just deserts || closing the courthouse door

Closing the Courthouse DoorAuthor(s): Jean Maclean SnyderSource: Litigation, Vol. 35, No. 1, JUST DESERTS (Fall 2008), pp. 43-49Published by: American Bar AssociationStable URL: http://www.jstor.org/stable/29760695 .

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Closing the Courthouse Door

by Jean Maclean Snyder

A battle is being waged today that threatens access to the courts for many plaintiffs. Those who would limit access have armed themselves with legal theories that once were consid? ered arcane law school subjects: federal preemption, sovereign immunity, and heightened pleading requirements, among others. The theories are being advanced by all three branches of the fed? eral government: executive, legislative, and judicial.

Ostensibly, the fight is about whether state or federal pre? emption and sovereign immunity law applies or whether strict

pleading requirements are being met. But the underlying issue is different. The reality is that increasingly, federal judges, leg? islators, and executive branch officials are viewing many kinds of private litigation as wrong-headed and wasteful, and they are

using their power, whatever the source, to curb litigation. Policy issues aside, for private lawyers, the question is whether courts

will continue to entertain damage claims for the injuries that long have been actionable in state or federal court. Increasingly, the answer is no.

Consider the case of Charles and Donna Riegel. Mr. Riegel became unconscious and suffered serious injuries while undergo? ing heart surgery. It turned out that the balloon catheter inserted into his clogged artery burst during surgery. The Riegels filed a lawsuit against the manufacturer of the catheter, Medtronic Inc., asserting causes of action based on strict liability and negligence as well as on breach of warranty and loss of consortium. The suit was filed in the Northern District of New York based on

diversity jurisdiction. Thus began a garden-variety product liability lawsuit in a

forum that tries such cases regularly. But it did not try this one. Medtronic raised the issue of federal preemption as an

affirmative defense. The theory was that the Medical Device

Jean Maclean Snyder is an attorney in Chicago, Illinois, and a former Editor-in-Chief of Litigation.

Amendments of 1976 (MDA) to the Food, Drug and Cos? metic Act (FDCA) preempted the Riegels' state common-law claims.

District Judge Lawrence E. Kahn agreed with Medtronic. In an unpublished opinion, he held that all the lawsuit claims were preempted except the negligent manufacturing claim insofar as it pled that Medtronic was negligent in applying the standards required by the federal Food and Drug Admin? istration (FDA) and the breach of express warranty claim. These claims were easily dismissed on a motion for summary judgment, however, because the plaintiff had not theorized that the device failed to meet the specifications approved by the FDA, and because Medtronic had provided a standard disclaimer of express warranty. The Second Circuit agreed with Judge Kahn's decision. Riegel v. Medtronic, Inc., 451 F.3d 104 (2nd Cir.2006).

This year, the U.S. Supreme Court affirmed the Second Circuit's decision, Riegel v. Medtronic, Inc., 128 S. Ct. 999

(Feb. 20, 2008). (Mr. Riegel had died, so only Mrs. Rie?

gel remained as a plaintiff.) Justice Antonin Scalia wrote the majority opinion, while Justice John Paul Stevens wrote

separately to concur in part and concur in the judgment, and Justice Ruth Bader Ginsburg dissented.

The Court held that the MDA's preemption clause bars common-law claims challenging the safety or effectiveness of a medical device marketed in a form that received pre market approval from the FDA. Justice Scalia reasoned that the FDA's premarket approval process for medical devices had established specific requirements that constitute require? ments within the meaning of the preemption clause of the MDA and that the Riegels' common-law claims were pre? empted because they were based on safety and effectiveness

requirements of the State of New York that were different from or in addition to the federal ones. Medtronic, 128 S. Ct. at 1006-11.

Litigation Fall 2008 Volume 35 Number 1



The MDA provides no remedy for the individual patient who has been injured. The Court's trumping of state tort claims in favor of the federal regulatory scheme means that the Riegels and others like them have no remedy at all.

Justice Ginsburg, the lone dissenter, did not exaggerate when she wrote that the Court's construction of the MDA "cut deeply into a domain historically occupied by state law." Id. at 1013. Further, although federal preemption is said to be based on Congress's intent, when the MDA was passed in

1976, no one thought that it would act to preempt approved devices from state tort claims. Not even the FDA argued for such a result until 2004. See Letter-Brief of the United States as Amicus Curiae, Horn v. Thoratec, No. 02-4597 (3rd Cir., filed May 14, 2004).

