By Lisa Seachrist
WASHINGTON — U.S. Sens. Phil Gramm (R-Texas) and Christopher Dodd (D-Conn.) introduced legislation to tie up a loophole that allows frivolous securities lawsuits barred from federal courts to find a home in state courts.
The bill, S. 1260, would require all class action suits filed on behalf of 25 or more plaintiffs to be filed in federal court and be subject to the federal rules of adequacy enacted in 1995 by the Private Security Litigation Reform Act.
"While we dealt with the problem [of frivolous lawsuits] in federal courts, we are now seeing a migration of these lawsuits to state courts with a real effort, and apparently a successful effort, to circumvent what we had done," said Gramm. "I have introduced this bill with Sen. Dodd to correct this problem."
Frivolous lawsuits plagued the biotechnology industry in the early 1990's. Immunex Corp., of Seattle, Xoma Corp., of Berkeley, Calif., and Cephalon Inc., of West Chester, Pa., all have been subject to class-action securities litigation when their stocks fell. Typically, the allegation in these suits was that the management of the company overstated the likelihood of regulatory success of their products and, as a result, mislead stockholders.
The volatile nature of biotechnology stocks and the unpredictability of the product approval process put the industry at high risk for this type of litigation.
Most companies when faced with securities litigation would settle the suit rather than incur the astronomical costs of defending themselves. And while the suits would typically allege that the plaintiffs suffered as a result of fraudulent company statements, the plaintiffs' attorneys would often structure the settlement so that they would receive anywhere from 40 percent to 60 percent of the settlement.
"In one case, the lead plaintiff, who has the final say in how the settlement is structured, owned a single share of the company's stock but was the brother-in-law of the plaintiffs' attorney," said David Schmickel, patent and legal counsel for the Biotechnology Industry Organization. "He was able to make that a very profitable settlement for the attorney. The situation was the epitome of abuse of litigation — litigation filed with the sole purpose to make the attorney money."
In December 1995, the Senate overrode a Clinton veto to correct the situation. The Private Security Litigation Reform Act required that lead plaintiffs in a class action suit be the largest stockholders and that the suit specify exactly what the company is alleged to have done wrong. The law also set up a system of proportional liability and provided an attorney misconduct clause that forced a lawyer judged to have committed misconduct to pay the legal expenses of the company defending itself.
The law seemed to slow the number of strike suits being brought against companies as their stocks fell, Schmickel said. However, the suits began to pop up in the state courts.
"The migration of frivolous lawsuits to state courts threatens the effectiveness of the reform act," Dodd said. "The problem is not totally out of hand yet. The trend lines are clear."
S. 1260 will move the class action suits consisting of more than 24 plaintiffs to the federal courts and subject them to federal law. The bill does not inhibit state regulators' ability to bring suit against unscrupulous companies nor does it inhibit individual action in state courts. And the bill only applies to stocks traded on the New York Stock Exchange, the American Stock Exchange and NASDAQ.
"Legislatively, we have been moving toward national standards for securities," Gramm said. "This bill sets national standards for stock traded on national markets."
"A lot of people think this is a very complicated issue," Schmickel said. "This is just a single bill to shut off an obvious loophole in the 1995 legislation." *