By HOWARD FINE
Orange County Business Journal
High technology firms in Southern California rejoiced when Congress overrode a presidential veto to adopt legislation to limit frivolous securities fraud lawsuits.
But just over a year later, a study from a major insurance firm looks like a killjoy.
The study shows that, after a brief-wait-and-see period early in 1996, attorneys went right back to work, filing 81 securities fraud lawsuits also known as “strike suits” in federal court from April through October 1996.
That was the same number of suits filed for that period in 1995, the study found.
“The decrease in federal securities fraud class actions, expected as a result of the 1995 reform act, has not occurred,” according to the study by National Economics Research Associates, a White Plains, N.Y.-subsidiary of insurance giant Marsh & McLennan Co.
What’s more, the study found a dramatic increase in state court securities fraud lawsuit filings as plaintiff’s attorneys sought an end run around the 1995 legislation, which was sponsored by Rep. Chris Cox, R-Newport Beach.
There were 78 cases filed in state courts from January through October 1996, a 63 percent increase over the 48 for the same period in 1995.
“As expected with the passage of federal reform, the forum has changed to the state courts,” said Tower Snow, who heads the securities litigation practice at Brobeck, Phleger and Harrison in San Francisco. “It’s like the wild west; state court judges are not used to dealing with these types of complex suits.”
Cox, who authored the 1995 reforms, said he was not surprised that there has not been a significant drop in securities fraud lawsuit filings.
“The law was designed to facilitate earlier dismissal of bad lawsuits,” he said. “Eventually, that may lead to fewer filings, but I would not expect that to happen immediately.”
Cox said there have been a handful of suits dismissed because the pleadings in the suit did not meet the law’s standards.
The rush to state courts has triggered another fight on Capitol Hill, where Cox and his tort reform allies are set for a push this session to plug the hole by giving federal law pre-emptive status over state laws.
Cox said that the White House “remains an obstacle” to passage of a standard to preempt state laws.
“The President is looking to undo parts of the 1995 reform act; he would like to weaken the pleading standard, regarding the defendants’ state of mind during the time of the alleged securities fraud,” he said.
President Clinton has not taken a public stand on having federal law preempt state law. But, in his message accompanying his veto of the 1995 reform act, Clinton said that legislators who inserted the stricter pleading standard “meant to erect a higher barrier to bringing suit than any now existing one so high that even the most aggrieved investors with the most painful losses may get tossed out of court before they have a chance to prove their case.”
But shareholder plaintiff’s attorneys and advocates say the study backs up their claims that there was no explosion of frivolous shareholder lawsuits in the first place.
“This is proof that there were not that many frivolous lawsuits being filed. Otherwise, there would have been a sharp drop in the number of federal filings,” said Sean Crowley, a political consultant who worked on the campaign for Proposition 211, the 1996 California ballot initiative that would have made it easier to file securities suits.
Voters defeated Proposition 211, which drew bipartisan opposition including opposition by President Clinton.
Not everyone agrees with the NERA study’s conclusions. Snow, one of the nation’s leading defense attorneys in securities fraud cases, said that a climate of reform actually led to a drop in the number of strike suit filings before last year’s law was passed.
Snow points to a steep drop in cases filed in the first 10 months of 1995, when federal filings fell 40 percent from 1994’s peak levels, as evidence of the prior trend.
Often referred to as strike suits, securities fraud lawsuits are typically filed when a company’s stock declines more than 10 percent. High technology companies, which frequently experience dramatic price swings in their stocks, have been hardest hit by strike suits and have pushed hard for reforms.
Their efforts seemed to pay off in December 1995, when Cox and his supporters trumped President Clinton and pushed through the only veto override of Clinton’s first term to enact stricter federal controls over securities fraud lawsuits.
Since the reform act was passed in December 1995, the law has gotten a mixed reception in the courts.
“It will probably take a series of court cases before the scope of the reforms is defined,” said Prof. John Coffee at Columbia Law School. “In the meantime, plaintiffs are out there testing the waters; they will continue to file cases until they are stopped by the courts.”
Experts believe the increased volatility on Wall Street will contribute to that trend. Even though the market overall has soared, wild swings in stock prices have now become more common, prompting the filing of securities fraud lawsuits.
Just last month, shareholder suits were filed against Costa Mesa-based software seller FileNet Corp. and Irvine-based sunglass maker Oakley Inc.
“When a company disappoints, it gets hammered by the market; they are a more attractive target for a lawsuit,” Snow said.