Ruling Tightens Standard in Investors’ Fraud Suits

In a major victory for California’s high-technology companies, an influential federal appeals court made it tougher Friday for shareholders to win securities fraud lawsuits against corporations.

Shareholders must now show that a company intended to commit fraud--not merely engaged in reckless conduct, according to a divided U.S. 9th Circuit Court of Appeals. The court’s opinion, which applies to California and eight other Western states, was its first interpretation of a 1995 law designed to curb abusive securities lawsuits.

“In the world of securities class-action legislation, this is big,” said Joseph Grundfest, a securities law expert at Stanford Law School. “It makes it harder to sue Silicon Valley companies [and] it gives them an additional measure of protection against litigation that they have viewed as harassing and frivolous.”

Corporations, especially California’s high-tech companies, have long complained that they were paying hundreds of millions of dollars in settlements and attorneys’ fees each year to fight shareholder suits, which often allege that a company’s plunging stock price resulted from mismanagement and fraud, not simply market forces.

The targeted firms say they are often faced with the dismal choice of spending small fortunes defending themselves or cutting their losses with a settlement. Often, they settle.

Tired of caving in to plaintiffs’ attorneys, executives from a hundred California high-tech companies joined corporate America in 1995 to overhaul the nation’s securities laws. That year they persuaded Congress to override President Clinton’s veto and pass the Private Securities Litigation Reform Act.

The law sought to make it tougher to pursue shareholder lawsuits against corporations. A key provision requires aggrieved shareholders to state “with particularity” any facts that suggest corporations intended to commit fraud.

But courts across the country have interpreted it differently. In fact, Friday’s 9th Circuit opinion is diametrically opposed to ones rendered by federal appeals courts in New York and Philadelphia.

But the 9th Circuit oversees more securities litigation than any of the other 11 federal circuits.

Securities experts such as Columbia University law professor John Coffee predicted that the issue would most likely have to be resolved by the U.S. Supreme Court. “There is a clear conflict” in the appellate courts, Coffee said.

For now, Silicon Valley executives are savoring their victory.

“It’s a just decision and it’s good for everybody, except possibly the plaintiffs’ lawyers,” said Mark Michael, senior vice president and general counsel of 3Com Corp.

Martin said 3Com spent $2 million on attorney fees defending a 1989 investor fraud suit that eventually was settled. The amount was more than the San Jose firm spent on legal services for all purposes in its first 10 years.

“This affects hundreds of cases that have been or will be filed under the reform act. . . . It does clarify and appropriately narrow the types of cases that will be brought.”

Bruce Vanyo, an attorney for Silicon Graphics Inc., said: “This is wonderful that after four years, we finally have a vindication.”

“Companies that commit real fraud are still going to get sued,” Vanyo said, “but companies that don’t commit fraud and simply had a bad quarter or unexpected surprises aren’t going to get sued.”

At Intel Corp., which has been the target of three unsuccessful investor suits in the last decade, company Vice President Peter N. Detkin called the decision “a great first step.” Before the decision, Detkin said, plaintiffs who filed such fraud suits would brag that “ ‘I’ve got a lottery ticket.’ This will limit that.”

The biggest loser in Friday’s ruling appears to be the law firm of San Diego attorney William Lerach, who has made a lucrative career out of filing class-action shareholder suits. Plaintiffs’ attorneys typically keep one-third of the amounts recovered in these cases. Since 1988, Lerach’s firm has raked in nearly $700 million from such cases, of which Lerach himself has pocketed about $100 million.

Leonard B. Simon, an attorney in Lerach’s San Diego office, said the firm plans to appeal the ruling.

“If this decision stands, it will be harder to plead securities fraud with the kind of information investors typically have--the kind of information possessed by people who are on the outside looking in.”

Friday’s decision involved a suit that Lerach and other attorneys filed against Silicon Graphics not long after the new law went into effect. The suit contended that executives issued deceptive statements to inflate the price of company stock to sell it for a total profit of $13.8 million.

The company denied any wrongdoing.

U.S. District Judge Fern M. Smith in San Francisco dismissed the suit in 1996. She held that the plaintiffs had failed to meet the stiffened pleading requirements of the new law.

After Smith’s decision, the Securities and Exchange Commission, which often views shareholder lawsuits as supplementing its own enforcement action, said the judge misinterpreted Congress’ intent.

“Proving a defendant’s actual knowledge of fraud in a securities case can be a daunting task, particularly when the evidence is entirely circumstantial,” SEC lawyers said in a friend-of-the-court brief.

But two judges on the three-member panel disagreed.

“We hold that, although facts showing mere recklessness or a motive to commit fraud and opportunity to do so may provide some reasonable inference of intent, they are not sufficient to establish a strong inference of intent,” wrote 9th Circuit Judge Joseph T. Sneed.

He was joined by Judge John S. Rhoades, a federal trial judge from Arizona, sitting by designation.

Judge James R. Browning dissented. Browning said the majority “raises the pleading bar higher than that envisioned by Congress.”

Times staff writer Charles Piller in San Francisco contributed to this report.