The Reform Act was passed by the Contract-with-America Congress to address its perception that securities class actions were reflexive, lawyer-driven litigation that often asserted weak claims based on little more than a stock drop, and relied on post-litigation discovery, rather than pre-litigation investigation, to sort the validity of the claims.  

The Reform Act’s centerpiece is its set of high hurdles plaintiffs must clear to avoid dismissal: heightened pleading standards for falsity and scienter and a safe harbor for forward-looking statements.  Together, these pleading standards yield a far higher dismissal rate for securities class actions than claims subject to notice pleading. 

But there are collateral consequences. 

Defendants and defense counsel too often put all of their eggs in one basket – the motion to dismiss.  In the interview process, there can be a myopic focus on the motion to dismiss, with defense-counsel candidates trumpeting the initial complaint’s weakness and their motion to dismiss record.  Nearly all defendants believe they didn’t say anything false, much less on purpose, so these evaluations are music to their ears.  To ramp up the optimism even more, some defense-counsel candidates make aggressive motion-to-dismiss pricing proposals. 

This is short-sighted.  Defendants then understandably don’t feel they need to pick the right lawyers to guide the litigation past the motion to dismiss stage.  Why would they, when all defense-counsel candidates have said the litigation will be dismissed?  Yet, overall, more cases survive the motion to dismiss than not, which means that defendants haven’t sufficiently evaluated the right lawyer for most of the litigation – class certification, fact and expert discovery, summary judgment, and mediation (and trial, if necessary).  

All of this means that when a motion to dismiss is denied, it is a jarring experience.  Defendants understandably are uncomfortable, their minds racing with many questions – for example: 

  • Do I have the right lawyer for the next stages?  Without having even discussed what happens after the motion to dismiss, they often have no idea. 
  • Do I have enough economic protection to win at one of the next stages and settle if I don’t win?  Since they didn’t evaluate the total litigation strategy and cost up front, they don’t know if they have enough D&O insurance to defend the litigation through class certification and summary judgment (and trial, if necessary) and still have enough to settle.  This problem is especially acute when each monthly bill after the motion to dismiss can be more than the entirety of the motion-to-dismiss billing. 

Far too often, this discomfort results in the defendants deciding they need to settle right away, before contesting class certification or evaluating the strength of a summary judgment motion.  And if defense counsel hasn’t conducted a good early case assessment, for cost reasons or otherwise, they aren’t in a good position to advise their clients or inform the insurers about the merits of the case.  This leads to premature and bloated settlements, detached from the merits of the litigation.  I’ve bemoaned the lack of “litigation” in “securities litigation” for years – please see here, for example. 

These dynamics have worsened the overall quality of motion to dismiss briefing too.  There are two ways to write a Reform Act motion to dismiss.  One is to lay out the pleading standards and point out what the complaint doesn’t allege.  That is simple, and simplistic, and can be done on a shoestring budget.  Yet given the Reform Act’s standards, this approach often results in dismissal.  The maxim “a broken clock is right twice a day” comes to mind.

The other way is to take full advantage of the Supreme Court’s directives in Omnicare and Tellabs that district courts consider, for falsity, the full context of the challenge statements and, for scienter, facts bearing on culpable and non-culpable inferences.  This allows defense counsel to tell a story of our clients’ honesty and good faith.  To state the obvious, this is the right way. 

But it can’t be done on a shoestring; it requires a thoughtful early case assessment (which can be done efficiently) since defense counsel need to know the facts to lean into the inferences.  And it requires lawyers truly devoted to the art of Reform Act motions to dismiss; even the very best general commercial litigators can’t capture the nuances a devoted securities litigator can. 

Just think what the dismissal rate could be if the defense bar filed excellent motions to dismiss in all cases. 

Finally, the blinkered focus on the motion to dismiss impacts derivative litigation.  As I wrote in my last post, we too often agree or move to stay derivative litigation pending the outcome of the securities class action motion to dismiss.  This is predicated on the hope that the securities class action will be dismissed.  This adds even more eggs to our securities class action motion to dismiss basket.  But if we engage in proper early case evaluation, we can make better decisions about which derivative cases to stay and which to move to dismiss.