Under the Supremacy Clause of the U.S. Constitution, state law that conflicts with federal law is "without effect." Cipol lone v. Liggett Group, Inc., 505 U.S. 504,516 (1992). (Internal citations and quotation marks here and elsewhere are omitted.) Consideration of issues under the Supremacy Clause begins with the assumption that historic police powers of the state are not superseded unless that is the "clear and manifest purpose of Congress." Id. Congress's intention to preempt state law

may be explicitly stated in the statute's language or it may be

implicitly contained in the law's structure, or the intention will be assumed if the state law actually conflicts with the federal law. Historically, these principles have amounted to a strong presumption against preemption. Id. at 523. The Riegel case shows how far this presumption has eroded.

Express preemption was the issue in Riegel. The MDA includes a preemption provision that states in pertinent part at 21 U.S.C. ? 360k(a):

[N]o State or political subdivision of a State may estab? lish or continue in effect with respect to a device intended for human use any requirement?(1) which is different from, or in addition to, any requirement applicable under this chapter to the device, and (2) which relates to the

safety or effectiveness of the device or to any other matter included in a requirement applicable to the device under this chapter.

The questions in Riegel were: (1) Did the federal govern? ment establish "requirements" applicable to the Medtronic's catheter, and if so, (2) did New York state common law impose requirements related to safety and effectiveness that were "different from or in addition to" the federal ones?

In analyzing the first question, Justice Scalia began with the regulations promulgated by the FDA, based on the Court's earlier ruling that such regulations "substantially informed" the analysis of preemption. Riegel, 128 S. Ct. at 1006. The

agency's regulation said that state requirements were pre? empted "only when the Food and Drug Administration has established specific counterpart regulations or there are other

specific requirements applicable to a particular device. . . ." 21 CFR ? 808.1(d). According to Justice Scalia, the FDA's

"rigorous" premarket approval imposes "requirements" under the MDA that are specific to individual devices because the FDA grants premarket approval only after it determines that a device offers a reasonable assurance of safety and effective? ness. It is true, he conceded, that the agency does not require the product to take any particular form. Yet agency rules do insist that the device be made with almost no deviations from

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the specifications in the manufacturer's applications, and the

agency allows marketing only after determining that the pro? posed labeling is neither false nor misleading. Therefore, he

concluded, federal law contains requirements for the catheter device itself and for its labeling. Id. at 1004-07.

The question of whether the Riegels' common-law claims constituted different or additional "requirements" under the

MDA might have looked challenging, but to Justice Scalia the answer was obvious. The term "requirements," he wrote, includes common-law duties based simply on the "normal

meaning" of the words. He did not discuss whether the state

requirements impermissibly varied from the federal law, either because the conclusion was obvious or because the Rie?

gels had waived arguing that the state claims were "parallel" to claims based on a violation of federal requirements. Id. at 1011.

Then he embarked on a policy argument. Excluding common-law duties from the scope of preemp?

tion would make little sense, he wrote. State tort law would

require products to be safer but less effective than products approved under a federal scheme because a jury "sees only the cost of a more dangerous design, and is not concerned with

benefits; the patients who reaped those benefits are not repre? sented in court." Id. at 1008. Indeed, he opined, state tort law was less deserving of preservation than state regulatory law because state regulators at least would be expected to apply the cost-benefit analysis that jurors would ignore. Finally, he accused the dissent of being motivated by "solicitude for those

injured by FDA-approved devices" while ignoring Congress's proper solicitude "for those who would suffer without new




medical devices if juries were allowed to apply the tort law of 50 states to all innovations." Id. at 1009.

