Law Professors, Litigation and Corporate Governance

For a time, SOX was the scapegoat for anyone looking to explain the apparent decline in US competitiveness for foreign listings. The additional costs and regulatory requirements discouraged companies from listing in the US.

With the Dow Jones Average still hovering around record highs, the reported decline in the number of fraud suits, and continued evidence of the premium obtained by foreign companies cross listing in the United States, the often intemperate criticism of SOX began to recede. For an article on the position taken by these critics, go here.

Attention has, instead, shifted to the role played by litigation in the competitiveness issue. A number of reports have taken a relatively balanced approach to the issue. Thus, the report issued by Mayor Bloomberg and Senator Schumer recognize the need for investor protection but call for a "fair and predictable legal environment" and criticize the "multi-tiered and highly complex nature of the US legal system."

So with that in mind, we come to a letter written by six law faculty (Professors Langevoort at Georgetown, Cox at Duke, Fisch at Forham, Perino at St. John's, Pritchard at Michigan, and Sale at Iowa) to Chairman Cox at the SEC asking the Commission to address the impact of securities litigation on the competitiveness of US capital markets. Four of the professors, by the way, are also together on a brief seeking reversal of the 8th Circuit's decision in Stoneridge. The letter takes a neutral position on the issue ("This letter does not endorse any particular set of changes because we do not necessarily agree among ourselves on the specifics of what should be done.") but notes three areas of concern. These include:

• "First, most private securities litigation is directed at corporations themselves as primary defendants, and those settlements are typically paid out of liability insurance, by the companies themselves or through a combination of both. To this extent, investors themselves fund the settlements, directly or indirectly, so that there is an immense amount of 'pocket shifting' that occurs. While pocket shifting is not necessarily bad (that is the nature of insurance, after all) such compensation is unnecessary for most large, well-diversified investors, and likely overcompensates them over time."
• Second, "when the current system delivers this compensation to those who bought or sold ruing the class period, it does so at a relatively high cost in terms of plaintiffs' and defendants' attorneys fees and related expenses. There may be ways of identifying those smaller victims of securities fraud who most need and deserve compensation and assuring their protection without incurring such high costs."
• "Third, the current system does a bad job at deterrence, because -- putting aside a couple of noteworthy exceptions -- settlements almost never come out of the pockets of the managers who allegedly executed the fraud."

The letter notes that "none of the concerns raised above assumes that a high percentage of securities class actions are low-merit or 'vexatious;' they apply even if we assume that all cases are reasonably well founded." The letter and an appendix which contains a number of specific points for possible discussion are posted on the DU Corporate Governance web site. The Commission has indicated that it intends to hold a roundtable on the subject sometime next year.

We will have more comments on this later. Suffice it to say that altering the system to ensure increased liability for the responsible individuals within a public company would meet with considerable opposition.