United States: U.S. Chamber Of Commerce's Institute Of Legal Reform Publishes Report On "Broken Securities Class Action System" And Proposes Reforms

On February 25, 2019, the U.S. Chamber of Commerce's Institute of Legal Reform (the "ILR") published a report entitled "Containing the Contagion:  Proposals to Reform the Broken Securities Class Action System" (the "Report").  The Report describes various trends and problems affecting the securities class action system, which have led to the filing of securities cases "reaching levels not seen since before the enactment of the Private Securities Litigation Reform Act (PSLRA) in 1995."  According to the Report, the three main drivers of the steep increase in securities litigation filings are: (1) cases alleging misstatements in connection with M&A activity; (2) so-called "event-driven litigation," whereby securities class actions are triggered by unexpected adverse events, such as fires, explosions, data breaches, and the like; and (3) the U.S. Supreme Court's decision in Cyan Inc. v. Beaver County Employees Retirement Fund (138 S. Ct. 1061 (2018)), which confirmed that state courts retain non-removable (with limited exceptions) concurrent jurisdiction over Securities Act of 1933 class actions.  The Report also describes perceived abuses and the need to curb such practices.  Finally, the Report urges action from different parts of the federal government including the SEC, federal courts, and Congress, calling on each to do its part in curbing non-meritorious lawsuits that can ultimately harm investors and the U.S. capital markets system.  

M&A Litigation:  According to the Report, M&A litigation comprised approximately half of the federal securities action filings in 2017 and 2018.  M&A litigation complaints, of course, usually allege, among other things, that disclosures to shareholders regarding the proposed transaction were false and deceptive, and historically parties frequently settled by the defendant company agreeing to supplement the disclosures and paying a fee to plaintiffs' lawyers.  In 2016, the Delaware courts, most notably in Trulia (129 A.3d 884 (Del. Ch. 2016)), curtailed this type of litigation and settlement practice, stating that it "far too often . . . serves no useful purpose for stockholders [and instead] serves only to generate fees for a certain group of lawyers," and giving notice that disclosure-only settlements would no longer be approved absent "a plainly material misrepresentation or omission."  Since then, M&A litigation has migrated from state courts to federal courts in the form of disclosure claims under Section 14 of the Securities Exchange Act of 1934, which often can be settled (or dismissed with the payment of a "mootness" fee to plaintiffs' counsel) on the basis of supplemental disclosures only.  

Event-Driven Litigation:  Another cause of the dramatic increase in securities lawsuits is what is referred to as "event-driven litigation," or securities class actions triggered almost by default when a company experiences an adverse public trauma and a subsequent stock drop.  These types of lawsuits are based on the theory that the unexpected adverse event is tied to the company's business or operational risks and that "the occurrence or the event upon which the case is based was the materialization of an under-disclosed or downplayed risk."  According to one of the studies cited by the Report, excluding M&A litigation, "the likelihood of an S&P 500 company being sued [in 2018] was the highest since 2002," with "one in every eleven companies [being] sued, amounting to 9.4% of such companies."

The Cyan Effect:  When the United States Supreme Court ruled in March 2018 that class actions under the federal Securities Act—including Section 11 claims alleging misrepresentations or omissions in connection with initial public offerings (IPOs)—still could be brought (and were generally immune from removal from state court, notwithstanding the Securities Litigation Uniform Standards Act of 1998 ("SLUSA")), the number of such claims brought in state court increased dramatically.  (We previously covered the Supreme Court's ruling in Cyan here.)  According to the Report, only a few such claims were filed prior to 2015, but that number has been growing, and in 2018, 33 such cases were filed in state courts, and approximately half of them had parallel federal actions.  The Report notes that the advent of parallel track of securities class actions in federal and state courts creates a number of significant problems, including (a) the likelihood a defendant company has to fight a "multi-front war"; (b) the state court actions being less likely to be dismissed; and (c) IPO companies facing more significant risk of being named in a securities lawsuit.  Because of these increased pressure points, defendants may be forced to settle without due regard for the merits of the claims.  

