On behalf of the 3,000 members of the American Electronics Association (AEA), I want to thank you for this opportunity to address this Subcommittee on the topic of securities litigation reform. My name is Robert C. Hinckley, and I am Vice President for Strategic Plans and Programs for Xilinx, Inc., a public technology company headquartered in San Jose California. At Xilinx, I am primarily responsible for the strategic management process and business development functions, as well as serving as the Company's General Counsel. I have worked as a practicing attorney for more than 20 years. Prior to joining Xilinx, I also served as General Counsel for two other major technology companies, NEC Electronics and Spectra-Physics, Inc. I have been an active participant in securities law reform for the past four years, serving as chair of a task force for the American Electronics Association in connection with securities law reform initiatives at the federal and state levels. I also am a member of a blue ribbon task force in California formed to consider possible reforms to California's state securities laws. As such, I am familiar with the general trends of securities class action litigation in California state and federal courts, and the impact of these cases on technology companies in particular.
The AEA is a national trade association representing the interests of technology companies throughout the United States. The AEA currently has 3,000 member companies, both public and private, representing virtually every segment of the technology company community. AEA member companies include some of the most prominent public companies in Silicon Valley. The technology sector constitutes one of the fastest growing industry segments in the U.S. economy over the past decade. In 1996, the technology sector in California represented the number one industry segment for the creation of new jobs in the entire country. This record of success has been built on cutting edge business strategies and entrepreneurial spirit, combined with research and development programs that consistently produce innovative products and services. We are proud of our accomplishments, and look forward to continued growth in the next decade.
We are still faced with many daunting challenges to the technology industry, including the unpredictable new challenges of a global marketplace and worldwide competition. As well, we are facing increased pressures from the U.S. capital markets to continue to do better in our financial performance from year to year, and, more precisely, from quarter to quarter, as institutional investors clamor for ever improving "bottom line" returns. While these pressures are not unique to technology companies, the difficulties of meeting or exceeding these marketplace demands are especially strong in our industry, where the introduction of new products in a timely fashion is critical to the success of so many of our companies, and the failure to introduce such products can be disastrous. The sheer unpredictability of the market for these new products, and of the associated revenues, make the business of forecasting extremely difficult for most technology companies. This fact perhaps explains why the technology sector is characterized by such significant volatility in earnings, and in turn, highly volatile stock prices. Similarly, based on unpredictable market conditions and other factors, technology companies often experience irregular order patterns, such that the likely revenues for a particular quarter are not truly knowable until very late in the quarter. This phenomenon is sometimes known as the "hockey stick" pattern of earnings, where much of a company's revenues are recognized in the last few weeks--sometimes the last few days--of a quarter.
Despite these inherent uncertainties in our business, we face the reality that Wall Street analysts want -- and aggressively seek out --"real time" information on the future prospects of the technology companies they follow. Similarly, institutional investors, who account for the great majority of the public ownership of most of our companies, have become increasingly demanding in their expectations. Being able to provide investors with forward-looking information therefore is a fervent wish for many technology companies, who hope that by providing such information, they might broaden and diversify the public ownership in their companies, and stimulate additional investor interest in their stocks. It is the rare CEO who would not want to have an on-going, healthy dialogue with the analysts and other stock market professionals who follow his or her company. Unfortunately, the reality is that it is the rare CEO who has such a dialogue today, for reasons that are directly germane to these hearings.
The simple fact is that today's technology companies continue to be a magnet for frivolous securities "strike suits." Our industry has seen little diminution in the number of suits brought against tech companies, and little change in the dynamics of these suits when they are litigated -- except that now many of these suits are being brought in state court under state law where the Reform Act does not apply. We are concerned that the provisions of the Reform Act are being undermined by this state court litigation. We are also seeing a new phenomenon -- parallel actions -- arising out of the same set of circumstances and brought against the same parties -- one filed in federal court, and one filed in state court. This new litigation tactic is being used to obtain the benefits of a federal forum while avoiding the federal discovery and pleading reforms. Indeed, many of the provisions of the Reform Act that the technology community believed to be crucial have turned out to be largely ephemeral as a result of this migration to state court, along with the filing of parallel actions.
