High court raises bar for investor lawsuits

Restriction is less than firms wanted

June 22, 2007|By Walter Hamilton and Jim Puzzanghera | Walter Hamilton and Jim Puzzanghera,Los Angeles Times

WASHINGTON -- In a decision that corporate America and trial attorneys claimed as a victory, the U.S. Supreme Court made it harder yesterday 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 filed that are thrown out.

But 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 yesterday'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 the second one this week by the court that was a defeat for shareholders and a victory for the defendant companies. The justices ruled Monday that securities underwriters on Wall Street are generally immune from civil antitrust lawsuits.

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

"Silicon Valley can breathe a sigh of relief," said Jim Hawley, general counsel of TechNet, an industry association that filed a brief with several other technology 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 out 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, as occurred in the Enron and WorldCom accounting scandals.

The ruling dealt with a lawsuit filed in 2002 against telecommunications equipment maker Tellabs Inc. by investors claiming that executives had publicly promoted the Naperville, Ill., 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 7th U.S. Circuit Court of Appeals in Chicago let the suit stand, saying a "reasonable person" could infer that the company had committed fraud.

The high court had been widely expected to adopt a high threshold. The question was how high.

Walter Hamilton and Jim Puzzanghera write for the Los Angeles Times. The New York Times contributed to this article.

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