A federal judge in Atlanta recently dismissed a class action lawsuit brought against SunTrust for fraud in the sale of auction rate securities. The case was not dismissed on the merits of investors’ claims against SunTrust, but based on technical legal requirements about what it takes to plead a claim. Those requirements are strict in securities fraud cases that get filed in federal court, especially class actions, but they do not apply to cases that get filed in arbitration.
Auction rate securities are fixed-income investments in which interest or dividends are set by periodic auctions. Typically, such securities were widely marketed as conservative cash equivalents, but the broker-dealers who sold them did not disclose that their liquidity was contingent upon the success of auctions that were in turn dependent upon the financial support of the brokerages and investment banks that ran the auctions. When the auctions for these securities froze in February 2008, thousands of investors were left holding over $300 billion in illiquid securities. Many investors were eventually able to cash out due to regulatory settlements and redemptions, while others have sold their securities at a deep discount on the secondary market. “But many investors are still unable to get access to their money,” says attorney Craig T. Jones, who represents a number of investors in auction rate securities case, “and even those who have obtained partial liquidity through regulatory settlements or secondary market sales have valid legal claims for their losses.” Jones’ firm, Page Perry of Atlanta, has been filing individual arbitrations of behalf of most investors, including those who were defrauded into buying auction rate securities without full disclosure of the risks.
“Our firm does handle some class actions,” says Jones, “and where you have a large number of claims that are each too small to bring separately, a class action is the best way to go.” But federal law requires that the complaint plead the facts with in more detail than is always possible when broad allegations are being made about a large group of people. The Private Securities Litigation Reform Act of 1995 imposes a heightened pleading requirement in all cases filed in federal court that allege securities fraud, not just in class actions, but the nature of class actions make them inherently more difficult for a lawyer to plead with the level of particularity required by the Act. In addition to the Private Securities Litigation Reform Act, recent Supreme Court decisions applying to all federal lawsuits have forced plaintiff’s lawyers to put much more detail in their lawsuits than was previously required, which is difficult to do when the company being sued often has sole possession of all the relevant documents and plaintiff cannot have access to them without first conducting discovery. The Atlanta SunTrust case, in which Jones’ firm was not involved , was dismissed because the judge ruled that the plaintiffs had not met the heightened pleading requirements under the 1995 Act.
“An interesting twist is that many of the investors who are now suing for investment fraud are corporate and institutional investors who lost large sums of money when the market crashed last year,” says Jones. “The irony is that many of them supported the Private Securities Litigation Reform Act as a way of controlling frivolous lawsuits, but now it is getting in their way. It is easy to be opposed to the idea of lawsuits?until you find yourself needing to file one.”
Some investors’ lawyers have preferred litigation to arbitration because of their belief that arbitrators are more likely to be slanted in favor of the securities industry, and because arbitrators are less inclined to give large awards since their livelihood depends upon being chosen for future arbitrations by lawyers for both sides. While arbitration is contractually required by virtually all brokerage account agreements, class actions are not subject to arbitration and have often been filed as a way to get investor claims in court rather than arbitration. But because of the increased difficulties in litigating securities fraud claims in federal court, arbitration is starting to look better with its streamlined procedures and emphasis upon equity rather than legal technicalities. For certain types of claims, such as those involving clear-cut broker misconduct or investment products that are widely considered to be flawed, the fact that arbitrators have industry experience is not necessarily a bad thing for investors. Furthermore, in smaller cases with less than $500,000 at issue, arbitration is often the only economical forum. While some investors’ lawyers would prefer that mandatory arbitration be abolished, as has been proposed in bills pending before both houses of Congress, even they recognize that arbitration has its place under certain circumstances.
The fact that the SunTrust class action has been dismissed does not preclude members of the plaintiff’s class in that case from filing their own individual claims. Because of mandatory clauses in the account agreements, most of those individual claims will have to be brought through arbitration rather than litigation, at least under current law. Page Perry is willing to talk with any investor who has a claim against SunTrust, or against any other bank or broker-dealer, whether it pertains to auction rate securities or some other flawed investment.