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.
CONTEXT NEWS
- 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."
(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)
Follow us on Twitter @ReutersLegal | Like us on Facebook