Justice Stevens concurred in the judgment although he conceded that the history and principal purpose of the MDA

preemption provision did not show any intent by Congress to preempt state tort claims. Instead, he said, the significance of the preemption provision "was not fully appreciated until

many years after it was enacted." Nevertheless, he concluded that the provision preempted tort claims because "its text does

preempt state law requirements that differ." Id. at 1011. Justice Stevens wrote separately because he did not agree

with Justice Scalia's policy argument. He observed that there was nothing to suggest Congress had thought that state tort remedies had impeded the development of medical devices, nor any evidence that Congress had sacrificed the develop? ment of better, safer devices so it could favor injured plain? tiffs. "This is a policy argument advanced by the Court, not

by Congress," he concluded. Id. at 1012. In dissent, Justice Ginsburg argued that Congress did not

intend to preempt state-law causes of action when it enacted the MDA, particularly because the presumption against pre? emption was strong where the doctrine would bar state actions in the health care field, an area of traditional state regulation. Id. at 1013. Given that the MDA was enacted in the wake of publicity over the extensive injuries and deaths caused by the Dalkon Shield intrauterine device and after hundreds of lawsuits had been filed against the device manufacturer, Jus? tice Ginsburg wrote, it seemed unlikely that Congress would have intentionally preempted state common-law tort actions without mentioning the subject. Id. at 1014-15. That was par? ticularly true because the federal scheme did not provide a

damages remedy for claims premised on a violation of FDA

regulations. Further, she wrote, the legislative history showed that a preemption clause was included because Congress sought to preempt the regulatory programs that some states had created in the absence of preclearance at the federal level. Id. at 1015-17.

Signaling a future battleground, Justices Ginsburg and Scalia sparred about whether tort lawsuits are preempted by drug or additive approval under the FDCA. Arguing against preemption, Justice Ginsburg pointed to the act's lack of a

preemption clause, Congress's intent, and the "long history of federal and state controls over drugs and additives in the interest of public health and welfare." Id. at 1016. In response, Justice Scalia warned that Justice Ginsburg's no-preemption conclusion "had not been established." Id. at 1009. In Novem?

ber, the Court was scheduled to consider the issue directly in Levine v. Wyeth, No. 06-1249, cert, granted, 128 S. Ct. 1118

(Jan. 18, 2008). The question in that case is whether federal law preempts a state-law product liability claim asserting that a drug manufacturer failed to include an appropriate warning label, when the drug in question has met the labeling require?

ments of the FDCA. If the Riegel case is a harbinger of future changes in the law,

it is also a showcase for the litigation scenarios that galvanize sentiment against plaintiffs' claims. The Medtronic balloon catheter inserted into Mr. Riegel's artery burst only after the doctor inflated it repeatedly beyond the maximum "rated burst

pressure" explicitly specified on the device label. The doctor

provided an affidavit explaining why: He had done this in the

past, he thought that exceeding the maximum recommended

atmospheres was "not outside the window" of the device's

testing in laboratory settings, and he had already tried several other balloons on Mr. Riegel and did not want to introduce another one. But he did not offer an opinion about whether the balloon burst because of a manufacturing defect or from one of the causes advanced by Medtronic related to Mr. Rie

gel's medical condition. The Riegels' only affirmative evi? dence of a defect was from their expert, an engineer, who, while initially claiming that a manufacturing defect caused the catheter to rupture, said "I have no opinion," when asked about Medtronic's physician-expert's opinion that Mr. Rie?

gel's medical condition probably caused the rupture. Riegels v. Medtronic, Inc., 451 F.3d 104 (2nd Cir. 2006). Nor did the Riegels provide any evidence to counter the defendant's claim that the balloon was produced in conformity with FDA

requirements and that it had been tested to ensure that it met the rated burst pressure. Riegel v. Medtronic, Inc., 2003 WL 25556778, *3 (N.D. N.Y. Dec. 3, 2003).

It may be that tort claims like the Riegels' exasperate some

judges, but it is not just products liability plaintiffs who are

finding the federal courts less friendly. And it is not just the

judicial branch that is promoting preemption. Since 2005, federal agencies have proposed or adopted lawsuit limits in 51 rules, according to an article by the Associated Press in

May. The National Highway Traffic Safety Administration now routinely claims that its regulatory actions preempt state law remedies, according to testimony by Georgetown Law

The judiciary has made sovereign immunity a

significant barrier.

Professor David C. Vladeck before the United States Senate Committee on the Judiciary's hearings on regulatory preemp? tion held in September 2007, available at http://judiciary. senate.gov/pdf/07-09-12VladeckTestimony.pdf. The Con? sumer Product Safety Commission also has joined the admin? istration's drive for preemption of state-law remedies for

injured consumers, including preemption of damage actions, according to Professor Vladeck's testimony.