For example, we strongly endorsed an effective safe harbor in the Reform Act. Unfortunately, the safe harbor in federal law does not reach state law claims, thereby exposing companies to the risk of lawsuit for disclosures that Congress intended the Reform Act to shield from liability. As a result, one of the most important provisions of the Reform Act has been rendered illusory. The threat of one class action in any one of 50 states is enough to muzzle a company.
Congress well understood the history of abusive securities litigation that preceded passage of the Reform Act. Congress recognized that certain abuses needed to be eliminated, and responded with a set of legislative reforms designed to bring a sense of balance to the litigation of these cases, and "level the playing field" to some extent. From the AEA's perspective, three key goals of the Reform Act were: (1) a "real" safe harbor for forward-looking statements; (2) heightened pleading standards; and (3) limitations on "fishing expedition" discovery before a trial court had determined whether a case should proceed past the pleading stage. Although the ultimate text of the Reform Act was the product of substantial compromises, nevertheless we believe that Congress heard our complaints about how the technology company community was being abused by these "strike suits", and took substantial steps to redress our grievances in each of these areas. We appreciate this Subcommittee's work and support for reform. For the reasons I will describe, however, we believe that Congress's efforts in the Reform Act have been frustrated by a continuing flood of litigation -- in particular, the migration of many lawsuits into state court.
As a first source of empirical evidence, we must look at the trend of lawsuits against high tech companies. As has been confirmed by Professors Grundfest and Perino at Stanford University, the technology sector continues to be the single biggest target for shareholder suits in the 12 month period following passage of the Reform Act, representing a whopping 34 % of all securities fraud class actions brought in federal court in that time period. Moreover, as has also been reported by Professors Grundfest and Perino, there was a dramatic increase in the number of state court suits filed after the Reform Act was passed, particularly in Northern California, and particularly against high tech companies headquartered there. Through the first ten months of 1996, California experienced almost double the number of new securities suits as any other state in the nation--and eight times the number of such suits filed in states such as New York and Texas. These numbers are generally consistent with pre-Reform Act trends, which reflected a disproportionate number of securities strike suits against California-based technology companies; however, the increase in state court suits is a new phenomenon that has developed post-Reform Act.
A second source of evidence is the trend of the decisions actually being issued by trial judges in the state courts. As an initial matter, based on my discussions with the lawyers defending these cases, it is difficult to discern any coherent rationale for the decisions of the superior courts in California (each representing a different county). Unlike the practice in federal court, state court judges tend to issue one sentence rulings on critical issues of law, leaving no opportunity for the litigants to discern the basis for the ruling, and, not coincidentally, leaving little or no basis for the ruling to be challenged in the appellate courts. These superior court rulings also are not published in any legal reporter, making it difficult for defendants to know what the judges of a particular court are doing with these cases. Much of the knowledge base of the lawyers defending the cases as to the decisional trends is based on the hit-or-miss practice of talking to other lawyers. As a result, no body of law is developing that will promote clarity or uniformity in the interpretation of the controlling California statutes upon which these state court suits are based. In some respects, California has returned to a form of "frontier justice", where individual judges dispense their particular form of rough justice with little time for careful reflection. Thus, within a hundred mile radius of our company's headquarters, the same case may meet with four very different forms of "justice", based on the proclivities of the judges in four different superior courts covering the Bay Area (Santa Clara, San Francisco, San Mateo, and Alameda).
Despite the practical difficulties of figuring out how judges are ruling, we have been able nonetheless to collect and review decisions by some of the courts that hear these cases. The trends in the decisions are, in a word, disturbing. Some of the trends are driven by peculiar aspects of California's civil procedure statutes and rules, while others are a product of different courts' interpretations of California's corporations law, and in particular its anti-fraud statutes. For despite the fact that these anti-fraud statutes have been on the books in California for almost thirty years, they have rarely been litigated until now. For many courts and many judges, therefore, the cases now being filed present legal issues of first impression, with little or no legislative history upon which to base critical judgments as to what the California legislature intended in 1968 when the laws were first promulgated.
