Suja Thomas, Why the Motion to Dismiss is Now Unconstitutional

November 2, 2007

Suja Thomas of University of Cincinatti College of Law recently posted Why the Motion to Dismiss is Now Unconstitutional, which is forthcoming in Minnesota Law Review.  In her article, Thomas argues that the Supreme Court’s decisions last term in Bell Atlantic Corp. v. Twombly and Tellabs, Inc. v. Makor Issues & Rights impermissibly impose on a plaintiff’s constititional rights to a jury trial.  Here is the abstract:

This Article is the first to address the issue of the constitutionality of the motion to dismiss. Until now, motions to dismiss have not been the subject of much academic commentary, in part because courts have rarely dismissed cases upon motions to dismiss. However, decisions by the Court this past term in Bell Atlantic Corp. v. Twombly and Tellabs, Inc. v. Makor Issues & Rights, Ltd. changed the civil procedure landscape tremendously. In these decisions, the Court “retire[d]” the fifty-year-old rule of Conley v. Gibson under which a complaint could not be dismissed unless there was “no set of facts” upon which relief could be granted. The Court cast this rule away in favor of a standard under which courts critically assess whether the claim is plausible and at times, examine inferences that favor both the plaintiff and the defendant. In setting up this new standard, the Court emphasized the concern that companies should not be subject to discovery and forced settlements in unmeritorious cases and also stressed that Congress and the rule-makers possessed the authority to establish pleading procedures. Under the new standards, courts will dismiss cases much more often using the motion to dismiss. This impending phenomenon of increased dismissals by judges before the fact-finder hears any evidence is noteworthy. It will compound a significant decline in the number of jury trials due to dismissals upon summary judgment, and this will occur in the presence of the Seventh Amendment that, by its text and history, strongly protects the right to a jury trial. Under established Supreme Court case law interpreting the Seventh Amendment, the “common law” governs the power of constitutional actors such as the courts and Congress to interfere with the jury trial. Under this case law, a modern procedure must satisfy the substance of the English common law jury trial in 1791 to be constitutional under the Seventh Amendment. This Article argues that Twombly and Tellabs did not adequately follow the Supreme Court jurisprudence on the Seventh Amendment. In Twombly, albeit not raised, the Court failed to recognize the Seventh Amendment issue that overlay its decision despite the significant effect of the decision on the right to a jury trial. In Tellabs, where it did recognize a Seventh Amendment question, the Court ignored the governing common law. These cases open up a new constitutional discussion that tests the limits of the Seventh Amendment. The Article shows that the new motion to dismiss standards do not adequately comport with the substance of the common law jury trial and thus are unconstitutional. Contrary to the common law, these standards permit courts to improperly assess the plausibility of facts and corresponding inferences pled by plaintiffs and weigh those inferences against inferences that favor defendants. The Article concludes that while Twombly and Tellabs were in the limited areas of antitrust and securities fraud, the standards set forth in those cases will be used to dismiss a variety of fact-intensive cases including those frequently dismissed upon summary judgment such as employment discrimination and other civil rights cases.


SEC Roundtable to Debate Policy on Shareholder Suits

October 3, 2007

BNAs Corporate Counsel Weekly (subscription required) reports that the SEC has planned a roundtable discussion on the status of shareholder securities litigation to be held in January 2008.  According to the BNA report, the roundtable was prompted by a letter from six law professors, including Professor Donald Langevoort of Georgetown, raising concerns that the current system does not work as well it could.  Among the concerns the professors raised in their letter are:

  •  securities fraud settlements typically are funded by the shareholders, directly or indirectly;
  • compensation to defrauded investors comes at a “relatively high cost” in lawyers’ fees and related expenses; and
  •  “the current system does a bad job at deterrence because … settlements almost never come out of the pockets of the managers who allegedly executed the fraud.”

All of these are valid and serious concerns.  Hopefully, the SEC and roundtable participants will brainstorm to devise ways to address these problems with a more creative approach than further dismantling the securities fraud liability regime. My view (which I present in this article  in Iowa Law Review) is that the D&O liability insurance system and the issue of personal liability for individual wrongdoing are the areas most deserving of careful attention for reform.


Melvyn Weiss to be Indicted

September 20, 2007

The New York Times and wire services are reporting that famed securities lawyer Mel Weiss will be indicted today in connection with a longstanding investigation into a kickback scheme by his law firm.  The firm, Milberg Weiss, has already been indicted and one of its former partners David Bershad has pleaded guilty in the investigation.  The expected charges against Weiss follow closely on the heels of a plea deal entered into by his former law partner, Bill Lerach, earlier this week.  The New York Times story is here: Prominent Lawyer to Be Indicted.


