June 10, 1998

Thank you, Mr. Chairman. First, I commend you for soliciting the views of Members who are not sponsors of H.R. 1689. I appreciate your willingness to work with all of us in crafting your amendment in the nature of a substitute. That substitute curtails some of the overly-harsh aspects of H.R. 1689, but I still have reservations about the bill's impact on investors with legitimate securities fraud claims.

First, like the original House bill and the Senate-passed bill, the substitute both removes and preempts, thus wiping out legitimate State lawsuits. Subsection (b) at the bottom of the first page provides that no class action based on State law alleging fraud in connection with the purchase and sale of a covered security may be maintained in State or Federal Court. Subsection (c) on page two provides that any such class action that is brought in State court shall be removed to a Federal district court, and dismissed.

The substitute's definition of "class action" is much broader than the definition used in federal securities fraud class actions brought pursuant to the Federal Rules of Civil Procedure.

The definition includes on page 6 a "grouping" provision that is overly broad and pernicious. It says that any time more than 50 individuals file State court complaints "in the same court involving common questions of law or fact," they will be deemed to be part of a "class action" under the bill if they are subsequently "joined, consolidated, or otherwise proceed as a single action for any purpose." Further, there has been no showing that these kinds of suits -- either individually or in the aggregate -- have resulted in actual abuse or present the potential for abuse attributable to strike suits.

For example, if an investment adviser churns the accounts of, or recommends unsuitable securities to the Widow Goodbody and his other senior citizen clients and more than 50 of them filed individual actions in the same State court, Widow Goodbody and the other plaintiffs could find that they have been joined as a class and their claims would be removed to federal court, preempted, and dismissed as a result of this legislation.

Let me posit further that the investment adviser did not hold up a sign saying "Guess what? I just defrauded you! And here's all the evidence." Let's say that he was a very smart crook and that the fraud was concealed. Let's also say that he is now living nicely somewhere, unknown, on his ill-gotten gains but that there are aiders and abettors, people who provided substantial assistance to the fraud, still in the State.

Forty-nine States and the District of Columbia allow for some form of aiding- and-abetting liability. Under the 1994 Central Bank Supreme Court decision, there is no aiding-and-abetting liability in private actions for most federal securities fraud claims. In addition, as a result of the 1991 Lampf Supreme Court decision, private actions under the federal securities laws must be brought within one year of discovery of the alleged violation, and no more than three years after the violation occurred. In contrast, 33 States allow for longer limitations periods.

The outrageous compound effect is that the Widow Goodbody had a remedy under State law before this bill. Now she has none at either Federal or State court.

Mr. Markey will be offering amendments to provide a more reasonable federal statute of limitations and to restore the ability of the Widow Goodbody to recover damages from aiders and abettors in federal court. I intend to vote for both of those amendments. If Members want to consolidate securities fraud cases at the federal level and cut off parallel State suits, you have to provide fair procedures and remedies at the federal level. If these amendments are not adopted, I will not even remotely consider supporting this legislation.

Last April, the SEC submitted a report to the President and the Congress on the first year of practice under the Private Securities Litigation Reform Act of 1995. That report concluded that the rush to the courthouse door had slowed somewhat but that there had been inadequate time to draw definitive conclusions about the impact of the 1995 Act on the effectiveness of the securities laws and investor protection. I agree with that conclusion and believe it still to be the case.

The available data shows an increase in State court actions in 1996, followed by a decline in State court actions back to 1994 levels while federal actions are way up. On May 29, 1998, the Wall Street Journal reported that the New York Attorney General's office had brought or settled 62 securities fraud cases last year, up 15 percent from 1996 and triple the number of cases filed in 1993. At the national level, the SEC last year brought cases against 120 entities for fraud against customers, a 9 percent increase from 1996 and double the figure in 1993. It makes sense that there would be a concomitant rise in private lawsuits, both individual and class actions. Willie Sutton said he robbed banks because that's where the money was. Likewise, the bull market has drawn unsavory operators to the securities markets because of the huge cash inflows. In our haste to solve a narrow problem, we should not throw roadblocks in the path of legitimate lawsuits. We fully expect people who have been defrauded to sue to recover their losses.

I note that the substitute contains exceptions for several classes of claims and I commend the chairman for this. I am particularly pleased to see that you preserve the right of State and local governments and their pension plans to pursue class actions in State courts. However, your requirement that they be named plaintiffs and authorize such participation severely limits the use of this exclusion, especially for the smallest, most vulnerable public entities and plans. Moreover, many causes of action will still be swept up by this bill. Without the amendments offered by Mr. Markey, this bill will be harsh and unfair.

Finally, I remain opposed and deeply troubled by the interplay of two of the key provisions of the 1995 Reform Act: (1) the heightened pleading standards and (2) the stay of discovery during the pendency of motion to dismiss. Specifically, the 1995 Act requires the complaint to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." The 1995 Act also requires a plaintiff in a private action to specify each statement alleged to have been misleading and the reasons why the statement is misleading. If an allegation is made on information and belief, the plaintiff must state with particularity all facts on which the belief is formed. The court is required to dismiss a complaint that does not meet these statutory pleading requirements. At the same time, the 1995 Act bars the plaintiff's access to these very facts. The 1995 Act provides for a stay of discovery during the pendency of any motion to dismiss unless the court finds that particularized discovery is necessary to preserve evidence or prevent undue prejudice. The Statement of Mangers noted that the House and the Senate had heard testimony that discovery in securities class actions "often resembles a fishing expedition" and that the cost of this discovery "often forces innocent parties to settle frivolous securities class actions." Nonetheless, these provisions operate at cross purposes to set up a catch-22 that will close the courthouse door to plaintiffs with meritorious claims.