In general, corporate defendants so far have failed in their efforts to have state court suits dismissed without leave to amend at the pleadings stage, and without incurring substantial expenses related to discovery. In the interests of brevity, I will summarize the results in just a few of the most recent cases, which demonstrate that even where defendants are successful in challenging the legal sufficiency of allegations contained in a complaint, California trial courts nevertheless often permit plaintiffs to conduct expensive and burdensome discovery in search of a factual basis for an amended pleading. Indeed, we are aware of only a very few cases in which a court has dismissed California state law claims at the pleadings stage of the litigation without leave to amend.
For example, in Strausz v. Geschke, No. 755730 (Cal. Super. Court, Santa Clara County), a securities fraud action involving Adobe Systems, Inc., the court overruled Adobe's demurrer to claims brought under Sections 25400 and 25500 of the Corporations Code alleging that defendants made certain allegedly false or misleading statements concerning, among other things, Adobe's then-current financial condition. Although the court sustained Adobe's demurrer with respect to claims brought under Sections 25401 and 25501 of the Corporations Code and for fraud under Sections 1709 and 1710 of the Business and Professions Code on the grounds that plaintiffs failed to plead reliance by each plaintiff upon the allegedly fraudulent statements, as required under the California Supreme Court's landmark decision in Mirkin v. Wasserman, 5 Cal.4th 1082 (1993), the court did not dismiss those claims with prejudice. Instead, the court permitted plaintiffs to proceed with substantial discovery, amend the complaint twice, and proceed with the case, before resolving threshold issues as to whether to permit a nationwide class in California state court under the state securities laws. Defendants' challenge to the nationwide class has simply been deferred by the court.
Similarly, in In re Oak Technology Securities Litigation, No. CV 758510 (Cal. Super. Court, Santa Clara County, Dec. 6, 1996), the court initially sustained demurrers to class claims brought against Oak Technology and certain of its officers and directors alleging that defendants violated certain provisions of the California Securities Act. However, based upon plaintiffs' representation that they intended to file an amended complaint, the court ordered Oak Technology and the other defendants (including certain market analysts) to comply with plaintiffs' demands for the production of documents before plaintiffs were required to file their amended pleading. In response, defendants filed a petition for a writ of mandate from the California Court of Appeal, in which defendants sought a stay of all proceedings, including discovery, until after a parallel federal action currently pending in the United States District Court for the Northern District of California against Oak and others is resolved. That petition currently is pending before the Court of Appeal.
In Cooperman v. Eubanks, No. CV756665 (Cal. Super. Court, Santa Clara County), a case involving Symantec Corporation, the court sustained defendants' demurrer to plaintiffs' securities fraud claims under California Business and Professions Code Sections 1709 and 1710, but overruled defendants' demurrer to plaintiffs' claims under California Corporations Code Sections 25400 and 25500. As in Strausz v. Geschke, discussed above, the court also specifically ruled that plaintiffs could proceed with their claims on behalf of a nationwide class in state court and under state law, without formally resolving that issue. Plaintiffs obtained substantial discovery before being required to file an amended complaint.
A similar result was reached in Pass v. Hyung Hwe Huh, No. CV758927 (Cal. Super. Court, Santa Clara County), a case involving Diamond Multimedia, Inc., where the court overruled defendants' demurrer to claims brought under Sections 25400 and 25500 that were based in part on the argument that plaintiffs had failed to allege any transaction that occurred "in this state." Defendants in that case thereafter filed a petition for a writ of mandate, but that petition was rejected by the Court of Appeal. The California Supreme Court granted defendants' petition for review concerning the "in this state" issue, and defendants' appeal currently is pending.