Congress is in on the act, too. Between January 2001 and June 2006, the House and Senate voted 57 times to preempt state laws and regulations, according to the report "Congres? sional Preemption of State Laws and Regulations," released

by U.S. Representative Henry A. Waxman. Some in Congress, including Rep. Waxman, are not happy

with this trend. In June, Rep. Waxman and Representative Frank Pallone Jr. introduced a bill to amend the language of the MDA preemption clause, to declare that the MDA does not preempt state tort actions.

While all three branches of the federal government are

using preemption to block the courthouse door, it is the judi? ciary that has made sovereign immunity a significant barrier for some.

Three significant cases decided within the last 10 years set the tone. In all three, the Supreme Court held that the Consti? tution forbids Congress from making state governments liable




in damages for violating their employees' rights under federal statutes. First, in Alden v. Maine, 527 U.S. 706 (1999), the Court ruled that under Article I of the United States Con? stitution, Congress did not have the power to subject non

consenting states to private suits for damages in state courts, so that a state could not be sued for damages under the Fair Labor Standards Act of 1938 in state or federal court. (Article I suits in federal court against non-consenting states by private parties had already been banned in Seminole Tribe of Flor? ida v. Florida, 517 U.S. 44 (1996). Then, in Kimel v. Florida State Bd. of Regents, 528 U.S. 62 (2000), the Court held that

Congress's powers under the Fourteenth Amendment (which allows Congress to enforce its terms) did not extend to abrogat? ing state sovereign immunity under the Eleventh Amendment

where the complaint was age discrimination. Thus, the Age Discrimination in Employment Act of 1967 (ADEA) could not constitutionally make states liable in damages. Finally, in Board of Trustees of the University of Alabama v. Garrett, 121 S. Ct. 955 (2001), the Court reached the same conclusion about the Americans with Disabilities Act of 1990 (ADA) (under Title I of the ADA regarding employment).

The Court also has limited private suits under Title II of the ADA (affecting access to programs, services, and activities of states and other public entities). Most significantly, in Tennes? see v. Lane, 541 U.S. 509 (2004), the Court held that Congress exceeded its authority when authorizing lawsuits under Title II, except when the person was invoking "basic constitutional

guarantees" such as access to the courts. Lower courts continue to struggle with the scope of sov?

ereign immunity under the Supreme Court's evolving doc? trine, with the Supreme Court weighing in from time to time.

Recently, the Court has approved one of Congress's efforts to

grant state employees damage actions for violations of federal

rights. In Nevada Dept. of Human Resources v. Hibbs, 538 U.S. 721 (2003), the Court held that Congress was empow? ered, under the enforcement power of the Fourteenth Amend? ment, to abrogate state sovereign immunity under the Family Medical and Leave Act, so that claims for damages as well as

equitable relief were proper. The Court distinguished this case from Kimel and Garrett partly on the ground that it involved

gender discrimination, subjected to heightened scrutiny, not discrimination based on age or disability.

The Supreme Court's decisions striking down provisions of the ADA and the ADEA are particularly problematic because the Court did not accept Congress's explanation that it aimed to eliminate unconstitutional discrimination by state

governments. Instead, much as Justice Scalia served up his own "evidence" about cost and benefits to find that Congress "intended" preemption in Medtronic, the Court did its own

fact-finding in Garrett and Lane (the ADA cases) and Kimel

(the ADEA case) and then decided that Congress was not jus? tified in concluding that age or disability discrimination was a problem.

The people most affected by the Court's sovereign immu?

nity jurisprudence are those with the greatest needs: people with disabilities and workers who need the protection of the federal minimum wage law and of rights providing unpaid family leave. For these people, there is no remedy when the federal laws meant to protect them are violated.

Plaintiffs bringing commercial cases to federal court also are meeting new barriers. It is not broad constitutional prin? ciples like preemption and sovereign immunity that stand in

the way, but rather it is the tightening of statutory rules gov? erning fees, settlements, and the structure of lawsuits from statutes such as the Class Action Fairness Act of 2005 and the Private Securities Litigation Reform Act of 1995 (PSLRA), and procedural mechanisms such as stricter pleading require? ments. Two of the evolving pleading requirements are dis? cussed below.

