The New Securities Class Action: Federal Obstacles, State Detours

The year 1995 will long be remembered as the year in which Congress first
tackled the thorny issue of tort reform. Rarely has such an issue so inflamed
passions and captured the attention of lawyers, legislators and legal experts alike.
While proponents of tort reform have complained of a broad range of claimed
abusive practices in tort lawsuits, the debate in 1995 focused on a relatively
narrow category of cases-class action lawsuits alleging securities law violations.

The Private Securities Litigation Reform Act of 1995 (the “Reform Act” or the
“Act”) represents the culmination of extensive lobbying efforts by accountants,
securities firms, and the high-technology industry to curtail what they perceived to
be abusive securities class action litigation. These entities felt that they had been
unjustly victimized by lawsuits alleging “fraud by hindsight.” In such suits, a
sudden drop in a company’s stock price was claimed to be evidence that the issuer
and its agents had been covering up the bad news that led to the price drop. A
central theme of the legislative history is that plaintiffs’ lawyers, rather than
faithfully representing investors, were acting for their own benefit. Critics of
securities class actions alleged that plaintiffs’ lawyers were filing suits against
“deep pocket” defendants-whether or not there was actual fraud-solely for their
settlement value. Moreover, the critics charged, plaintiffs’ lawyers were taking an
exorbitant share of these settlements for themselves, leaving defrauded investors
with only a fraction of the damages that the investors had suffered. Proponents of
securities class actions countered that plaintiffs’ lawyers serve an essential role in
deterring fraud. Putting obstacles in the enforcement of the securities laws by
plaintiffs’ attorneys would cause investors to lose confidence in the markets.

We do not take sides in the debate and express no views on the accuracy of
these competing characterizations of the role of plaintiffs’ lawyers. A brief review
of the legislative history makes clear, however, that Congress did take sides,
crediting the arguments of critics who asserted that plaintiffs’ lawyers were the
central problem with private securities litigation. Thus, the enactment of the
Reform Act can be seen as an attempt by Congress to erect obstacles in the path of
the plaintiffs’ bar.