At first glance, Pittsburgh seems ideal for the headquarters of
( FMKT). The city's links to the steel industry and lingering blue-collar image provide strong symbolism for the online commodities auction company, reminding investors that this dot-com is poised to mine the business-to-business sector.
But three months after its astounding Wall Street debut, FreeMarkets' stock has fallen sharply. Ten lawsuits accused the company of failing to disclose it would lose its top client,
, a charge FreeMarkets vigorously disputes.
While precipitous stock drops can lead to litigation, FreeMarkets also is a target of shareholder lawsuits for another, more subtle reason. Pittsburgh is in Pennsylvania, which has emerged as one of the country's testing grounds for challenging a five-year-old federal law aimed at reducing shareholder lawsuits by shifting the burden of proof in cases that, by their nature, revolve around allegations of fraud.
Other challenges to the
Securities Litigation Reform Act of 1995
in many other areas of the country have been shot down by appeals courts, most notably in California, where executives of high-technology companies have lobbied intensively for protection from what they viewed as frivolous shareholder lawsuits. But the
Court of Appeals for the 3rd Circuit
, in Pennsylvania, is one of only four jurisdictions where a successful challenge to the law is still possible. That means shareholder plaintiff attorneys, their livelihoods unsettled, are increasingly going after companies like FreeMarkets.
"They're basically going into circuits where there's no standard on record," said Bruce G. Vanyo of the defense firm
Wilson, Sonsini, Goodrich & Rosati
, of Palo Alto, Calif. Vanyo helped draft the litigation reform act.
Since 1995, little has changed statistically. After the Securities Litigation Reform Act was passed, some 235 companies were sued in 1998, breaking the prior record of 227 set in 1994, according to the
Stanford Securities Class Action Clearinghouse
. And while many shareholder lawsuits end in settlements, the frequency of settlements and the cost has changed little since 1995, according to a June 1999 study by
, an independent legal research firm.
But it is too soon to conclude that the 1995 act will not affect settlements, cautions Laura E. Simmons, author of the study. Volume, too, is misleading. The
shows the law was intended to stymie frivolous lawsuits, not simply reduce litigation.
Still, "there is a very significant split in the judiciary and it's going to take the
" to resolve the issue, said Joseph Grundfest, a Stanford University professor of law and business who has testified before Congress on the issue.
The litigious path to places like Pennsylvania started in the wording of the Securities Litigation Reform Act, drafted by lawyers for West Coast computer and software companies.
To discourage frivolous suits, the act attacked the early stages of a class action lawsuit. First, it specified that the firms that file suits must demonstrate that their clients have suffered the greatest demonstrable losses of all the shareholders involved in identical lawsuits.
Since the lawsuits are routinely initiated by the attorneys, "it is almost a race to put out a press release," said Paul F. Bennett, a plaintiff's attorney for
Gold, Bennett & Cera
of San Francisco.
Already, the new rules have spawned new routines.
"We all talk about our experience and our expertise and how we've been doing this for so many years," said Richard Greenfield, of the Paoli, Pa., plaintiffs' firm
Greenfield & Goodman
. "Some clients do a beauty contest and some just go with the first law firm they contact. The purpose is to let the world know, so the ideal biggest shareholder will take notice."
Second, to plaintiff's lawyers' endless consternation, the Securities Litigation Reform Act instructed judges to halt the discovery process once a company moves to dismiss a case.
"There is a tremendous risk of losing critical information," said Bennett, the San Francisco plaintiffs' lawyer. "It forces the judge to make a guess as to whether there is a case."
In laying out the changes,
meant to give judges a standard to use in making that guess, said Joe Flaharty, the spokesman for Rep. Anna Eshoo, a California congresswoman who pushed the bill through Congress over a presidential veto in just two years.
But the final legislation was at best vague on the burden of proof, perhaps the most significant standard. Judges have responded with divergent interpretations. While no standard has been set in the 3rd Circuit, which includes the Pennsylvania court where Freemarkets has been sued, judges in California have set stringent burdens of proof.
In one closely watched case against
, a California court ruled that
, by far the best known plaintiff's firm, would have to show that the company's management acted with "deliberate recklessness."
"I defy you or any judge, smart as they are, to define what that means," said Dan Berger, of the New York firm
Bernstein, Litowitz, Berger & Grossmann
. "From a plaintiff's point of view, it's much more difficult to bring fraud cases through the 9th Circuit," which includes California.
Milberg Weiss, whose lawyers did not return repeated calls for comment on various cases, neglected to appeal the case to the Supreme Court before the deadline passed in January.
Academics and lawyers for both sides say the Securities Litigation Reform Act has emboldened California judges. In response, plaintiffs' firms first began filing lawsuits in state courts, prompting a second round of changes to the law.
Though plaintiffs' lawyers continue to sue California companies, lawyers on both sides say that, absent a Supreme Court decision, they are closely watching cases like FreeMarkets, in the 3rd Circuit, as well as companies in the 2nd, 4th and 10th circuits.
Of course, defense firms thrive on the suits as well. In places like Pennsylvania, they are eagerly bracing for the storm as California courts create increasingly strict burdens of proof.
"Some forward-looking law firms have done a good job of cultivating those companies to find a way to hook up with them before they can pay the going rate," said Bob Ridge, attorney for
Katarincic & Salmon
, a Pittsburgh defense firm.