In Sharma v. Insignia Solutions, PCC, No. CV757058 (Cal. Super. Court, Santa Clara County, March 24, 1997), the court sustained defendants' demurrers in part and overruled them in part. Specifically, the court held that plaintiffs adequately stated claims for securities law violations against the company and certain of the individual defendants because the "complaint contains sufficient allegations of misrepresentations in that [Insignia Solutions] possessed adverse information that it failed to disclose in [its] prospectus," and because "plaintiffs may allege conspiracy pursuant to Corp. Code section 25500." In so holding, the court apparently did not address the requirement that the elements of fraud be pleaded with particularity. Although the court initially sustained defendants' demurrers to plaintiffs' California Corporations Code section 25400 and 25500 claims on the grounds that those sections do not apply to purchases or sales of securities not alleged to have occurred in California, the court granted plaintiffs leave to amend.
In Herman v. Scott, No. BC13877 (Cal. Super. Court, Los Angeles County, May 29, 1996), a case involving Insurance Auto Auctions, Inc., the court denied defendants' motion for judgment on the pleadings. Defendants in that case had argued that Corporations Code Section 25400(d) on its face did not apply to them because none of those defendants had sold any Insurance Auto Auctions stock. Rejecting the numerous federal court decisions that had interpreted Section 25400(d) to apply only to persons who were actual sellers, the court held that "[d]efendants need not be sellers" because "Corporations Code Section 25400 applies to defendants so long as they willfully participated in any violation of the statute." Thus, the court refused to limit the application of Section 25400, and instead adopted a broad interpretation of the statute, permitting plaintiffs to sue persons who, at best, are only remotely related to the conduct at issue.
Based on our experience thus far, it appears that the filing of parallel state and federal cases represents a new litigation tactic adopted by plaintiffs' counsel in order to obtain the benefits of a federal forum while avoiding the more restrictive discovery rules now applied in federal courts since the Reform Act took effect. California statutes governing discovery are broad and, as the following cases suggest, most courts have been extremely reluctant to impose any additional substantive limitations on plaintiffs' ability to pursue discovery in securities class actions cases.
In Maizel v. Marinaro, for example, a securities fraud action pending in the California Superior Court for the County of Santa Clara, plaintiffs allege that Network Computing Devices ("NCD") and certain of NCD's officers and directors violated the California Securities Act by falsifying certain of its financial statements and failing to disclose certain allegedly negative information concerning NCD's business and future prospects. In addition, plaintiffs alleged that an underwriter of NCD's 1993 initial public offering, Morgan Stanley & Co. Incorporated, schemed with NCD to issue false earnings forecasts. Defendants moved to stay the state court action on the grounds that four substantively identical actions were pending in the United States District Court for the Northern District of California. Defendants argued, among other things, that plaintiffs' state law claims had been brought in a duplicative state court action rather than as pendent claims in one or more of the four substantively identical federal actions in order to improperly avoid the more stringent procedural rules applied to securities fraud claims in federal court under the Reform Act. Although the trial court denied defendants' motion to stay, and the Court of Appeal also denied defendants' petition for a writ of mandate ordering the trial court to stay the action, the California Supreme Court directed the Court of Appeal to review defendants' petition on the merits and to issue an order to show cause why a writ of mandate should not be entered. The Court of Appeal will not reach defendants' petition on the merits, since the case settled in January 1997. However, several other cases are likely to be decided by the same Court of Appeal on this same issue in 1997.
In Pass v. Hyung Hwe Huh (discussed above), the court denied Diamond Multimedia's motion to stay proceedings pending resolution of a parallel and substantively identical action pending in the United States District Court for the Northern District of California. Defendants have appealed that ruling to the Sixth District Court of Appeal and that appeal is pending. Defendants' appeal has been consolidated with similar appeals of denials of motions to stay proceedings in two other cases -- In re Oak Technology Securities Litigation, No. CV758510 (Cal. Super. Court, Santa Clara County, October 22, 1996), and Lee v. IMP, Inc., No. CV 760793 (Cal. Super. Court, Santa Clara County, December 11, 1996).
