A federal appeals court in California this month made it easier for stockholders to pursue cases against financial institutions whose stock prices drop suddenly.

The Ninth Circuit Court of Appeals, ruling Dec. 9, said stockholders can build a case if they can provide conflicting public and private statements of a business's economic outlook.

Other courts, including the influential Second Circuit Court of Appeals in New York, have required stockholders to prove "a strong inference of fraudulent intent" before requiring an institution to provide documents and statements to plaintiffs. That standard is harder for shareholders to meet.

"It's a pain in the neck," American Bankers Association deputy general counsel Michael F. Crotty said of the Ninth Circuit decision. "We have been deprived of that opportunity to dismiss cases, and that is important."

The decision, according to Mr. Crotty, will allow stockholders to use lawsuits as clubs to force banks to settle meritless cases just to avoid high legal fees.

The Ninth Circuit's decision merely spells out what shareholders must prove to get a case started. Financial institutions may try to dismiss the lawsuit after plaintiffs receive documents, sworn statements, and other pieces of evidence.

In the case, stockholders of Glenfed Inc., which was the parent of California giant Glendale Federal Bank, argued that the thrift misled them in 1990 Securities and Exchange Commission filings by claiming that it could sell a real estate development subsidiary without a loss. But, at a board meeting, thrift officials said no market existed for development companies.

The stockholders asserted that this conflict shows that bank officials are guilty of securities fraud.

Stockholders also claim that six months before regulators required Glenfed to significantly boost its loan-loss reserve, the thrift reported that is was "secure and healthy."

Help for banks in the Ninth Circuit, which covers eight western states including California, could be near.

The split among appeals courts makes it more likely the U.S. Supreme Court will hear the Glenfed case if the bank appeals, Mr. Crotty said.

John Allebrand, a spokesman for the banking company, decline to comment on its plans.

Ronald Glancz, a partner with Venable, Baetjer, Howard & Civiletti law firm in Washington, D.C., said the case places banks in a tough spot.

"We've had situations, particularly in the Northeast, where the economy just turned," Mr. Glancz said. "What the shareholders are saying is you should have predicted it. That's just not possible."

The controversy among the different circuits centers on how specific a stockholder must be in a complaint. The stockholders say they cannot include details until after they've examined a bank's records and talked to its officers. Financial institutions, however, argue that stockholders must present enough details to show they have a legitimate claim.

"This is pretty key and different judges look at it differently," said banking attorney James F. Stapleton of Day, Berry & Howard.

"There can be nuances about how specific it can be."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.