The Private Securities Litigation Reform Act (PSLRA) of 1995 made significant changes to the parameters of pleading, discovery, liability and class representation in cases under the federal securities laws.
The PSLRA has set more stringent norms than Federal Rules of Civil Procedure or United States Rules of Civil Procedure for class action lawsuits in securities. It stipulates full disclosure of the terms of proposed settlement to investors. It prohibits bonus payment to plaintiffs. It authorizes the court to decide on the most adequate plaintiff in class actions based on securities laws.
When a securities fraud complaint of the plaintiff survives a defendantís motion to dismiss it, the matter proceeds to the discovery stage involving the disclosure of voluminous documents and witness action of dozens of witnesses. The exercise is very time consuming and expensive and may cost millions of dollars to the defendants in terms of legal fees and costs. The outcome of a motion to dismiss is crucial since stakes go up substantially when the motion to dismiss is denied.
In the next step the plaintiff may seek class action certification for his motion. In case the plaintiff succeeds in getting a securities fruad class action certification, his case stands upgraded to a securities class action lawsuit. The significance of such class action is that the defendant may become liable in damages to multiple or innumerable persons of the specified class.
At this juncture the defendant faces severe pressure to settle the matter even in the face of a relatively weak case of the plaintiff since if the matter goes to trial even with a small chance of loosing the jury verdict, the consequences could be disastrous for the defendant.
The failure of a motion to dismiss leads to the discovery process that very often results in class certification and expensive settlement to the peril of the defendant. Frivolous security law suits resulting in extorted settlements were not uncommon.
In this background the PSLRA mandated more demanding and rigorous standard for pleadings in security fraud action cases in order to reduce the number of frivolous litigations that may survive motions to dismiss. In three specific ways it stipulated for precision and strength in the factual allegations in the complaint.
The PSLRA requires a plaintiff to identify in his complaint specifically the allegedly fraudulent statements and explain why they are misleading, failing which the complaint is dismissed. By such requirement the PSLRA enables defendants to explain as to why the challenged statement is, in fact not, misleading.
The PSLRA also requires a plaintiff to allege that the defendant knowingly and deliberately made the fraudulent statement with wrongful state of mind, or that he was reckless in not recognizing that the statement was false (the legal expression for this state of mind is "scienter"). This requirement allows defendants to obtain dismissal of cases where the plaintiff merely alleges of a false statement and declares that the defendant "must have known" that the statement was false due to his position within the company. This requirement of culpability is frequently extremely difficult for plaintiffs to satisfy, without the benefit of discovery, since plaintiffs often cannot get witnesses or documents that might demonstrate the defendant's wrongful state of mind in making the false statement.
The US Supreme Court, Justice Ruth Bader Ginsburg, ruled on June 21, 2007, that the plaintiffs would have to show a "cogent inference" of intent to deceive or defraud, thereby raising the standard of pleading for all plaintiffs in securities litigation matters.
Finally, the PSLRA also mandates that a plaintiff shall have the burden of proving that the act or omission of the defendant caused the loss for which the plaintiff seeks damages.