is that a plaintiff must plead facts that are often uniquely within the defendant’s possession, but is precluded from exploring documents such as company records that would demonstrate the defendant’s knowledge of the falsity of any statements.

The PSLRA also limits a plaintiff’s ability to seek relief from the court.  The PSLRA undermines the trial court’s discretion to guide discovery by limiting discovery during the pendency of a motion to dismiss to exceptional circumstances where particularized discovery is necessary to preserve evidence or prevent undue prejudice to a party.  Securities Act § 27(b)(1); Exchange Act § 21D(b)(3)(B).

  1. The Effects of the PSLRA on Securities Litigation

It will take years to assess the impact of the PSLRA as courts struggle to interpret its provisions.  Securities cases filed since the passage of the PSLRA are moving very slowly through the courts as judges consider the effects of its provisions in a cautious and deliberate manner.  See Securities and Exchange Commission, Office of the General Counsel, Report to the President and the Congress on the First Year of Practice Under the Private Securities Litigation Reform Act of 1995, April, 16, 1997 (hereinafter “SEC Report”), Section VIII.  At least some courts, however, have interpreted the language in the act exactly as its opponents feared, creating almost insurmountable obstacles for defrauded investors trying to recover their losses.

  1. The Heightened Pleading Requirement: Actual Knowledge?

The most significant problem to potential plaintiffs presented by the PSLRA involves the heightened pleading requirement found in the statutory safe harbor provision.  Three federal district courts have already issued rulings so restrictive that they threaten almost all private enforcement of the securities laws.  In re Silicon Graphics, Inc. Securities Litig,, C 96-0393, 1997 WL 337580 (N.D. Cal. June 5, 1997); Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42 (D. Mass. 1997); Powers v. Eichen, Case No. Civil 96-1431-B (AJB) (S.D. Cal. Mar. 13, 1997).  In one of those decisions — holding that reckless wrongdoers are no longer liable to the victims of their fraud under the PSLRA — the SEC took the extraordinary step of filing a brief in the district court to protest the result, arguing that the judge had misread the legislative history, and thus incorrectly nullified 20 years of widely established securities law.  In re Silicon Graphics, Inc. Securities Litig., Fed. Sec. L. Rep. (CCH) 99,325 (N.D. Cal. 1996); 1996 U.S. Dist. Lexis 16989.

Apparently in reliance on a single footnote in the PSLRA’s Statement of Managers, a federal judge in the Northern District of California held that the PSLRA required plaintiffs to “allege specific facts that constitute circumstantial evidence of conscious behavior by defendants.”  Id. at 95,962.  The court held that the plaintiffs must allege facts that would “create a strong inference of knowing misrepresentation on the part of the defendants” in order to survive a motion to dismiss.  Id. at 95,963.  In effect, the court found that reckless behavior can never constitute securities fraud under the PSLRA.

Following the court’s order granting the motion to dismiss, the Silicon Graphics plaintiffs filed an amended complaint, which the defendants again moved to dismiss.  It was in connection with that motion that the SEC filed its amicus curiae brief urging the court to reconsider its earlier decision, arguing that requiring plaintiffs to allege actual knowledge or conscious behavior effectively eliminated recklessness as a sufficient state of mind for liability under Section 10(b) of the Exchange Act, greatly eroding the deterrent effect of Section 10(b) actions.  Brief of the Securities and Exchange Commission, amicus curiae, In re Silicon Graphics Securities Litig., Fed. Sec. L. Rep. 99,325 (N.D. Cal. 1996) (hereinafter “SEC Brief”).[3] The SEC advocated that the “look the other way” defense has no place in securities law, because “practical necessities” require a recklessness standard.  Id.  Proving a defendant’s actual knowledge of fraudulent misconduct in a securities action can be a “daunting task” for plaintiffs, and if the PSLRA were interpreted to require such proof of actual knowledge, it would “for all intents and purposes disembowel” the private enforcement of the federal securities laws.  Id.  Despite the SEC’s urging, however, the court dismissed the plaintiffs’ amended complaint, again finding the allegations too generic to withstand the heightened pleading requirements of the PSLRA.  In re Silicon Graphics, Fed. Sec. L. Rep. ¶99,468 (CCH), 1997 WL 285057 (N.D. Cal. May 23, 1997)

Despite the Silicon Graphics decision, most other federal district courts have interpreted the PSLRA more reasonably and consistently with long-standing securities fraud principles, finding that an allegation of recklessness is sufficient to state a claim for liability.  However, the lasting effect of the PSLRA remains to be seen.  No appellate court has yet ruled on the provisions of the PSLRA, and it is impossible to arrive at any supportable generalization regarding its effects.

  1. The Effect of the PSLRA on Securities Actions in State Courts

Less than two years have elapsed since the passage of the PSLRA.  Thus, any conclusions about the effects of the PSLRA on the filing of securities actions in state courts must clearly be viewed as preliminary observations.  Nevertheless, based on a premature analysis of the scanty evidence provided by less than two years’ worth of experience under the PSLRA, the securities industry has been making claims that, despite the passage of the PSLRA, the flood of “frivolous” securities lawsuits has not waned; instead, they argue, plaintiffs are cleverly “circumventing” the requirements of the PSLRA by merely filing their complaints in state courts.  In reality, the evidence suggests that no such “flood” exists; most sources have been able to identify only a handful of securities class actions pending in state court, fewer than 70 nationwide.  SEC Report, Section VII. This number represents an infinitesimally small percentage of the roughly 15 million civil cases filed in state courts each year.

