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Enron, WorldCom, Tyco, Adelphia, Arthur Andersen. The list goes on. High-profile scandals over the past year involving accounting irregularities and alleged securities fraud have filled the headlines, occupied congressional committees and have made Securities and Exchange Commission Chairman Harvey Pitt something of a celebrity. The scandals have also caused a piece of major securities legislation, the Sarbanes-Oxley Act, to race through Congress and into law with lightning speed. All of this has come on the heels of the bursting of the dot-com bubble and the seemingly unending downward spiral of the stock market. Bill Lerach, one of the nation’s premier securities litigators on the plaintiffs’ side of the fence, has been quick to proclaim, “I told you so.” But has the current wave of scandals opened the courthouse doors wider for securities class action lawsuits, which were narrowed considerably by the Private Securities Litigation Reform Act of 1995? The answer so far is no. By enacting that legislation in December 1995, Congress expressly intended to end the widespread abuses associated with securities class action litigation. Lawmakers chose to do this by, among other things, clamping down on professional plaintiffs and elevating the pleading standard in securities fraud class actions. The PSLRA got off to a somewhat slow start. That changed with the first Ninth Circuit decision interpreting the statute, In re Silicon Graphics Inc. Sec. Litig., 183 F. 3d 970. In that case, the court held that the PSLRA should allow to go forward only those cases that alleged particular contemporaneous facts showing that corporate statements were false at the time they were made. Since the publication of the Silicon Graphics decision in the summer of 1999, every published decision by the Ninth Circuit involving the appeal of a dismissal under the PSLRA has affirmed the dismissal. In the months since the Enron scandal hit, the Ninth Circuit has published five reported decisions interpreting the PSLRA’s pleading standards. Every case resulted in a decision to affirm the trial court’s dismissal. These cases have remained true to Congress’ intent to stop cases based on allegations of fraud-by-hindsight. Last February, the Ninth Circuit issued its decision in Brody v. Transnational Hospitals Corp., 280 F.3d 997. In Brody, the court clarified that circumstances under which a shareholder could bring a securities fraud case based on an alleged failure to disclose are limited. Failure-to-disclose cases are among the most common types of securities class actions. In Brody, the Ninth Circuit held that a statement made to the market by a company or its executives that is “incomplete” is not a violation of the securities laws. The statement must be made misleading by the failure to include the omitted facts. As an example, the court explained that a statement about a company’s overall sales growth does not violate the securities laws if it does not include a breakdown of sales within specific geographic regions. Right after Brody, the Ninth Circuit decided In re The Vantive Corporation Sec. Litig., 283 F.3d 1079, a case with which I was involved in defending in the trial court and on appeal. The Vantive case was the first one in which the Ninth Circuit dealt with a matter involving accounting fraud allegations. In the wake of the Enron headlines, Vantive offered a real opportunity for the Ninth Circuit to alter its course if it believed the PSLRA had gone too far. The decision, however, not only affirmed the district court’s decision to dismiss the case but made clear that pre-PSLRA cases, such as Cooper v. Pickett, 137 F. 3d 616, which applied a lower pleading standard for plaintiffs, were no longer good law. The Vantive ruling held that cases alleging accounting fraud are required to plead the same type of detailed facts as any other type of case alleging securities fraud. It also held that allegations that a company violated generally accepted accounting principles without specific facts identifying the transactions at issue and “detail[ed] facts giving rise to a strong inference of scienter” – fraudulent intent – as to the challenged transactions are not sufficient to state a claim of securities fraud. A week after the Vantive decision, the Ninth Circuit issued its opinion in Lipton v. Pathogenesis, 284 F.3d 1027, again affirming a dismissal of a securities fraud complaint. Significantly, Vantive and Pathogenesis involved situations in which the district courts dismissed the cases with prejudice without first giving the plaintiffs an opportunity to file an amended complaint to correct the shorting in their pleading. Most recently, the Ninth Circuit issued its opinion in Gompper v. VISX, Inc., 298 F.3d 893. This ruling, handed down in August, may be the most significant. Here, the Ninth Circuit held that the PSLRA not only changed the pleading requirements reflected in Rule9(b) of the Federal Rules of Civil Procedure but that it also changed the standard for deciding motions to dismiss under Rule 12(b)(6) of the Federal Rules. In every case under the PSLRA, including Silicon Graphics, the Ninth Circuit judged the plaintiffs’ complaint against the Rule 12(b)(6) standard. Under that standard, the court is required to accept as true all of the factual allegations of the complaint and to consider all reasonable inferences from the facts alleged in favor of the plaintiffs. In Gompper, the court held that in cases involving the PSLRA, courts are also required to consider reasonable inferences from the facts alleged against the plaintiffs. This represents a significant departure from prior law. Far from retreating from Silicon Graphics, the Ninth Circuit has maintained the PSLRA as an effective filter against cases involving fraud-by-hindsight. Of course, the