Tuesday, March 20, 2007

Another Call to Eliminate Private Securities Lawsuits

Amidst the current clamor over the competitiveness of the U.S. financial markets, a recurring theme has been the burden on the financial markets of U.S. litigiousness. One variant of this theme that has gotten air time is the idea that private securities lawsuits should be eliminated. The most prominent proponent of this idea is Stanford Law School professor Joseph Grundfest, whose Wall Street Journal op-ed piece on this topic (here, subscription required) was the subject of a prior D & O Diary post (here).

The editorial page editors at the Journal clearly like this particular idea, because on March 20, 2007, they ran a second op-ed piece on this same topic, this one (here, subscription required) entitled "Capital Complaints," by Peter Wallison of the American Enterprise Institute. (Wallison served as White House counsel during the Reagan administration.)

Wallison’s article starts with the notion that the "financial pre-eminence of the U.S. is eroding," and if "you listen closely to what foreign and U.S. business and financial people are saying, there’s one central cause – private class action enforcement of the SEC’s Rule 10b-5." Wallison invokes a parade of horribles weighing on U.S. competitiveness, each component of which "is exacerbated by class action risk." The solution, according to Wallison, "is restoring what Congress originally intended – enforcement of Rule 10b-5 only by the SEC."

I have previously reviewed elsewhere (here) the reasons why an SEC monopoly on enforcement of the securities laws is not necessarily in investors’ best interests. Essentially, I believe that private investors ought to have the ability to seek redress of their grievances without having to depend on an over-burdened SEC to enforce their rights. And while Congress may not have originally put an explicit private right of action in the securities laws, during the decades since the courts first implied a private right of action, Congress has revised the securities laws multiple times but has never gone back to legislatively prohibit private lawsuits.

The most significant problem I have with Wallison’s article is its very premise, that the most significant cause in the erosion of U.S. financial markets is the existence in the U.S of private securities class action lawsuits. Would foreign companies view the U.S more favorably if they "only" had to worry about the SEC? And as I have discussed at length previously (most recently, here and here), the causes of the increased competitiveness in the global financial marketplace are myriad, diverse, and subtle, and have more to do with the growth overseas capital and the increased sophistication of overseas markets.

The only evidence that Wallison cites for his premise that the existence of private securities lawsuits is undermining U.S. competitiveness is his assertion that the cause is apparent if "you listen closely to what foreign and U.S. finance people are saying." I don’t doubt that this particular notion may have a certain currency in certain circles, and that people who talk to each other all the time have persuaded themselves, but that does not make it true. If you look at what companies are doing rather than what "finance people" are saying, the picture looks quite a bit different.

For example, if Wallison’s premise were true, you would think there would be evidence that foreign companies were fleeing the U.S. because of the threat of litigation. While the evidence shows that some companies are, indeed, leaving the U.S. securities markets, it is not for the reasons Wallison cites.

A March 19, 2007 CFO.com article entitled "Bluff or Bluster?" (here) takes a look at delistings from U.S. exchanges, and concludes that "predictions of mass delistings have failed to materialize" and the companies "that have delisted rarely cite onerous regulation." Of the 12 European companies that delisted from the NYSE in 2006, "nine were because the company was taken over." Of the remaining three, one (Vivendi) delisted to save costs because its trading volume was virtually nonexistent; one, Tatneft, and energy company controlled by the Russian state of Tatarstan, delisted after failing to submit audited financials; and one, Espirito Santo Financial, a Luxembourg-based company that delisted because its trading volume on Euronext was six times greater than on NYSE.

The CFO.com article also notes another important point that often gets overlooked amidst the hubbub about U.S. competitiveness; that is, while its global equity market share may be declining, its participation in the debt marketplace is booming. According to the article, the number of European companies going to the U.S. to raise debt capital increased by 77 percent between 2000 and 2006, and the annual volume of debt raised during that period grew from $174 billion to $396 billion.

In other words, the global marketplace is dynamic and is changing in many ways, with a variety of effects and from a diversity of causes. To seize a single aspect as the sole or even the most important cause, and to use that as the pretext for radical changes to the enforcement of our securities laws, simply ignores the complexity of the global marketplace. Given the diversity of causes and effects, the elimination of private lawsuits would have only an uncertain impact on U.S. competitiveness, but it would eliminate the means by which private investors can seek redress without depending on the government to take up the cause on their behalf.

None of this should be interpreted to suggest that I think our system of private securities litigation could not be improved. Anyone who watches these cases up close knows that that system can be wasteful and excessive. But while it undoubtedly can (and should) be improved, I do not think it is in the best interests of investors or the markets for private securities lawsuits to be eliminated.

Professor Larry Ribstein has some interesting comments on his Ideoblog (here) about Wallison’s column.

One final observation: as I have previously noted (here), differences between the litigation systems in the U.S. and elsewhere may be diminishing over time. A recent interesting post along those lines can be found on the Drug and Device Law blog (here).


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