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Securities Law Expert Warns Against Measure

Ballot: He says the state could become a haven for litigation if voters approve initiative in November.


California could become a mecca for securities litigation if a November ballot initiative sponsored by plaintiffs' lawyers is approved by voters, according to a securities law expert.

"It is difficult to overstate the importance of this November initiative," said Joseph A. Grundfest, a former commissioner for the Securities and Exchange Commission and a professor at Stanford University Law School. "If this passes, California will dominate securities litigation nationwide."

Grundfest, who was in Los Angeles this week and gave a speech to 100 securities attorneys Wednesday, noted that the November initiative--dubbed "the Retirement Savings and Consumer Protection Act"--was prompted by the historic federal Securities Litigation Reform Act of 1995.

That law, enacted over a presidential veto late last year, was designed to limit securities suits by requiring plaintiffs to provide more proof of corporate wrongdoing at the outset of a case.

The law was originally passed at the urging of company executives who said they were being hit by rafts of frivolous suits that only served to distract managers and harm shareholder values. However, attorneys argued that company managers--particularly at technology companies--consistently overstated the value of their products and their ability to bring them to market. That caused investors to pay exorbitant amounts for shares that would have sold for far less had the companies been more realistic about their projections. In the six months the new law has been in effect, the number of federal securities cases filed nationwide has dropped dramatically. Nearly 40 federal securities fraud cases have been filed since passage of the act--roughly half the previous year's volume, Grundfest said.

However, state securities cases are booming. In California alone, 20 such cases have been filed in the last six months, roughly a fivefold increase from a year ago.

"What this suggests is that the influence of the reform act was not on the volume of securities litigation, but on the location of the suits," said Grundfest, who supported the bill.

Notably, although plaintiffs' lawyers had argued that the new law would derail legitimate suits involving investors who had lost money because of false and misleading statements by company managers, post-law rulings indicate otherwise, Grundfest said.

Specifically, Grundfest cited a case against Chantal Pharmaceuticals, which was allowed to proceed because plaintiffs' attorneys pointed out significant insider selling immediately before the release of earnings restatements that sent the company's stock plunging on the open market. (Chantal's stock price fell to $6.50 per share from more than $28 after the company drastically reduced and restated both profit and sales, under pressure from its auditors.)

However, in other instances, cases have been dismissed because there was no real "inference of fraud," Grundfest said.

Generally speaking, federal judges have been willing to infer fraud--and thus allow securities suits to proceed--when there was insider selling during the period in which fraud was alleged and when there have been allegations involving accounting problems, he said.

But these recently won curbs on federal lawsuits will prove worthless if California's November ballot initiative--sponsored by San Diego plaintiffs' attorney William Lerach--is voted into law, Grundfest said.

The reason is that securities lawyers would all file suit here, using a provision in the law that says the state has jurisdiction as long as the targeted company has at least one California shareholder, he said.

The California initiative is also vastly more plaintiff-friendly than federal law. To be specific, where federal law now requires proportionate liability--those accused of wrongdoing are generally only liable to the extent of their guilt--the California law would impose joint and several liability.

In other words, any named defendant could be ruled 100% liable for securities fraud judgment, even if that defendant was only tangentially involved.

Anyone who "aided and abetted" wrongdoers could also be ruled liable. Juries could award punitive damages in securities suits, something that is not now possible under federal law.

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