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Chamber of Commerce Conference Focuses on Private Securities Litigation Reform

Commissioners Roel Campos and Paul Atkins were among the speakers at yesterday's Chamber of Commerce conference on the Private Securities Litigation Reform Act ("PSLRA"). The Act, which has been in place for 10 years, is not working the way it was intended, according to the Chamber's Institute for Legal Reform. Chamber President Thomas Donohue asked Senator Christopher Dodd (D-CT), who also spoke at the conference, to consider oversight hearings into whether additional changes to the private class action litigation system are needed. Litigation reform is among the Chamber's top priorities.

Campos said he believes the SEC is doing its part to curb meritless lawsuits, citing its amicus brief in the Supreme Court's Dura Pharmaceutical case. Campos observed that there is a lot of research on the costs of litigation, including a report issued in connection with the Chamber's conference, but said it is also important to consider the costs and damages caused by fraud.

In response to an inquiry about whether he is satisfied with the SEC's application of the Sarbanes-Oxley Act Fair Funds provisions, Campos acknowledged that the SEC has not done very well. The initial cases involved mutual funds whose many intermediaries made the distribution to shareholders very difficult. In the future, the SEC may not be so ambitious he said. It may apply a "rough justice" approach and give the money back to the mutual funds.

Jonathan Eisenberg, a vice president at Merrill Lynch & Co., noted that securities class actions are almost uniquely an American phenomenon. Europe, like the U.S., also saw a run-up in tech stocks in the 1990s, followed by huge drops in stock prices, but there was virtually no litigation, he said. The PSLRA is working to some degree, he said, because more cases are being dismissed, but it has been a disappointment to those with high expectations. Plaintiffs' lawyers still know that the name of the game is to survive the motion to dismiss, which generally results in a substantial settlement based on the size of the losses.

One possible remedy discussed by the panelists would give defendants the same right of appeal that plaintiffs have to balance their appellate rights. Another potential remedy is to revisit the fraud on the market theory, which drives virtually all securities class action suits. If the theory came up today, it would be hard to make a case that the Supreme Court would embrace, in Eisenberg's view.

Simon Lorne, a former SEC general counsel now with Millennium Partners, LP, said the question of whether PSLRA is working is the wrong question. The question is whether securities litigation is fixed, in his view. Lorne said that Campos properly raised the question of whether investors benefit under the Act. Lorne also criticized the SEC for the WorldCom settlement in which he said the SEC took $800 million from defrauded creditors and gave it to defrauded shareholders.

Alan Salpeter, a partner with Mayer, Brown, Rowe & Maw, LLP, said that many of the provisions of the Act have not worked as intended. The heightened standard of pleading has not worked as intended in his view. He referred to one of his cases that was dismissed three times and now is in discovery. District court judges are reluctant to dismiss, he said. As for giving defendants the right to appeal, Salpeter said he didn't know if it has a chance of passage.

Salpeter also said that when institutional investors are named as lead plaintiff, they are so afraid of criticism that they will walk away from a deal that appears fair in order to drive a harder bargain. One glimmer of hope is that courts are increasingly scrutinizing class actions, he said.

Kenneth Lehn, a former chief economist for the SEC and now a professor of finance at the University of Pittsburgh, said that private securities litigation has a two-fold purpose, to deter fraud and to compensate victims. He believes that PSLRA is failing on both counts. The system is broken, in his view, and merely transfers large sums of money from one set of investors to another, rather than from the perpetrators of the fraud to the victims.

Donald Langevoort, a law professor at Georgetown University, added that fraud creates the illusion of wealth that was never there in the first place. As for the fraud on the market theory, it has the effect of enlarging the class beyond those who could actually prove reliance, he said. The Act is an awkward insurance system, he said, and not one that would be chosen if starting anew. Langevoort said he believes in the need for strong deterrence but believes the case for substantial reform is very strong.

Former Commissioner Steven Wallman, now the chief executive for Foliofn, Inc., said the debate is the same one that has been going on for a very long time. The fundamental question is what is best for the protection of investors. Unless people think of a new way to approach it, Wallman said they would be arguing these same points 10 years from now. Unless the economics are changed, Wallman said the fundamental question will not be resolved. This is a politically charged issue involving trial lawyers versus business, he said, when it should be about investors.

Langevoort suggested that a useful band-aid would be damage caps that reasonably reflect net costs. In an ideal world, he said enforcers would go after individual wrongdoers much more aggressively. He suggested going after the pensions, bonuses and trading profits of those who engineer frauds.

Atkins provided the luncheon keynote address, during which he expressed concern about the potential for double-dipping under the Fair Funds provisions. Double-dipping may occur if investors are compensated under the Fair Funds provisions and also seek compensation in the litigation system.

Another matter of interest to Atkins is the increase in premature disclosures of SEC settlement agreements in situations where a party reaches a settlement with the enforcement staff but the Commission has not approved it. The agreement with the enforcement staff is not binding, he said. The Commission will not give rubber stamp approval to enforcement staff recommendations, he said. The Commission may modify or disapprove a settlement if it does not believe it meets policy objectives. Companies typically err on the side of caution, Atkins said, but if they disclose a preliminary settlement agreement they are at risk that it may be materially misleading.