Plight of the Private Securities Litigation Reform Act in the Post-Enron Era: The Ninth Circuit's Interpretation of Materiality in Employer-Teamster v. America West, The

Brigham Young University Law Review, 2004 by Hall, Patrick

I. INTRODUCTION

In the wake of Enron and other recent corporate scandals, the Bush administration and Congress acted swiftly to protect investors and punish corporate fraud with more severity than ever before.1 Interestingly, President Bush and Congress do not appear to be alone in the crackdown on corporate fraud. The recent string of corporate collapses has also prompted state and federal courts to reevaluate their positions on securities fraud litigation.2 On February 13, 2003, the Ninth Circuit Court of Appeals in Employer-Teamster Joint Council v. America West Airlines arguably joined the crackdown on corporate fraud by refusing to apply the Third Circuit's bright-line rule3 that a misrepresentation or omission under section 10b-5 of the securities Exchange Act is immaterial as a matter of law if the market does not immediately react upon disclosure of the misrepresented or omitted fact. In denying defendants' motion to dismiss under the heightened pleading requirements of the Private Securities Litigation Reform Act (PSLRA),4 the Ninth Circuit invoked the following rationale: "In this era of corporate scandal, when insiders manipulate the market with the complicity of lawyers and accountants, we are cautious not to raise the bar of the PSLRA any higher than that which is required under its mandates."5

The majority's post-Enron rationale did not go unchallenged. In dissent, Judge Tallman noted, "There is no doubt in this post-Enron era suspicions have been raised regarding corporate malfeasance and insider trading. But the law is the law. Under the Reform Act, the burden to plead facts with particularity establishing the required element of materiality remains squarely on plaintiffs."6 Judge Tallman concluded that "[t]he market's collective yawn to the allegedly material news [was] fatal to plaintiffs' ability to successfully establish the reliance element of their cause of action" and is "contrary to what the Supreme Court and our sister circuits have said in similar cases."7

The Ninth Circuit's decision to reject the Third Circuit's brightline rule was particularly surprising given the fact that the Ninth Circuit has arguably been one of the most corporate-friendly forums in the federal circuit since enactment of the PSLRA.8 Consequently, by its own admission,9 the Ninth Circuit's refusal to adopt the Third Circuit's bright-line rule can reasonably be attributed to the seismic shift in the political and economic landscape following the Enron collapse. Despite the Ninth Circuit's admission10 that it was influenced by factors extraneous to the pleading requirements established by the PSLRA and Rule 10b-5, this Note argues that the Ninth Circuit Court of Appeals reached the correct legal conclusion-neither the PSLRA nor Rule 10b-5 endorse the Third Circuit's bright-line test that a misrepresentation or omission is immaterial if the market fails to react immediately upon disclosure of the misrepresented or omitted fact. While Congress certainly intended the PSLRA to deter frivolous securities fraud claims, it did not intend to fetter plaintiffs with an impossibly strict standard of materiality, nor did it intend to create an absolute safe harbor for corporate officials to make fraudulent representations. This Note concludes that the PSLRA should remain good law, but Congress, the Supreme Court, or both should intervene to resolve the confusion that has arisen as courts have struggled-as did the Ninth Circuit in America West-to interpret and apply the PSLRA pleading standards.11 Most importantly, Congress or the Supreme Court should identify the impact, if any, the PSLRA had on the standards of materiality and reliance that were adopted by the Supreme Court in Basic Inc. v. Levinson. Likewise, Congress or the Supreme Court should define the contours of the fraud-on-the-market theory in litigating claims under the PSLRA. Indeed, much of the disagreement and confusion surrounding cases like America West has arisen because Congress failed to even address the materiality and reliance elements in the text of the PSLRA.

This Note begins in Part II with a brief discussion and background of the 1934 Act and the PSLRA, paying particular attention to the development of the fraud-on-the-market theory under the 1934 Act and the PSLRA. Part III provides the factual and procedural background of America West. Part IV advances two primary arguments: (1) the Ninth Circuit properly rejected the Third Circuit's bright-line rule that a misrepresentation or omission is immaterial as a matter of law if the market fails to immediately react upon disclosure of the alleged misrepresentation or omission, and (2) the PSLRA should survive the post-Enron era, but the status of the fraud-on-the-market theory and, most importantly, the appropriate standard of materiality under the PSLBA should be clarified through legislative decree or judicial interpretation. Part V offers a brief conclusion.

II. BACKGROUND

To understand the issues presented in America West, it is essential to understand some legal and historical background concerning the Securities Exchange Act of 1934 and the PSLRA, especially the development of the fraud-on-the-market theory and the development of the standards of materiality and reliance for pleading securities fraud under each of the two acts.