Revisiting Birnbaum: Changed Conditions and the Providence of the Purchaser-Seller Rule

Abstract

The long-simmering dispute over exploitation of the private securities litigation system boiled over in the mid 1990s. Fueled by concerns that opportunistic plaintiffs’ lawyers filed class actions on news of any substantial decrease in share prices and that the resultant settlements rarely reflected the merits of the underlying suit, the corporate lobby looked to Washington for relief. Congress responded in 1998 with the Securities Litigation Uniform Standards Act. The Uniform Standards Act preempted certain state law securities class actions. By preempting these causes of action, Congress ensured that the Reform Act’s chosen set of rules and remedies, rather than those of the states, would be applied to covered securities class actions. Perhaps unsurprisingly, plaintiffs responded by testing the bounds of Uniform Standards Act preemption. If plaintiffs could avoid preemption, they could avoid the Reform Act’s strict standards. Of the myriad techniques attempted, the pleading of “holding claims” proved particularly resistant to Uniform Standards Act preemption. Holding claims are those in which plaintiffs assert that they have been fraudulently induced to hold onto their shares. Since the Supreme Court’s landmark adoption of the Birnbaum doctrine in 1975, plaintiffs who allege fraud due to induced holding have had no standing to bring Rule 10b-5 civil suits. Thus, those who can only allege that they were induced to forebear the sale of their securities have no standing to seek civil damages under 10b-5. At the time of the decision, the Birnbaum doctrine appeared to be a resounding loss for holding plaintiffs and other non-purchaser-sellers, resigning them to state court where common law fraud theories, derivative litigation, Blue Sky laws, and various other state causes of action would be their only relief. But in an ironic reversal of fortunes, the Uniform Standards Act turned the holding claim into a sword for plaintiffs to wield. According to some courts, since holding claims were not legitimate 10b-5 claims, they were left unpreempted by the Uniform Standards Act. By construing their claims as holding actions or other non-purchaser-seller frauds, plaintiffs could evade the Reform Act’s strict standards and keep their claims in state court. And most importantly, typical purchaser-seller securities claims could often be asserted as holding claims. Thus, purchaser-turned-holding claims and other non-purchaser-seller claims soon flocked to state court, sheltered from federal preemption and primed to make use of more liberal rules of procedure for what would otherwise be 10b-5 claims. Scholarship discussing this troubling migration of securities claims to state court has focused on whether the scope of Uniform Standards Act preemption should be broad enough to rein in holding and other non-purchaser-seller claims. Courts have had equal trouble interpreting the Uniform Standards Act in a manner that best resolves the complex policy issues arising out of the preemption question. Little effort, however, has been spent reflecting on the impact of the Uniform Standards Act and the Reform Act on the providence of the Birnbaum rule itself. This Note suggests that the recent statutory reforms have significantly altered the balance of equitable considerations weighed by the Supreme Court in its original treatment of non-purchaser-seller securities fraud claims. Unsurprisingly, the difficulties posed by the Uniform Standards Act and the Reform Act arise because Birnbaum’s conclusions were drawn in a different legal context, and thus the issue may be best treated by revising the Birnbaum rule with an eye to the post-Uniform Standards Act securities law landscape.