I just came across this essay by Richard Epstein on the Stoneridge case. The whole thing is interesting, but here's an extended excerpt:
Yet, normatively speaking, why should secondary violators be able to escape private damage suits like those brought against primary wrongdoers? One way to end the discrepancy is to deny all private damage actions against primary offenders, which is not as farfetched as it sounds.
The key vice of these private suits is to overdeter wrongful conduct. For example, the class that sued Charter let all unfortunate buyers at inflated prices recover for their market losses. But it does not require the lucky sellers of overpriced stock to disgorge the fortuitous profits from selling overpriced stock. The net damage recovery from this temporary imbalance in the markets far exceeds the social losses from the underlying chicanery. Across the board, harsh penalties for nondisclosure now induce firms to remain silent lest they incur huge liabilities for modest misstatements. Administrative remedies can be better calibrated to the severity of the underlying wrong.
Even if a damage suit against primary wrongdoers makes sense, the second round of suits is overkill. Allow this suit against Scientific-Atlanta and Motorola, and then no iron barrier protects any vendors from charges of "knowingly" engaging in fraudulent transactions with hundreds of potential buyers who thereafter mischaracterize these deals in their own financial accounting. Just what fraction of the total loss is attributable to their actions as opposed to other financial gimmicks? And should secondary actors be held liable for all losses if it is hard to isolate a distinct fraction for which they are responsible? The current law of joint and several liability suggests that no apportionment will be made unless it can be made.
Imposing crushing litigation burdens on second-tier defendants who receive no direct benefit from the public fraud is a heavy-handed way to improve transparency of securities markets. The expanded liability has two vices: First, it chews up huge social losses in litigation costs that detract key executives from their major jobs. Second, it leads to erroneous findings on liability rates of error whereby some innocent defendants pay large sums while some guilty parties go free. No system that costly and erratic supplies effective deterrence against fraud.
True, but aren't there many cases in which tortious conduct produces a net "social loss" that's far less than the harm suffered by the individual plaintiff? And have we ever cared about unintended beneficiaries of tortious conduct?
That's another interesting sentence.
Bpbatista- First, the SEC doesn't bring criminal proceedings, that's the AG's office(and we all know what a good job the AG has done lately). Second, what about restitution? The SEC &AG doesn't get any money back in the pocket of the victims. Third, you seriously think the threat of a class action doesn't deter corporations from committing fraud and other acts of malfeasance- I'd say they're alot more scared of that then the SEC. Fourth, what upsets you about the lawyers "lining their pockets"?,(it's called profit and it's what drives capitalism- or are you not a capitalist?) and that only happens after they get a settlement or verdict for the victims.
I find it remarkably embarrassing that normally libertarian types say rely on SEC enforcement. Hayek was right about capitalism and his reasoning is why we need a private right of action to enforce the securities. Private parties have much more information and much more incentive than does the government.
Do Lerach, Milberg &Co do this either? Getting the victim a coupon for for $100 off your next mortgage refi while the attorneys make millions is perverse if the victim really suffered any real loss in the first place.
Kevin
kdonovan- I agree completely that a coupon is poor compensation, but it beats no compensation, which is the alternative that Bpbatista would apparently prefer.
Amen. This case is a bad poster child for scheme liability.
Contrary to your implication, the DOJ obtains roughly 150 convictions for corporate fraud per year. On the civil side, the SEC launches more than 900 investigations and 500 civil or administrative proceedings per yer.
"Second, what about restitution? The SEC &AG doesn't get any money back in the pocket of the victims."
Once again, look at the facts. If you read the brief joined by Professor Epstein in this case, you would know that (1) the Fair Funds provision of the Sarbanes-Oxley Act allows the government to disgorge and return money to the investors, and (2) the SEC has collected more than $8 billion for such distribution on the last 5 years.
And relatively speaking, SEC disgorgement not that great. $8 billion over five years is much less than in private actions, deducting attorney's fees. The SEC got disgorgement of $500 million in WorldCom, I think, and private settlements are north of $4 billion.
Don't give the government too much credit. I dug up that GAO report. The most recent was 2002. The SEC boasted that it had obtained over $3 billion in disgorgement in the prior four years. The GAO audit found that only 14% of that amount was actually distributed to shareholders. 28% was actually waived by the government, so I'd call the government's number false and misleading. The rest was sitting around uncollected.
Epstein's arguments against liability for "secondary" actors are also unpersuasive. For example, the claim that allowing liability would mean there is
displays ignorance of the way securities fraud suits are actually litigated. The PSLRA and subsequent court decisions have created higher barriers to getting a securities case past the pleading stage than exist for any other type of civil action. For example, plaintiffs must allege facts that create a "strong inference" of scienter. Those courts that have allowed scheme liability claims have set a very high bar allowing claims to proceed past the pleading stage only when there are very compelling, detailed allegations of clear wrongdoing--allegations that can seldom be made prior to discovery. You hear lots of hypothetical arguments that recognizing scheme liability will lead to innocents being dragged into court, but are there any actual examples of such cases making it past the pleading stage?