At least one study has reported an increase of filings in state court in 1996 compared to previous years; however, its authors also admitted that “[i]t is too soon to draw any firm conclusions from these data with respect to the effect the PSLRA has had on the aggregate number of securities class action lawsuits filed per year” and “we do not attempt to draw any conclusions from these data concerning . . . trends in state court filings.”  Joseph Grundfest and Michael Perino, Securities Litigation Reform: The First Year’s Experience, Stanford Law School, Release 97.1, February 27, 1997, at 10-11 (hereinafter “Stanford study”); see also Joint Written Testimony of Joseph A. Grundfest and Michael A. Perino before the Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Securities, July 24, 1997.[4]

Moreover, the Stanford study was based on an extremely small sample; an increase of just a few cases could result in a significant increase in the percentage of cases filed.  Given the small total number of cases filed in state court, a slight annual increase of 10 or 20 cases will substantially skew the percentages.  In addition, the Stanford study focuses on the PSLRA’s effect on the total number of filings without any regard to the actual incidence of fraud.  As discussed below, SEC regulators have acknowledged that the incidence of securities-related fraud has increased dramatically in recent years.  If the incidence of fraud has increased, then the study’s observation that filings have remained roughly constant, or even decreased, since the passage of the PSLRA may in fact reflect a significant decrease in protections for investors — exactly what the opponents of the PSLRA feared and predicted would be the result of its passage.

Furthermore, although the PSLRA presents obstacles to plaintiffs filing securities class actions in federal court, choosing to file an action for securities fraud in state court instead of federal court presents additional obstacles for plaintiffs:  not every state even provides a private right of action for claims based on securities fraud, and it is often difficult to establish jurisdiction over the defendants in the particular state.  SEC Report, Section VII.  Furthermore, few states provide remedies for private plaintiffs that are as broad as the federal remedies for securities fraud.  Id.  As a result of these limitations on state remedies, plaintiffs in securities class actions are not filing in state courts in significant numbers.

In sum, what little evidence exists regarding the filing of securities class actions in state courts since the passage of the PSLRA suggests only a moderate increase in state court filings in 1996.  Furthermore, although the year is not yet over, the evidence thus far indicates that state court filings have actually decreased in 1997.  See Securities Class-Action Lawsuits Make Comeback in Federal Court, Wall Street Journal, July 9, 1997, at B11.  Thus, there has not been nearly enough time to fully evaluate the effects of the PSLRA on the number of securities class actions filed in state courts.

[1]Frank Lalli, Your 1000 Letters of Protest May Stop this Congress from Jeopardizing Investors, Money Magazine, November, 1995, at 11(2).

In comments submitted to the Securities Exchange Commission on May 1, 1996, the American Association of Retired Persons, the Consumer Federation of America and the National Council of Individual Investors observed that “[w]hile the Act was touted as a way to eliminate frivolous lawsuits, its practical repercussion is that many investors with meritorious claims will be denied access to the courts.”  Letter from Martin Corry, Director, Federal Affairs, American Association of Retired Persons, et al., to Jonathan G. Katz, Secretary, Securities and Exchange Commission (May 1, 1996).

[2]The PSLRA amended the 1933 Act and the 1934 Act.  Citations within this article are to the 1933 Act and 1934 Act as amended by the PSLRA.

[3]The SEC’s brief reviewed the legislative history of the PSLRA and concluded that the act did not eliminate recklessness as a scienter standard for private securities actions:

Nowhere did the Conference Committee suggest that it was eliminating recklessness as satisfying the scienter requirement, or, indeed, that it was eliminating evidence of motive and opportunity or circumstantial evidence of fraudulent intent (be it conscious or reckless) as factors that the courts might consider in determining whether the strong inference had been established.  Instead, Congress simply elected not to attempt to codify the guidance provided in Second Circuit case law, preferring to leave to the courts the discretion to create their own standards for determining whether a plaintiff has established the required strong inference.

SEC Brief.

[4]The testimony given before the Senate incorporated much of the findings in the original study, but also included some more recent data; therefore, the discussion of the Grundfest and Perino findings applies to both the study and their testimony.

SECURITIES CLASS ACTIONS: THE PLAINTIFFS’ PERSPECTIVE – Part III

This is Part 3 in a 4 part series on Securities Class Actions by Martin Chitwood.

Standards for Class Certification Under Rule 23

To promote private enforcement of the federal securities laws, courts endorse a liberal construction of Rule 23 in securities cases.  See Kennedy, 710 F.2d at 717-18; In re KnowledgeWare, Inc. Shareholder Litig. Master File No. 1:92-CV-1651-JTC, at 11 (N.D. Ga. Jan. 31, 1993) (order granting class certification).  Accordingly, “when a court is in doubt as to whether to certify a class action, the court should err in the direction of allowing the suit to go forward as a class action.”  In re DCA Sec. Litig., Civil Action No. 1:89-CV-2195-RCF, at 4-5 (N.D. Ga. December 21, 1990) (order granting class certification) (hereinafter “DCA Sec. Litig. Order”); Eisenberg v. Gagnon, 766 F.2d 770, 785 (3d Cir. 1985).

