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Bush Brief May Help Slow Lawsuit Abuse

August 22, 2007

By James R. Copland

Last week, the Bush administration filed a long-anticipated legal brief in a case, Stoneridge Investment v. Scientific-Atlanta, with broad-reaching implications for investors.

Resisting pressure from the securities litigation arm of Trial Lawyers Inc. and its friends in Congress and elsewhere, U.S. Solicitor General Paul Clement advised the Supreme Court not to expand the scope of private shareholder liability suits to third parties.

If the court accepts the government’s advice — and that of both U.S. stock exchanges and hosts of former Securities and Exchange commissioners and distinguished academics — those of us concerned about America’s financial leadership will all rest easier.

The current turmoil in our capital markets notwithstanding, the United States remains a world financial leader, but cracks are beginning to show. Last year, European stock exchanges raised $40 billion more in public capital than ours, and total European initial public offerings outnumbered those in the U.S. almost 3-to-1.

Various commissions looking at our capital market competitiveness in the past year have invariably pointed to the American system of securities regulation and litigation as a competitive disadvantage.

The Stoneridge case is of monumental import because it threatens to increase these litigation costs substantially. In Stoneridge, the lawsuits, filed as class actions on behalf of a company’s shareholders, seek money from equipment vendors that entered into what are alleged to be “sham transactions” with the company. Waiting in the wings are lawsuits filed against investment banks, with potential liability in the billions of dollars.

The law here is actually rather clear. Nothing in the securities laws as written enables private investors to file lawsuits over alleged frauds. Courts have inferred such “private rights of action” stemming from section 10(b)(5) of the Securities Exchange Act of 1934, but the Supreme Court limited such private suits to “primary” violators in 1994 in a case called Central Bank of Denver v. First Interstate Bank of Denver. The court expressly declined to embrace liability for companies “aiding and abetting” frauds that injured shareholders.

After Central Bank, Congress quickly jumped in to clarify that the Securities and Exchange Commission itself had authority over an entity that “knowingly provides substantial assistance to another” in securities-related frauds. But Congress wisely decided not to extend such authority to private lawsuits.

If the Supreme Court decides to endorse such suits notwithstanding congressional inaction, the implications for U.S. competitiveness could be profound. Anyone doing business with a publicly listed American company would be subject to a potential lawsuit should that company’s stock price tank — and would thus have to hire extra auditors and take out insurance policies to protect against such lawsuits. The disadvantages for listing on American stock market, already significant, would be that much more substantial.

The threat posed to U.S. competitiveness by expanding shareholder liability should be borne in mind as trial lawyers and their allies try to argue that the Bush administration’s position is “pro-business” and “anti-investor.” Investors in the American stock market are protected as never before.

Those who lose money from corporate fraud can recoup losses from the SEC directly through the “fair funds” provision of the Sarbanes-Oxley Act of 2002. Trial lawyers like William Lerach — whose former firm and former law partners are under federal indictment for allegedly paying kickbacks to plaintiffs to gin up spurious lawsuits — have argued that they fill a needed gap in deterring fraud, given the SEC’s limitations. But academic research shows that the vast majority of private lawsuits follow, rather than lead, SEC investigations.

The fact is that average American investors are ill-served by losing yet more of our public capital to private and overseas markets — the direct consequence of giving the lawyers what they want in Stoneridge.

American companies have not heretofore faced a significant capital shortfall even as IPOs have increasingly moved overseas, but today’s interest rate environment and congressional tax wrangling may imperil the private equity model that has sustained us of late.

Here’s to hoping that the Supreme Court does the right thing, as a matter of law and for investors, as well as for businesses — save the big-business behemoth that is Trial Lawyers Inc.

Original Source:



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