February/March 2009 / Cover Story
How Tort Reform Paved the Way for the Financial Meltdown
The author, formerly one of the most active securities class action plaintiff attorneys, argues that important investor safeguards were nullified under the banner of tort reform when Congress passed the Private Securities Litigation Reform Act of 1995, which changed the rules governing shareholder lawsuits alleging securities fraud. Pleading the case was made far more difficult, especially with respect to scienter (intent to defraud), by requiring the pleading of specific facts raising the “strong inference” of guilty knowledge. Discovery was forbidden, joint and several liability and damages were restricted and marshaling the racketeering statute was prohibited. According to the author, the result was that civil sanctions for securities fraud were reduced dramatically while the ability of victims to sue was made far more difficult.
The Supreme Court upheld the “strong inference” pleading requirement, and the federal rules were changed to allow courts to accept challenges to class certification orders-which they have done frequently, always decertifying the class.
The author advocates two reforms: The requirement of pleading specific facts to show a “strong inference” of scienter should be changed to a “reasonable” inference, the same standard used for other fraud suits, and courts should be granted discretion to allow the shareholder plaintiff limited discovery to meet the pleading burden.