The damage allocation concern is pretty much nonsense as well. The traditional rule is that joint tortfeasors are jointly and severally liable--making it the wrongdoers' burden, not the victim's, to sort out among themselves the proper allocation of damages. The PSLRA creates a special rule for securities cases that is, once again, more favorable to defendants than is typical in other areas of tort law. It limits joint and several liability only to "knowing" violators.
The concern about distracting fraudulent executives from their duties is downright comical.
Finally, Epstein repeats the assertion that scheme liability "leads to erroneous findings on liability rates of error," but simply saying that over and over can't substitute for evidence (or even any examples).
And please stop all this holier-than-thou babble about lawyers like Lerach, Spitzer and their ilk just being your friendly neighborhood capitalists! They aren't capitalists, they are parasites on the productive members of society who improve everyone's standard of living. Hermann Goering would be green with envy if he knew that someone was promoting the Big Lie labeling class action lawyers as 'capitalists.'
How many businesses do class action 'capitalist' lawyers build? How many cars, trucks? Houses? Computers? Airplanes? Antibiotics? Railroads? How many bushels of grain do they produce? How much software? How much do they add to the GDP?
Class action lawyers are to society as lampreys are to coho salmon. Not a week goes by that I don't get multiple solicitations to join a class action suit against a company that was caught up, like they all were, in the NASDAQ bubble of 2000.
It's bad enough that private sector class action lawsuits are filed at the drop of a hat - most times in the expectation of a hefty payoff just to make the class action lawyer go away. And the 'class' gets a meager bone thrown to them, like "Your next six trades are free," while the lawyers get the 'action.'
But now these politicians want to make it real easy to sue the acquaintences of productive businesses that may have done something improper. You know - the same pols who take the big, big bucks from the very same class action attorneys.
kdonovan, Bpbatista, Joe Jackson, and Tony Tutins raise some excellent points. Another point of view, which is undoubtedly held by the public, is this: a large segment of the class action attorneys are purely self-serving rapacious jackals, salivating at the prospect of multi-$megabuck settlements/verdicts, for mistakes regarding market timing.
The legal profession used to have a strong ethics component, but it seems more and more that those days are long gone. Why? Because the legal profession always has better things to do than to police its own members.
Quis custodiet ipsos custodes??
So how did this case get anywhere? All that the set-top box companies knew is that Charter wanted to pay extra per box, provided the box companies rebated the surcharge in proportion to the advertising they ran. Will there be any transaction too innocuous to imply the third parties had scienter?
Houston Lawyer had it right on another thread: for any proposed transaction, both sides will have to trot out their lawyers and accountants to scrutinize how the other side will account for their cash flows, for the benefit of unknown investors in the other company.
What the class action lawyers do primarily is inspire the generation of reams of boilerplate disclaimers designed to cover companies' derrieres. Consider this typical discourse on the dreaded Forward Looking Statement:
CAUTIONARY LANGUAGE REGARDING FORWARD-LOOKING STATEMENTS
The following types of statements:
Projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items;
Statements of plans or objectives for future operations;
Expectations or plans of future economic performance; and
Statements of assumptions underlying the foregoing types of statements
are "forward-looking statements" as defined by the Private Securities Litigation Reform Act of 1995. Also words such as "anticipate", "believe", "estimate", "intend", "may", "will", "expect", "plan" and "project" and similar expressions as they relate to Ticona, Celanese or the management of each are intended to identify such forward looking statements. Although Ticona and Celanese believe the expectations contained in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove correct. Investors are cautioned that all forward-looking information is subject to various risks and uncertainties that could cause actual results to differ materially from the forward-looking statements, including, without limitation, changes in general economic, business and political conditions, fluctuating exchange rates, the length and depth of product and industry business cycles, changes in the price and availability of raw materials, actions by competitors, application of new or changed accounting standards or other government agency regulations, changes in the degree of patent and other legal protection afforded to the products of Ticona and Celanese, production disruption or interruption due to accidents or other unforeseen events, delays in the construction of facilities, and potential liability for remedial actions under existing or future environmental regulations and potential liability resulting from pending or future litigation. Neither Ticona nor Celanese assumes any obligation to update these forward-looking statements, which speak only as of their dates.
Now, precisely how does adding such statements make the market a much safer place to put money?
But the empirical evidence is all consistent that securities litigation encourages larger stock markets.
Oh, and that language isn't any worse than that found in voluntarily negotiated contracts. You going to suggest that contracts aren't important?
To the contrary, one of the Stoneridge amici showed that the percentage of global IPOs listing in the U.S. fell from 37% to 10% over a five-year period. According to a study overseen by Mayor Bloomberg and Senator Schumer, "the U.S. exchanges are rapidly losing ground to foreign rivals." Why? Because, in the words of SEC Commissioner Paul Atkins, "abusive class actions that result in few or imaginary benefits for class members" but provide "large cash fees" to plaintiffs' attorneys "add to the global perception that the U.S. legal system operates as a 'lottery-like' system of justice."