Rules 23(a) and (b) contain the substantive requirements for certification of a class.  In order to maintain a class action, the plaintiff bears the burden of establishing the four class requirements of Rule 23(a) — numerosity, commonality, typicality and adequacy — and must also demonstrate that one of the three fact situations of Rule 23(b) is present.  Rule 23(b)(1) authorizes class action treatment where separate actions would “create a risk of inconsistent or varying adjudications” that would “establish incompatible standards of conduct” for the party opposing the class, or where separate adjudications would “as a practical matter be dispositive of the interests of the others” in the class who are not parties to that adjudication.  Rule 23(b)(2) authorizes a class action when the party opposing the class has acted on grounds generally applicable to the class, making final injunctive or declaratory relief appropriate with respect to the class as a whole.  Finally, Rule 23(b)(3) permits a class action to be certified when common questions of law and fact predominate as to all members of the class and a class action is superior to alternative methods for the fair and efficient adjudication of the controversy.  Rule 23(b)(3) is the most frequently used basis for certifying a class in securities class actions; therefore it is the only section of Rule 23(b) that will be discussed herein.

In determining the propriety of a class action, “the question is not whether the . . . plaintiffs have stated a cause of action or will prevail on the merits, but rather whether the requirements of Rule 23 are met.”  Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177-78 (1974) (quoting with approval Miller v. Mackey Int’l Inc., 452 F.2d 424, 429 (5th Cir. 1971)).  See also Cox v. American Cast Iron Pipe Co., 784 F.2d 1546, 1557 (11th Cir).  The most pertinent considerations in a court’s ruling on a motion pursuant to Rule 23 are the requirements of the rule itself and the allegations in the complaint, which must be accepted as true for the purpose of deciding whether a class should be certified.  E.g., Shelter Realty Corp. v. Allied Maintenance Corp., 574 F.2d 656, 661 n.15 (2d Cir. 1978); Westlake v. Abrams, 565 F. Supp. 1330, 1337 (N.D. Ga. 1983); see also Kirkpatrick, 827 F.2d at 722-23; In re T2 Medical, Inc. Shareholder Litig., Civil Action No. 1:92-CV-1564-RLV, at 16  (N.D. Ga. Nov. 17, 1993) (order granting class certification).  Consequently, the sole issue presented in a motion for class certification is whether Plaintiffs have fulfilled the requirements of Rule 23, not whether plaintiffs will prevail on the merits of their claims.  DCA Sec. Litig. Order, at 4.

Furthermore, the policies underlying the need for class action litigation in general necessarily require that Rule 23 be interpreted liberally.  “[For] the interests of justice require that in a doubtful case . . . any error, if there is to be one, should be committed in favor of allowing a class action.”  Eisenberg v. Gagnon, 766 F.2d 770, 785 (3d Cir.) (quoting Esplin v. Hirschi, 402 F.2d 94, 101 (10th Cir. 1968)).  See also Giles v. Ireland, 742 F.2d 1366, 1372 (11th Cir. 1984); Freeman v. Motor Convoy, Inc., 700 F.2d 1339, 1347 (11th Cir. 1983).

Each of the elements of Rule 23 is discussed more fully below.

  1. The Class Requirements of Rule 23(a)

Rule 23(a) provides:

One or more members of a class may sue or be sued as representative parties on behalf of all only if (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class, and (4) the representative parties will fairly and adequately protect the interests of the class.

Fed. R. Civ. P. 23(a).  All four of these class requirements must be met before a class may be certified under Rule 23.

  1. Numerosity

Rule 23 does not define what a class is or how its members should be determined.  In general, however, to satisfy the numerosity requirement, although a plaintiff need not prove the exact number or identity of class members, he must show that the number is exceedingly large and that joinder is impracticable.  See Evans v. United States Pipe & Foundry Co., 696 F.2d 925, 930 (11th Cir. 1983); In re Carbon Dioxide Antitrust Litig., 149 F.R.D. 229, 232 (M.D. Fla. 1993).  Class actions consisting of fewer than 150 members have been held to satisfy the numerosity requirement, e.g., Kreuzfeld, A.G. v. Carnehammar, 138 F.R.D. 594, 599 (S.D. Fla. 1991) (certifying a class of approximately 130 members and noting that the numerosity requirement has been satisfied with as few as 25 or 30 class members) as have class actions involving millions of class members, e.g., In re NASDAQ Market-Makers Antitrust Litig., 169 F.R.D. 493 (S.D.N.Y. 1996) (class of at least a million securities investors certified).  Furthermore, where the putative class is geographically dispersed across the United States, as is the case in many securities actions, joinder of all class members is almost always considered impracticable.