Perceived Abusive Conduct:  The Report also describes the need to curb what it referred to as "plaintiffs' bar's abusive litigation practices."  Among those practices are: (a) individual plaintiffs increasingly being appointed as lead plaintiffs, rather than institutional plaintiffs, which are less likely to endorse less meritorious claims and contrary to the PSLRA's intent to encourage plaintiffs with the largest claims to take charge of such litigation and class counsel; (b) concentration of extensive litigation activity in a few firms (for example, one study found that three plaintiffs' law firms appeared as counsel of record on more than half of the initially-filed complaints in non-M&A securities cases); and (c) arguably excessive fees awarded to plaintiffs' lawyers in settlements.  

The ILR proposes various reforms to address these problems, urging the SEC, federal courts, and the U.S. Congress to lead these efforts.  First, the Report proposes that the SEC undertake a project to evaluate the current state of securities litigation, with a focus on identifying abuses, and (largely by filing amicus briefs in federal court) suggest practical ways to address these abuses.  Second, the Report proposes that federal courts follow the approach adopted by the Delaware Chancery Court and seek to identify and sanction abusive litigation challenging mergers and acquisitions.  And third, the Report proposes a host of federal statutory changes to eliminate abuses in securities class actions, including (1) overturning Cyan to ensure that federal securities class actions are heard only in federal court; (2) centralizing M&A litigation so that a limited number of federal courts can establish standards to deter abusive claims; (3) enacting an "investors' bill of rights" to require disclosure of relationships between plaintiffs' lawyers and plaintiffs, bar individuals and entities from serving as plaintiff in more than five cases in 36 months, and require federal courts to more closely scrutinize fee requests; (4) eliminating certain tactics employed by plaintiffs' attorneys by staying opt-out claims until the resolution of any related class action, providing for interlocutory appeal of denials of motions to dismiss, and strengthening the PSLRA's pleading standard and stay of discovery pending the resolution of the motion to dismiss; and (5) adopting a cap on damages for non-IPO cases that gives priority to small investors.  

The ILR Report has already received significant publicity, and—with its mix of new ideas and reiteration of longer-standing proposals—hopefully may spur further dialogue with respect to beneficial reform.  Whether or not securities class actions will be a legislative priority in the current political environment, of course, is a separate question.

On February 25, 2019, the U.S. Chamber of Commerce's Institute of Legal Reform (the "ILR") published a report entitled "Containing the Contagion:  Proposals to Reform the Broken Securities Class Action System" (the "Report").  The Report describes various trends and problems affecting the securities class action system, which have led to the filing of securities cases "reaching levels not seen since before the enactment of the Private Securities Litigation Reform Act (PSLRA) in 1995."  According to the Report, the three main drivers of the steep increase in securities litigation filings are: (1) cases alleging misstatements in connection with M&A activity; (2) so-called "event-driven litigation," whereby securities class actions are triggered by unexpected adverse events, such as fires, explosions, data breaches, and the like; and (3) the U.S. Supreme Court's decision in Cyan Inc. v. Beaver County Employees Retirement Fund (138 S. Ct. 1061 (2018)), which confirmed that state courts retain non-removable (with limited exceptions) concurrent jurisdiction over Securities Act of 1933 class actions.  The Report also describes perceived abuses and the need to curb such practices.  Finally, the Report urges action from different parts of the federal government including the SEC, federal courts, and Congress, calling on each to do its part in curbing non-meritorious lawsuits that can ultimately harm investors and the U.S. capital markets system. 

M&A Litigation:  According to the Report, M&A litigation comprised approximately half of the federal securities action filings in 2017 and 2018.  M&A litigation complaints, of course, usually allege, among other things, that disclosures to shareholders regarding the proposed transaction were false and deceptive, and historically parties frequently settled by the defendant company agreeing to supplement the disclosures and paying a fee to plaintiffs' lawyers.  In 2016, the Delaware courts, most notably in Trulia (129 A.3d 884 (Del. Ch. 2016)) curtailed this type of litigation and settlement practice, stating that it "far too often . . . serves no useful purpose for stockholders [and instead] serves only to generate fees for a certain group of lawyers," and giving notice that disclosure-only settlements would no longer be approved absent "a plainly material misrepresentation or omission."  Since then, M&A litigation has migrated from state courts to federal courts in the form of disclosure claims under Section 14 of the Securities Exchange Act of 1934, which often can be settled (or dismissed with the payment of a "mootness" fee to plaintiffs' counsel) on the basis of supplemental disclosures only. 

