We suggest that plaintiffs in securities fraud cases should use state inspection statutes to obtain discovery about potential cases of securities fraud. How should a plaintiff with a legitimate securities fraud case proceed under the Reform Act.
PRIVATE SECURITIES LITIGATION REFORM ACT PROVISIONS
In Part I, we discuss those provisions of the Reform Act that disadvantage private securities fraud plaintiffs by making it more difficult to pursue securities fraud litigation. Enhanced pleading requirements for securities fraud complaints require Rule 9(b) of the Federal Rules of Civil Procedure ("FRCP").
Heightened Pleading Requirements for Securities Fraud
The Reform Act requires courts to dismiss complaints that do not meet the new pleading standards.5 Plaintiffs seeking to enforce their pleadings may file discovery requests seeking additional information from defendants. However, unless the court finds discovery necessary to preserve evidence or prevent undue prejudice, all discovery is suspended if the defendant files a motion to dismiss the case.36 If the complaint is dismissed, the new legislation requires that the court makes specific findings on the factual and legal basis for the complaint to determine whether the defendant is entitled to an award of attorney's fees and costs.37.
Stay of D iscovery
The Reform Act eliminates the court's discretion and requires it to stay discovery while a motion to dismiss a securities fraud complaint filed under the Securities Act or the Exchange Act is pending.41 Defendants who receive a dismissal will benefit from greatly reduced legal costs. For plaintiffs, however, the change means that in most cases they will have to seek evidence of fraud without the assistance of the court.
Measures to Restrict Class Actions
These provisions will undoubtedly discourage plaintiffs' attorneys from rushing to file poorly drafted complaints with little investigation and no consultation with the client. To the extent that they reduce incentives for small shareholders and corporate advisers to detect securities fraud, they will also reduce capital market oversight.
Sanctions for Rule 11 Violations
The Reform Act requires courts to make specific findings regarding each party's and attorney's compliance with the Rule 11 requirements.5 6 If the court finds that there has been a violation of Rule 11, it is required to impose sanctions.57 If the violation occurs in a responsive pleading or dispositive motion, the presumptive sanction is the reasonable attorney's fees and expenses incurred by the opposing party as a direct result of the violation.5" If the complaint "substantially fails" to comply with Rule 11 , the presumptive sanction is the total amount of the opposing party's attorneys' fees and expenses for the entire action.59.The Effects of the Reform Act on Securities Fraud Complaints As Congress intended, the Reform Act brings severe procedural and.
The Effects of the Reform Act on Securities Fraud
STATE INSPECTION STATUTES AS A DISCOVERY DEVICE IN
4 The claim belongs to the company, and the company must - through its board - decide whether the claim must be asserted. the Board to take action to remedy the alleged wrongdoing, or to state specifically why it need not require action by the Board (ie, plead "demand futility").66 If the claimant makes a claim to the Board, the claimant admits that the claim is required and can only regain control of the lawsuit by establishing that the board has improperly denied the claim.6 7. If they demand that the board take action, the board will control the future handling of the case. decide not to pursue the lawsuit, deny the shareholders' claims and decide to dismiss the complaint in a required action.
To establish an unjustified denial of a request by the board of directors, the shareholder must state, with specific facts, facts that create a reasonable doubt that the board acted independently or with due diligence when responding to the shareholder's request. The court in Grimes stated that, for purposes of investigating the board's actions in denying a request, a plaintiff may not use normal discovery procedures under the rules of civil procedure. 68 Alternatively, the plaintiff could argue that even if the board is independent, the majority of the board is unable to act independently for some other reason, such as being dominated and controlled by an interested party.
In cases of unjustified rejection, the court must determine whether there is a reasonable doubt that the board of directors acted with due diligence when rejecting the shareholder's request.
Derivative Lawsuits and the "Tools at Hand"
Using State Inspection Statutes in Potential Securities
THE COSTS OF USING THE DELAWARE INSPECTION STATUTE
116 This description is taken from an accompanying article by one of the authors on a related topic. For a more complete discussion of the procedures used in litigating an inspection case under the Delaware statute, see Thomas, supra note 1. The shareholder must also offer to bear reasonable expenses incurred by the corporation in connection with the production of the information.
