Breakingviews-Shareholder watchdogs should be unmuzzled
(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)
By Reynolds Holding
NEW YORK, Feb 12 (Reuters Breakingviews) - Shareholder watchdogs should be unmuzzled. Complaints from aggrieved groups often get bounced from court because of overly strict rules on evidence. The ones that do survive have proven effective at deterring fraud, leading influential U.S. District Judge Jed Rakoff to suggest that the law ease up. It would be useful policy.
The crackdown on securities fraud class action lawsuits began in 1995, when Congress said shareholders must show at the outset that a company intended to mislead them. In 2005, the U.S. Supreme Court said such collective allegations also have to demonstrate that disclosure of a company's lies - and not, say, an economic downturn - caused the stock to lose value. The high court stiffened standards again in 2007.
Predictably, the number of such cases roughly halved in a decade, to about 260 in 2010, according to a Lewis & Clark Law School study. Last year, their number fell to 43, reported NERA Economic Consulting.
Public companies benefited, but deterrence may have suffered. Recent research from New York University and the University of Michigan found that shareholder class actions punish fraud harshly. They prompt more and bigger settlements from companies and the exit of more senior executives than Securities and Exchange Commission investigations do. They also provoke a more negative reaction from markets.
Even courts are acknowledging their value and the folly of limiting them too strictly. In considering whether to dismiss a securities fraud class action against Boston hedge fund Sonar Capital Management, for instance, Rakoff complained that many "meritorious" suits get "knocked out" because Congress wanted to curb supposedly frivolous litigation. He called it "lousy policy."
The jurist's reputation for speaking out on controversial matters has spread, so it's tempting to dismiss these latest comments as more Rakoff being Rakoff. In this case, though, he's not just being cranky, he's right. Giving plaintiffs at least some access to information from defendants at the beginning of a lawsuit would be a narrow but helpful opening.
The lack of post-crisis financial prosecutions has heaped pressure on the SEC and other regulators. Investors probably could add useful bite to their bark.
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- U.S. District Judge Jed Rakoff on Feb. 8 dismissed a securities fraud class action lawsuit that claimed a former manager at Sonar Capital gave the hedge fund inside information that was the basis for illegal trades.
- The judge suggested at a hearing that the investors who filed the lawsuit had failed to meet the initial-proof standards established by the 1995 Private Securities Litigation Reform Act and other laws designed to curb shareholder litigation. "The result of the PSLRA is that many suits that are meritorious get knocked out," Rakoff said at the hearing. He added that the act might be "lousy policy, but that's the law."
- Court decision: link.reuters.com/cem85t
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(Editing by Jeffrey Goldfarb and Martin Langfield)
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