Most plaintiffs in securities actions involving nationally traded securities are routinely able to satisfy the numerosity requirement, demonstrating that the class is sufficiently numerous so that joinder of all members is impracticable.  See, e.g., Evans v. U.S. Pipe & Foundry Co., 696 F.2d 925, 930 (11th Cir. 1983); T2 Medical Order at 9 (granting certification even though the precise number of purchasers was unknown); DCA Sec. Litig. Order at 5 (“Numerosity is generally presumed when a claim involves nationally traded securities.”);  Nat’l Data Corp. Order at 5.

  1. Commonality

Rule 23(a)(2) requires that in order for an action to be certified as a class action, the claims of the class members must involve common questions of law and fact.  This “commonality” requirement of Rule 23(a)(2) is satisfied if the “named representatives’ claims have the same essential characteristics as the claims of the class at large.” Appleyard v. Wallace, 754 F.2d 955, 958 (11th Cir. 1985) (quoting De La Fuente v. Stokely-Van Camp, Inc., 713 F.2d 225, 232 (7th Cir. 1983)).  The rule does not require that every question of law or fact be common to each class member, only that some questions be common, and those questions be central to the action.  Cox v. American Cast Iron Pipe Co., 784 F.2d at 1557; Nat’l Data Corp. Order at 5-6; T2 Medical Order at 10.  The plaintiff must show that class members share a “substantially identical factual situation” and that the “questions of law raised by the plaintiff are applicable to each class member.”  In re Amerifirst Sec. Litig., 139 F.R.D. 423, 428 (S.D. Fla. 1991) (quoting Weiss v. York Hospital, 745 F.2d 786, 808 (3d Cir. 1984)).  See also Powers v. Stuart-James Co., 707 F. Supp. 499, 502 (M.D. Fla. 1989).

In a typical securities class action under Section 10(b) of the Exchange Act and SEC Rule 10b-5, the commonality requirement is easily satisfied.  Where the plaintiffs have alleged that the defendants made material misrepresentations about a company through uniform public statements or by a failure to disclose material facts, the common question requirement of Rule 23(a)(2) is ordinarily met.  See, e.g., Lipton v. Documation, Inc., 734 F.2d 740, 743 (11th Cir. 1984); Blackie v. Barrack, 524 F.2d 891, 902-05 (9th Cir. 1975) (holding that common questions of law and fact abound where alleged fraud involves uniform written documents like news releases).  As Judge Vining of the Northern District of Georgia observed in T2 Medical,

The plaintiffs assert claims of fraud on the market based on a continuous course of conduct by the defendants involving a series of misrepresentations and omissions, made by or on behalf of the defendants, over a period of approximately seven months.  The plaintiffs allege that the defendants released such misinformation in order to artificially inflate the stock price for their own financial gain.  The court finds that the alleged misrepresentations and omissions are common to all T2 Medical shareholders who owned stock during the period at issue.  Moreover, there are questions of law common to all class members, including whether the defendants’ misrepresentations and omissions constituted fraud-on-the-market.  The court finds that questions of both law and fact common to the members of the class exist.

T2 Medical Order at 10; see also 4 H. Newberg & A. Conte, Newberg on Class Actions, §18.05 (3d ed. 1992).

In a typical securities class action for violations of the federal securities laws, each class member’s claims arise out of the same set of facts and are based upon common legal theories; therefore, satisfying the commonality requirement is rarely difficult.  Some examples of the common questions of law and fact that are often present in shareholder class actions based on securities fraud include:

(a)        Whether defendants violated §10 of the Exchange Act;

(b)        Whether the Company’s publicly disseminated releases and statements during the Class Period omitted and/or misrepresented material facts, and whether defendants breached any duty to convey material facts or to correct material facts previously disseminated;

(c)        Whether Defendants participated in and pursued the common course of conduct complained of in the Complaint;

(d)       Whether, with respect to the claims of the Class asserted under the Exchange Act, Defendants acted knowingly or recklessly in omitting and/or misrepresenting material facts;

(e)        Whether the market price of the Company’s common stock during the Class Period was artificially inflated due to the material nondisclosures and/or misrepresentations described in the Complaint; and

(f)        Whether the members of the Class have sustained damages and, if so, what is the appropriate measure of damages.

  1. Typicality

The “typicality” element of Rule 23(a)(3) requires “a nexus between the class representative’s claims or defenses and the common questions of fact or law which unite the class.”  Kornberg v. Carnival Cruise Lines, Inc., 741 F.2d 1332, 1337 (11th Cir. 1984).  “A plaintiff’s claim is typical if ‘it arises from the same event or practice or course of conduct that gives rise to the claims of the other class members, and her or his claims are based on the same legal theory.’”  In re Domestic Air, 137 F.R.D. at 698 (quoting 3 Newberg on Class Actions, §18.09 at 464).  Obviously, in order to satisfy this requirement, the named plaintiff must be an actual member of the class, but typicality does not require that all claims or defenses be identical; where a strong similarity of legal theories is present, the typicality requirement will be satisfied despite the existence of substantial factual differences.  Appleyard v. Wallace, 754 F.2d at 958; Kornberg, 741 F.2d at 1337 (“[a] factual variation will not render a class representative’s claim atypical unless the factual position of the representative markedly differs from that of other members of the class”) (citations omitted).