If the case proceeds to trial and the court grants the plaintiff's request, it will normally order the immediate production of the documents. 21 With this background in mind, we turn to our analysis of the inspection case data. First, we requested from the clerk of court's office a list of cases filed and resolved by settlement or judgment from 1981-1994 under title 8, section 220 of the Delaware Code.
Using this list, we searched each case file to find the date of plaintiff's claim for an inventory list or books and records; the date of the outcome of the trial;. the handling of the case by the parties or the court; the claimant's stated purpose in bringing its claim; and the number of pages of court papers filed by each party.
The Stocklist Cases
Most of the cases in our sample that were dismissed by the courts were dismissed because the plaintiff failed to state a "proper purpose" for the inventory list request.'39. 131 In three of the four refusals ordered by the court, the court found that the plaintiff did not state the true intention. Our hypothesis is that we can indirectly measure legal costs as a function of the number of pages filed.” We discussed our approach.
149 We define the query date as the date of the claimant's written request to the company to provide information (in this case a share list). We define the outcome date as follows: in cases where the court ruled in favor of the claimant, we used the date for providing the information. In cases where the court ruled against the plaintiff, we used the date of the court's final order to resolve the claim.
For the settlement in favor of the claimant, we used the date for the submission of the information from the parties' dismissal clause.
The Books and Records Cases
ANALYSIS OF RESULTS
First, based on our sample of litigation cases, we were unable to measure the number of successful shareholders who obtained documents under Delaware's inspection statute without resorting to litigation. As a result, our statistics may overestimate the costs to shareholders of using the inspection procedure to obtain information.'7 5 Second, we cannot determine every reason why cases may have been settled without the shareholder receiving the stock list or books and registrations. In some of these cases, it is possible that the shareholder has filed a lawsuit to pressure the company to provide other facilities, has received the information without mentioning it in the determination filed in court, or has decided for reasons that not related to the court case which no longer needed the stock list or books and records.
We have partially overcome this problem by collecting additional information from the lawyers who handled these cases.176 However, as noted above, there are still many cases with uncertain outcomes. Third, we cannot measure the plaintiff's success in obtaining all the books and records necessary to properly investigate the suspicion of mismanagement or fraud. In other words, we cannot substantiate our hypothesis (discussed in footnote 153 and accompanying text) that there are statistically significant differences between the number of pages filed by successful and non-.
With all these qualifications in mind, we turn to our analysis of the data.
Is the Delaware Inspection Statute an Effective Discovery
In fact, there may be some net cost reductions if it is faster and cheaper to obtain information about potential securities fraud through an inspection procedure - which is an expedited and summary procedure - than through the normal discovery process in a securities fraud case. 186 Discovery in terms of the inspection statute can also be more focused than in a securities fraud case.18 7 . any) discovery in the fraud case. First, and most obviously, the Reform Act makes the ordinary discovery procedure unavailable to plaintiffs in securities fraud cases. To make this comparison, one would need to gather information on the time and cost of discovery in securities fraud cases.
While we cannot quantify the number of cases where this may be the case, it should be remembered that the claimant only needs to find sufficient evidence to meet the requirements for fraud. Fourth, plaintiffs with strong grounds to suspect corporate wrongdoing and sufficient evidence to plead specific fraud should not have to wait the additional time to litigate an accounting case. Although plaintiffs who suspect corporate wrongdoing will not want to wait the additional time to find out whether they will obtain the books and records before filing their securities fraud action, the court could allow the plaintiffs to continue their inspection case and to refrain from ruling on motions to dismiss in the securities fraud action until the inspection case is resolved.
Although a major shareholder could argue that it should occupy this lead position by virtue of the Reform Act's presumption that the largest shareholder is the most appropriate lead plaintiff, that presumption can be rebutted.19 Shareholders who have already brought a books and records action and discovered evidence of fraud should have a convincing argument that they have the right to be the main plaintiff. We conclude that many shareholders will be reluctant to rely on the Delaware inspection statute as a method of detecting pre-securities fraud litigation. To communicate with other shareholders. regarding proposals from the management or proposals for voting at the annual meeting 6. duty as a board member 7. 3 1 59 a In total, the total number of applications from table 1 exceeds that given.
