On Dec. 19, 1995, President Bill Clinton vetoed the Private Securities Litigation Reform Act, commonly known as the PSLRA. Days later, the United States House and Senate both overrode the president’s veto with strong support from Democrats and Republicans alike, and the bill became law on Dec. 22, 1995.
Politics aside, the PSLRA is a gift to an individual or entity named as a defendant in a federal securities lawsuit. It was passed for the express purpose of ending abusive practices committed in private securities litigation, including “strike suits,” where a party files suit based on the scantest of evidence in the hopes of securing a quick — and lucrative — settlement.
The PSLRA provides defendants with an arsenal of defenses against a securities lawsuit, and requires federal courts to review and sanction abusive lawsuits sua sponte. Despite these protections, both case law and multiple academic studies indicate that 20 years after its enactment, the PSLRA is not being used as zealously as either Congress intended or its provisions allow.
Mandatory Sanctions for Abusive Litigation
Perhaps the strongest, and most underused, protection available under the PSLRA is the provision obligating federal courts to review the pleadings in the vast majority of federal securities lawsuits for compliance with Federal Rule of Civil Procedure 11. If any such pleading is found to have violated Rule 11, the PSLRA mandates the imposition of sanctions against the offending party and/or attorney. The offending party is not, as is usually the case under Rule 11, given the opportunity to modify or withdraw the frivolous pleading to avoid sanctions. In fact, some federal courts have held that frivolous securities lawsuits may be subject to sanctions ever after being voluntarily dismissed.
Given the chilling effect that the PSLRA’s mandatory Rule 11 review should have on frivolous securities lawsuits, why isn’t this provision more frequently invoked? In theory, the PSLRA requires federal courts to carry out a Rule 11 review and, where appropriate, impose sanctions sua sponte. However, in practice, it appears that district courts often overlook this provision and defendants neglect to bring it to courts’ attention. Defendants to a potentially frivolous federal securities lawsuit are therefore well-advised to reference the PSLRA’s mandatory Rule 11 review in their motion to dismiss, either in the brief or in a footnote thereto, to ensure that the underlying lawsuit is subjected to a Rule 11 review.
Heightened Pleading Standards and Stay of Discovery
The PSLRA also advantages defendants in moving to dismiss a securities lawsuit. Thanks to the PSLRA, a plaintiff may no longer attempt to force a quick settlement by serving burdensome and intrusive discovery at the outset of a securities lawsuit. To the contrary, with few exceptions, once any defendant files a motion to dismiss, the PSLRA mandates a universal stay of discovery during the motion’s pendency.
The PSLRA likewise imposes demanding pleading standards on securities fraud claims. Gone are the days where securities plaintiffs filed bare-bones complaints in the hopes of uncovering securities fraud in discovery. Now, a plaintiff attempting to plead securities fraud must identify every allegedly fraudulent statement in the complaint and explain why each such statement is misleading.
To the extent a securities fraud claim requires a showing of a mental state such as scienter, the complaint must also state with particularity facts giving rise to a “strong showing” that the defendant carried out each alleged act or omission with scienter. If a claim fails to meet either of these heightened pleading requirements, the PSLRA explicitly mandates that the claim “shall” be dismissed.
Class Action Certification and Notice
The PSLRA imposes additional obligations on plaintiffs attempting to proceed on a securities class action lawsuit, including strict certification and notice requirements. In order to remedy the scourge of the “professional securities plaintiff,” the PSLRA requires that every plaintiff who seeks to serve as a representative for a securities class action file a sworn certification with the complaint confirming, without limitation, that the plaintiff did not purchase the security that is the subject of the complaint at the direction of plaintiff’s counsel or in order to participate in a federal securities lawsuit, identifying any other federal securities lawsuit in which the plaintiff sought to serve as a class representative filed in the prior three years, and confirming that the plaintiff will not accept any payment for serving as a class representative beyond the plaintiff’s pro rata share of any recovery. Federal courts have held that a failure to file this certification is fatal to the maintenance of a putative securities class action.
In addition to the certification, a plaintiff seeking to proceed on a securities class action lawsuit must also provide potential class members with notice of the action no later than 20 days after the date on which the complaint was filed. The PSLRA requires that a plaintiff provide such notice in a widely circulated national business-oriented publication or wire service. Like the certification requirement, securities plaintiffs commonly either completely disregard or fail to comply with the PSLRA’s formal notice requirements, which federal courts have not looked upon kindly.
Safe Harbor for Forward-Looking Statements
Prior to the passage of the PSLRA, a securities issuer could be held liable for forward-looking statements included in securities filings that ultimately proved to be inaccurate. According to the PSLRA’s proponents, this looming threat of liability forced issuers to disclose fewer and less robust projections of, for example, an issuer’s revenue, income, and anticipated operations in securities filings thereby harming investors and potential investors. Congress addressed this concern by including a safe harbor provision in the PSLRA in order to “loosen the muzzling effect of potential liability for forward-looking statements, which often kept investors in the dark about what management foresaw for the company.”
With few exceptions, if an issuer complies with the PSLRA’s safe harbor provision, a securities claim cannot be premised on a forward-looking statement, even if that statement ultimately proves to be inaccurate. In order to qualify for the PSLRA’s safe harbor protections, a forward-looking statement need only be identified as “forward-looking” and “be accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.”
Even in the absence of the foregoing language, a forward-looking statement still falls under the PSLRA’s safe harbor protections if it is immaterial or if the plaintiff cannot prove that a defendant had actual knowledge that a forward-looking statement was false or misleading. If any of these conditions are present, a private securities claim based on a forward-looking statement that ultimately proved to be inaccurate is subject to dismissal.
Originally published in Law360, January 23, 2015