Ordinarily, the claims asserted by plaintiffs in a securities class action arise from the same events and practices and are based on the same legal theories as the claims of absent class members; the named plaintiff is seeking to prove that defendants committed the same unlawful acts against an entire class.  Thus, in those situations, most courts have found that all members of the class have identical claims, and therefore, the typicality requirement of Rule 23(a)(3) is usually satisfied.  See, e.g.Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718, 722-25 (11th Cir. 1987); Kennedy v. Tallant, 710 F.2d 711, 717 (11th Cir. 1983).

In the Eleventh Circuit, neither a named plaintiff’s degree of investment experience and sophistication nor his degree of reliance will usually preclude satisfaction of the typicality requirement.  Kennedy, 710 F.2d at 717; AmeriFirst Sec. Litig., 139 F.R.D. 423, 429 (S.D. Fla. 1991).

  1. Adequacy

Rule 23(a)(4) requires that the named plaintiffs fairly and adequately protect the interests of the class.  Rule 23(a)(4) has been interpreted as imposing a two-fold standard:  (1) the named plaintiffs must have interests in common with, and not antagonistic to, those of the other members of the class; and (2) the plaintiffs’ attorneys must be qualified, experienced, and generally able to conduct the litigation.  Kirkpatrick, 827 F.2d at 726; Powers v. Stuart-James Co., 707 F. Supp. at 503; DCA Sec. Litig. Order at 13; T2 Medical Order at 13-14.  The first aspect of the adequacy requirement is usually satisfied unless the named plaintiff has an interest that might be in some way adverse to other class members.  In typical securities actions, however, the representative plaintiff’s interests are common with the interests of the class and are not adverse or antagonistic to any class member.  In those situations, the named plaintiffs meet the adequacy requirement of Rule 23(a)(4) because their interests are directly aligned with the interests of absent class members — each plaintiff claims to have been damaged by the same alleged conduct, and each has precisely the same interest as members of the class to achieve the maximum possible recovery.

With respect to the second prong of the “adequacy” inquiry  — the qualifications of counsel — the named plaintiff’s attorneys must exhibit that they are qualified and experienced in antitrust class action litigation, and “will pursue with vigor the legal claims of the class.”  Kirkpatrick v. J.C. Bradford & Co., 827 F.2d at 727.  As Judge Vining has noted:  “The Court should focus its attention on counsel for the class, not the class representative, when determining adequacy of class representation . . . .”  See In re T2 Medical, Inc. Shareholder Litig. Order, Civil Action No. 1:92-CV-1564-RLV, p.3 (N.D. Ga. Oct. 27, 1992) (citing Kirkpatrick, 827 F.2d at 727).  In assessing the competence of counsel, the courts in the Eleventh Circuit have held that “there is a presumption of competence in the absence of proof to the contrary.”  DCA Sec. Litig. Order at 14.

  1. The Requirements of Rule 23(b)(3): Common Questions of Law and Fact Predominate and a Class Action is Superior to Any Other Method of Adjudication

In addition to satisfying the four class requirements of Rule 23(a), a plaintiff seeking class certification must show that at least one of the conditions set forth in Rule 23(b) is also present.  Rule 23(b) provides in relevant part:[1]

An action may be maintained as a class action if the prerequisites of subdivision (a) are satisfied, and in addition:

* * *

(3) the court finds that the questions of law or fact common to the members of the class predominate over any questions affecting only individual members, and that a class action is superior to other available methods for the fair and efficient adjudication of the controversy.

  1. Common Questions of Law and Fact Predominate

By its terms, Rule 23(b)(3) requires only that the common issues “predominate”; they need not be dispositive of the entire litigation. See 7A Wright, Miller & Kane, Federal Practice and Procedure: Civil 2d § 1778 at 528 (1996).  “Rule 23 does not require that all the questions of law and fact raised by the dispute be common.”  Kirkpatrick v. J. C. Bradford & Co., 827 F.2d at 725, (quoting Cox v. American Cast Iron Pipe Co., 784 F.2d 1546, 1557 (11th Cir. 1986)).  See also In re Domestic Air Transp. Antitrust Litig., 137 F.R.D. 677 (N.D. Ga. 1991).

The Northern District of Georgia has recognized that in cases where (1) the named plaintiffs allege that a series of misrepresentations and omissions by the defendants resulted in an artificially inflated price of the defendants’ common stock and (2) the named plaintiffs are entitled to the presumption of reliance, as they often are in shareholder class actions involving securities traded on a national market, “the common questions of law and fact easily predominate over questions affecting individual class members.”  DCA Sec. Litig. Order at 8, 15-16.  Moreover, “Courts generally focus on the liability issue in deciding whether the predominance requirement is met, and if the liability issue is common to the class, common questions are held to predominate over individual questions.”  In Re: Alexander Grant & Co. Litig., 110 F.R.D. 528, 534 (S.D. Fla. 1986) (quoting Dura-Bilt Corp. v. Chase Manhattan Corp., 89 F.R.D. 87, 89, 93 (S.D.N.Y. 1981)).

