What Counts as Fraud? An Empirical Study of Motions to Dismiss Under the Private Securities Litigation Reform Act

Abstract

This article presents the findings of a study of the resolution of motions to dismiss securities fraud lawsuits since the passage of the Private Securities Litigation Reform Act in 1995. Our sample consists of decisions on motions to dismiss in securities class actions by district and appellate courts in the Second and Ninth Circuits for cases filed after the passage of the Reform Act to the end of 2002. These circuits are the leading circuits for the filing of securities class actions and are generally recognized as representing two ends of the securities class action spectrum. Post-PSLRA, the Second Circuit applies the least restrictive pleading standard to securities claims and the Ninth Circuit applies the most restrictive.The Ninth Circuit's post-PSLRA reputation as being a tougher venue in which to win securities fraud class actions is born out by a significantly higher dismissal rate. The differences between the two circuits are also reflected in factors that correlate with dismissal. For example, allegations of violations of accounting principles other than revenue recognition correlate negatively with dismissal in the Second Circuit. This coefficient, however, is insignificant in our regressions for the Ninth Circuit. Allegations of revenue recognition violations are insignificant in both circuits, whether or not the issuer has been forced to restate those revenues. The circuits part ways on other factors as well: the Second Circuit is significantly less likely to dismiss cases with allegations of false forward-looking statements, a surprising result given the stringent standards for such statements imposed by the PSLRA. The Ninth Circuit is significantly less likely to dismiss complaints with allegations of '33 Act violations and the Second Circuit is more likely to dismiss cases brought by the Milberg Weiss firm. When it comes to insider trading, however, the two circuits are both skeptical and the allegations correlate with dismissal in both circuits.

Carrot or Stick? The Shift from Voluntary to Mandatory Disclosure of Risk Factors

“…For example, the likelihood an earnings warning will result in a lawsuit filing or an allegation of false or 11 misleading projections is significantly lower after enactment of the PSLRA (Johnson et al 2007), suggesting the safe harbor dissuades potential plaintiffs from pursuing disclosure-related complaints. Moreover, lawsuits containing allegations of fraud in forward-looking statements are more likely to be dismissed in the post-PSLRA period (Pritchard and Sale 2005), which also reduces defendants' legal costs from securities fraud class actions.…”

Punitive Damages in Securities Arbitration: An Empirical Study

“…Even within a single legal subject area, such as this study's focus solely on securities issues, geographical variation emerges. For example, the outcomes of federal securities cases and federal civil rights trials, the rate at which bankruptcies are filed, the mode of bankruptcy filing, and the outcome of bankruptcy cases show strong geographical effects despite their shared substantive areas and presumably shared governing federal legal rules (see, for example, Eisenberg et al 1997;Eisenberg 1989;Pritchard and Sale 2005;Sullivan, Warren, andWestbrook 1989, 1994). Geographical variation in adjudicated outcomes is not limited to the United States.…”

Do the Merits Matter Less After the Private Securities Litigation Reform Act?

“…23 The empirical evidence on the sounds in fraud doctrine effect on dismissal rates for Section 11 claims is mixed. Pritchard and Sale (2003) provide evidence from the post-PSLRA period that while the Ninth Circuit is less likely to dismiss a Section 11 claim (compared with a Rule 10b-5 claim), the Second Circuit is equally likely to dismiss both types of claim. The application of the sounds in fraud doctrine to joint Rule 10b-5 and Section 11 claims is consistent with the shift on the part of plaintiffs' attorneys 14 toward more Section 11-only claims in the post-PSLRA period as detailed in Panel C of Table 1 (as a means to avoid the doctrine).…”

“…17 In contrast, Ali and Kallapur (2001) provide evidence of significant negative cumulative abnormal returns from the day before the congressional vote on the conference committee bill on the PSLRA to the next trading day after the PSLRA's enactment. Pritchard and Sale (2003) examine the impact of the PSLRA's heightened pleading standards on the ability of plaintiffs to survive a motion to dismiss. They hypothesize that hard evidence accounting claims (particularly related to revenue restatements) are more likely to survive a post-PSLRA motion to dismiss.…”