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Be careful what you ask for. You may just get it. Take, for example, the Private Securities Litigation Reform Act, which Congress passed in December 1995 over President Clinton’s veto. The securities defense bar pushed hard for passage of the Reform Act, which was designed to deter frivolous and abusive class action “strike suits” against companies, as well as create uniformity in the way courts handle securities fraud complaints. Five years later, if anything, the stated goals of the Reform Act seem more elusive than ever. Circuit courts still disagree over the pleading standards imposed by the act. In fact, securities defense lawyers who seek to reconcile the act’s requirements on the issue of intent are asking the nation’s highest court to review a ruling from the 2nd U.S. Circuit Court of Appeals that has helped make New York City a mecca for these suits. And securities class action filings in federal courts have actually increased, from 188 in 1995, to 238 in 1999, according to National Economic Research Associates (NERA), an economic consulting and analysis firm based in New York. The same study shows that average settlements for these cases has also risen sharply, from pre-reform act levels of $8.5 million to $12.0 million in the years 1996-1999. If the history-making $2.8 billion settlement Cendant Corp. that was agreed to last December is factored in, that figure jumps to $45.8 million. The likelihood that a company will be sued by shareholders has climbed to a mind-boggling 57.5 percent, according to NERA. Depending on whom you ask, the reasons for this upsurge differ markedly. The plaintiffs’ bar claims that fraud is common in today’s stock market, and point to the prevalence of accounting restatements and illicit insider trading. Defense attorneys, on the other hand, blame the increase in lawsuits on the extreme volatility of the stock market in recent years. “You don’t sue when you’re making money,” said Robert E. Zimet, a partner at Skadden, Arps, Slate, Meagher & Flom. LOWERING COST OF SETTLEMENT Mark H. Gitenstein, a partner in the Washington, D.C., office of Mayer, Brown & Platt who helped draft the reform act and coordinated the lobbying effort for its passage, said he never thought the act would affect the number of cases filed. Rather, he said, the act was intended to reduce the cost of settling frivolous claims by encouraging the courts to dismiss such cases early on. It requires that securities fraud complaints meet a heightened pleading standard, and stays discovery pending any motion to dismiss. “What drives up defense costs is that these cases go on forever,” Gitenstein said. The act, he added, “was designed to ensure that people who are truly injured get a substantial recovery sooner, and with less money going to lawyers.” Indeed, the number of cases being dismissed stands at about 30 percent, compared with about 13 percent before passage of the act, said Greg Markel, a securities litigator with the New York office of Brobeck, Phleger & Harrison. Hillary Sale, a professor at the University of Iowa College of Law who has conducted a study of all available securities fraud decisions issued since 1995, attributes this rise in the percentage of dismissals directly to the reform act. She argued that the overworked federal courts have, in fact, too readily accepted the opportunity that Congress has offered them to exercise docket control by eliminating typically complex and time-consuming securities fraud cases early on. “I am stunned by what the courts are doing,” Sale said. Fred Dunbar, a senior vice president with NERA, has said this trend may well reverse over time as the plaintiffs’ bar learns which type of pleadings will withstand a motion to dismiss. At least one plaintiffs’ firm is learning to work around the discovery stay. Milberg Weiss Bershad Hynes & Lerach, which dominates the securities plaintiffs’ bar, has an in-house unit and outside consultants, including private investigators, forensic accountants, former company employees and industry experts to conduct pre-filing investigations of possible fraud claims. PLEADING STANDARD At the time of its enactment, the reform act’s heightened pleading standard, which mandates that complaints “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind,” was trumpeted as a sure-fire deterrent to securities class actions nationwide. So far, the standard has proved to be anything but that. The circuit courts’ interpretations of the provision have been all over the place, with the 9th and 2nd Circuits at either ends of the spectrum and the 1st, 3rd, 6th and 11th Circuits scattered in-between. The 9th Circuit has articulated the most defense-friendly standard. Its 1999 decision in In re Silicon Graphics Inc. Securities Litigation, 183 F3d 970, affirming a 1997 decision from the Northern District of California, requires pleadings to provide “in great detail, facts that constitute circumstantial evidence of deliberately reckless or conscious misconduct.” Stock sales before a steep drop in stock market value alone do not satisfy the standard. The winds blow in a different direction on the East Coast. In 1998, the Southern District of New York ruled that a plaintiff claiming fraud need plead only that the defendant had “motive and opportunity,” a standard that can be met, for example, by alleging stock sales by corporate executives before a surprise announcement that causes stock prices to drop. This year, the 2nd Circuit affirmed the ruling in Novak v. Kasaks, 216 F3d 300, although the parties disagree as to the grounds of the affirmance. Now the defendants in Novak, which involves a decline in stock value of the clothing retailer Ann Taylor, are petitioning the U.S. Supreme Court for certiorari, arguing that the 2nd Circuit’s reading of the statute is incompatible with that of the 9th Circuit’s, and warrants review. The issue “couldn’t be riper,” said Zimet, who is counsel for the petition. “We have a smorgasbord of approaches” among the circuits to a statute “whose entire purpose was to harmonize and unify the case law,” he added. Milberg Weiss partner Keith M. Fleischman, counsel for the respondents opposing the petition, disagreed. He argued that “any splits in the circuits right now are relatively minor.” “Even the 9th Circuit is continuing to refine its decision in Silicon Graphics,” Fleischman said, citing to a Sept. 29, 2000, decision from that court, Howard v. Everex Systems Inc., 2000 US App. LEXIS 23973, which he contended is a further clarification of the law. “It’s not the proper time for the Supreme Court to step in and interpret a new law that is still being defined by courts throughout the country,” he added. CIRCUITS ARE SPLIT, BUT … Observers agreed that a split in the circuits exist, but expressed skepticism that the High Court would be interested because the justices only very rarely take on private securities fraud cases. One defense lawyer, who asked not to be identified, stated that he did not think Novak was “the case to motivate the court” because the issue of motive and opportunity was dealt with in a partial settlement before the 2nd Circuit ruling, and was not directly addressed by the appeals court. Moreover, lawyers say that this is the first request for review of a decision interpreting the reform act. The plaintiffs did not appeal the Silicon Graphics appellate ruling. “They were worried about getting an answer they didn’t like,” said Charles Rothfeld, a partner in the Washington, D.C., office of Mayer Brown & Platt. The Novak case also resulted in a shift of filings from the Northern District of California to the Southern District of New York, where the plaintiff-friendly decision was issued, according to Securities and Exchange Commission attorney David Levine. Securities class actions are unusual in the sense that they are national in scope, giving the plaintiffs a lot of leeway in choosing a forum, explained Mayer Brown’s Rothfeld. The U.S. Supreme Court is scheduled to review the cert petition in Novak early next month.

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