Event-Driven Litigation:  Another cause of the dramatic increase in securities lawsuits is what is referred to as "event-driven litigation," or securities class actions triggered almost by default when a company experiences an adverse public trauma and a subsequent stock drop.  These types of lawsuits are based on the theory that the unexpected adverse event is tied to the company's business or operational risks and that "the occurrence or the event upon which the case is based was the materialization of an under-disclosed or downplayed risk."  According to one of the studies cited by the Report, excluding M&A litigation, "the likelihood of an S&P 500 company being sued [in 2018] was the highest since 2002," with "one in every eleven companies [being] sued, amounting to 9.4% of such companies."

The Cyan Effect:  When the United States Supreme Court ruled in March 2018 that class actions under the federal Securities Act—including Section 11 claims alleging misrepresentations or omissions in connection with initial public offerings (IPOs)—still could be brought (and were generally immune from removal from state court, notwithstanding the Securities Litigation Uniform Standards Act of 1998 ("SLUSA")), the number of such claims brought in state court increased dramatically.  (We previously covered the Supreme Court's ruling in Cyan here.)  According to the Report, only a few such claims were filed prior to 2015, but that number has been growing, and in 2018, 33 such cases were filed in state courts, and approximately half of them had parallel federal actions.  The Report notes that the advent of parallel track of securities class actions in federal and state courts creates a number of significant problems, including (a) the likelihood a defendant company has to fight a "multi-front war"; (b) the state court actions being less likely to be dismissed; and (c) IPO companies facing more significant risk of being named in a securities lawsuit.  Because of these increased pressure points, defendants may be forced to settle without due regard for the merits of the claims. 

Perceived Abusive Conduct:  The Report also describes the need to curb what it referred to as "plaintiffs' bar's abusive litigation practices."  Among those practices are: (a) individual plaintiffs increasingly being appointed as lead plaintiffs, rather than institutional plaintiffs, which are less likely to endorse less meritorious claims and contrary to the PSLRA's intent to encourage plaintiffs with the largest claims to take charge of such litigation and class counsel; (b) concentration of extensive litigation activity in a few firms (for example, one study found that three plaintiffs' law firms appeared as counsel of record on more than half of the initially-filed complaints in non-M&A securities cases); and (c) arguably excessive fees awarded to plaintiffs' lawyers in settlements.  

The ILR proposes various reforms to address these problems, urging the SEC, federal courts, and the U.S. Congress to lead these efforts.  First, the Report proposes that the SEC undertake a project to evaluate the current state of securities litigation, with a focus on identifying abuses, and (largely by filing amicus briefs in federal court) suggest practical ways to address these abuses.  Second, the Report proposes that federal courts follow the approach adopted by the Delaware Chancery Court and seek to identify and sanction abusive litigation challenging mergers and acquisitions.  And third, the Report proposes a host of federal statutory changes to eliminate abuses in securities class actions, including (1) overturning Cyan to ensure that federal securities class actions are heard only in federal court; (2) centralizing M&A litigation so that a limited number of federal courts can establish standards to deter abusive claims; (3) enacting an "investors' bill of rights" to require disclosure of relationships between plaintiffs' lawyers and plaintiffs, bar individuals and entities from serving as plaintiff in more than five cases in 36 months, and require federal courts to more closely scrutinize fee requests; (4) eliminating certain tactics employed by plaintiffs' attorneys' by staying opt-out claims until the resolution of any related class action, providing for interlocutory appeal of denials of motions to dismiss, and strengthening the PSLRA's pleading standard and stay of discovery pending resolution of the motion to dismiss; and (5) adopting a cap on damages for non-IPO cases that gives priority to small investors. 

The ILR Report has already received significant publicity, and—with its mix of new ideas and reiteration of longer-standing proposals—hopefully may spur further dialogue with respect to beneficial reform.  Whether or not securities class actions will be a legislative priority in the current political environment, of course, is a separate question.

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