Bill Lerach to Plead Guilty to Conspiracy Charge

September 18, 2007

The New York Times reports that famed securities plaintiffs’ lawyer, William Lerach, has agreed to plead guilty in connection with a federal investigation into kickbacks allegedly paid to securities litigation plaintiffs by his former law firm, Milberg Weiss.  Lerach is expected to serve one to two years in prison, forfeit $7.75 million to the government, and pay a $250,00 fine.   Here is the New York Times story:   Lawyer Will Plead Guilty in Kickback Scheme.


Lerach Retires

August 29, 2007

Famed securities plaintiffs’ lawyer Bill Lerach has retired from his firm, Lerach Coughlin Stoia Geller Rudman & Robbins, amid a continuing federal criminal investigation into an alleged kickback scheme run by his former firm Milberg Weiss.  Here is the WSJ story (subscription required): Milberg Figure Lerach Retires Amid Plea Talks.


Criminal Conviction in First Option Backdating Trial

August 8, 2007

The New York Times reports today that former Brocade Communications Systems Chief Executive Gregory Reyes was convicted on ten counts of conspiracy and fraud in the first criminal trial connected to the option back-dating scandals.  Here is the story: Ex-Brocade Chief Convicted in Backdating Case.  

Reyes, who did not personally receive any tainted options, faces up to 20 years in prison.  An interesting quote in the New York Times story comes from a human resources employee who testified at trial that Reyes told her the practice was “not illegal if you don’t get caught.” This quote seems to capture the mentality of many corporate employees and executives caught up in misconduct; from market timing to insurance bid-rigging to analyst fraud.  A variation of the view is “if everyone is doing it, it can’t be wrong.”  Such self-serving rationalizations certainly help the individuals engaged in unethical conduct live with themselves, but they seem not to stand up well as a defense in a criminal trial.


Former Milberg Weiss Partner Pleads Guilty to Conspiracy

July 10, 2007

Former Milberg Weiss partner David Bershad has pled guilty to one count of conspiracy in connection with an ongoing investigation into illegal kickbacks that his former firm allegedly paid to individuals who served as lead plaintiffs in class action securities litigation.  According an article in today’s New York Times, Bershad has detailed how the firm, beginning in the 1970s, recruited a “stable” of clients by secretly paying them up to ten percent of the legal fees the firm obtained. 

The article reports that Bershad has agreed to disgorge $7.75 million and pay a $250,000 fine.  He will also cooperate with the government’s investigation of other participants in the alleged conspiracy. The plea should put pressure on the Milberg Weiss firm and partner Steven Schulman who have also been indicted.  Partner Melvyn Weiss and former partner William Lerach have not been indicted, but they may also face pressure from Bershad’s guilty plea.


Supreme Court Rules against Investors in Closely-Watched Case

June 22, 2007

The Supreme Court released its decision in Tellabs Inc. v. Makor Issues and Rights Ltd., ruling against the plaintiffs and in favor of defendant, Tellabs.  The New York Times published summary of the opinion today.

The 8-1 decision by Justice Ruth Bader Ginsburg is a slight setback for the plaintiffs’ bar in securities litigation but hardly the victory opponents of shareholder securities litigation might have hoped for.

In her majority opinion, Justice Ginsburg clarifies what kinds of allegations are sufficient to meet the Private Securities Litigation Reform Act’s (PSLRA) pleading standard of a “strong inference” of scienter (intent to deceive).  The Court rejected the 7th Circuit’s standard in the lower court opinion that a strong inference is created if a “reasonable person could infer” that the defendant acted with the required state of mind.  The court found this standard too permissive in light of the PSLRA’s intention to create a heightened pleading standard.  To qualify as “strong”, the Court held, “an inference must be more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of non-fraudulent intent.” Because the lower courts had evaluated the plaintiffs’ complaint against an inappropriate standard, the Court remanded the case.

Importantly, however, the majority opinion also rejected the defendant’s position that plaintiffs’ failure to show any monetary gain to the individual defendant (the corporation’s CEO) negated a strong inference of scienter.  The majority also rejected the position of Justices Scalia and Alito in concurring opinions that to survive a motion to dismiss the inference of scienter must be more plausible (rather than as plausible) as any competing explanation.  

