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With the resignation of William Donaldson as head of the Securities and Exchange Commission, there has been much speculation about whether the SEC or Congress will cut back on the reforms enacted in the wake of the celebrated collapses of WorldCom, Adelphia and others in the “decade of scandal.” One area badly in need of reform is the Private Securities Litigation Reform Act’s (PSLRA) requirement that securities complaints must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. 78u-4(b)(2). The PSLRA’s heightened burden to plead intent comes close to requiring clairvoyance, or at least near-omniscience, from securities plaintiffs. The burden is extremely difficult to meet, even in meritorious cases. This is evident, for example, from the early 2002 order of a Mississippi federal district court dismissing one of the first securities complaints against WorldCom’s chief executive officer, Bernard Ebbers, and its chief financial officer, Scott Sullivan, because the complaint failed to support a strong inference of the defendants’ intent to defraud. Even more remarkable is this: The court’s decision was clearly a correct interpretation of the PSLRA’s heightened pleading requirement, even though it operated-in that instance-to require the dismissal of a securities complaint against two men who later pleaded guilty to, or were found guilty of, criminal securities fraud. If anyone needed proof that the PSLRA’s “reforms” went too far in the necessary effort to weed out strike suits, this decision was it. There has been little indication that Congress intends to scale back the PSLRA. Now, however, there is reason to hope that the federal courts will take steps to ensure that the courts remain open to plaintiffs with legitimate securities claims. In a decision issued earlier this year, City of Monroe Employees Retirement Sys. v. Bridgestone Corp., 399 F.3d 651 n.25 (6th Cir. 2005), a panel of the 6th U.S. Circuit Court of Appeals dropped a tantalizing footnote into an otherwise routine review of an order dismissing a federal securities class action. In discussing the PSLRA’s pleading requirements, the court noted that it took “no position as to the constitutionality of the Reform Act’s heightened scienter pleading requirements.” The fact that the court went out of its way to raise a constitutional issue, though it had not been briefed, demonstrates the growing concern that the PSLRA’s “intent pleading” requirement is excessively stringent and, quite possibly, unconstitutional. In reality, Section 10 of the Exchange Act doesn’t contain a requirement that a plaintiff prove intent to defraud. The courts simply engrafted an intent requirement onto Section 10 and Rule 10b-5 claims in their interpretations of the statute. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976) (securities plaintiffs must plead “a mental state embracing an intent to deceive, manipulate or defraud.”). Even under these cases, however, a plaintiff was required only to prove to the jury that the defendant had acted with fraudulent intent. The plaintiff was not required to plead intent to defraud with particularity, because, under Fed. R. Civ. P. 9(b), “malice, intent, knowledge or other condition of mind of a person” could “be averred generally” in the complaint. The PSLRA changed that: It requires that “the complaint” of a securities plaintiff plead facts giving rise to a “strong inference that the defendant acted with the required state of mind.” This pleading burden is higher, on its face, than the plaintiff’s burden of proof at trial. The trial burden, which the PSLRA left unchanged, can still be satisfied by a jury’s finding that the defendant acted recklessly or, in some circuits, with severe recklessness. Importantly, nothing in the PSLRA requires that the jury find a securities violation based upon a higher, “strong inference of intent” standard. Seventh Amendment problem This was precisely the constitutional issue the 6th Circuit perceived: Because the pleading burden imposed by the PSLRA is higher than the plaintiff’s burden of proof at trial, plaintiffs may be deprived of their constitutional right to a jury trial under the Seventh Amendment. There is no question that plaintiffs have the right to a jury trial in a securities case. Nor is there any question that there are cases in which “a juror could conclude that the facts pleaded showed scienter, but that conclusion would not be the most plausible of competing inferences.” City of Monroe, supra, at n.25. In a given case, then, a complaint might have to be dismissed under the PSLRA for failure to plead “a strong inference of the required state of mind,” even though a weaker inference would be enough to sustain a verdict at trial. In the words of the 6th Circuit, this presents a “Seventh Amendment Problem.” The PSLRA’s pleading requirement threatens to become a chokepoint that strangles even the most meritorious claims. This was not the result that Congress intended, and it is not one the Constitution should permit. The 6th Circuit has raised an important question: It remains to be seen how other courts, or Congress, will answer it. Kathy D. Patrick is a partner at Gibbs & Bruns of Houston, where she represents institutional investors in securities cases. She can be reached via e-mail at [email protected].

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