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Bar raised for suits by investors

A Supreme Court ruling is likely to lower the number of cases filed.

June 22, 2007|Walter Hamilton and Jim Puzzanghera | Times Staff Writers

WASHINGTON — In a decision that both corporate America and shareholder lawyers claimed as a victory, the U.S. Supreme Court made it harder Thursday to sue companies for securities fraud.

The justices ruled 8 to 1 that investors had to show a likelihood of wrongdoing in the early stages of a case before it could proceed to trial. The ruling is seen as likely to cause a reduction in the number of lawsuits filed and possibly an increase in the proportion of suits that are thrown out.

However, the majority opinion written by Justice Ruth Bader Ginsburg stopped short of the tougher restrictions that many in corporate America had sought and left room for legitimate cases by aggrieved investors to proceed, experts said.

"This was something of a victory for investors in that Justice Ginsburg raised the bar but not that high," said Donald Langevoort, a Georgetown University securities law professor.

Typically, plaintiffs can build much of a case in a suit's evidence-discovery phase. But Thursday's ruling, by setting a higher standard for plaintiffs trying to defeat dismissal motions made by defendants, will make it harder to reach the discovery phase.

The decision was hailed by business groups, particularly high-technology companies, which tend to have volatile stock prices and as a result often face lawsuits when their shares unexpectedly tumble.

"Silicon Valley can breathe a sigh of relief," said Jim Hawley, general counsel of TechNet, an association that filed a brief with several other tech groups urging the court to set a high hurdle for shareholder lawsuits.

Several class-action attorneys also expressed relief, however, saying the court did not endorse a tougher threshold that would have harmed their legal specialization.

The decision "may cut some of the lawsuits, but it won't make a dramatic difference," said Herbert Milstein, a partner at Cohen, Milstein, Hausfeld & Toll in Washington.

The case had been closely watched because it dealt with issues at the center of the debate over so-called frivolous lawsuits filed against companies on behalf of their shareholders.

Business groups claim that attorneys who represent shareholders launch unfounded lawsuits to pressure companies into paying settlements. Firms say they indeed often feel compelled to settle to avoid the cost of litigation and the risk of eventually losing in court, even if the plaintiffs' case isn't that strong.

Investor advocates counter that fraud occurs more frequently than businesses suggest as executives seek to maintain high stock prices and enrich themselves, such as in the Enron Corp. and WorldCom Inc. accounting scandals.

The ruling dealt with a lawsuit filed in 2002 against telecom equipment maker Tellabs Inc. by investors claiming that executives had publicly touted the company's outlook when they knew it was worsening.

The case's fate hinged on the legal interpretation of a law passed by Congress in 1995 to reduce securities lawsuits.

The law said plaintiffs must show a "strong inference" of corporate malfeasance for a case to proceed. But lower courts read that guideline in different ways, with some courts being far more hospitable to securities cases than others.

In the Tellabs case, the U.S. 7th Circuit Court of Appeals in Chicago let the suit stand, saying a "reasonable person" could infer that the company had committed fraud.

The Supreme Court had been widely expected to adopted a high threshold. The question was how high.

Justices Antonin Scalia and Samuel A. Alito Jr. wrote separate opinions calling for a stricter standard than Ginsburg outlined. Justice John Paul Stevens dissented.

James Masella, a corporate defense attorney at Blank Rome in New York, said legitimate cases could still have their day in court. One example, he said, might be a case in which executives issued a glowing sales forecast and sold stock shortly before bad news emerged and the stock plummeted.

"In cases where there's more than just a stock-price dip, a press clipping and a hope and a prayer, the complaint should survive," Masella said.

Securities class-action lawsuits have been declining significantly. Some experts attribute the drop to reforms that companies undertook because of tough laws passed in the wake of the Enron and WorldCom debacles.

"The price of committing fraud has gone up, so the appetite for fraud in the executive suite has gone down," Stanford law professor Joseph A. Grundfest said.

Others contend that the falloff is temporary because the buoyant stock market has made investors feel less need to litigate and that lawsuits will pick up when the market falters.

The Tellabs case marks the second Supreme Court ruling this week that favors Wall Street and business interests. On Monday, the court ruled that people who lost money on initial public stock offerings in the late-1990s Internet boom couldn't sue IPO underwriters under U.S. antitrust laws.

walter.hamilton@latimes.com

jim.puzzanghera@latimes.com

Hamilton reported from New York and Puzzanghera from Washington.

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