High court gives clarity to litigation venues: in a key decision issued earlier this year, the Supreme Court has restricted the ability of plaintiffs' attorneys to shop for accommodating state venues for class action suits. Most must now be pursued in more predictable federal courts.
A recent Supreme Court decision, however, will bring predictability to one legal issue that weighs heavily on financial executives. In Merrill Lynch v. Dabit, the high court ruled that plaintiffs' lawyers no longer may bring securities class action lawsuits in state courts where the securities at issue are listed nationally and traded on a national exchange. Instead, they must pursue their cases in federal courts, as Congress intended and where the law generally is applied more predictably and less parochially.
The Dabit decision caps a long-fought legal and legislative battle to rein in securities class action lawsuits. As recently as the mid-1990s, virtually nothing prevented plaintiffs lawyers from churning out these lawsuits every time bad news was reported about a corporation or every time a company released a negative earnings report. It didn't matter that the lawsuits had no merit. Corporations tended to settle quickly, rather than risk costly jury verdicts and expose executives to time-consuming document discovery and depositions (interviews given under oath).
In a first attempt to shut down the securities class action mill, Congress enacted the Private Securities Litigation Reform Act of 1995 ("PSLRA"). That law made it difficult to file securities lawsuits at the drop of a hat because it required plaintiffs' lawyers to make very detailed factual allegations about the supposed fraud. The law also stopped document discovery and depositions until a court determined if the allegations were sufficiently detailed and otherwise legally sufficient. In this way, Congress intended to eliminate frivolous securities class action lawsuits.
But the PSLRA had an unintended effect: It made state courts a more attractive place to file securities lawsuits because state courts did not require detailed fact allegations and did not stop document discovery and depositions. Accordingly, plaintiffs' lawyers began suing in state courts.
While plaintiffs' lawyers couldn't accuse corporations of violating federal securities laws (those claims may be made in federal courts only), they could accuse corporations of common law fraud or violating state (as opposed to federal) securities laws. These accusations could be as deadly to a corporation as a violation of the federal securities laws, if proven at trial.
But even before the corporation had its day in court, plaintiffs' lawyers could rifle through corporate files and distract executives with endless depositions. In short, the PSLRA gave plaintiffs lawyers a dangerous incentive to sue in a relatively plaintiff-friendly forum, state courts.
The Law at Issue
Frustrated by the plaintiffs' lawyers' end-run around the PSLRA, Congress enacted the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), the law at issue in Dabit. SLUSA sought to close the PSLRA's legal loophole by making federal courts the exclusive forum for securities class action lawsuits based on state law. Congress gave SLUSA teeth by requiring federal judges to summarily dismiss these lawsuits if filed in state courts. In this way, Congress signaled its distaste for bringing securities class action lawsuits in state courts.
There was one catch. Because SLUSA applied to class action lawsuits "in connection with the purchase or sale" of securities, some courts concluded that so-called "holder" lawsuits could proceed in state court. (A holder lawsuit is brought by an investor who owned a security at the time of the fraud and, due to the fraud, held and did not sell the security.)
As such, it is different from a "purchaser" or "seller" lawsuit, which is brought by an investor who purchased or sold a security because he was duped by the corporation's fraud. Holders cannot sue under the federal securities laws; only purchasers or sellers may do so. If a holder wants to sue, he must do so under state, not federal, law. Therefore, some courts reasoned that it made sense for SLUSA to allow holders to sue in state court, while forcing purchasers and sellers to sue in federal court.
The Dabit Decision
The Supreme Court disagreed. In Dabit, the Court unanimously ruled that Congress intended all class action lawsuits involving securities listed nationally and traded on a national exchange to proceed in federal court, where the law is more predictable. The Court explained that, if holders were allowed to sue in state court, while purchasers and sellers were forced into federal court, "the prospect is raised ... of parallel class actions proceeding in state and federal court, with different standards governing claims asserted on identical facts."
"That prospect," the justices concluded, "squarely conflicts with the congressional preference for national standards for securities class action lawsuits."
