The split decision, issued Friday by a panel from the U.S. Court of Appeals for the Ninth Circuit, is especially important to high-tech companies, whose volatile stock prices make them a favorite target of plaintiffs' attorneys. The ruling found that a 1995 law requires complaints for securities fraud to be dismissed unless they cite specific facts that establish that fraud has taken place.
An attorney representing plaintiffs in the case said it was all but certain he would ask for a rehearing by a larger panel of judges. If the decision survives, it will be ripe for consideration by the Supreme Court, because it stands in stark contrast to rulings reached by two separate appeals courts in different cases. For now, however, attorneys representing publicly traded firms were celebrating Friday's win.
"It's a blockbuster decision," said Shirli Weiss, a litigator at Gray Cary Ware & Freidenrich. "The decision requires that plaintiffs [filing a complaint] state the underlying facts, documents, and sources of information. That's very important because it prevents plaintiffs from alleging fraud by hindsight."
High-tech firms have complained for years that federal laws made them vulnerable to costly lawsuits whenever their stock price took a tumble. Even when such lawsuits were clearly flawed, critics charged, dismissals typically came only after the company had spent millions of dollars in legal or settlement costs.
Responding to the criticism, Congress in 1995 passed the Private Securities Litigation Reform Act, which raised the requirements for plaintiffs alleging stock fraud. At issue in Friday's decision was exactly what Congress intended the new standard to be.
In a 2-1 ruling, the Ninth Circuit panel said plaintiffs must show "deliberate or conscious recklessness," in proving that a company intended to violate securities laws.
"A private securities plaintiff proceeding under the [Private Securities Litigation Reform Act] must plead, in great detail, facts that constitute circumstantial evidence of deliberately reckless or conscious misconduct," U.S. Circuit Judge Joseph Sneed wrote for the majority. "By reminding trial courts that Congress intended to bar those complaints that fail to raise a strong inference of intent, the deliberate recklessness standard best serves the [Private Securities Litigation Reform Act's] purpose."
Sneed was joined by U.S. District Judge John Rhoades, who was specially appointed to the panel. U.S. Circuit Judge James Browning dissented, arguing that the majority opinion was out of line with the Private Securities Litigation Reform Act and with appeals courts in other parts of the country.
"The majority raises the pleading bar higher than that envisioned by Congress, and places the Ninth Circuit at odds with both the Second and Third circuits," Browning wrote.
Friday's decision stemmed from a lawsuit shareholders filed against SGI (formerly known as Silicon Graphics) in early 1996. When the suit was filed, SGI had recently confirmed rumors that revenues for its fiscal second quarter would miss analysts' forecasts, prompting the stock to drop to 22 per share, compared to more than 44 four months earlier.
The lawsuit alleged that unspecified "negative internal reports" showed that SGI officers knew of a sales slowdown months before they reported it publicly. U.S. District Judge Fern Smith of San Francisco ultimately dismissed the complaint, ruling that its failure to cite specific contents or authors made it deficient under the Private Securities Litigation Reform Act.
Friday's decision affirms that lower-court ruling. But it also contradicts rulings made earlier by the U.S. Courts of Appeals for the Second and Third circuits, which both have interpreted the law as imposing a much lower threshold on plaintiffs bringing securities fraud suits. If the Ninth Circuit's decision going the other way survives a rehearing, the Supreme Court would be much more inclined to hear the case to clear up the conflict.
The split might also mean that more securities fraud cases will be brought in New York and Pennsylvania, where the Second and Third circuits are headquartered, according to attorneys who represent high-tech companies. In the meantime, "there will be interesting tactical battles that get fought" as a result of the conflict, said Bill Alderman, a defense attorney at Orrick Herrington & Sutcliffe.
But William Lerach, whose Milberg Weiss Bershad Hynes & Lerach represented shareholders in the SGI suit and is known for the great number of stock fraud lawsuits it files, disagreed, saying that "venue choices in federal securities cases are pretty limited" already.
He agreed with his opponents, however, on the likelihood of the Supreme Court ultimately interpreting the Private Securities Litigation Reform Act, noting that two additional cases are now winding through separate appeals courts.
"However they rule, they're just going to increase the conflict," Lerach said. "The fact that you had the Second and the Ninth circuits in sharp disagreement--that in and of itself would probably be enough."