Ninth Circuit has been bound by stare decisis to follow Silicon Graphics, but recent events have not caused the court to take any of the opportunities over the last year to distinguish Silicon Graphics. Indeed, the Ninth Circuit has even taken Silicon Graphics a bit further. Congress, however, is not bound by stare decisis and is, of course, answerable to the voters. The instant outcry for reform following the litany of corporate scandals gave Congress the perfect opportunity to pull back from the PSLRA. Indeed, before the WorldCom scandal broke, a district court in Mississippi dismissed a securities fraud class action suit against the company and its executives under the PSLRA. However, nothing in the Sarbanes-Oxley legislation addresses the PSLRA or the gatekeeper function of its pleading requirements. Indeed, opening the courts to increased private securities litigation never even seriously came up in the debates leading up to the enactment of Sarbanes-Oxley. Instead, the bulk of the new law involves increased penalties and sentences for securities fraud criminal convictions and an increased budget for the SEC. Clearly, Congress has voiced its preference for the public enforcement of the securities laws over private class action litigation. Increased public enforcement of the securities laws will certainly have an impact on the securities litigation practice. Nevertheless, Sarbanes-Oxley contains provisions that have had an immediate impact on the executive suites of publicly traded companies. These provisions require the chief executive officer and chief financial officer of every publicly traded company to certify the truthfulness of quarterly statements filed on SEC Form 10-Q and annual reports on SEC Form 10-K and to certify on an annual basis the adequacy of internal reporting systems. This legislation followed the SEC’s order this past summer that required the CEOs and CFOs of the largest 947 public companies to certify that their companies’ reports and proxy statements filed since their last 10-Ks do not contain any false statements of material fact or omit facts necessary to make those documents, as of the date of their filing, not misleading. These provisions in Sarbanes-Oxley and the SEC order are intended to ensure that senior corporate officers, particularly CEOs, are involved in public reporting. The Sarbanes-Oxley legislation also codifies the role of audit committees and establishes the minimum qualifications for audit committee membership. These provisions also regulate the relationship between auditors and public companies by making the auditors answerable to audit committees rather than management. They also require a company’s audit committee to regulate the use of non-audit services from the company’s outside auditors, whose services have also been restricted by the new statute. Whether these provisions will have an impact on securities litigation remains to be seen. Sarbanes-Oxley contains two other provisions that may affect securities litigation. First, it provides protections for “whistleblowers” and requires audit committees to establish procedures for the receipt, retention and treatment of complaints received by the issuer regarding accounting, internal accounting controls or auditing matters. This section of the new law also is aimed at protecting the “confidential, anonymous submission by employees” of “concerns regarding questionable accounting or auditing matters.” In order to meet the PSLRA’s pleading requirements, plaintiffs have increasingly relied on current and former employees of the companies they sue. Sarbanes-Oxley arguably gives whistle-blowers an alternative to class action lawyers for airing their concerns. Second, Sarbanes-Oxley requires that in the event of a restatement of a company’s financial reports due to “the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws,” the CEO and CFO must reimburse the issuer for any “bonus or equity-based compensation” and profits realized from the sale of the issuer’s stock in the year following the publication of the original financials. The new law also bars company loans to directors and executive officers. These provisions may yield litigation over whether a particular reinstatement should result in reimbursement or whether particular types of compensation ought to be considered as loans. Ironically, the one provision in Sarbanes-Oxley that touches upon private securities litigation may have little overall impact. The legislation increased the statute of limitations for securities fraud from one year after the discovery of the facts giving rise to the claim or three years from the date of the violation to two years from discovery or five years from the violation. Because securities class action suits are almost always filed within days of the collapse of a company’s stock price, the statute of limitations is rarely an issue. To be sure, cases occasionally have been filed on the eve of the expiration of the statute of limitations. The lengthened limitations period, however, will likely not increase the number of those cases because of the competition among plaintiffs attorneys to be the first at the courthouse. The ultimate long-term impact of this past year’s financial scandals and enactment of Sarbanes-Oxley has yet to be determined. To be sure, public sentiment and congressional action are reflecting changing attitudes about corporate America. However, it is clear that the reforms intended by Congress in passing the Private Securities Litigation Reform Act have survived and remain intact. Robert W. Brownlie is a partner in the San Diego office of Gray Cary Ware & Freidenrich. He co-chairs the firm’s business and technology litigation group and focuses on securities and corporate litigation. His e-mail address is [email protected]

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