The Supreme Court ruling in Dabit is a victory for corporate America and the predictability that it thrives on. Plaintiffs' lawyers no longer may shop around for the most sympathetic state court. They must sue in federal court. This promotes predictability by ensuring that securities class action lawsuits will be subject to rigorous scrutiny by federal courts applying federal standards. Although those standards are applied somewhat differently among the federal courts, those differences are minor (and well known) compared to the array of standards among the 50 states.
Dabit also promotes predictability by ensuring that the same procedural rules apply to all securities class action lawsuits. For example, in federal court, a corporate defendant has two opportunities to dismiss a lawsuit before trial: a motion to dismiss (which tests the legal sufficiency of a plaintiff's case) and a motion for summary judgment (which tests the factual sufficiency). In contrast, some states afford defendants only one pre-trial dismissal opportunity, and state court judges generally are more reluctant than their federal counterparts to dismiss cases before trial.
Additionally, document discovery and depositions may proceed full force in state courts almost from the moment a securities lawsuit is filed. That is not the case in federal courts, where document discovery and depositions are put on hold to protect a defendant, at least until a court decides that the lawsuit is legally sufficient.
Further, the federal rules generally limit depositions to seven hours, something state rules do not do. Finally, federal courts generally are less willing than state courts to grant plaintiffs class status. By driving more securities lawsuits into the federal courts, Dabit levels the playing field for corporate defendants.
But Dabit does not bar plaintiffs' lawyers from state courts altogether. SLUSA's requirement that an investor sue in federal court applies only to lawsuits brought on behalf of more than 50 people. It does not bar an investor from state court if he sues for himself or on behalf of 50 or fewer people.
Although a state court lawsuit by the average shareholder might not seem daunting to a corporation, the same lawsuit by an institutional investor, such as an insurance company or state pension fund, could pose a far greater threat. Additionally, SLUSA applies only to lawsuits concerning securities traded nationally and listed on a national exchange; it does not bar an investor from state court if he sues over private equity or debt offerings. These lawsuits, typically between sophisticated, well-heeled parties, likewise could prove troublesome for corporate defendants.
Dabit is a sound decision because it gives effect to the law that Congress passed. It also brings a measure of predictability to securities law by requiring plaintiffs' lawyers to file many types of securities class action lawsuits in federal court. That measure of predictability is good for the markets, corporate America and a financial executive's peace of mind. Nonetheless, Dabit is not a panacea. Even after Dabit, plaintiffs' lawyers may bring certain types of securities lawsuits in state courts.
Jeffrey Q. Smith (email@example.com) is a Senior Partner in the Business Litigation Group at law firm King & Spalding in New York. James K. Goldfarb (firstname.lastname@example.org) is an Associate in that group. The views expressed here are their own.
RELATED ARTICLE: Checklist: What Suits Can Be Brought Where
A securities class action lawsuit must be brought in federal court if it:
* seeks damages on behalf of more than 50 people;
* is based on state or local law;
* involves equity or other securities traded nationally and listed on a regulated national exchange; and
* alleges that the defendant misrepresented or omitted a material fact or employed a manipulative device or contrivance in connection with the purchase, sale or holding of the equity or other security.
The 1998 SLUSA law does not prevent an investor from bringing a securities lawsuit in state court when:
* The investor seeks damages on behalf of 50 or fewer people; or
* the lawsuit involves private equity or debt offerings; or
* the lawsuit seeks damages on behalf of 50 or fewer people and involves any security.
RELATED ARTICLE: takeaways
* State laws are very uneven when it comes to their treatment of corporate lawsuits, and in recent years, plaintiffs' attorneys have focused on states unfriendly to big business.
* In an important decision for corporations, Merrill Lynch v. Dabit, the U.S. Supreme Court ruled that class action suits in which a company is listed nationally and trades on regulated national exchanges can no longer be pursued in state court, but must go to federal court.
* The decision does not apply, however, where a suit is brought seeking damages on behalf of fewer than 50 people, or if the suit involves private equity or debt offerings.
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|Title Annotation:||managing litigation|
|Author:||Goldfarb, James K.|
|Date:||Dec 1, 2006|
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