At the Professional Liability Underwriting Society's D&O
Symposium last week, U.S. Senior District Judge Jed Rakoff took
great care to say almost nothing newsworthy as a panelist
discussing trends in securities class action litigation. Almost
nothing. Rakoff did make one controversial point. The Private
Securities Litigation Reform Act of 1996, he said, gave judges
tremendous discretion to decide if a class action complaint
should be dismissed. As a result, Rakoff said, trial judges are
too likely to apply their own ideology in deciding whether
securities cases should go forward.
A recently published article in the Case Western Reserve Law
Review backs Rakoff's theory with quantitative evidence. (Thanks
to the White Collar Crime Prof Blog, where I first saw mention
of the study.) Authors Dain Donelson and Robert Prentice, of the
University of Texas's McCombs School of Business, looked at 144
securities fraud class actions against major accounting firms to
determine whether they could discern a pattern in rulings on the
defendants' fraudulent intent. They could not. After a lot of
calculations involving squiggly symbols and underlying
"dependent variables" such as regulatory investigations and
accounting restatements, Donelson and Prentice concluded that
"few factors are consistently viewed by the courts as indicative
(or not) of auditor scienter."
"The law of pleading scienter against external auditors in
(securities fraud) cases is so vague and inconsistent that, as a
practical matter, judges have virtually unfettered discretion to
reach any conclusion they deem appropriate," the paper said.
The Case Western study, as the authors acknowledge, builds
on previous examinations of securities class action case law
since 1996, which more or less agree that uncertainty has
permitted trial judges considerable latitude in scienter
rulings. Auditor cases are a special class, Donelson and
Prentice wrote, because of the "special treatment" they have
traditionally enjoyed under laws that generally discourage
liability against them and because of particular red flags that
crop up in cases against them.
The authors discount auditors' grousing that uncertainty
works against them, calling the fear that auditors will be held
liable in frivolous cases "overblown." But they say that both
auditor defendants and securities class action lawyers suffer
when uncertainty about the law prevents them from assessing the
settlement value of cases. That leads to prolonged and
inefficient litigation, which benefits neither side.
Moreover, the third part of the paper discusses the unseen
biases that judges bring to discretionary decisions. "While few
question federal judges' subjective honesty, there are
substantial grounds upon which to challenge their rationality
and objectivity," the authors wrote. They proceed to discuss
such factors as overconfidence; self-serving bias, which leads
people to reach conclusions supporting their pre-existing views;
and hindsight bias, which overemphasizes the ability to have
predicted events. The paper presumes that most judges go into
cases with a bias in favor of accountants and against class
action lawyers. When that bias dovetails with their broad
discretion to determine dismissal motions, the authors write,
"it seems more likely that plaintiffs will be disadvantaged, but
whatever the direction of bias, unfettered discretion is likely
to lead to more judicial errors of judgment than would occur
under a regime of clearer and more settled law."
(Reporting by Alison Frankel)
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