Uniform Standards in Private Securities Litigation: Limitations on Shareholder Lawsuits

Uniform Standards in Private Securities Litigation: Limitations on Shareholder Lawsuits

98-164 A
Updated May 20, 1998
CRS Report for Congress
Received through the CRS Web
Uniform Standards in Private Securities Litigation:
Limitations on Shareholder Lawsuits
Michael V. Seitzinger
Legislative Attorney
American Law Division
Summary
The 104 Congress enacted the Private Secu
th
rities Litigation Reform Act, P.L. 104-
67, to address the perceived problem of an increase in frivolous shareholder lawsuits.
The stated reasons for bringing those lawsuits were varied -- fraud, mismanagement,
nondisclosure of material information--but practically all of the lawsuits involved the loss
of money by shareholders of the corporation. The Act limits shareholder lawsuits in
federal courts. There are currently bills in Congress which would remove most state
securities antifraud cases to federal courts.
Background
Whether a shareholder lawsuit is meritorious or frivolous, the corporation sued in
many cases must spend a great deal of money in defending itself. In some cases a
corporation will settle the lawsuit in order to save large defense expenses. Critics have
described these settlements as legal extortion.
Most shareholder lawsuits have been brought as alleged violations of the Securities
Act of 1933 and the Securities Exchange Act of 1934, in particular the antifraud provision
of the 1934 Act, referred to as section 10(b).
Because of a belief that unwarranted securities lawsuits have harmed American
businesses, Congress enacted legislation to attempt to assure that securities class action
lawsuits have some merit and are not frivolous. The Private Securities Litigation Reform
Act attempts to limit these abuses of the securities laws by such actions as having the court
appoint a lead plaintiff determined to be the most capable of adequately representing the
interests of class members, prohibiting a person from being a lead plaintiff in no more than
five class actions in a three-year period, guaranteeing that plaintiffs receive full disclosure
of settlement terms, eliminating coverage of securities fraud by the Racketeer Influenced
and Corrupt Organizations Act, providing for a safe harbor for forward-looking
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statements, providing for proportionate liability, and providing for auditor disclosure of
corporate fraud.
Since enactment of P.L. 104-67, there have been allegations that more frivolous
securities lawsuits are being brought in state courts. Congress has responded to these
charges by introducing bills in both the House and the Senate. The House bills are H.R.
1653 and H.R. 1689; the Senate bill is S. 1260. These bills would prohibit bringing certain
securities antifraud cases in state courts.
Discussion
P.L. 104-67, the Private Securities Litigation Reform Act, was enacted to address the
perceived problem of an increase in frivolous shareholder lawsuits. The stated reasons for
bringing those lawsuits were varied--fraud, mismanagement, nondisclosure of material
information--but practically all of the lawsuits involved the loss of money by shareholders
of the corporation. Some of the lawsuits had merit because some corporate managers had
without doubt misled or defrauded investors. However, some of the lawsuits were called
frivolous and were brought, according to critics, when, for example, the share value of the
stock of a corporation went down for reasons having nothing to do with the culpability of
corporate managers.
Whether a shareholder lawsuit is meritorious or frivolous, a corporation sued must
usually spend a great deal of money in defending itself. It has not been uncommon for a
corporation sued by disgruntled investors to agree to a substantial settlement out of court.
Some of these settlements have been described by critics as legal extortion because,
despite the absence of wrongdoing by managers, corporations were essentially forced to
pay out large sums of money to avoid even larger expenses associated with legal defense.
Most shareholder lawsuits have been brought as alleged violations of the two major
federal securities laws. These laws, the Securities Act of 1933 and the Securitie
1
s
Exchange Act of 1934, were enacted in large measure in response to the intens
2
e
speculation in securities which led to the Stock Market Crash of 1929. The principal
philosophy governing these securities laws is that investors and prospective investors
should have access to all material information about corporations which offer securities
so that the public can make informed investment decisions. Disclosure of all material
information is the major requirement of the federal securities laws. The Securities and
Exchange Commission (SEC) does not rule on the riskiness of investments in particular
companies; instead, it is charged with making certain that the public has all of the
necessary information for making its own investment decisions.
The 1933 Act attempts to assure the availability to the public of adequate reliable
information about publicly offered securities. In order to accomplish this, the Act makes
it illegal to offer for sale or to sell securities to the public unless they are registered with
1 15 U.S.C. §§ 77a et seq.
2 15 U.S.C. §§ 78a et seq.

