Ruling Tightens Standard in Investors' Fraud Suits
Courts: Shareholders must show company acted deliberately, U.S. 9th
Circuit says in decision hailed by high-tech executives.
By DAVAN MAHARAJ, HENRY WEINSTEIN, Times Staff Writers
In a major victory for California's
high-technology companies, an influential
federal appeals court made it tougher Friday for
shareholders to win securities fraud lawsuits against
corporations.
Shareholders must now show that a company
intended to commit fraud--not merely engaged in
reckless conduct, according to a divided U.S. 9th Circuit Court of
Appeals. The court's opinion, which applies to California and eight other
Western states, was its first interpretation of a 1995 law designed to
curb abusive securities lawsuits.
"In the world of securities class-action legislation, this is big," said
Joseph Grundfest, a securities law expert at Stanford Law School. "It
makes it harder to sue Silicon Valley companies [and] it gives them an
additional measure of protection against litigation that they have viewed
as harassing and frivolous."
Corporations, especially California's high-tech companies, have long
complained that they were paying hundreds of millions of dollars in
settlements and attorneys' fees each year to fight shareholder suits,
which often allege that a company's plunging stock price resulted from
mismanagement and fraud, not simply market forces.
The targeted firms say they are often faced with the dismal choice of
spending small fortunes defending themselves or cutting their losses with
a settlement. Often, they settle.
Tired of caving in to plaintiffs' attorneys, executives from a hundred
California high-tech companies joined corporate America in 1995 to
overhaul the nation's securities laws. That year they persuaded Congress
to override President Clinton's veto and pass the Private Securities
Litigation Reform Act.
The law sought to make it tougher to pursue shareholder lawsuits against
corporations. A key provision requires aggrieved shareholders to state
"with particularity" any facts that suggest corporations intended to
commit fraud.
But courts across the country have interpreted it differently. In fact,
Friday's 9th Circuit opinion is diametrically opposed to ones rendered
by federal appeals courts in New York and Philadelphia.
But the 9th Circuit oversees more securities litigation than any of the
other 11 federal circuits.
Securities experts such as Columbia University law professor John
Coffee predicted that the issue would most likely have to be resolved by
the U.S. Supreme Court. "There is a clear conflict" in the appellate
courts, Coffee said.
For now, Silicon Valley executives are savoring their victory.
"It's a just decision and it's good for everybody, except possibly the
plaintiffs' lawyers," said Mark Michael, senior vice president and general
counsel of 3Com Corp.
Martin said 3Com spent $2 million on attorney fees defending a 1989
investor fraud suit that eventually was settled. The amount was more
than the San Jose firm spent on legal services for all purposes in its first
10 years.
"This affects hundreds of cases that have been or will be filed under the
reform act. . . . It does clarify and appropriately narrow the types of
cases that will be brought."
Bruce Vanyo, an attorney for Silicon Graphics Inc., said: "This is
wonderful that after four years, we finally have a vindication."
"Companies that commit real fraud are still going to get sued," Vanyo
said, "but companies that don't commit fraud and simply had a bad
quarter or unexpected surprises aren't going to get sued."
At Intel Corp., which has been the target of three unsuccessful investor
suits in the last decade, company Vice President Peter N. Detkin called
the decision "a great first step." Before the decision, Detkin said,
plaintiffs who filed such fraud suits would brag that " 'I've got a lottery
ticket.' This will limit that."
The biggest loser in Friday's ruling appears to be the law firm of San
Diego attorney William Lerach, who has made a lucrative career out of
filing class-action shareholder suits. Plaintiffs' attorneys typically keep
one-third of the amounts recovered in these cases. Since 1988, Lerach's
firm has raked in nearly $700 million from such cases, of which Lerach
himself has pocketed about $100 million.
Leonard B. Simon, an attorney in Lerach's San Diego office, said the
firm plans to appeal the ruling.
"If this decision stands, it will be harder to plead securities fraud with the
kind of information investors typically have--the kind of information
possessed by people who are on the outside looking in."
Friday's decision involved a suit that Lerach and other attorneys filed
against Silicon Graphics not long after the new law went into effect. The
suit contended that executives issued deceptive statements to inflate the
price of company stock to sell it for a total profit of $13.8 million.
The company denied any wrongdoing.
U.S. District Judge Fern M. Smith in San Francisco dismissed the suit in
1996. She held that the plaintiffs had failed to meet the stiffened pleading
requirements of the new law.
After Smith's decision, the Securities and Exchange Commission, which
often views shareholder lawsuits as supplementing its own enforcement
action, said the judge misinterpreted Congress' intent.
"Proving a defendant's actual knowledge of fraud in a securities case can
be a daunting task, particularly when the evidence is entirely
circumstantial," SEC lawyers said in a friend-of-the-court brief.
But two judges on the three-member panel disagreed.
"We hold that, although facts showing mere recklessness or a motive to
commit fraud and opportunity to do so may provide some reasonable
inference of intent, they are not sufficient to establish a strong inference
of intent," wrote 9th Circuit Judge Joseph T. Sneed.
He was joined by Judge John S. Rhoades, a federal trial judge from
Arizona, sitting by designation.
Judge James R. Browning dissented. Browning said the majority "raises
the pleading bar higher than that envisioned by Congress."
Times staff writer Charles Piller in San Francisco contributed to this
report.
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