Justices Asked to Clarify Intent-to-Deceive Test For Securities

WASHINGTON - Seeking to rein in private securities fraud suits, a broad coalition of financial services and manufacturing trade groups asked the U.S. Supreme Court this month to decide what legal standard should apply.

The American Bankers Association, Securities Industry Association, and three other groups said the justices have put off this issue for two decades. Now is the time to resolve it, the groups wrote in a July 8 friend-of-the-court brief in Montgomery Securities and PaineWebber Inc. v. Richard Dannenberg.

The dispute centers on the meaning of scienter, a legal term defined as "embracing an intent to deceive."

Investors can file securities fraud suits when a company's stock price dips unexpectedly. The suits often claim that officers misled investors about the company's financial condition, causing the stockholders to loose money. To win, investors must prove scienter. However, the lower courts have disagreed over how high a legal hurdle scienter presents.

Joseph A. Grundfest, a Stanford University law professor and lead counsel on the brief, said the parties want to know if recklessness constitutes an intent to deceive.

"We would like to think that the answer is no," added Stuart Kaswell, general counsel to the Securities Industry Association.

Private securities fraud suits, filed under Section 10(b) of the Securities Act of 1934, cost the industry more than $200 million annually, said Mr. Grundfest, a former Securities and Exchange commissioner. Plus, companies spend millions of dollars more on attorney fees.

Banks and manufacturers often claim the suits are nothing more than blatant attempts to shake them down for a settlement. They've documented numerous cases where an investor with only a few shares files suit, collecting a settlement far in excess of his losses.

Congress currently is considering restricting these suits.

Banks are victims of securities fraud suits quite frequently, said Michael Crotty, deputy general counsel for litigation at the American Bankers Association. "The very kind of vexatious, frivolous, and extortionate law suits described in the brief are common," he said.

The suits are also quite expensive to defend, Mr. Crotty said.

"These are lengthy proceedings," Mr. Crotty said. "They involve a great deal of discovery, which means you have guys mucking around through your files for God knows how long. You have officers sitting for depositions. It is very disruptive to the day-to-day operations of the bank."

In the brief, the groups said Supreme Court action could make these disputes less expensive to argue. Judges, more comfortable with what the legal standard is, would be less hesitant about a dismissing a frivolous case before trial. That would make it harder for investors to extract settlements to unworthy suits, they said.

Also, the groups said excluding recklessness from the definition would only benefit the process. Plaintiffs who believe they were deceived could still file suit and judges could dismiss claims they believed were baseless.

Attorneys representing Montgomery Securities and Mr. Dannenberg did not return calls for comment.

Mr. Crotty said he expects the court to accept the case on Oct. 2, the day it announces its fall schedule.

"They twice before specifically reserved the question for a later date," Mr. Crotty said. "Well, when is that later date going to come if not now?"

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