State of Alert

It may mean a bit more business, but a spate of fraud class actions in state courts has a good number of Silicon Valley defense lawyers reaching for the aspirin. The state court actions almost always follow similar fraud claims filed in federal court, which has California defense lawyers beating back the suits on several fronts at once.

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It may mean a bit more business, but a spate of fraud class actions in state courts has a good number of Silicon Valley defense lawyers reaching for the aspirin. The state court actions almost always follow similar fraud claims filed in federal court. That has defense lawyers beating back the suits on several fronts at once. “You have to concern yourself with a different set of statutes, and a different court,” said Shirli Fabbri Weiss, a partner in the San Diego Office of Gray Cary Ware & Freidenrich. The so-called derivative suits, which don’t have anything to do with the exotic financial transactions of the same name, use federal class actions as a springboard to allege fraud and insider trading. Companies that announce they’re restating earnings or have suffered a significant loss in value shortly after executives sold stock are generally hit with both kinds of suits. The federal suit targets the company specifically — even if individual employees were the ones responsible for the fraud. In state courts, the suits are instead aimed at the individuals. “What they’re about in theory could be very noble — it’s not fair that the company should pay when it’s the people who did wrong,” said David Steuer, a Wilson Sonsini Goodrich & Rosati partner in Palo Alto, Calif. But Steuer contends the recent flurry of derivative suits in the Valley is a different story. He sees them as a money-grab by plaintiffs’ lawyers and is currently defending about 20 clients from such actions. “The suits are always asserted before the [federal] securities case is decided,” Steuer said. “[Plaintiffs] just have the complaint filed with no knowledge of whether it’s true.” Plaintiffs’ lawyers, of course, view the suits differently. “It’s really a way to get recourse against some of these insiders who are hiding behind the Reform Act,” said Robert Schubert, partner at San Francisco plaintiffs’ firm Schubert & Reed. The act to which Schubert refers is the 1995 federal rewrite of the laws governing securities lawsuits. For one thing, the reforms put fraud class actions under federal jurisdiction. It also forced plaintiffs’ lawyers to prove more of their case up front before conducting intense discovery. And discovery in the federal suits is halted whenever defense lawyers make a motion to dismiss, and they almost always do. The reforms left intact the state court remedy for plaintiffs to sue company insiders. And unlike in federal court, there’s no delay in discovery if the complaint is challenged. “The securities reform act made it difficult — until the complaint is upheld, there’s no discovery,” Schubert said. “State court has none of this presumption against these cases.” And California judges have so far been more lenient in letting derivative cases proceed. Until the past few years, plaintiffs’ lawyers filed derivative suits in Delaware and mostly to fight mergers. Plaintiffs’ lawyers have been gradually shifting their venue to where the target companies do business. For technology companies, that means the suits are filed more often in California. Longtime plaintiffs’ lawyers also see some market strategy behind many derivative suits. The class action plaintiffs’ bar has also gotten crowded, and it’s harder to win lead plaintiff’s status in the federal suits. Lead status usually goes to the lawyer representing the largest investor in the company targeted in the class action. With institutional investors increasingly turning to fewer firms to represent them in class actions, smaller firms are being left in the cold, plaintiffs’ lawyers say. “You may find law firms that are not [federal] players choosing to file derivative cases as a way to maintain some role in securities litigation,” said Joseph Tabacco Jr., a partner at San Francisco’s Berman DeValerio Pease Tabacco Burt & Pucillo. The state court actions also move along quicker, Tabacco said. Maneuvering around the derivative cases has become old hat for defense lawyers, dismissing the cases as just another money-maker for plaintiffs’ firms. “The game never stays the same — every year or two, there’s some new twist,” said Norman Blears, a Heller Ehrman White & McAuliffe partner in Palo Alto.

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