In Bell Atlantic v. Twombly, 111 S. Ct. 1955 (May 21,2007), the Supreme Court elaborated on the requirements associated

with the relaxed notice-pleading standard of Fed. R. Civ. P. 8.

Twombly says that a complaint must provide "enough factual matter" to suggest that the alleged event took place; that is, to make it plausible. Id. at 1965. The Court left the district courts to determine how much factual matter is "enough," but in the antitrust context, where liability under ? 1 of the Sherman Act applies only when the challenged anticompeti? tive conduct stems from an agreement, a showing of parallel conduct will not suffice. Thus, stating a ? 1 claim "requires a

complaint with enough factual matter (taken as true) to sug? gest that an agreement was made." Id. In deciding a motion to

dismiss, courts must be mindful that "proceeding to antitrust

discovery can be expensive" and that even largely groundless claims give plaintiffs a right that represents "an in terrorem increment of the settlement value." Id. at 1966-67.

The Twombly court said it was interpreting, not abandoning, Rule 8. After all, the Rule says it "requires a 'showing,' rather




than a blanket assertion, of entitlement to relief." Id. at 1965, n. 3. Rule 8 had lapsed into misuse partly because of oft-quoted language from Conley v. Gibson, 355 U.S. 41 (1957) that "a

complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." The "no set of facts" language had been "questioned, criticized, and explained away long enough," said the Court.

Now, it is "best forgotten as an incomplete, negative gloss on an accepted pleading standard." Id. at 1968-69.

The Supreme Court's decision in Twombly did not disturb the pleading allowances traditionally provided to civil rights litigants proceeding pro se. See Erickson v. Pardus, 127 S. Ct. 2197, 2200 (2007) (per curiam) (reaffirming the tradi? tional principal under which plaintiffs proceeding pro se may expect that their pleadings will be liberally construed and that their complaints, "however inartfully pleaded, [will] be held to less stringent standards than formal pleadings drafted by lawyers").

Depending on your point of view, Twombly applies only to claims under the Sherman Act's restraint of trade provision, to those antitrust claims as well as to other commercial cases, or to all lawsuits except pro se complaints. This past spring, the Ninth Circuit weighed in, stating that Twombly abrogated the usual notice pleading rule in Conley and Rule 8, "[a]t least for

purposes of adequate pleading in antitrust cases," Kendall v. Visa U.S.A., Inc., 518 F.3d 1042, 1047 (9th Cir. 2008). Since

then, the Second Circuit has applied Twombly to an antitrust case (Ross v. Bank of America, N.A. (USA), 524 F.3d 217, 225 (2d Cir. 2008)), and the Seventh Circuit has applied it to a complaint brought under the Racketeer Influenced and

Corrupt Organizations Act (Limestone Development Corp. v.

Village ofLemont, III., 520 F.3d 797, 802-03 (7th Cir. 2008)). These cases lend support to the conclusion that Twombly will be confined to complex commercial cases.

One month after deciding Twombly, the Supreme Court took aim at private securities fraud actions. In Tellabs, Inc. v.

Makor Issues & Rights, Ltd., Ill S. Ct. 2499 (June 21, 2007), the Court held that in determining whether a plaintiff has ade?

quately pled scienter under the heightened pleading standard of the PSLRA, the court must consider plausible inferences

favoring defendants as well as those favoring the plaintiff.

The significance of Tellabs is not clear.

The decision interpreted a statutory term of the PSLRA, an act avowedly intended to curb litigation. As the Tellabs court noted, Congress sought to limit perceived abuses of the

private right of action under Section 10(b) of the Securities

Exchange Act of 1934, namely "nuisance filings, targeting of deep-pocket defendants, vexatious discovery requests and

manipulation by class action lawyers" (quoting the House Conference Report). Id. at 2508. Securities fraud cases have

always had a heightened pleading standard because of the par? ticularity requirement of Fed. R. Civ. P. 9(b) for fraud or mis? take and "condition of mind"; the PSLRA sought to heighten

the requirements further and to make them uniform, particu? larly with regard to scienter. Besides imposing strict pleading requirements, the PSLRA prescribes procedures for appoint? ing lead plaintiffs and lead counsel in class action litigation, limits recovery damages and attorneys' fees, mandates the

imposition of sanctions for frivolous litigation, and authorizes a stay of discovery pending resolution of any motion to dis? miss. Id. at 2509.

