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Analyzing Post-Market Boom Jurisprudence in the Second and Ninth Circuits: Has the Pendulum Really Swung too Far in Favor of Plaintiffs?

B.A., Political Science, Reed College, May 1997. J.D., Benjamin N. Cardozo School of Law, June 2005. Notes Editor, Cardozo Public Law, Policy, and Ethics journal. I want to express my thanks to Professor Daniel Crane for reviewing early drafts of this note and for providing me with guidance and encouragement. I also want to thank the staff of the Cardozo Public Law, Policy, and Ethics journal for their efforts in bringing this note to publication.

I. Introduction.

The collapse of the late 1990s market bubble, and the subsequent revelations of corporate fraud that fueled the unprecedented growth, have spawned a new surge in securities litigation.1 Unlike shareholder class action litigation of the past, which primarily focused on the fraudulent conduct of corporate insiders, these lawsuits target a larger group of actors. Today's shareholder litigation seeks to hold both corporate issuers and their capital market gatekeepers liable for fraudulent practices that have implicated the integrity of every level of the securities industry.2

A number of fraudulent practices defined business as usual on Wall Street during the recent market boom. According to regulators and in- vestors, the most common practices included: "laddering," a practice developed by investment firms and corporate executives who agreed to secretly buy and sell their initial public offering (IPO) shares at certain prices to spur demand;3biased accounting practices that failed to reflect the true financial health of the corporate issuer;4conflicts of interest resulting from the failure of analysts and investment bankers to observe the "Chinese wall" designed to separate them and prevent them from working together to attract clients;5and, a practice known as "spinning" where Wall Street firms handed out shares of sought-after IPO's to corporate executives and directors in exchange for high commissions and the promise of future business.6Even Wall Street officials acknowledge that the late 1990s was a period defined by corporate practices that often failed to comply with federal and state regulations.7

The information regarding many of these corporate transgressions came to light, in large part, because of the vigorous enforcement efforts of New York's Attorney General Elliot Spitzer and other attorneys general throughout the country.8Given the enormous loss of market capital that investors have shouldered as a result of the fraudulent practices described above,9it is not surprising that public officials have enhanced enforcement efforts. Regulators have focused a particularly scrutinizing eye on capital market gatekeepers.10However, budgetary restrictions have limited the enforcement efforts of federal and state regulators,11 which means that most of the corporate fraud that occurred during the late 1990s will come to light solely through the class action lawsuits filed on behalf of aggrieved investors.

Private enforcement of federal securities laws is premised on a private attorney's general model.12In essence, this model deputizes attorneys in private practice to search out fraud that might not otherwise come to light. Arthur Levitt, former Chairman of the Securities and Exchange Commission (SEC), affirmed the importance of private enforcement when he stated that "private rights of action are not only fundamental to the success of our securities markets, they are essential to the SEC's own enforcement program."13Even the United States Supreme Court has described private securities actions as a "necessary supplement" to the SEC's enforcement regime.14

Congress has taken a different view of the role private class action lawsuits play in the enforcement of federal securities laws. In an effort to protect the integrity of the capital markets from an alleged proliferation of "strike suits,"15Congress enacted the Private Securities Litigation Reform Act16(PSLRA or Reform Act) in 1995 to implement procedural hurdles that prevent all but the most obvious cases of corporate fraud from surviving past the pleading stage. However, in this post-Enron era, the spirit encouraging the passage of the Reform Act seems to have dissipated, and as a result, some courts are "stating explicitly that private litigation plays an important role in deterring fraud and must not be discouraged by overbroad barriers."17 This has encouraged some com-mentators to wonder whether "the pendulum has swung too far and too fast"18in favor of plaintiffs.

This note will argue that the pendulum has not swung too far in favor of plaintiffs, but merely corrected the imbalance created by the PSLRA's overly burdensome pleading requirements. To support this argument, Part II analyzes federal securities jurisprudence prior to the enactment of the PSL...

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