Where the claims involve securities that are actively traded on a national market, plaintiffs in securities class actions are usually entitled to a presumption of reliance under the “fraud-on-the-market” theory.  Furthermore, where plaintiffs’ claims of securities violations under § 10(b) of the Exchange Act allege, inter alia, a fraud-on-the-market claim, courts have held that such claims are ideally suited to class action treatment. See Tapken v. Brown, No. 90-691-CIV-MARCUS, 1992 WL 178984, at *17 (S.D. Fla. March 13, 1992).  The fraud-on-the-market theory was expressly endorsed by the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 227 (1988) and has been explained by Judge Vining as follows:

The fraud-on-the-market theory is based on the idea that information about a corporation’s expected future value is quickly and accurately incorporated into the price at which the corporation’s securities trade in public markets.  The defendants are liable for any material misrepresentation which is proved to have caused the price of a security traded on an open and developed securities market to deviate from the security’s efficient price.  The security’s efficient price is assumed to be the price at which the security would have traded in the absence of the misleading information.  Individuals who purchase or sell the security during the period of price deviation, and who are injured as a result, are entitled to recover regardless of whether those individuals knew of the misrepresentation or misleading omission.  Persons seeking to recover under the fraud-on-the-market theory need not prove individual reliance.  The inquiry in a fraud-on-the-market case is not whether an individual investor was fooled but rather if the market as a whole was fooled.

T2 Medical Order at 15-16 (citations omitted).  Because reliance is not an individual issue, but an issue that is presumed for a class as a whole upon certain showings, the fraud-on-the-market theory provides a predominant common issue in most securities fraud cases.   Lipton, 734 F.2d at 745.

Thus, the predominant issues for claims asserted under the Exchange Act are most often the defendants’ state of mind in making the alleged misrepresentations and/or omissions and the effect of their statements or omissions on the market for the Company’s stock, which together determine the defendants’ overall liability.  Issues of defendants’ liability to the class are virtually always common to each member of the class.  Therefore, with the exception of individual damages calculations, the respective factual and legal elements of liability in most securities class actions will predominate over individual issues.

“Individual” issues such as the amount of damage suffered by each class member are generally considered subordinate to the common issues concerning the defendants’ liability.  Most courts have consistently held that the existence of individual damage issues is insufficient to preclude class certification.  See In re: Alexander Grant & Co. Litig., 110 F.R.D. at 534 (“[O]nce liability and the relevant dates are established, assignment of damages becomes a ministerial task.”); see also Bogosian v. Gulf Oil Corp., 561 F.2d 434, 456 (3d. Cir. 1977) (“[I]t has been commonly recognized that the necessity for calculation of damages on an individual basis should not preclude class determination when the common issues which determine liability predominate.”); Presidio Golf Club v. National Linen Supply Corp., 1976-2 CCH Trade Cases ¶61,221 at 70,630-31 (N.D. Cal. 1976), (quoting Blackie v. Barrack, 524 F.2d 891, 906 n.22 (9th Cir. 1973) (“The fact that a defendant may be able to defeat the showing of causation as to a few individual class members does not transform the common question into a multitude of individual ones; plaintiffs satisfy their burden of showing causation as to each by showing [generalized damage] as to all.”)); 4 Newberg on Class Actions §18.27 at 18-89 (“Individual damages questions do not preclude a Rule 23(b)(3) class action when the issue of liability is common to the class.”).

  1. A Class Action is Superior to Other Available Methods of Adjudication

Rule 23(b)(3) further requires that the class action be superior to other available methods for the fair and efficient adjudication of the controversy.  In many securities class actions, not only does certification of a class provide a superior method with which to adjudicate the action, it may be the only realistic method for redress.  Absent a class action, the individual claims of many class members may be so small that the cost of litigation would be far greater that the value of those claims.

As the Supreme Court has recognized, “Class actions . . . permit the plaintiffs to pool claims which would be uneconomical to litigate individually . . . .  [M]ost of the plaintiffs would have no realistic day in court if a class action were not available.”  Phillips Petroleum, 472 U.S. at 809.  Multiple lawsuits by individual class members would be costly and inefficient, and the exclusion of those class members that cannot afford separate representation would be neither fair nor provide an adjudication of their claims.  Northwestern Fruit Co. v. A. Levy & J. Zentner Co., 116 F.R.D. 384 (E.D. Cal. 1986).

Courts have repeatedly recognized the general superiority of class treatment in securities fraud actions involving large numbers of investors.  See, e.g., Escott v. Barchris Constr. Corp., 340 F.2d 731, 733 (2d Cir. 1965); Nat’l Data Corp., Order at 4; Werfel v. Kramarsky, 61 F.R.D. 674, 682-83 (S.D.N.Y. 1974).  In addition, “separate actions by each of the class members would be repetitive, wasteful, and an extraordinary burden on the courts”.  Kirkpatrick, 827 F.2d at 725.

In addition, Rule 23(b)(3) requires the court to consider the following factors:

(1)        the interest of members of the class in individually controlling the prosecution of separate actions;

(2)        the material differences between the present litigation and litigation concerning this controversy already commenced by potential class members;

(3)        the desirability of concentrating the litigation in the particular forum; and

(4)        the difficulties likely to be encountered in litigation as a class action.

