Do differences in pleading standards cause forum shopping in securities class actions?: Doctrinal and empirical analyses

Wisconsin Law Review

Volumn 2009, Issue 2, 2009, Pages 421-453

  Cox, James D ^a   Thomas, Randall S ^b   Bai, Lynn ^c  

^a DUKE UNIVERSITY   (United States)

^b VANDERBILT UNIVERSITY   (United States)

^c UNIVERSITY OF CINCINNATI   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 79958731656     PISSN: 0043650X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (31)

1. Christopher M. Fairman, The Myth of Notice Pleading, 45 ARIZ. L. REV. 987, 990 (2003).
2. See also Charles E. Clark, Simplified Pleadings, 2 F.R.D. 456, 462-73 (1943) (describing the then-new rules and procedures to reach merit determinations).
3. Pub. L. No. 104-67, 109 Stat. 737 (1995). We do not believe a compelling case has been made that the PSLRA, and particularly the heightened pleading requirement, was a significant cause in the wide-spread reporting abuses that caused the collapse of U.S. securities markets in 2002. Some commentators point toward the reforms introduced by the PSLRA, and particularly the heightened pleading requirement, as contributing to the environment that fostered the numerous financial reporting scandals that came to light in 2001 and 2002. See, e.g., André Douglas Pond Cummings, "Ain't No Glory in Pain": How the 1994 Republican Revolution and the Private Securities Litigation Reform Act Contributed to the Collapse of the United States Capital Markets, 83 NEB. L. REV. 979, 1028-29 (2005) (arguing that the PSLRA stripped away important investor protections that facilitated abuses that ensued in the late stages of the 1990s bull market);
4. Daniela Nanau, Analyzing Post-Market Boom Jurisprudence in the Second and Ninth Circuits: Has the Pendulum Really Swung Too Far in Favor of Plaintiffs?, 3 CARDOZO PUB. POL'Y & ETHICS J. 943, 946-47 (2006) (suggesting prodefendant substantive and procedural developments contributed to unabashed conflicts of interest, reporting violations, and manipulative practices in public offering of securities). We believe this gives too much credit to the reforms introduced in 1995 and too little credit to the ability of lawyers to meet the heightened pleading requirement. On this point, it is relevant that Congress's response to the frauds was not to repeal any provision of the PSLRA. On the contrary, Congress's response was the enactment of the Sarbanes-Oxley Act of 2002, with multiple provisions intended to strengthen the financial reporting system, not facilitate the conduct of securities class actions.
5. Two other PSLRA innovations that have significantly impacted the conduct of securities class actions were enacted to reduce the likelihood of strike suits. Adding a catch-22 feature to the heightened pleading requirement is the PSLRA's bar to the plaintiff gaining discovery when a motion to dismiss is pending. See 109 Stat. 737, 747 (codified as amended at 15 U.S.C. § 78u-4(b)(3)(B) (2006)). Thus, not only must the plaintiff set forth with particularity facts establishing the defendant's knowledge or recklessness in committing a misrepresentation, the plaintiff must rely on means other than the pre-PSLRA practice of fishing through the defendant's records to gather the required facts. It has been suggested that "constrained and targeted discovery" focused on filling gaps in the complaint that were surfaced through the lens of the heightened pleading requirement would eliminate this catch-22 problem. See Elliott J. Weiss & Janet E. Moser, Enter Yossarian: How to Resolve the Procedural Catch-22 that the Private Securities Litigation Reform Act Creates, 76 WASH. U. L.Q. 457, 506-07 (1998).
6. The other cornerstone of the PSLRA is a mechanism by which the court selects a lead plaintiff from competing petitioners. See § 21D(a)(3), 109 Stat. at 743 (codified as amended at 15 U.S.C. § 78u-4(a)(3)). Pursuant to the latter provision, after a securities lawsuit is filed on behalf of a class, notice is given to the class inviting interested parties to petition to be named the suit's lead plaintiff. The statute provides a rebuttable presumption that the petitioner with the largest loss from the alleged violation is the "most adequate" plaintiff. 15 U.S.C. § 78u-4(a)(3)(B)(iii). Among the selected lead plaintiff's tasks is to recommend to the court who should be counsel for the suit. By enacting the lead plaintiff provision, Congress sought the participation of institutional investors, believing they might reduce the frequency of misguided suits while in other cases assuring that settlements were fair to the class members. Empirical evidence supports Congress's belief as to the latter, as the presence of an institutional plaintiff yields statistically significant greater returns. See James D. Cox & Randall S. Thomas, Does the Plaintiff Matter? An Empirical Analysis of Lead Plaintiffs in Securities Class Actions, 106 COLUM. L. REV. 1587 (2006) [hereinafter Does the Plaintiff Matter?]. Institutional investors also appear to moderate the fees awarded to the suit's counsel such as through presuit negotiations.
