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Lessons From The PSLRA

Thanks to Walter Olson for inviting me to guestblog and to Jonathan Wilson for posting today about my practice area.

As noted, I am a securities litigator and publish The 10b-5 Daily, a blog devoted to news and analysis related to securities class actions. Jonathan's post raises the question: how do you eliminate the causes of "easy money" litigation? In the area of securities litigation, however, Congress has already tried to do just that.

The Private Securities Litigation Reform Act of 1995 ("PSLRA") was designed to deter abusive lawsuits and encourage the voluntary disclosure of information by corporate issuers. To that end, Congress established heightened pleading requirements for securities fraud, an automatic stay of discovery in securities fraud cases pending the resolution of a motion to dismiss, a system for selecting a lead plaintiff in a case brought as a class action, and a safe harbor from liability for forward-looking statements. Yet "easy money" litigation, in the form of speculative securities class actions alleging fraud and brought on behalf of investors, continues.

It is surprising that tort reformers do not talk more about the PSLRA, because it illustrates the difficulties of reforming the civil justice system. For the moment, let's just look at the lead plaintiff/lead counsel provisions. The PSLRA provides, in a nutshell, that the lead plaintiff in a securities class action shall be the investor who applies for the position and has the largest financial loss. The selected lead plaintiff gets to pick who will act as lead counsel for the proposed class of investors.

The idea was to create an incentive for institutional investors to put themselves forward as lead plaintiffs. In turn, these institutional investors would have the resources and legal sophistication to closely monitor and run the cases. So what actually happened?

First, the only institutional investors that proved to be really interested in acting as lead plaintiffs were union/public pensions funds. A PricewaterhouseCoopers study of securities class actions filed in 2004 found that (a) institutional investors made up about 50% of all lead plaintiffs, but (b) 72% of these institutional investors were union/public pension funds. Whether most union/public pension funds (as opposed, for example, to investment banks) have the legal resources to closely monitor a complex civil litigation is debatable.

Second, the plaintiffs' bar sensibly reacted to the PSLRA by developing close relations with union/public pension funds (some have suggested a bit too close relations), thereby creating a stable of potential plaintiffs. This was much like the lawyer-driven practice, involving individual investors, that Congress had wanted to stop.

Finally, institutional investors naturally gravitated to the best cases (i.e., the cases with the most pre-filing evidence of fraud), leaving more tenuous cases to be led by individual investors. In this sense, the PSLRA's lead plaintiff provisions arguably made good cases even better (by putting in place stronger lead plaintiffs), but had no effect on the potentially frivolous cases that troubled Congress.

In sum, Congress' good intentions suffered from an unwillingness to simply spell out what it wanted and give the courts the power to effectuate it. The "largest financial stake" was probably a poor proxy for "an investor with both the incentive and the means to closely monitor and control the litigation."



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.