See Fed. R. Civ. P. 23(b)(3).

First, the class action is often the only feasible method of adjudication where those who have been injured are in a poor position to seek legal redress because they do not have enough information or because redress is disproportionately expensive.  Nat’l Data Corp. Order at 4.  Thus, in many, if not most securities class actions, few members of the class would, as a practical matter, be in a position to proceed individually.

Additionally, actions based on large-scale securities fraud are almost always better managed as class actions.  Prosecution of these actions on a class basis is much more efficient than individual adjudication of thousands of claims.  Further, because shareholders may find individual litigation cost-prohibitive, the class mechanism provides a means for fair and efficient resolution of these claims.  Finally, there are seldom any significant or unusual difficulties in the management of securities fraud cases.  Therefore, the class action device is almost always the superior method for adjudicating the claims of shareholders in an action based on allegations that the defendants have violated the federal securities laws, particularly those actions involving claims asserted under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5.

[1]As discussed above, the other two subsections of Rule 23(b) are rarely invoked in the securities class action context; therefore, only Rule 23(b)(3) will be discussed herein.

SECURITIES CLASS ACTIONS: THE PLAINTIFFS’ PERSPECTIVE – Part II

This is Part 2 in a 4 part series on Securities Class Actions by Martin Chitwood.

Class Actions: Procedural Issues

Rule 23 of the Federal Rules of Civil Procedure (hereinafter “Rule 23”) governs federal class actions; however, the Local Rules of the Northern District of Georgia also contain important provisions specific to class actions.  Both should be thoroughly reviewed before filing a class action complaint.

Local Rule 23.1A requires that each class action complaint contain the designation “Complaint—Class Action” in the style of the case.  L.R. 23.1A, N.D. Ga.  The complaint must also contain a section titled “Class Action Allegations” that states the following:

(1) The section of Rule 23 of the Federal Rules of Civil Procedure which is claimed to authorize maintenance of suit by class action.

(2) The size (or approximate size) and definition of the alleged class.

(3) The basis of the named plaintiff’s or plaintiffs’ claim to be an adequate representative of the class, or, if defendants, the basis of the named defendant’s or defendants’ claim to be an adequate representative of the class.

(4) The alleged questions of law and fact which are common among members of the class.

(5) The allegations necessary to satisfy the criteria of section (b)(1) or (b)(2) of Rule 23 or to support the findings required by section (b)(3) of Rule 23.

(6) For actions requiring a jurisdictional amount, the basis for determination of that amount.

L.R. 23.1A, N.D. Ga.  The complaint must also define the class in a manner that is precise, clear, and presently ascertainable.  The definition of the class is of critical importance because it identifies both the persons entitled to relief and those to be bound by a final judgment.  The appropriate class definition may also be affected by other factors, such as the applicable law and choice-of-law considerations, which may sometimes necessitate the use of sub-classes.  See generally Manual for Complex Litigation, Third, § 30.14, at 217-218 (1995).

Before a case may proceed as a class action, the plaintiff must move for, and receive, “certification” of the class by the court.[1]  Although Rule 23(c) provides only that the court should determine “as soon as practicable” whether an action may be maintained as a class action, Local Rule 23.1B requires a plaintiff to move for class certification within ninety days after filing the complaint.  Whether and when a class is certified and how it is ultimately defined significantly affects the management and outcome of the litigation.  Early certification of a class is crucial, because it can affect who the parties are, the timing and scope of discovery and motion practice, and the approach to settlement negotiations.  See generally Manual for Complex Litigation, Third, § 30.14, at 217-218 (1995).

The defendants in a purported class action often seek a court order early in the litigation limiting precertification discovery to specific class-related issues and staying any discovery on the merits of the action until after the court rules on the plaintiff’s motion for class certification.  However, this type of bifurcated discovery procedure is problematic because discovery relating to class issues usually overlaps substantially with merits discovery.  For example, an important factor in determining whether a class should be certified is the similarity between the claims of the class representatives and those of the other class members — an inquiry that often requires discovery on the merits of the action.  Id. at 215-216 (citing Chateau de Ville Prod., Inc., v. Tams-Witmark Music Library, 586 F.2d 962 (2d Cir. 1978)).  As a result, bifurcating class and merits discovery leads to unnecessary duplication of discovery and disputes among counsel over the appropriate scope of discovery at the class certification stage.  See Manual for Complex Litigation, Third, § 30.12, at 215.

The plaintiff should prepare for the possibility that the court will hold an evidentiary hearing before ruling on a motion to certify a class.  The evidentiary hearing serves the limited purpose of allowing a court to assess how class claims will be presented and defended at trial.  Manual for Complex Litigation, Third § 30.13, at 217.  Consistent with the standard of review on a motion for class certification, the purpose of the hearing is not to evaluate the merits of the plaintiff’s claims; rather, the court will examine how the plaintiff intends to prove his case, not whether the plaintiffs can prove the case.  Id.  See Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177-78 (1974) (holding that courts have “no authority to conduct a preliminary inquiry into the merits of a suit in order to determine whether it may be maintained as a class action.”).

