As most readers are aware, in 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA), which, among other things, sought to eliminate a perceived “race to the courthouse” whereby plaintiffs’ attorneys rushed to file complaints the moment a company’s stock price dropped, in hopes that the first filer would take control of a class action. Now, if multiple plaintiffs and counsel seek to control a securities class action, the court makes a determination of the “most adequate” plaintiff, which presumably eliminates incentives to file early (although now that I think about it, I would have thought “adequate” is not a word that can be qualified; it’s like “perfect circle,” it either is or it isn’t. But I digress).
All that’s fine; but, just to get this process started, plaintiffs (and their counsel) still have to file complaints. Can’t have a lead plaintiff determination until there’s, you know, an actual case on the docket. And because the mere filing of a complaint doesn’t guarantee appointment as lead – with the fees that follow – plaintiffs (and their counsel), have little incentive to put a lot of effort into those initial complaints, which are more like placeholders until the cases are consolidated and an actual lead is appointed by the court. At that time, the appointed lead plaintiff – and its counsel – will take control of the action by filing a new, well researched, consolidated complaint, and matters proceed from there. Defendants don’t have to respond to the initial complaints and they usually don’t, since those will be replaced by the operative complaint once there’s a lead in place.
Anyway, a while back, I posted about a situation where a court actually sanctioned a law firm for filing a bare bones initial complaint, on the grounds that the complaint was so sparse, the firm could not in good faith have believed it to satisfy Rule 11 obligations.
Which I thought was, you know, unfair – yes, the complaint was inadequate, but the initial ones always are; the system pretty much encourages it.
Well, now we have a sort of analogous situation, though it worked out rather better for the law firm.
After Silicon Valley Bank (SVB) collapsed, several investor-plaintiffs and their counsel filed initial complaints. One of these, filed by Hialeah Employees’ Retirement System, Asbestos Workers Philadelphia Welfare and Pension Fund, and Heat & Frost Insulators Local 12 Funds, repped by Bernstein Litowitz (BLBG), alleged Section 11 claims against officers and directors of SVB and SVB’s underwriters, and Section 10(b) claims against officers and directors of SVB, and SVB’s auditor, KPMG.
Eventually, the cases were consolidated, and two lead plaintiffs were appointed: Norges Bank and Sjunde AP-Fonden. The appointed lead counsel was BLBG and Kessler Topaz.
BLBG and Kessler filed a new consolidated complaint – much more thoroughly researched. This new consolidated complaint also had both Section 11 and Section 10(b) claims, but lead plaintiff Sjunde AP-Fonden was not listed as a plaintiff for the Section 11 claims; instead, lead plaintiff Norges Bank was listed as a Section 11 plaintiff, along with “additional plaintiffs” Asbestos Workers and Heat & Frost Insulators Local, i.e., two of the funds that had appeared on BLBG’s earlier complaint (I assume because Sjunde AP-Fonden did not have Section 11 standing).
This new consolidated complaint no longer raised Section 10(b) claims against KPMG; instead, it only raised Section 11 claims against KPMG.
After initial motion practice, the court sustained the Section 11 claims against KPMG, and the case proceeded to discovery.
Based on materials uncovered in discovery, BLBG and these four named plaintiffs – the two leads, and the two additional plaintiffs – moved to amend the complaint to add Section 10(b) claims against KPMG, on the ground that they now had evidence that KPMG had acted intentionally or recklessly in signing off on SVB’s financials.
KPMG opposed the amendment with two procedural arguments. First, KPMG argued that the amendment was time barred. Why? Because BLBG, repping Asbestos Workers and Heat & Frost Insulators Local, had previously filed a Section 10(b) claim against KPMG more than two years earlier. BLBG must have had a good faith basis for the complaint, which functioned as a concession that BLBG and the plaintiffs it represented were on notice of their 10(b) claims by that date – and if there was no such good faith, then BLBG would have violated its Rule 11 obligations.
Second, KPMG argued that even if the Section 10(b) claim was not time barred, it was at least waived, because it had been alleged in an earlier complaint and then dropped from the consolidated complaint.
The court rejected both arguments.
The court first held that there was no way a viable Section 10(b) claim could have been pled before discovery; too many critical facts were contained in confidential audit materials. Did that mean that BLBG acted in bad faith by filing the first – inadequate – Section 10(b) claim against KPMG? No:
KPMG ignores the most obvious explanation: Bernstein Litowitz, on behalf of different clients, filed a complaint that they, in good faith, believed would be supported when the dust had settled around SVB’s titanic failure. That complaint included a claim against KPMG that, upon reflection and the benefit of new information, they ultimately decided could not be sustained by the evidence available to them. Then, when KPMG produced documents and other materials during discovery, Bernstein Litowitz learned that they had in fact been right the first time. The timeline indicates that the attorneys representing Plaintiffs did what any good attorneys should do when they realize a potential claim lacks sufficient basis: they opted not to bring it.
The reference to “different clients” is a little odd; the original complaint was brought on behalf of Asbestos Workers and Heat & Frost Insulators Local, both of whom, as above, were on the consolidated complaint – but as Section 11 plaintiffs, not Section 10(b) plaintiffs. But the point here is, even if that initial complaint was deficient, it was brought in the heat of the moment in the wake of an extraordinary bank failure, and its existence did not suggest any misconduct on the part of BLBG.
As for KPMG’s second argument about waiver, that too turned on the identity of the plaintiffs:
KPMG is right that a plaintiff may waive a claim if he has alleged it in an earlier complaint and then voluntarily dismissed it. But that is not what happened here: these Plaintiffs never brought this claim. The best KPMG can point to is that Bernstein Litowitz brought a Section 10(b) claim against KPMG on behalf of a different plaintiff. The Court has no basis to conclude that Lead Plaintiffs had anything to do with that decision, and they should not be prejudiced because of decisions made by counsel before Lead Plaintiffs engaged them….
Once again, fair enough – the lead plaintiffs were not on the earlier complaint, and the lead plaintiffs (not Asbestos Workers and Heat & Frost Insulators Local) were the only ones named as Section 10(b) plaintiffs in the consolidated complaint (though one does wonder what happens at class cert; can Asbestos Workers and Heat & Frost Insulators Local be included in the Section 10(b) class?).
But of course, all this kind of ignores the underlying reality, which is that plaintiffs in a securities class action are very different than plaintiffs in other kinds of cases. Securities class actions – and I do not say this in a derogatory manner – are lawyer-driven. Lawyers identify the case, they identify the plaintiffs, and they do the research to substantiate the claims. BLBG may have been repping different plaintiffs at different times, but it would have been doing the legwork throughout, as well as making judgments about which claims to bring (along with Kessler, after the lead counsel appointment).
Anyhoo, my point is – this would all this would be easier if courts would just accept that the PSLRA’s set up really does encourage filing hasty, minimally-researched complaints because that’s the only feasible way you get to the point where a lead is appointed and the case gets going, and everyone should just be okay with that.