The Manhattan Institute is hosting a conference today to discuss the dramatic decline in Wall Street’s competitiveness: Last year, Europe and even China surpassed America in public offering dollars raised on their stock exchanges. Drawing on the expertise of noted scholars and practitioners, our conference will consider how America can regain its top position.
One proposal, now under consideration at the Securities and Exchange Commission, is to allow public companies to change their bylaws to opt for arbitration in lieu of traditional classÃ¯Â¿Â½action shareholder suits. This idea not only makes complete sense, but it also is feasible to accomplish given that the SEC could effect the change without having to go through a Congress beholden to the litigation industry.
Why should we be excited about this idea? America’s unique securities lawsuits are regularly cited among the top reasons executives would prefer to be listed abroad. For the diversified shareholder, these suits accomplish little: They merely shift dollars from one set of investors to another, so the common investor with a broad portfolio of securities is equally as likely to be a plaintiff as a defendant.
Only one group is sure to prosper from securities litigation: the plaintiffs’ lawyers. And securities classÃ¯Â¿Â½action lawyers have been profiting handsomely indeed. Even excluding Enron and WorldCom litigation, securities settlements in 2006 totaled a recordÃ¯Â¿Â½shattering $10.6 billion, more than 300% above those in 2005.
The lawyers argue that the threat of such litigation deters corporate fraud. But academics who have studied the issue, such as Michael Perino at St. John’s Law School, have found this deterrent effect largely illusory.
In any event, the proposal would give shareholders both options. Shareholders who thought that securities lawsuits offered protection would be unwilling to hold shares of companies that opted for arbitration without a discount on price. Even shareholders unaware of a company’s bylaws would be protected by this discount pricing effect, because prices are set at the margin by hedge funds and large institutional investors.
I’d wager that you wouldn’t see much of a share discount at all for companies that decided they’d rather arbitrate suits; you might even see a premium. Allowing an arbitration option would surely be a good market test of the efficacy of securities lawsuits.
The market test might take some time to work itself out. Securities classÃ¯Â¿Â½action lawsuits are such highÃ¯Â¿Â½stakes and unpredictable affairs that they always settle. Even though professional arbitrators are likely to be more predictable and reasonable than lay jurors, it would take actual arbitrated disputes before anyone would know the exposure through the new system.
Still, it’s exciting to see the SEC talking about this salutary reform. If the reform goes through, it won’t be a panacea, as companies listed in America still face far higher regulatory burdens and prosecutorial threats than those listed abroad. But if the SEC takes this step in the right direction, all New Yorkers should smile... well, maybe except for the securities lawyers