The Right to Sue Vs. Suing Too Easily

By Robert Barnes and Carrie Johnson
Washington Post Staff Writers
Thursday, March 29, 2007

Congress imposed a "very high burden" for shareholders to meet before they can sue companies they suspect of fraud, the Bush administration told the Supreme Court yesterday, as justices considered the balance between deterring corporate wrongdoing and discouraging speculative lawsuits.

Justices seemed sure that Congress meant for securities fraud lawsuits to face a tougher road in federal courts, but also were concerned that its actions created a confusing legal landscape and a questionable barrier to cases that otherwise would be decided by a jury.

It is the first time the court has considered the heart of a 1995 congressional act that required plaintiffs' allegations to show "particularity" and detail, and said claims must give rise to a "strong inference" that company officials had the intent to do wrong. If not, the law said, the suits "shall be dismissed."

Business interests have been mounting a renewed assault on costly shareholder lawsuits. Recent industry-funded reports have called for new limits on investors' ability to sue corporations, and the Supreme Court is accepting an increasing number of cases that touch on the issue.

"We're happy to see these cases get the court's attention, and so far so good with the decisions the court has issued," said Robin Conrad, a senior vice president at the U.S. Chamber of Commerce's litigation center. "It's very important to the business community to get these issues aired."

In the case before the court, Tellabs Inc. v. Makor Issues & Rights, investors allege that Richard Notebaert, then Tellabs' chief executive, made false and misleading statements in an attempt to inflate the stock price of the fiber-optic equipment manufacturer. Specifically, they say Notebaert indicated that demand for one of its products was growing when actually it was slowing, said that another product was ready for delivery when it wasn't and made misleading statements about the company's revenue projections.

After Tellabs disclosed that revenue was down and demand for its best-selling network device had dropped, the company's stock price fell to $15.87 from a one-time high in the period covering the lawsuit of more than $67.

Industry has made it a priority to make investors show executives' wrongful intentions before winning access to corporate documents. Congress passed the Private Securities Litigation Reform Act of 1995, containing the "strong inference" requirement, to limit what companies complained were frivolous but expensive and time-consuming suits.

"And we believe that that requirement does impose a very high burden" on plaintiffs unlike that in other civil suits, said Deputy Solicitor General Kannon K. Shanmugam, representing the government.

But Harvard University law professor Arthur R. Miller said "there's no reason to believe" that Congress wanted to cut off cases that judges under traditional law would find "trial worthy."

In this case, the district judge thought the lawsuit did not meet the stricter standards, but the U.S. Court of Appeals for the 7th Circuit reversed.

Chief Justice John G. Roberts Jr. and Justice Antonin Scalia indicated they saw no evidence the appeals court had decided the case using the Reform Act's rules, and Scalia said he hoped the court would "establish some standards for how you go about determining whether there's a strong inference or not" for lower courts that have interpreted the law in different ways.

"And I hope we're going to recognize that Congress thought it was doing something," when it changed the law, Justice Anthony M. Kennedy said.

Carter G. Phillips, who represented Tellabs, said it was clear Congress wanted plaintiffs' claims in these kinds of cases treated differently than in other cases, where allegations are seen in the light most favorable to plaintiffs.

But several justices worried about squaring the heightened standards with the Constitution's Seventh Amendment right to a jury trial. And Justice Ruth Bader Ginsburg said it is odd to subject a lawsuit's allegations before discovery of evidence to a tougher standard than plaintiffs would have to prove to a jury.

The court has shown a keen interest in such lawsuits this term. On Monday, it agreed to hear a dispute over whether investors can sue "secondary actors" -- accountants, lawyers, investment bankers -- in a securities fraud.

"Most of these cases either have or will have the propensity of making private securities cases harder to prosecute and win," said Gary Brown, a corporate lawyer at the firm Baker Donelson. "That's another way of addressing 'runaway' securities litigation."

Chris Mather, a spokeswoman for the American Association for Justice, a trade group for trial lawyers, said, "Raising the burden of proof would make it virtually impossible for shareholders to hold negligent corporations accountable. This has the potential for locking the courthouse doors."

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