The Private Securities Litigation Reform Act of 1995: Impact on Accountants

Article excerpt

After almost three years of debate, the Congress in late 1995 enacted the Private Securities Litigation Reform Act of 1995 (the Reform Act) over President Clinton's veto in an attempt to curb abusive securities litigations, principally class actions. Although this legislation has been one of the primary goals of the AICPA and the Accountants Coalition (who deserve much of the credit for its passage), it is hardly a panacea that will bring securities claims against accounting firms to a halt, even though it does attempt to right the playing field on which securities litigations are fought.

Provisions Impeding Securities Litigation

To be sure, the Reform Act discourages the initiation of abusive securities litigation, and this may be the principal advantage gained by the accounting profession. The act does this in two ways: First, it seeks to wrest control of class actions from the plaintiffs' bar, the primary beneficiary of securities class actions whose members campaigned heavily against the legislation. Second, it increases the responsibilities of class action plaintiffs and their attorneys in an effort to curb abusive practices.

Prior to adoption of the Reform Act, securities class actions were commenced and managed by members of the plaintiffs' bar. The new act requires the court to designate the lead plaintiff in each class action, and that plaintiff presumptively will be the individual or entity with the greatest financial interest in the litigation. Thus, pension funds and mutual funds are likely to control future class action cases. Moreover, the court designated lead plaintiff is empowered to appoint (with the court's approval) the class counsel, which means that the law firm that initiated the action will not necessarily share in the spoils of the litigation. This, in fact, has already happened in one securities class action in which a major pension fund that had been designated as the lead plantiff replaced plaintiff's counsel with a law firm of its own choice.

In addition, the plaintiff who first initiates the action must carefully review the complaint and certify to the court the accuracy of the pleadings. An erroneous certification could lead to significant sanctions.

Thus, the new legislation is likely to slow the rush to the courthouse to file a class action every time a stock takes a precipitous drop. In the first six months following the adoption of the Reform Act the number of new case filings dropped dramatically. On the other hand, these new requirements are unlikely to deter securities law claims where there has been a restatement of a company's financial statements precipitates a decline in its stock.

Another likely effect of the act is that future class actions may be prosecuted more vigorously. Heretofore, many class action suits were settled at a relatively early stage in the litigation, in large measure to avoid mounting litigation costs on both sides.

Under the Reform Act, not only will there be an interested lead plaintiff who must approve the settlement of the case, a far more extensive notice of the settlement will have to be sent to all class members detailing the maximum recovery that might be attained if the plaintiffs prevail and the percentage of that amount represented by the proposed settlement. This raises the possibility that many "early" settlements simply may not be approved and that the class will demand a more extensive prosecution of claims.

While these changes are certainly bad news for the plaintiffs' bar, they are not necessarily good news for the accounting profession. There is a strong possibility that institutional investors and their hand-picked attorneys may prosecute cases longer and more vigorously. Thus, although this change is likely to reduce the number of securities class actions, it may well increase the severity of those cases that are brought against accounting firms.

Leveling the Playing Field

The new legislation also contains at least three provisions that will make it more difficult for accounting firms to be held liable in securities law cases. …