Sherman Law Firm Predicts PSLRA Pleading Standards and Recent Novastar Subprime Dismissal Could Lead to Increased Bear Stearns "Opt-Outs"

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Late last week, the United States District Court for the Western District of Missouri sunk one of the first 'subprime securities' class action claims, dismissing the Novastar Subprime Class Action (In Re 2007 Novastar Financial Securities Litigation, Case No. 07-0139-CV-W-ODS, U.S. District Court, Western District of Missouri) on the grounds that Plaintiffs were unable to satisfy the stringent pleading requirements of the PSLRA. The Novastar Subprime dismissal may influence Bear Stearns employee shareholders when it comes time to decide whether or not to "opt-out" of Bear class actions.

The Public Securities Litigation Reform Act (PSLRA) was enacted in 1995 in order to curb abusive tactics in the filing of securities litigation class actions. The perception at the time was that a class action was filed every time an issuer's stock price fell, regardless of the actual cause of the price drop. As a result of abusive class action filings, class legal costs were eating through the working capital of many corporations.

The PSLRA dramatically raised the pleading standards for plaintiffs in securities fraud cases. Among other things, the PSLRA requires class action complaints to describe in factual detail that a fraud was knowingly committed, and explain how the fraud caused - as a matter of fact and a matter of law - the losses for which the class seeks to recover.

The result of these heightened pleading standards is that the PSLRA makes it much more difficult for class action lawyers to draft a securities fraud complaint that is capable of surviving a motion to dismiss by corporate defendants. In fact, the website '10b-5 Daily' states that NERA Economic Consulting recently concluded that "more than 30%" of securities fraud class actions have been dismissed since the PSLRA became effective.

According to 10b-5 Daily, "NERA also reports that a significant portion of cases are dismissed within the first two years. The Second Circuit (New York) and Ninth Circuit (California), which together receive the most cases, dismiss approximately 20% within this time period. The Fourth Circuit has the highest rate, dismissing 31% of cases within two years..."

Most of the putative Bear Stearns litigation filings fall into the subprime class action category. While it certainly is too early to know what the PSLRA survival rates for class action complaints arising from the subprime securities collapse, the first major decision - the Novastar Subprime case - is not a great sign for the class action crowd. In what may be a harbinger of the fate of subprime crisis class actions, Kevin LaCroix reports in the June 6, 2008 post in the D&O diary that Judge Ortie Smith of the U.S. District Court for the Western District of Missouri dismissed the subprime-based NOVASTAR CLASS ACTION LITIGATION due to plaintiff's failure to satisfy the requirements of the PSLRA. According to Mr. Lacroix, Judge Smith dismissed the Novastar complaint with prejudice for failing to adequately plead falsity and scienter (knowledge and intent to defraud). Time will tell whether other subprime class actions, including Bear Stearns Class Actions, have similar problems surviving PSLRA dismissal motions.

Based on the post-PSLRA history of class action litigation, it is virtually certain that Bear Stearns class action complaints will be challenged under the heightened pleading requirements of the PSLRA. If Bear Stearns class action claims suffer the same fate as Novastar class action did last week, that would almost certainly be the end of the road for Bear Stearns class action participants. For individual "opt-out" Bear Stearns plaintiffs, on the other hand, the PSLRA is unlikely to impact opt-out litigation in any material way.

The decision to "opt-out" or "stay in" will very likely have serious consequences for Bear Stearns plaintiffs. Whether the dismissal of Novastar has a dramatic impact on the litigation strategy pursued by former Bear Stearns employees remains to be seen.

By Brett Sherman
The Sherman Law Firm

See more on this issue: The Bear Stearns Law Blog

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