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the SEC. Registration under the 1933 Act covers only the securities actually bein
3
g
offered and only for the purposes of the offering which have been described in the
registration statement. Material required to be included in the registration is specified.4
Certain kinds of transactions are exempted from required registration.5 These exempted
transactions include private placements, intrastate offerings, and small offerings. Certain
kinds of securities are also exempted. Among the exempted securities
6
are government
securities, bank and savings and loan securities, and short-term commercial paper.
The 1934 Act is concerned with a variety of different areas, such as the creation of
the Securities and Exchange Commission, the regulation of publicly-held companies,
7
8 the
regulation of the trading markets, and the ongoing process of disclosure to the investing
9
public through the filing of periodic and updated reports with the SEC. Any issuer which
10
has a class of securities traded on a national securities exchange or total assets exceeding
$1,000,000 and a class of equity shareholders with at least 500 shareholders must register
with the SEC. Annual reports, referred to as 10-K’s,
11
and other reports, such a
12
s
quarterly reports, referred to as 10-Q’s, and material change reports, referred to as 8
13
-
K’s,14 as required by the SEC, must be filed.15
These reports require disclosure to the SEC and to shareholders of all material
financial information and all other material information. Failure to disclose is actionable,
and it is often allegations of nondisclosure which have formed the basis of shareholder
lawsuits. For example, section 18(a) of the Securities Exchange Act grants an express
16
private right of action to investors who have been injured by reliance upon material
misstatements or omissions of fact in reports which have been filed with the SEC. Section
10(b) of the 1934 Act,17 the general antifraud provision, and Rule 10b-5, issued by the
18
SEC to carry out the statutory fraud prohibition, provide for a cause of action for injuries
3 15 U.S.C. § 77e.
4 15 U.S.C. § 77g, which refers to Schedule A, located at 15 U.S.C. § 77aa.
5 15 U.S.C. §77d.
6 15 U.S.C. § 77c.
7 15 U.S.C. § 78d.
8 15 U.S.C. §§ 78l-78o.
9 15 U.S.C. §§ 78g-78i.
10 15 U.S.C. § 78i.
11 15 U.S.C. § 78l.
12 17 C.F.R. § 240.13a-1.
13 17 C.F.R. § 240.13a-13.
14 17 C.F.R. § 240.13a-11.
15 15 U.S.C. § 78m.
16 15 U.S.C. § 78r(a).
17 15 U.S.C. § 78j(b).
18 17 C.F.R. § 240.10b-5.

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which have been caused by omissions, misrepresentations, or manipulations of material
facts in statements other than those filed in documents with the SEC.19
In the 104 Congress both the House and the Senate had multiple bills concernin
th
g
securities litigation reform. Bills in the House included Title II of H.R. 10, referred to in
the Republicans’ Contract with America as the Common Sense Legal Reforms Act; H.R.
1058, which is what Title II of H.R. 10 was designated after being separated from the tort
reform proposals of Title I of H.R. 10; H.R. 555, and H.R. 675. Bills in the Senate
included S. 240 and S. 667. The House passed H.R. 1058, and the Senate passed its
version of H.R. 1058 (formerly S. 240). On November 28, 1995, the Conference
Committee reconciling the House and Senate versions of private securities litigation
reform issued House Report 104-369. This bill passed both Houses of Congress.
President Clinton vetoed it, but both the House and the Senate overrode the veto, and the
measure is now law.
P.L. 104-67 attempts to limit frivolous lawsuits and other perceived abuses of the
securities laws by such actions as having the court appoint a lead plaintiff determined to
be the most capable of adequately representing the interests of class members, prohibiting
a person from being a lead plaintiff in no more than five class actions in a three-year
period, guaranteeing that plaintiffs receive full disclosure of settlement terms, eliminating
coverage of securities fraud by the Racketeer Influenced and Corrupt Organizations Act,
providing for a safe harbor for forward-looking statements, providing for proportionate
liability, and providing for auditor disclosure of corporate fraud.
Since enactment of P.L. 104-67, there have been allegations that more frivolous
securities lawsuits are being brought in state courts. Congress has responded to these
charges by introducing bills in both the House and the Senate. The House bills are H.R.
1653 and H.R. 1689; the Senate bill is S. 1260. These bills would prohibit bringing certain
securities antifraud cases in state courts.
H.R. 1653, referred to the Subcommittee on Finance and Hazardous Materials of the
Committee on Commerce, is referred to as the Securities Litigation Improvement Act of
1997. It would amend the Securities Act of 1933 and the Securities Exchange Act of
1934 to prohibit bringing a private civil action in a state court or under state law, including
a pendent state claim to an action under federal law, which alleges either: 1. a
misrepresentation or omission in connection with the purchase or sale of any covered
security or 2. that the defendant used or employed any manipulative or deceptive device
in connection with the purchase or sale of any security.
H.R. 1689, also referred to the Subcommittee on Finance and Hazardous Materials
of the Committee on Commerce, is referred to as the Securities Litigation Uniform
Standards Act of 1997. It would amend the Securities Act of 1933 and the Securities
Exchange Act of 1934 to prohibit bringing a private class action based upon state or
municipal law in state or federal court by any private party alleging: 1. an untrue statement
or omission in connection with the purchase or sale of a covered security or 2. that the
defendant used any manipulative or deceptive device in connection with the purchase or
19 See, e.g., State Teachers Retirement Board v. Fluor Corp., 654 F.2d 843 (2d Cir. 1981),
and Goldberg v. Meridor, 567 F.2d 209 (2d Cir. 1977).

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sale of any security. A “class action” would be defined as any single lawsuit or group of
lawsuits in which damages are sought on behalf of more than twenty-five persons, one or
more named parties seek to recover damages on a representative basis, or one or more of
the parties seeking to recover damages did not personally authorize the filing of the
lawsuit.
S. 1260 was referred to the Subcommittee on Securities of the Committee on
Banking, Housing, and Urban Affairs. As introduced, it was very similar to H.R. 1689.
After the White House and the Securities and Exchange Commission agreed to support
the bill if certain changes were made in it, the Committee on April 29 approved the bill
with the following changes: 1. Class action was redefined to increase the limit on the
number of parties allowed in state suits from twenty-five to fifty; 2. Shareholders could
continue to bring lawsuits in Delaware courts under a state law which holds the
information which corporations give to shareholders to higher standards than given to the
general public; 3. There was also an agreement to include in the Senate report language
that stated that P.L. 104-67 was not intended to prohibit plaintiffs from filing claims
alleging “reckless misconduct” by a nationally traded company. S. 1260 was approved by
the Senate 79-21 on May 13, 1998.