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INSIGHT- Behind Major US Case Against Shareholder Suits, A Tale Of Two Professors

Publication Date: 
May 23, 2014
Alison Frankel

Reuters reports on Professor Joseph Grundfest's efforts to slow the spread of securities fraud litigation through extensive research.

For two months last summer, Stanford Law School professor Joseph Grundfest locked himself away in his home office in California's Portola Valley. Grundfest's house overlooks the Santa Cruz Mountains, but his attention was fixed on the piles of paper - mostly U.S. Supreme Court opinions and Congressional reports from the 1930s - stacked on his desk and the surrounding floor. Grundfest researched and wrote for weeks with monastic obsessiveness, speaking to hardly anyone but his research assistants and his wife, who made sure he was eating.

When he emerged in August, Grundfest - an influential former Commissioner at the U.S. Securities and Exchange Commission who now sits on the board of the private equity firm KKR & Co - had in hand a 78-page paper larded with more than 400 footnotes. His aim was nothing less than to destroy securities fraud class action lawsuits by shareholders, which have been the bane of many businesses in the U.S. since the Supreme Court endorsed the cases 26 years ago.


The intellectual jousting match between Grundfest and Pritchard is no longer just academic. Any day now, in the case Halliburton Co v. Erica P. John Fund, the Supreme Court will decide the future of securities fraud class actions, litigation that has generated more than $80 billion in settlements and untold billions more in legal fees. Grundfest and Pritchard filed competing friend-of-the court briefs, both supporting Halliburton but advocating different rationales for curtailing shareholder cases.

The court may, of course, decide to make no change, but if the justices do rein in securities fraud litigation, it's widely expected that they will lean on arguments advanced by Pritchard or Grundfest.

But which one?


"Recent evidence suggests that [the Basic decision] may rest on a faulty economic premise," wrote Justice Samuel Alito. "In light of this development, reconsideration of the Basic presumption may be appropriate."


Those were the words that sent Grundfest into seclusion last summer, to put on paper an idea he'd been mulling for several years. The Supreme Court's invitation to revisit Basic was a chance to make business history - even if curtailing the cases would cost him the fees he occasionally earns as an expert for defendants.

Grundfest's thesis went even further than Pritchard's. In broad terms, his paper argued that Basic can't override the language of Section 18. Investors, he said, can't recover money damages at all without showing they relied on corporate misstatements.

In its details, Grundfest's approach offered features to win over the Supreme Court's conservatives. It was grounded in the text of the 1934 law, which is the preferred approach of Justices Scalia and Clarence Thomas. It would allow the court to avoid an economic debate on the efficient capital markets hypothesis. And its most subtle advantage was that the Supreme Court wouldn't have to overturn Basic altogether, which would make it more palatable for a court traditionalist like Chief Justice John Roberts to support.

Grundfest was itching to test the theory in a live case. He asked one of the lawyers to whom he'd sent a draft, George Conway of Wachtell, Lipton, Rosen & Katz, whether Wachtell had any candidates. Conway, a corporate defense lawyer who has dabbled in conservative politics, said he'd be on the lookout.

Less than a month later, the perfect opportunity appeared: Halliburton petitioned the Supreme Court to review an appeals court's decision allowing shareholders to proceed with a class action over decade-old claims that the oil-services giant underestimated its asbestos liability. Grundfest and Conway, who volunteered his time, honed the professor's 78-page paper into a brief urging the Supreme Court to take Halliburton's case. Grundfest, also working without pay on this project, jumped on the phone and the computer to rally support for his filing.

"It was a labor of love," said Conway in an email. Added Grundfest: "Totally pro bono, not a nickel from anywhere."


"We should make Bingo cards!" Grundfest said. Later that night, he did. On plain white paper labeled "Halliburton Bingo," the squares included "Section 18(a)," "Justice White," and "Lerach," a reference to the former plaintiffs lawyer Bill Lerach, who was convicted of criminal conspiracy for his role in a kickback scheme, and whose tactics prompted Congress to reform private securities litigation. Grundfest also included himself and Pritchard - in separate squares. The next morning, he handed the Bingo cards out to friends.


Weeks later, as he waited for the Supreme Court's opinion, Pritchard declined to hazard a guess about the outcome, predicting only that Chief Justice Roberts will be the swing vote. Grundfest, meanwhile, was still hoping his ideas will influence the court. He said he could envision a three-way split in which the three most liberal justices ruled to leave Basic untouched, the three most conservative voted to overturn it and the three in the middle opted to leave Basic intact and add a price-impact test. That would mean a victory for Pritchard and corporate defendants-even if it's not all that Grundfest, Halliburton and the broader business lobby had hoped for.

"It's 50-50-50," Grundfest said.