The Evolution of Securities Class Action Law: Congress Places Limits on Class Actions

The 1933 Act and 1934 Act created broad restrictions on corporate fraud, along with mechanisms for investors to sue corporations for making misleading statements. And fifty years later, Basic v. Levinson (1988) endorsed the fraud on the market theory, making it feasible to bring securities fraud class actions on behalf of large numbers of investors affected by misleading statements. While securities class actions were a powerful tool for addressing corporate abuses, critics argued that class actions were too burdensome for corporate defendants. Unsurprisingly, many of the corporate interests who were held accountable by class actions joined in the criticism.

 The worry over meritless class actions was compounded by a fear that companies facing class actions could be extorted into agreeing to a settlement. If a class action was not dismissed by the judge, the process of discovery would begin, which meant the plaintiffs could demand documentary evidence from the defendant. Defending companies sometimes found it cheaper to agree to a settlement than to proceed with litigation.

 Another problem, which was specific to securities class actions, was that investors (or, more accurately, the plaintiff law firms) often rushed to be the first to file a securities class action when the price of a security went through a significant decline. This was known as the “race to the courthouse.” If a small investor was the first to file a class action they could be “in control” of the litigation, which really meant that the law firm representing that small investor would control the litigation—even against the wishes of investors who had suffered far more economic harm.

Read the full article to learn how the Private Securities Litigation Reform Act of 1995, Securities Litigation Uniform Standards Act of 1998, and Class Action Fairness Act of 2005 addressed concerns raised over class actions.