7. See Michael A. Perino, Markets and Monitors: The Impact of Competition and Experience on Attorneys' Fees in Securities Class Actions 2 (St. John's University Sch. of Law Legal Studies Research, Working Paper No. 06-0034, 2006), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=870577.
8. However, not all the news regarding institutions is positive. See James D. Cox & Randall S. Thomas, Letting Billions Slip Through Your Fingers: Empirical Evidence and Legal Implications of the Failure of Financial Institutions to Participate in Securities Class Action Settlements, 58 STAN. L. REV. 411, 424 (2005) (finding that in 118 securities class-action settlements, 72 percent of institutions that could participate in a settlement do not submit a claim once the suit is settled even though their mean loss was almost $850,000);
9. see also James D. Cox & Randall S. Thomas, Leaving Money on the Table: Do Institutional Investors Fail to File Claims in Securities Class Actions?, 80 WASH. U. L.Q. 855, 875-77 (2002) (revealing similar findings in a small pilot study).
10. See, e.g., Michael A. Perino, Did the Private Securities Litigation Reform Act Work?, 2003 U. ILL. L. REV. 913, 947-48.
11. Fed. R. Civ. P. 9(b). The 1937 advisory committee notes on Rule 9(b) are limited to: "See English Rules Under the Judicature Act (The Annual Practice, 1937) O. 19, r.22." See 2 JAMES WM. MOORE ET AL., MOORE'S FEDERAL PRACTICE 9 app. 02 (3d ed. 2008).
12. The text of Rule 9(b) has remained unchanged by subsequent amendments. See Christopher M. Fairman, An Invitation to the Rulemakers - Strike Rule 9(b), 38 U.C. DAVIS L. REV. 281, 286-87 (2004) (finding the history of Rule 9(b) to be scant and quoting the English Rules Under the Judicature Act: "'Wherever it is material to allege malice, fraudulent intention, knowledge, or other condition of the mind of any person, it shall be sufficient to allege the same as a fact without setting out the circumstances from which the same is to be inferred⋯. Fraud must be distinctly alleged and proved. The acts alleged to be fraudulent must be stated otherwise no evidence in support of them will be received,'" and quoting the architect of the Rules, Judge Clark's explanation for Rule 9(b): "'While useful, this rule probably states only what courts would do anyhow and may not be considered absolutely essential.'")
13. See, e.g., 141 CONG. REC. S19150 (daily ed. Dec. 22, 1995) (statement of Sen. Domenici) (stating that the PSLRA's pleading standard "is the Second Circuit's pleading standard");
14. 141 CONG. REC. S19068 (daily ed. Dec. 21, 1995) (statement of Sen. Dodd) (asserting that the PSLRA met the Second Circuit's standard and that courts could be expected to look to the Second Circuit opinions for guidance in interpreting the PSLRA's pleading standard);
15. see also 141 CONG. REC. H15219 (daily ed. Dec. 20, 1995) (statement of Rep. Lofgren) (stating that the Second Circuit's standard was embodied in the PSLRA). These professions are at odds with the earlier adoption by the Senate of an amendment sponsored by Senator Specter expressly incorporating the Second Circuit's criteria into the PSLRA.
16. See 141 CONG. REC. S9222 (daily ed. June 28, 1995). This provision was, however, removed in the ensuing conference between the differing House and Senate versions.
17. See H.R. REP. NO. 104-369, at 1-30 (showing that the bill emerging from the Conference Committee did not include the provision sponsored by Senator Specter). In place of the Specter amendment was the Conference Committee's statement that "[b]ecause the Conference Committee intends to strengthen existing pleading requirements, it does not intend to codify the Second Circuit's case law interpreting this pleading standard." Id. at 41. For a close review of the PSLRA's legislative history,
18. see Michael B. Dunn, Note, Pleading Scienter After the Private Securities Litigation Reform Act: Or, a Textualist Revenge, 84 CORNELL L. REV. 193, 243-44 (1998) (concluding that Congress did not intend to address whether recklessness could give rise to liability, but rather wished to address only the pleading issue). (Pubitemid 128443755)
19. Professors Grundfest and Pritchard cogently develop the view that not just the Congress but the courts benefit from ambiguity, finding something of a symbiotic relationship each has in adhering to the necessity of ambiguity of outcome as often the necessity for reaching legislative consensus. See Joseph A. Grundfest & A.C. Pritchard, Statutes with Multiple Personality Disorders: The Value of Ambiguity in Statutory Design and Interpretation, 54 STAN. L. REV. 627, 649 (2002).