In Tellabs, the Court considered a group of plaintiff shareholders' claims that Tellabs, a manufacturer of equip?

ment used in fiber optics networks, and several of its execu? tives had engaged in a scheme to deceive the investing public about the true value of Tellabs stock in violation of ? 10(b).

The PSLRA governs the case. Concerning scienter, the act

requires the plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted with the

required state of mind." 15 U.S.C. ? 78u-4(b)(2). Before Tellabs, the circuits had been divided about the

meaning of "strong inference." Some, like the Seventh Circuit

(whose Tellabs decision had been appealed), used traditional

language to describe the PSLRA's requirements for scienter, stating that a complaint would survive a motion to dismiss if it alleged "facts from which, if true, a reasonable person could infer that the defendant acted with the required intent. Faced

with two seemingly equally strong inferences, one favoring the plaintiff and one favoring the defendant, it is inappropri? ate for us to make a determination as to which inference will

ultimately prevail, lest we invade the traditional role of the fact finder." Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 602 (7th Cir. 2006). The Seventh Circuit explicitly rejected the stricter standard adopted by the Sixth Circuit that

"plaintiffs are entitled only to the most plausible of compet? ing inferences." Fidel v. Farley, 392 F.3d 220, 227 (6th Cir.

2004). The Supreme Court sought to resolve the issue. In deciding whether a plaintiff had met the "strong infer?

ence" standard, the Supreme Court held, the district court must "engage in a comparative evaluation" of inferences put forward by the plaintiff and "competing inferences rationally drawn from the facts alleged." Moreover, to meet the essen? tial element of scienter, a plaintiff must put forward facts that would raise a "strong inference" of scienter, that is, the infer? ence must be "cogent and at least as compelling as any oppos? ing inference of nonfraudulent intent." Tellabs, 111 S. Ct. at 2504-05.

In dissent, Justice Stevens argued for the use of a prob? able cause standard, noting "the benefit of its grounding in an already familiar legal concept" and observing, "it is most

unlikely that Congress intended us to adopt a standard that makes it more difficult to commence a civil case than a crimi? nal case." Id. at 2517.

On remand, the Seventh Circuit's Judge Richard Posner

questioned how the comparative standard could be squared with the long-held notion that all reasonable inferences must be drawn in favor of the plaintiffs when deciding a motion to dismiss. He said: "To judges raised on notice pleading, the idea of drawing a 'strong inference' from factual allegations is mysterious." Makor Issues & Rights Ltd. v. Tellabs, Inc., 513 F.3d 702, 705 (7th Cir. 2008). Others said that the deci? sion might result in frequent mini-trials, all before discovery had commenced. See In re Proquest Securities Litigation, 527 F. Supp. 2d 728, 746-47 (E.D. Mich. 2007) (observing, in the course of denying the defendants' motions to dismiss,




that deciding whether "the rather elusive notion of scienter" has been adequately pled is "an exercise in logic" and that

deciding a motion to dismiss in such a case "is akin to hold?

ing a mini-trial on the merits of the case based only on the

complaint"). Yet so far, the significance of Tellabs is not clear.

Beyond doubt, though, judges are conducting mini-trials at early stages of securities cases. That is not just because of Tellabs. Contributing as well are the strict pleading man? dates of the PSLRA, which require the plaintiff to plead each element of the case with great particularity. More and more, at the dismissal motion stage, courts are freely considering volumes of documents propounded by both parties, includ?

ing documents relied on in the complaint (press releases and

transcripts of conference calls are fair game) and documents

subject to judicial notice under Fed. R. Evid. 201(d), includ?

ing Securities and Exchange Commission (SEC) filings, stock

price data, records and reports of administrative bodies such as notices and opinion letters, and admissions in pleadings and other documents in the public record that contradict a party's factual assertions. See In re Intelligroup Securities Litigation, 527 F. Supp. 2d 262, 273-74 (D. N.J. 2007).