The Diamond Multimedia case illustrates another significant procedural advantage available to plaintiffs in California courts: the availability of discovery to plaintiffs even after the court has determined that plaintiffs' complaint is defective. Even though the discovery master in the Diamond Multimedia case recommended that the trial court stay merits discovery among the parties pending a ruling on plaintiffs' expected class certification motion, plaintiffs elected to pursue discovery against third parties, arguing, among other things, that such discovery was necessary to cure the pleading defects identified by the court in response to defendants' demurrers. The discovery master declined to rule on one third party's motion to stay discovery, citing the strong policy in California favoring discovery to permit plaintiffs to cure pleading deficiencies. Unfortunately, there is case law in California suggesting that plaintiffs may be permitted to conduct discovery for purposes of identifying facts sufficient to plead a legally cognizable claim, notwithstanding the fact that this "fishing expedition" imposes significant burdens and costs upon both defendants and third-parties. Of course, under federal law, discovery not only is not permitted after a motion to dismiss has been granted, but since the enactment of the Reform Act, is not permitted even while a motion to dismiss is pending.
In Adler v. Prism Solutions, Inc., No. CV764547 (Cal. Super. Court, Santa Clara County), plaintiffs asserted causes of action under both state law and federal securities law. The defendant moved to stay discovery, invoking the Reform Act. Despite the fact that the case contained claims under federal securities law, which are governed by the provisions of the Reform Act, the court refused to stay discovery. The defendant sought a writ of mandamus in the Court of Appeal. The appellate court responded with a one sentence denial of the writ petition. Thus, notwithstanding the presence of federal securities claims in state court, discovery was permitted to proceed.
In Shores v. Cinergi Pictures Entertainment, Inc., No. BC149861 (Cal. Super. Court, Los Angeles County), the California Superior Court held that plaintiffs would not be permitted to circumvent the Reform Act's stay of discovery provisions by bringing their Securities Act claims in state court. However, the court also denied defendants' motion to stay discovery with respect to the identical discovery plaintiffs had sought with respect to their state law negligent misrepresentation claim. As a result, the "stay" order was essentially meaningless.
After obtaining substantial discovery from Symantec Corporation in their state law action (discussed above), plaintiffs in Cooperman v. Eubanks filed a parallel action alleging violations of the federal securities laws against Symantec and others in the United States District Court for the Northern District of California, some ten months after the original state complaint was filed. By delaying filing of the federal action, plaintiffs avoided any motion to stay the state court action pending resolution of federal proceedings (similar to those filed by defendants in litigation involving Network Computing Devices, Oak Technology, IMP, Inc., and Diamond Multimedia, discussed above). This tactic has become more widespread, as more "companion" federal suits have been filed in 1997 following the first wave of state court suits in 1996.
Several courts have rejected defendants' motions to stay merits discovery pending a ruling on class certification. In the new wave of state cases in California, defendants have sought to challenge the named plaintiff's ability to represent a nationwide class (i.e., a class including out-of-state purchasers or sellers) in cases brought in California under California law. In addition, defendants have challenged class claims under Mirkin v. Wasserman, 5 Cal.4th 1082 (1993), in which the California Supreme Court held that certain claims such as common law fraud and deceit or negligent misrepresentation cannot be brought unless each plaintiff pleads and proves that he or she actually read and relied on the alleged false or misleading statements. Accordingly, defendants in several cases have moved to sequence class and merits discovery in order to defer the enormous expense defendants and third-party witnesses are forced to incur in responding to plaintiffs' "merits" discovery requests. Unfortunately, many courts, such as the court in Werczberger v. StorMedia, Inc., No. CV760825 (Cal. Super. Court, Santa Clara County, December 31, 1996) and Adler v. Prism Solutions, Inc., No. CV764547 (Cal. Super. Court, Santa Clara County, May 27, 1997), have rejected this common-sense approach.
Although most of the companies sued in California courts to date have been companies based in California, at least two foreign companies have been sued in California courts for alleged violations of California law. Discreet Logic, Inc. is a Canadian company headquartered in Toronto, but has been sued in parallel actions in both the United States District Court for the District of Massachusetts and in the California Superior Court for San Francisco County. Although defendants in the state court action moved to dismiss plaintiffs' state law claims on grounds of forum non conveniens, that motion was denied, forcing Discreet Logic to litigate in both forums. Similarly, Shiva, Inc. -- a Massachusetts company -- recently was sued in the California Superior Court for Los Angeles County. Such cases, if permitted to go forward, could dramatically increase the scope and effect of California law and, ultimately, could lead to a similarly dramatic increase in the number of foreign companies sued in California courts.
