Shareholder suits handcuffed by court

The ruling is good news for high-tech companies. Because of the volatile nature of their stocks, Silicon Valley companies are sued more often than any other industry.

The divided court ruled that in order to sue for stock fraud, plaintiffs must show that corporate officers were "deliberately reckless" in making optimistic financial forecasts that turned out to be severely wrong. The opinion Friday went the furthest yet in interpreting the four-year-old Private Securities Litigation Reform Act (PSLRA) in favor of defendants.

"We hold that a private securities plaintiff proceeding under the PSLRA must plead, in great detail, facts that constitute circumstantial evidence of deliberately reckless or conscious misconduct," Judge Joseph Sneed wrote for the majority.

Judge James Browning dissented, writing that the opinion "raises the pleading bar higher than that envisioned by Congress and places the Ninth Circuit at odds with both the Second and Third Circuits."

Supreme Court next?
Indeed, Sneed acknowledged that "not all courts share our view," making the issue ripe for Supreme Court review. The Second Circuit, for instance, has allowed suits to proceed by merely pleading that corporate officers had the "motive and opportunity" to commit fraud or by pleading simple recklessness.

But Sneed said that Congress intended the pleading standards to be even more stringent than the Second Circuit's holding.

"In sum, the legislative history supports our conclusion that the PSLRA pleading standard is higher than the standard of the Second Circuit," Sneed wrote, "Congress must have intended a standard that lies beyond mere recklessness."

Footpaths in the snow?
Specifically, Sneed wrote in affirming a decision of San Francisco District Judge Fern Smith, the existence of insider trading does not, on its face, make fraudulent intent.

Insider trading has long been the centerpiece of stock fraud class actions, with plaintiffs' lawyers often filing boilerplate language in their complaints. The king of these cases, William Lerach, called insider trading "footpaths in the snow" and used it as exhibit one that corporate officers lied about the company's financial well being to artificially inflate the stock.

"As the district court recognized, mere boilerplate pleadings will rarely, if ever, raise a strong inference of intent or otherwise satisfy the PSLRA's particularity requirement," Sneed wrote. "The district court also concluded that the sales of stock were not so suspicious as to create a strong inference of fraudulent intent."

Stanford Law Professor Joseph Grundfest said the insider trading issue is one of the more significant parts of the opinion. Fully 60 percent of all securities class-action suits use insider trades as evidence of fraud.

With Sneed's opinion, "You now have to evaluate the insider's trading behavior in context," Grundfest said.

Influential case
Judges have been sitting on hundreds of cases throughout the country, with few settling as all parties awaited this decision. Of the 643 cases the Stanford University Law School Securities Clearinghouse tracks, fewer than 100 have been resolved.

"The courts have been waiting for this," said Sara Brody, a partner at Brobeck, Phleger & Harrison, a San Francisco law firm. "I would expect a number of district court judges, particularly in California, to start deciding motions to dismiss."

Brody said a motion to dismiss In re Oak Technology Inc. Securities Litigation, for instance, has been pending before San Jose Senior Judge Spencer Williams since December 1997.

Domino effect
There are also a number of similar cases on appeal that will probably now be decided in short order, Brody predicted.

In re Silicon Graphics Inc. Securities Litigation was filed by Milberg, Weiss, Bershad, Hynes & Lerach in 1996 after Silicon Graphics announced that its earnings had grown only 22 percent, rather than the 40 percent previously projected. Lerach accused officers of knowing their projections were false in order to boost the stock price. As proof of their intent, Lerach pointed out that insiders sold 400,000 shares during the time of the alleged fraud.

But Bruce Vanyo of Wilson, Sonsini, Goodrich & Rosati argued that the heightened pleading standard mandated by the Reform Act required the case to be thrown out, which the Ninth Circuit ordered on Friday.

Both sides of the bar anticipate that either the Supreme Court or an en banc Ninth Circuit will weigh in on the issue.

The ruling comes the same week the Congress overwhelmingly passed a law that would greatly limit the number of class actions that could be filed because of anticipated computer failures due to the Year 2000 problem.