Securities fraud plaintiffs are further hindered by other recent Supreme Court decisions. In June 2007, the Court found that securities laws preempted antitrust claims, Credit Suisse Securities v. Billing, 111 S. Ct. 2383 (June 18, 2007). Early this year the Court put a halt to plaintiffs' efforts to use a "scheme liability" theory of reliance to assert fraud against secondary actors, in Stoneridge Investment Partners v. Scien?

tific-Atlanta, 128 S. Ct. 761 (Jan. 15, 2008). Animating these decisions and those interpreting them is an

antipathy to private securities actions. As described by Judge Garrett Brown, chief judge for the District Court of New

Jersey, this attitude is based on the courts' realization that

nearly half of all class actions in federal court are securities class actions, "which necessarily consume significant judi

Judges are conducting mini-trials at early stages of securities cases.

cial resources"; "business realities" mean that an issuer has a

great incentive to settle any lawsuit, regardless of the merits; and securities class action settlements are mammoth. Judge Brown cited a study finding the annual aggregate amount of such settlements to be $1,906,333,333, a number greater than the annual amount of all public monetary sanctions. Intelli?

group, 527 F. Supp. 2d at 279. To see how the principles play out, consider Pugh v. Tri?

bune Co., 521 F.3d 686 (7th Cir. 2008), the first (and as of this writing, the only) circuit opinion construing Stoneridge (and which also relies on Twombly and Tellabs). This consoli? dated appeal arose from undeniably criminal conduct: Some

employees of the Tribune Company's subsidiary fraudulently boosted circulation figures at two newspapers, Newsday and the Spanish-language Hoy, so that they were able to charge advertisers more and thereby inflate revenues. Ultimately,

Tribune and its independent auditor discovered and publicly disclosed the fraud, resulting in a $90 million charge against earnings. The appeal addressed the trial court's dismissal of two lawsuits triggered by a decline in Tribune's stock prices that followed disclosure of the fraud. One was a securi? ties class action brought by purchasers of Tribune common stock against Tribune, some of its executive officers, and five

employees of Newsday. The other was an action based on the

Employee Retirement Income Security Act of 1974 (ERISA) brought by participants in Tribune pension plans.

Tribune and its executives and one subsidiary employee were dismissed from the securities complaint under Tellabs; they lacked the requisite scienter because the circulation fraud was designed to deceive them as well as everyone else, and because Tribune had commenced a timely internal investiga? tion that ultimately uncovered the fraud. In determining that the shareholders' complaint failed to establish a strong infer? ence of scienter, the court made conclusions about the facts that in another context might have been deemed inappropri? ate on a motion to dismiss, such as deciding that the plain? tiffs' allegation that it was "a relatively easy task" to verify the accuracy of newspaper sales was "wholly conclusory"; that their allegation that the mismatch between circulation fig? ures and revenues (which in fact had existed for three years before Tribune launched an investigation) "may not have been so 'obvious'" as they had contended; and that their allegation that Tribune intentionally or recklessly created weak circula? tion controls was inadequate because it contained only one

specific allegation about control deficiency, which the court deemed to be insufficient. Pugh, 521 F.3d at 694-695.

The remaining four defendants, all subsidiary employees who pled guilty to federal criminal fraud charges, also were

dismissed; the legal underpinning for the dismissals was

Stoneridge.

Stoneridge rejected liability for those who do business with a public company, such as vendors, investment banks, and

accounting firms, on the theory that such secondary actors are not liable for securities fraud even if they aid and abet a public company's fraud scheme because they do not communicate material misrepresentations that stockholders rely on. Those who aid and abet securities fraud may be liable for criminal

penalties and civil enforcement by the SEC, or even for direct claims if they commit primary violations or violate specific rules governing their businesses or professions, but they are not liable to stockholders on a claim based on securities fraud.

Stoneridge, 128 S. Ct. at 773-74. The Seventh Circuit applied that reasoning to the guilty

employees at Tribune. Like the third-party vendors in Ston?

eridge, those defendants had made no statements that the pub? lic relied on. Further, their sham transactions did not create

liability for the same reason that the secondary actors' "scheme

liability" was rejected in Stoneridge: The causal chain from those transactions to Tribune's false financial statements was too attenuated.

