NEW YORK-Recent developments in a class-action lawsuit alleging securities fraud against CellStar Corp., a cellular handset distributor, have emerged as a vanguard test of part of a new federal law intended to limit frivolous securities litigation.
Although the new statute is highly complex, two of its key provisions involve who has legal standing to sue and what companies can say about their prospects without fear of being sued. The law affects only cases filed after its enactment.
In May, the New York law firm of Milberg, Weiss, Bershad, Hynes & Lerach sued CellStar on behalf of individual investors. The lawsuit alleges, in part, that CellStar’s management artificially inflated sales figures and other financial projections to boost the price of the company’s stock. Between October 1995 and April 1996, CellStar’s stock price fell to $6 from more than $30 per share.
Earlier this month, U.S. District Court Judge Jerry Buchmeyer, sitting in Dallas, accepted a request by the State of Wisconsin Investment Board that it become lead plaintiff in the lawsuit against CellStar, which is headquartered in Carrollton, Texas. In honoring the Wisconsin Investment Board’s request, Judge Buchmeyer ousted Milberg, Weiss as lead plaintiff, although the firm has requested installation as a co-lead plaintiff.
The case is one of the few to test a provision defining who can sue that is part of the Private Securities Litigation Reform Act of 1995, enacted last December, said Richard A. Rosen, a defense attorney who is a partner in the law firm of Paul, Weiss, Rifkind, Wharton & Garrison, New York. Under this provision, any plaintiff bringing a class-action lawsuit under the federal Securities Exchange Acts of 1933 and 1934, “must publish (what amounts to) a help wanted ad for additional plaintiffs so that other shareholders who may wish to can join the case.” The 1933 law primarily governs initial and secondary public securities offerings, while the 1934 statute covers mostly-but not only-ongoing filings like annual and quarterly reports required by the Securities and Exchange Commission.
“There has been a concern for some time that there are too many class-action suits by lawyers who essentially buy a plaintiff (like) people who have (purchased) a few shares in a technology company, which is always susceptible to things going awry,” said David A. Lipton, a professor at Catholic University of America School of Law, Washington, D.C. “The law disallows a small shareholder from pestering a company, rushing in to sue and saying, `why don’t you settle out of court?”‘
The new law not only gives the largest single shareholder in a company priority as lead plaintiff, but also allows that shareholder to decide whether to proceed with the lawsuit, according to Lipton. In the CellStar case, the Wisconsin Investment Board maintained that it was the largest single shareholder in the company during the time period covered by the lawsuit. At one time, the fund owned $27 million of CellStar stock, accounting for approximately 20 percent of all shares not owned by management and directors of the company. The pension fund, which no longer owns any CellStar stock, said it lost $14 million on its investment in CellStar.
Roger Dennis, dean of the Rutgers University School of Law at Camden, N.J., said Judge Buchmeyer’s decision, “is not a surprising development; in fact, it is precisely what the new securities statute intended … to give the judge in a class-action the authority to pick a plaintiff with more of the economic interests of the class at stake, a repeat player who understands how the markets work, who can hire good lawyers.”
However, Steven J. Toll, a plaintiff’s attorney and partner in Cohen, Milstein, Hausfeld & Toll, Washington, D.C., offered a different perspective. “In some sense, the new law is not a bad idea (for getting) more people involved,” he said. “But from our experience, large players (like institutional investors) are closely allied with management and (therefore) it is difficult for them to distance themselves from their close links with companies. They may or may not be vigorous (in representing the class).”
Regarding forward-looking verbal or written statements a company makes about its prospects, Lipton said the new law has created a safe harbor provision that follows the “bespeaks caution doctrine” that has evolved from decisions by a number of courts.
“When an eligible issuer makes a forward-looking statement, there are limits on liability if it turns out to be wrong,” Rosen said. The safe harbor covers secondary, not initial, public offerings of securities, as well as securities trading.
“There are a lot of hurdles; the forward looking statements must (for example) be qualified by appropriate warnings as to what could make them turn out to be wrong,” Rosen said.
While there are a number of cases in the judicial pipeline testing the safe harbor provision, so far the intention of the new law to encourage companies to make predictions without fear isn’t happening, attorneys interviewed said.
