Supreme Court Blocks ‘Wasteful’ Class Actions by Stockholders

By Gina Holland | March 30, 2006

The Supreme Court has made it more difficult for investors to join forces to file high-stakes fraud lawsuits against companies.

The 8-0 decision handed down on March 21 blocks state class-action lawsuits by stockholders who contend they were tricked into holding onto declining shares.

Justice John Paul Stevens, writing for the court, said that to rule otherwise would allow “wasteful, duplicative litigation.”

The decision does not shut the door to lawsuits filed by individual stockholders, but rather to suits brought on behalf of large groups.

“There had been some upswing in these after the Enron and WorldCom scandals,” said Columbia Law School professor John Coffee, who believes it will be too expensive for individual stock owners to pursue such suits.

It was a major victory for Merrill Lynch & Co., which faced a spate of lawsuits prompted in part by New York Attorney General Eliot Spitzer’s 2002 probe into the investment banking firm’s practices.

Spitzer uncovered records showing that Merrill Lynch analysts publicly recommended that investors buy stocks that were described privately as a “disaster” or “dog.” Merrill Lynch agreed to a $100 million fine.

Former Merrill Lynch brokers said in the Supreme Court case that the company’s overly positive appraisals caused them to give bad advice — and eventually lose customers and money in their own investments.

The case required the court to consider a 1995 federal law, passed over a presidential veto after Republicans took control of Congress, and a follow-up law approved three years later intended to restrict investor class-action lawsuits.

The Merrill Lynch brokers filed a class-action suit under state law in Oklahoma, but the justices said in Tuesday’s decision that Congress intended to prevent their claims and others like them.

“Public companies no longer have to fear the threat of securities class-actions in 50 different states under potentially 50 different sets of laws,” said Jay Kasner, a New York attorney who represented Merrill Lynch.

William Federman, the Oklahoma City attorney for the brokers, said Congress had already barred federal court lawsuits claiming that someone was duped into holding onto stocks. Now they can no longer be filed in state courts.

“It sends a signal to investors this court is seeking to continue what Congress started, to protect big business,” Federman said.

Nineteen states, led by New York, backed the brokers and urged the justices not to “strip states of essential authority to protect their citizens from fraud in securities transactions.” The others were California, Connecticut, Hawaii, Illinois, Iowa, Michigan, Minnesota, Mississippi, Montana, New Jersey, New Mexico, Ohio, Oklahoma, Oregon, South Carolina, Vermont, Washington and Wisconsin.

Coffee said the ruling shows that the Supreme Court, like Congress, is concerned about class-action lawsuits.

The opinion cited congressional findings of nuisance lawsuits that target “deep-pocket defendants.”

“The magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities cannot be overstated,” Stevens wrote.

Merrill Lynch spokesman Bill Halldin said, “The fact that the court was unanimous confirms what we said from the start: This case had no merit.”
The court’s ruling did not end part of the lawsuit that involves employee claims of lost income due to Merrill Lynch fraud.

New Justice Samuel Alito did not participate in the case because it was argued before he joined the court.

The case is Merrill Lynch v. Dabit, 04-1371.

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