Twombly was invoked in the Seventh Circuit's decision

upholding the dismissal of the ERISA complaint. Yet this

tougher pleading standard hardly was necessary. The com?

plaint alleged that the Tribune Employee Benefits Committee and some of its members continued to offer Tribune stock in the benefit plans when it was imprudent to do so, despite a duty to investigate and uncover the wrongdoing promptly. That was not a winning argument. The court had already rejected the




argument that the investigation was too late when it dismissed the securities claims. Further, the Seventh Circuit noted, "even if the defendants had possessed the power of clairvoyance" so that

they could have foreseen the stock price drop, they still might have kept the Tribune stock. That was so because the court's

analysis of the stock price and the company's statements about the circulation fraud did not show a price drop as great as the

plaintiffs had pled, and because the company's ERISA plans required the plan fiduciaries to make available a fund consist?

ing primarily of Tribune stock. Pugh, 521 F.3d at 699, 702. Whether the Supreme Court's recent cases made a differ?

ence in the outcome of Pugh, and the extent to which they will influence future cases, is still in flux. The judges who dismissed the claims in Stoneridge and Pugh hardly shed a tear. Instead, like many courts dismissing securities fraud lawsuits, they accused the plaintiffs of engaging in "fraud by hindsight" or "reverse engineering" when fashioning their securities fraud actions. On the other hand, some courts like the First Circuit had imposed a higher scienter standard than the one adopted in Tellabs, making it harder to deny a motion to dismiss. Thus, in April, the First Circuit reversed the trial court's dismissal of a ? 10(b) action, noting that applying the Tellabs scienter standard had led it to deny the dismissal

motions that the trial court had granted under the tougher pre Tellabs standard. The court added a note of charitable cau? tion toward the plaintiffs not common these days: "In cutting off the case on the pleadings by citing hindsight, the court is essentially making a prediction that the discovery pro? cess will yield only evidence that requires the benefit of the

hindsight bias to seem adequate to support the allegations." Mississippi Public Employees' Retirement System v. Boston

Scientific Corp., 523 F.3d 75, 90 (1st Cir. 2008). Consistent with those doubts, the First Circuit said that on remand, if the trial court chose to do so, it could allow "a limited discovery period on the issues raised." 523 F.3d at 79.

Perhaps this is the compromise forced by stricter pleading requirements: creating a hybrid process somewhere between

a motion to dismiss (with no discovery) and a summary judgment motion (after full discovery). That was the pro? cedure used by the California trial judge whose dismissal of an antitrust claim was affirmed (under Twombly's reason?

ing) in Kendall v. Visa U.S.A., Inc., 518 F.3d 1042 (9th Cir. 2008). After dismissing the initial complaint for failure to

plead adequate facts, District Judge Joseph L. Tauro allowed the plaintiffs to conduct discovery before filing an amended

complaint. That complaint too was deficient, so he dismissed it without leave to amend. It was the second dismissal that the Ninth Circuit affirmed in Kendall, 518 F.3d at 1045-46.

Despite these impediments to litigation, the number of securities fraud filings is on the rise, according to a joint study conducted by Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research. From 2006 to 2007, the number of filings rose from 116 to 166, a 43 percent increase that the researchers attributed to the

subprime crisis and stock market volatility. Data collected on the Clearinghouse's website shows that 2008 filings are on target to surpass those in 2007. See http://securities. stanford.edu/companies.html. These new filings should give the courts plenty of chances to try out Twombly and Tellabs and help shape new law.

Federal preemption, sovereign immunity, and stricter

pleading requirements are not the only new mechanisms that limit access to the courts. Readers can add their own favorites; possibilities include standing-to-sue limitations, limitations on fees and other procedural matters flowing from the Class Action Fairness Act of 2005, and fee limits and elaborate exhaustion of remedies requirements in the Prison Litigation Reform Act of 1995. Lawyers may lament that the new legal doctrines are driven by the ideological preferences of judges and public officials, as some certainly are. Yet the most con? sistent message of these federal officials is not "states' rights" or "we're pro business" or "leave it to the feds." It is "Let's call a halt to lawyer-driven, abusive litigation."

It is up to us, the lawyers, to show them that they're wrong. 10

49 Litigation Fall 2008 Volume 35 Number 1



just deserts || closing the courthouse door

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