Overall, the Tellabs opinion is a welcome clarification of the pleading standard created by the PSLRA.  It is less favorable to plaintiffs’ than the 7th Circuit’s standard but much more generous than the standard sought by defendant and embraced, to some extent, by Justices Scalia and Alito. 


Scooter, Paris, Criminal Sentencing and Corporate Law

June 12, 2007

Pundits, politicians and ordinary citizens are vigorously debating whether famous defendants Scooter Libby and Paris Hilton are getting what they deserve, or whether, instead, they are unfairly being made an examples of because of their fame and notoriety.  Similar questions were raised when Martha Stewart served her sentence for obstruction of justice.

This roiling debate has led me ponder what we want from criminal sentences and how to judge whether they are fair.  Our sentencing policies and practices are expected to acheive many goals.  We want criminal sentences to deter future crimes, punish the wrongdoer, teach the criminal “a lesson”, and avenge harm to society or individual victims.  Fairness also requires that like cases be treated alike, a sentiment that seems to be driving the current popular debate.

Where one of society’s goals in sentencing is deterring future crime, we may misstep when we reflexively demand “hard time for hard crime.”  This view is advanced by scholars Paul Robinson and John Darley, who argue that, counter to common perceptions, excessively harsh penalties are not likely to deter crime.  Instead Robinson and Darley argue that to induce compliance with law, legal penalties must be consistent with citizens’ intuitions of desert.  That is, the public must believe the law is fair and reasonably enforced if they are to be expected to obey it. 

This insight from criminal law can also be applied to the corporate liability context, where the corporate officials who breach their fiduciary duties or violate securities laws can face the prospect of harsh monetary penalties.  In each instance, the financial penalty is measured by harm caused to the corporation and its investors, a figure which can easily run into hundreds of millions of dollars. 

This specter of draconian penalties for corporate law violations has led to a peculiar reality that corporate officers and directors almost never personally pay damages for their violations of law.  Instead, such penalties are averted through a number of protective legal doctrines and through insurance and indemnification provions which ensure that third parties almost always pay costs associated with defending corporate officials against charges of wrongdoing.

In my article Law, Norms, and the Breakown of the Board I argue that a new approach is needed to enhance the legitamacy of corporate law rules and promote law compliance by corporate officials.  Moderate penalties, applied more consistently would likely fit the bill.  To be effective, such penalties must directly affect culpable actors.  We should therefore should require corporate wrongdoers to pay personally at least a portion of the penalty for the legal violation.  Requiring personal payments from culpable corporate officials can be accomplished through changes in D&O insurance policies and practices, or through reforms of the litigation settlement process.  In particular, judges can reject settlements of shareholder lawsuits that do not provide for personal payments when there is credible evidence of wrongdoing by individual defendants.


Has the Justice Department Achieved what the PSLRA Could Not?

June 1, 2007

Today’s New York Times reports that famed securities plaintiffs attorney Bill Lerach may leave the firm he founded three years ago.  Lerach is the lead attorney in the ongoing Enron securities litigation and has already recovered $7.3 billion for shareholders in the case. Here is the story: Top Lawyer, Under Fire, May Depart.

The Times reports that Lerach’s expected departure may be part of a deal to spare his firm an indictment in connection with an ongoing investigation into allegations of kickbacks paid to securities class action plaintiffs.  Lerach’s former firm, Milberg Weiss, and two of its former partners are currently under indictment in connection with the alleged scheme.

If the Times reports are true, there is a certain irony in the trajectory of Lerach’s career since Congress adopted the Private Securities Litigation Reform Act of 1995 (PSLRA), a bill said to be designed to put Lerach out of business.  Instead, the PSLRA only served to strengthen Lerach’s position as the top securities litigator in the country. 

More ironic is the fact that the PSLRA’s lead plaintiff provisions should have eliminated any temptation to “bribe” individual shareholders to serve as class action plaintiffs.  Under the lead plaintiff provisions, institutional investors with the largest stake in shareholder suits became the most attractive potential clients.  Many such investors are willing to pay plaintiffs firms to monitor their portfolios and, due to their significant stakes in the corporations, should need little inducement to serves as lead plaintiffs in securities litigation.

So, the PSLRA which was designed to destroy Lerach did not, and the practice of relying on “professional plaintiffs” that the PSLRA was designed to eliminate may yet lead to his downfall.


Follow

Get every new post delivered to your Inbox.