A number of conclusions can be drawn from this abbreviated discussion of current cases in California state courts. First, it is obvious that in important areas, California state law as it is now being interpreted is in direct conflict with our federal securities laws, and with the Reform Act in particular. Second, it will be many years before any reliable, predictable body of law will develop in the appellate courts from which California companies may be guided in the conduct of their affairs. Third, in the meantime, the goals and objectives of the Reform Act are being undermined and rendered illusory for all practical purposes.
Given this stark reality of conflicting and hard-to-interpret state court rulings in California, one might well ask if California is the only example of abusive securities litigation in the state courts. While the problems in California certainly are magnified by the large number of technology companies headquartered there, California does not stand alone. On the contrary, the threat of abusive state court litigation exists in many states where technology companies are active. For the reasons discussed below, the securities laws of most of these states afford only scant protection to technology companies.
The majority of states have adopted a version of the Uniform Securities Act, first promulgated in 1956, and later amended in 1985. The Uniform Act originally was intended to foster a truly uniform national law at the state level, and by its terms was meant to be coordinated in its interpretation with related federal securities laws. Unfortunately, this promise of uniformity and coordination at the state level has failed. For one thing, while some 39 states have adopted the Uniform Act, there are a number of crucial exceptions -- including some of the biggest industrial and high technology centers in the U.S. (California, Illinois, New York, Texas, Ohio, and Florida.) For whatever reasons, those states have chosen to go their own way, thus rendering a truly uniform state scheme impossible.
Second, even among those states that have adopted the Uniform Act, other provisions of state law dramatically enhance the ability of plaintiffs to sue, and at the same time substantially increase the risk to companies that go to trial. (For example, the ability to recover punitive damages varies considerably from state to state.)
Third, despite the promise that the Uniform Securities Act will be coordinated with federal securities laws, no state except Arizona has codified a "safe harbor" for forward-looking statements. Thus, it is a matter of guesswork whether a particular state will apply the federal "bespeaks caution" doctrine in a state court case involving purely state law claims. In one case in California, Adler v. Prism Solutions, the superior court applied the bespeaks caution doctrine only as to the federal claims being asserted in that action -- and refused to apply it as to the state law claims.
It is instructive to note that the Uniform Act, as most recently amended, appears to acknowledge the problems faced by nationally-traded public companies in defending civil securities suits in multiple forums. In the 1985 amendments, the National Conference of Commissioners on Uniform State Laws included a new provision narrowing the category of defendants who may file so-called "in connection" claims similar to those authorized by Section 10(b) of the 1934 Act (including claims involving any deceptive or fraudulent device, scheme or artifice to manipulate the market). Specifically, Section 605(c) of the 1985 Uniform Act expressly exempts from civil liability any transaction in a security "traded on a national securities exchange or quoted on a national automated quotation system administered by a self-regulatory organization." This exemption makes clear that at least for some purposes, the Commissioners understand that nationally-traded securities uniquely affect interstate commerce, and should be treated differently. Unfortunately, only six states have adopted the 1985 Uniform Act. Thus, the Commissioners' more modern view that nationally-traded securities are entitled to heightened protection has yet to receive widespread attention from the states. There likewise is no evidence that many states will consider or act upon this view at any time in the future. Once again, therefore, the promise of a truly uniform national law appears to be only a distant prospect at the state level. After forty years, now is the time for Congress to step in.
We urge Congress to enact legislation establishing uniform standards for securities class action litigation. Our securities anti-fraud laws will be hopelessly "balkanized" in the absence of a truly uniform national standard. Only by creating a national standard can there be any assurance that the Reform Act provisions are being fully implemented. We believe that if the federal reforms are given a chance to work, they will work, resulting in benefits to all participants in the capital markets.
Thank you.
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