20. See, e.g., Perino, supra note 14, at 915-16, 929, 942-47 (reviewing 1499 securities class actions filed between 1996 and 2001 and concluding that the Second Circuit and intermediate standards contributed to there being as many, or even more, filings after the PSLRA's enactment than were filed before). This is not to say that the pleading standard has not had its impact. The rate of dismissals of securities fraud cases has nearly doubled since the passage of the PSLRA. Compare RONALD I. MILLER ET AL., NERA ECON. CONSULTING, RECENT TRENDS IN SHAREHOLDER CLASS ACTION LITIGATION: BEYOND THE MEGA-SETTLEMENTS, IS STABILIZATION AHEAD? 4 (Apr. 2006), available at http://www.nera.com/image/bro- recenttrends2006-sec979-ppb-final.pdf (reporting a dismissal rate of 40.3 percent for securities class actions filed from 1998 to 2003),
21. with ELAINE BUCKBERG ET AL., NERA ECON. CONSULTING, RECENT TRENDS IN SHAREHOLDER CLASS ACTION LITIGATION: ARE WORLDCOM AND ENRON THE NEW STANDARD? 3 (July 2005) (finding a dismissal rate of 20.3 percent for securities class actions filed from 1991 to 1995).
22. See COMM. ON CAPITAL MKTS. REGULATION, INTERIM REPORT OF THE COMMITTEE ON CAPITAL MARKETS REGULATION 11-15, 18 (Nov. 30, 2006), available at http://www.capmktsreg.org/pdfs/11.30Committee-Interim-ReportREV2.pdf (calling for a variety of substantive reforms in the antifraud rule to provide greater clarity and fewer private suits, including the introduction of alternative-dispute mechanisms such as arbitration). One need look no further than a recent Supreme Court decision to find similar expressions of the harm securities litigation does to U.S. global competitiveness. See Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761, 766, 773-74 (2008) (rejecting a scheme-liability approach to reach third-party vendors who knowingly participate in a plan to inflate their vendee's revenues).
23. See James D. Cox & Randall S. Thomas, SEC Enforcement Heuristics: An Empirical Inquiry, 53 DUKE L.J. 737 (2003).
24. See Stephen J. Choi et al., Do Institutions Matter? The Impact of the Lead Plaintiff Provision of the Private Securities Litigation Reform Act, 83 WASH. U. L.Q. 869, 885 (2005);
25. Cox & Thomas, Does the Plaintiff Matter?, supra note 8, at 1624, 1630-32; Perino, supra note 7, at 14.
26. Cox & Thomas, Does the Plaintiff Matter?, supra note 8, at 1631.
27. The relatively low value for the goodness of fit in this equation suggests that the regression results would benefit from the inclusion of further control variables such as proxies for case quality. Unfortunately, to date we and other researchers in the field have been unable to come up with good proxy variables for case strength. For further discussion of the Cox and Snell R-square statistic, see D.R. COX & E.J. SNELL, ANALYSIS OF BINARY DATA (2d ed. 1989).
28. See Debra Lyn Bassett, The Forum Game, 84 N.C. L. REV. 333, 337, 364-68 (2006) (discussing forum selection in the context of a federal system that anticipates that states will reflect in their laws different social choices, a rationale that is greatly weakened when forum selection is driven by differing interpretations of a federal statute);
29. see, e.g., Keeton v. Hustler Magazine, Inc., 465 U.S. 770, 779 (1984) (upholding prosecution in a libel suit in the only possible state where the statute of limitations had not run, reasoning, "Petitioner's successful search for a State with a lengthy statute of limitations is no different from the litigation strategy of countless plaintiffs who seek a forum with favorable substantive or procedural rules or sympathetic local populations"). For the view that appointed judges may be as susceptible as elected judges to creating and nurturing procedural and substantive opportunities for forum shopping, see Todd Zywicki, Is Forum Shopping Corrupting America's Bankruptcy Courts?, 94 GEO. L.J. 1141, 1156-57 (2006).
30. See George D. Brown, The Ideologies of Forum Shopping - Why Doesn't a Conservative Court Protect Defendants?, 71 N.C. L. REV. 649, 651 (1993) (pointing out that forum shopping not only is counter to the reasoning of Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938), but threatens a variety of conservative values such as multiplicity of suits and manipulation of the judicial system);
31. Note, Forum Shopping Reconsidered, 103 HARV. L. REV. 1677, 1695 (1990) (arguing that forum shopping is but part of a continuum of activities within the legal system that crosses into the impermissible area where it entails the plaintiff's manipulation of rules to defeat what is perceived as the "correct" legal result).