Reform Act Offers New Loopholes in Securities Litigation

Article excerpt

BOSTON _ An investor buys securities that turn out to be worthless. He sues for fraud, showing that the seller omitted critical facts in describing the offer. In court, the seller says "I forgot." With that, he escapes responsibility.

A ludicrous notion? Not at all. It will be the law if a bill that reaches the floor of the U.S. House of Representatives this week wins final passage. It is the latest installment of the Newt Gingrich Contract: House Resolution 10, to change the country's civil damage and securities law.

Title II is called the Securities Litigation Reform Act. That sounds like a measure full of technicalities, and it is. But it demands attention, because it would weaken the world's best system for policing securities markets. It would "reform" many victims of fraud out of court.

The idea of excusing the maker of a fraudulent statement because he "forgot" the truth seems too far out for even the most zealous advocates of ripper legislation. But it is there in black and white.

Under the law as it stands today, an investor who sues for fraud must show that the defendant made a fraudulent statement "knowingly" or "recklessly." The bill says a defendant can be found reckless only if his conduct presented a danger of misleading people so obvious that he "must have been consciously aware of it. For example, a defendant who genuinely forgot to disclose, or to whom disclosure did not come to mind, is not reckless."

The "I forgot" defense is one among many examples of loopholes that this legislation would carve into securities law. The bill was much criticized as originally drafted. In committee the Republican majority amended some of the criticized sections _ but put in new loopholes.

A victim who sued would have to provide, in his first court filing, specific alleged facts showing that the defendant knowingly or recklessly made fraudulent statements. It is very hard, indeed often impossible, for a plaintiff to know such things about the defendant's state of mind before his lawyer has obtained documents and testimony in discovery.

This section of the bill adds that when a suit makes such a charge as representing the plaintiff's belief, it must "set forth with specificity all information on which that belief is formed. …