Washington's Biggest Decision
For America's global economic strength, Washington's biggest decision in 2007 will not be made in Congress or the White House but in the Supreme Court, in a case, Stoneridge v. Scientific-Atlanta, that one journalist has called "the most important securities case in a generation." Yet to read the media coverage, you would never know how much is at stake, not just for U.S. companies but for every investor.
Since the first federal securities legislation in the 1930s, the law has drawn a line between those who commit securities fraud and everyone else. If you violate federal rules, you may be the target of a private lawsuit. Not your outside accountants or financial advisers. Not any company with which you did business. You.
Without this sharp, clear line, unscrupulous lawyers would have a hunting license to stalk any company that did any business with any publicly traded firm found guilty of violating U.S. securities law, if the company could in any way be charged with knowing, sort of knowing or "recklessly" not knowing of the fraud. It is this line that the high court is being asked to erase.
The Stoneridge facts are simple. A cable television company accounted for a purchase of set-top boxes in a way that inflated profits and landed three senior executives in jail. Securities class-action law firms -- the kind that once sued companies when their stock prices dropped, until Congress outlawed the practice -- brought action against the boxes' manufacturers. Both the federal district and circuit courts threw out the suit.
The Supreme Court will review a similar suit, involving Enron. The Bush administration is considering how to weigh in, as a friend of the court.
Last month, the securities-strike-suit bar launched a full-blown public relations campaign, designed to influence the Securities and Exchange Commission, the administration and ultimately the justices. Adopting their line, one major national newspaper announced, "Unless it sides with shareholders, the SEC could be criticized as an ally of business for wanting to restrict the number of ways investors can sue." In other words, the best way to help investors is to wrap up America's publicly traded companies in unending chains of securities lawsuits.
This amazing idea is almost the exact opposite of reality, as a long line of legal and financial scholars has found.
For example, in cases of fraud, do court judgments and settlements compensate shareholders for their losses? Not unless having shareholders pay themselves qualifies as compensation. As Donald Langevoort of the Georgetown University law school has noted, "By all accounts, nearly all the money paid out as compensation in the form of judgments and settlements comes, in one way or another, from investors themselves."
Then, too, in litigation, all shareholders are not created equal. Michael Perino of the St. John's University law school has said of the difference, securities class-action settlements "often benefit former shareholders at the expense of current ones. In effect, they can amount to little more than a transfer payment with enormously high transaction costs in the form of contingency fee awards."
Summing up the injustice of securities settlements, SEC former chief economist Kenneth Lehn has said: "When a company pays a large [supposedly pro-investor] judgment, that money comes out of the hide of existing shareholders. . . . It is not moving from the perpetrators of the fraud to the victims of the fraud."
Simply put, expanding private litigation will increase, not diminish, burdens on investors. For what purpose? The SEC has full enforcement authority against secondary violators, can compensate investors and exercises prosecutorial discretion. For discretion, the securities litigation bar seems to follow the rule of 13th-century religious warriors: "Kill them all! Let God sort them out!"
Treasury Secretary Henry M. Paulson Jr. has said that the cost of abusive litigation is "an Achilles' heel of our economy." Whether the Supreme Court will make this Achilles' heel worse is the real issue in these cases. In the name of investor protection, will the court drive even more IPOs to foreign securities exchanges and even more U.S. companies to going private? Will it damage the U.S. investment environment more than it is already, all in the name of saving it? And will the cost of additional litigation smother U.S. businesses competing in the global economy?
Saying no to the Stoneridge trial lawyers: That's the real way for the Supreme Court -- and for the administration in advising the court -- to be pro-investor.
John Engler, a former governor of Michigan, is president of the National Association of Manufacturers, based in the District.