[1]  Although Rule 23 does not use the term “certification,” it is commonly used to refer to the process by which a court finds that an action has satisfied the requirements to proceed as a class action under Rule 23.  See Manual for Complex Litigation, Third, § 30.14, at 217-218 (1995).

SECURITIES CLASS ACTIONS: THE PLAINTIFFS’ PERSPECTIVE – Part I

This is Part 1 in a 4 part series on Securities Class Actions by Martin Chitwood.

Introduction

American capital markets operate under the provisions of the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”).  The purpose of those bills was

to protect the investing public and honest business; . . . to prevent further exploitation of the public; . . . to place adequate and true information before the investor; to protect honest enterprise; . . . [and] to restore the confidence of the investor . . . .

  1. Rep. No. 47, 73rd Cong., 1st Sess., at 1 (1933). In particular, Section 10-b of the Exchange Act and its Rule 10b-5 deterred fraudulent conduct by insuring that companies were punished when they misrepresented or exaggerated information to unlawfully affect the price of their stock.

Because the Securities Exchange Commission (“SEC”) does not collect investment losses for defrauded investors, private causes of action under the Securities Act and the Exchange Act have played an important role in supplementing the enforcement powers of the SEC.  As one court observed:

The most effective control and deterrent to over-reaching and wrongful conduct in the capital raising area is the presence of private lawyers who are willing to devote their time, their energy, and their own personal resources to vindicate the rights of individual investors who have been importuned, misled, or who somehow have been fraudulently deprived of their money.

In re Public Service of New Mexico, No. 91-0536M (S.D. Cal. July 28, 1992), at 8.

The United States Supreme Court has also recognized that one of the “essential tool[s]” in achieving the purpose of the Exchange Act (i.e., the promotion of full and fair disclosure by companies issuing securities) is the private right of action implied under Section 10(b) of the Exchange Act and SEC Rule 10b-5.  Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); Herman & MacLean v. Huddleston, 459 U.S. 375, 380 (1983).  As the Eleventh Circuit has noted, class actions in particular serve the “public interests in the private enforcement of various regulatory schemes, particularly those governing the securities markets.” Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718, 727 (11th Cir. 1987).

In a class action lawsuit, a “class representative” sues on behalf of himself and all other persons who were similarly harmed by the same wrongdoer or wrongdoers.  This process enables potential plaintiffs to pool claims for litigation that would be economically inefficient to litigate individually.  Such potential plaintiffs “would have no realistic day in court if a class action were not available.”  Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 809 (1985).  Therefore, a class action is the preferred mechanism whenever a large number of persons have been similarly harmed by an alleged wrongdoer or wrongdoers and the individual amount of damages suffered by each potential plaintiff may be too small to justify litigating on an individual basis.

Actions alleging violations of the federal securities laws are often ideal for class action treatment because they involve a large number of shareholders who have suffered damages in amounts that are small enough to make  litigating them individually cost prohibitive, but that when pooled together are quite large.  Thus, courts frequently certify classes in cases involving claims of securities fraud.  E.g., In re T2 Medical, Inc. Shareholder Litig., Civil Action No. 1:92-CV-1564-RLV  (N.D. Ga. Nov. 17, 1993) (order granting class certification); In re Nat’l Data Corp. Sec. Litig., Master File No. 1:90-CV-1037-JEC (N.D. Ga. Mar. 31, 1993) (order granting class certification) (hereinafter Nat’l Data Corp. Order); In re KnowledgeWare, Inc. Shareholder Litig. Master File No. 1:92-CV-1651-JTC  (N.D. Ga. Jan. 31, 1993) (order granting class certification); In re DCA Sec. Litig., Civil Action No. 1:89-CV-2195-RCF (N.D. Ga. December 21, 1990) (order granting class certification); see also 4 H. Newberg & A. Conte, Newberg on Class Actions §18.05 (3d ed. 1992).

Class actions also provide a mechanism to resolve numerous related claims in one forum, establishing a uniform standard for conduct and preserving judicial resources.  Thus, “it is well-recognized that class actions are a particularly appropriate means for resolving securities fraud actions.”  In re Nat’l Data Corp. Sec. Litig., Master File No. 1:90-CV-1037-JEC, at 4 (N.D. Ga. Mar. 31, 1993) (order granting class certification) (citing Kennedy v. Tallant, 710 F.2d 711, 718 (11th Cir. 1983)).  The class action mechanism provides a vehicle for the private enforcement of the federal securities laws because “a large number of individuals may have been injured, although no one person may have been damaged to a degree which would have induced him to institute litigation solely on his own behalf.”  Id. (quoting Green v. Wolf Corp., 406 F.2d 291, 296 (2d Cir. 1968)).

This article outlines the fundamentals of a securities class action from the perspective of the plaintiff class, with an emphasis on the procedures for obtaining “certification” of the action as a class action under the Federal Rules of Civil Procedure.  It also discusses selected provisions of the Private Securities Litigation Reform Act of 1995 (“PSLRA”) and its impact on securities class actions.  Although the discussion encompasses all class actions based on violations of the federal securities laws, particular attention is paid to those actions in which the plaintiffs are shareholders asserting claims arising under Section 10(b) of the Exchange Act, 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5.