When lawyers for Silicon Graphics and some of its shareholders square off in federal appeals court tomorrow, high-tech companies and investors advocates alike will be watching closely.
At stake in the case, to be argued in the U.S. Court of Appeals for the Ninth Circuit in San Francisco, is how far Congress intended to raise the requirements for filing stock fraud lawsuits when it enacted the Private Securities Litigation Reform Act of 1995.
Although shareholders have filed dozens of securities fraud cases since the law took effect, In Re Silicon Graphics Securities Litigation is believed to be the only case to reach the appellate level. Attorneys on both sides of the issue say it is likely to result in a landmark decision that will profoundly affect when and how future securities cases can be litigated.
"This is the first big case to interpret this new statute, and it will have a dramatic effect on the way these cases are filed and litigated," said Jerry Birn, an attorney from Wilson Sonsini Goodrich & Rosati who is representing SGI.
As a testament to the intense interest it has created, four national groups--including the Securities and Exchange Commission, Securities Industry Association, American Electronics Association, and Washington Legal Foundation--have filed amicus or "friend of the court" briefs.
"This is a ground-breaking case, and all [the amicus parties] want it to go their way," said Len Simon an attorney from Milberg Weiss Bershad Hynes & Lerach who is representing SGI shareholders. "There will be a lot of hell to pay and work to be done to undo the effects of a negative ruling."
Enacted in December of 1995, the Private Securities Litigation Reform Act, or PSLRA, significantly raises the requirements for the filing of stock fraud suits. It requires shareholders to "state with particularity facts giving rise to a strong inference that the defendant" defrauded investors. It is the only law to date that Congress has passed over the veto of President Clinton, who worried that the law would unfairly curb investors' ability to sue for fraud.
The intent of the law was to limit the number of shareholder lawsuits filed against companies that experience sharp stock drops. The law was of particular interest to high-tech firms because their volatile stocks tend to make them a favorite target of plaintiffs attorneys.
Under the law plaintiffs "have to allege more, with more specificity and [they] have to do it without the benefit of discovery," the often costly, fact-finding part of a case that can last months or years, said Robert Varian, a securities defense attorney at Brobeck, Phleger & Harrison. Previously, plaintiffs generally were required only to state why they believed a fraud took place, a standard that technology companies said was unfair.
"There's unquestionably many shareholder cases that have merit," said Wilson Sonsini's Birn. "But there were an overwhelming number that seemed to be the proverbial fishing expedition, reflexively filed on a stock drop in the hopes that a company decides that it's cheaper to settle than to fight the lawsuit." The PSLRA, he added, was designed to end that practice.
And in many cases, the law has done just that. SGI shareholders filed suit in January of 1996, shortly after the company confirmed rumors that revenues for its fiscal second quarter would miss analysts' forecasts. SGI's stock dropped to about $22 a share, compared to more than $44 a share just four months earlier.
The shareholder lawsuit alleged that SGI committed fraud by announcing in October of 1995 that its second quarter revenue would be on target with analysts' predictions in an attempt to inflate the price of SGI stock. It alleged that SGI was well aware in October that there were problems with a reorganization of its North American sales force, as well as snags in selling its Indigo2 product line, but concealed them from investors. The suit also took aim at six SGI executives who sold nearly $14 million worth of stock shortly before the drop.
In September 1996, U.S. District Judge Fern Smith of San Francisco dismissed the case, finding that the shareholders' reference to unspecified "negative internal reports" in the complaint was not enough to meet the "strong inference" requirements of the PSLRA. Smith gave plaintiffs' attorneys permission to refile the complaint if they could bolster it with more specific allegations.
A month later, plaintiffs' attorneys filed an amended complaint that slightly altered some of the allegations. While it made specific reference to internal SGI documents that allegedly discussed problems that would cause SGI to miss analysts' forecasts, the amended complaint failed to provide the specific contents or authors. In May of 1997 Smith again dismissed the suit.
"If the court allowed plaintiffs to go forward with such general allegations, the strengthened standard of the [PSLRA] would lose its meaning," Smith ruled. Although the amended complaint contained allegations more elaborate "than the ones dismissed in September 1996, they remain too generic to create a strong inference of fraud" under the statute.
Smith went on to outline the type of detail she believed was necessary to support a claim of securities fraud. "The allegations should include the titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information."
The judge said that without such detail, "any company that has announced low earnings would be vulnerable to allegations that such reports exist."
Smith's decision is by no means the last word on the PSLRA. In the 30 months since the law took effect, dozens of other courts have offered competing interpretations, in part diluting the intent of Congress to create uniform standards for securities litigation across the country.
The Ninth Circuit's decision could be issued anywhere from one month to a year or more from now. While it will be binding in only nine states, it is likely to provide strong persuasive authority in other jurisdictions as well. A number of legal observers add that they would not be surprised if the Supreme Court ultimately heard the case.
Simon, the attorney representing the plaintiffs, said it would be a mistake for Smith's ruling to become the standard for how the law is construed by the courts.
"I think she's misread the law in three or four ways, and we expect her to be reversed," he said. "I don't know what more we could have alleged."