Meritorious cases promote the efficient working of free markets. Don't make the mistake, though, of thinking that more litigation is always better. Investment in U.S. markets is shrinking because there are too many abusive lawsuits.
Does that seem like what's happened?
Sure, there are dishonest plaintiff's lawyers just like any other profession, especially where there's money to be made. Maybe we should outlaw baseball players because of Bonds, et al. But ad hominem attacks are not useful.
If someone lied to you to get you to invest in his private trucking business, how would you react if his defenses to your fraud claims were: hey, why should I pay when others profited from my lies? or, your lawyer is a rich, greedy plaintiff's attorney?, or the company and insurance will pay (and raise rates) so you're doing a bad thing?
Now, how about you find out his accountant knowingly and actively created false documents, knowing they were intended to deceive you into investing in the trucking company? Or his lawyer lied about the details of his client contracts?
I'm saying that the empirical evidence is clear that nations with private rights of action to enforce the securities laws and with stronger securities laws have much more investment. Cross country research shows that private rights of action and more stringent regulation are associated with greater market capitalization/GDP; market capitalization/sales; lower cost of capital, adequacy of capital, and less market volatility. That's with statistical significance and with a variety of control variables.
The facts on private rights of action are as I presented them. And the economy did very well in the 1980s, 1990s, and recently, when Bill Lerach was around gumming things up. What's more, the stock market did fabulously well in that era.
Oh, and do you know what the initials PSLRA stand for? Do you know the nature of the "lead plaintiff" requirements it established.
The government is far, far too large already - and its rate of growth is accelerating. I was simply refuting your claim that we need the current huge class action level of redress.
Congress didn't go nearly far enough in the 90's in limiting class action suits. I do not believe class action suits have any merit. None at all. And note that now our "representatives" want to help out their class action money-donating cronies by allowing more people to be sued by the Lerachs of society. Better by far for the economy when class action suits are entirely eliminated; the rest of us can probably get by without our settlement of a $50 Microsoft coupon. An individual action would go a lot farther than a coupon in making a truly defrauded investor whole - which a class action never does.
Nice try framing your argument by trying to limit it to the 1980's and 1990's, too. As I stated perfectly clearly above, I was referring to a preceding era, before people like Lerach were around constantly filing class actions against companies for unexpected turns in the stock market. In the 1880's and 1890's, for example. You know, when there weren't class action parasites living off of the producing members of society - and when the economy typically grew at double digit rates.
And of course I know what the PSLRA stands for! As does every dues-paying member in good standing of the Puget Sound Labrador Retrievers Association.
You are wrong about the allegations in Stoneridge. The plaintiffs allege that Charter informed the vendors that they needed to fool their auditors so that the phony revenues could be reflected in their financial statements, and for that reason, they, among other things, agreed to back-date contracts. See the petitioners' brief.
Furthermore, I am not a lawyer so I don't know exactly what qualifies as "facts that create a 'strong inference' of scienter." However, if facts such as changes in prices and increases in the complexity of contracts that contemporaneous with the fraud are sufficient to create a 'strong inference' of scienter, then it is likely that this new liability will quickly degenerate into little more than a tax on transactions with public companies.
Jiffy, I think that was Tony's point. It is not enough to simply allege that the vendors knew for the case to proceed.
Thanks, Montie. None of the "facts" meant to implicate Scientific Atlanta, etc. have any facts to back them up. The statement of facts contains bald conclusory statements that purport to implicate Motorola, etc., such as "the agreement had no legitimate business purpose." As I've said before, co-op advertising is common in the consumer electronic industry. Motorola didn't want to spend the money, so Charter agreed to supply them with funds. I happen to know that Motorola's acquisition of GI was not the financial success that they might have hoped it would be. [N.B. I have never bought, sold, or owned stock in any of these companies or in their competitors.]
Here petitioner's brief is confusing. First, the statement of facts allege that the cost of the advertising was 4-5 times what Motorola normally would have paid elsewhere, then it refers to the SEC's accusation that the cost of the advertising was 4-5 times what other advertisers paid Charter. So, is the alleged 4X multiplier what Motorola would have paid some Charter competitor, or what other advertisers would have paid Charter? And, is a 4-5X price range for advertising unreasonable? What does Charter's rate card look like?
The backdating seems relatively innocuous: The deal with the prices inflated to cover advertising was meant to cover goods shipped Sept 1 to Dec. 31. So, although the deal wasn't concluded till late September, the contract was dated at a date before the period began, in August.
Most important, no one can deny that this case represents "Imposing [a] crushing litigation burden on second-tier defendants who receive no direct benefit from the public fraud" This case was dismissed in favor of Defendants twice by the district court and once by the circuit court of appeals. But the plaintiffs refused to drop the matter. Now the unlucky set top box vendors have to defend themselves in front of the Supreme Court, something that they never bargained for when they tried to make a sale so we could all sit home and enjoy HDTV.