Confronting the circularity problem in private securities litigation

Wisconsin Law Review

Volumn 2009, Issue 2, 2009, Pages 333-350

  Fisch, Jill E ^a  

^a UNIVERSITY OF PENNSYLVANIA   (United States)

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EID: 72049127051     PISSN: 0043650X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (55)

1. REPUBLICAN CONTRACT WITH AMERICA (1994), available at www.house.gov/house/contract/CONTRACT.html.
2. See Jill E. Fisch, Class Action Reform: Lessons from Securities Litigation, 39 ARIZ. L. REV. 533, 535 (1997) (describing claims of abusive private litigation).
3. Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified at 15 U.S.C. § 77z-1).
4. See, e.g., ANJAN V. THAKOR ET AL., THE ECONOMIC REALITY OF SECURITIES CLASS ACTION LITIGATION 5 (2005), available at http://www.institute forlegalreform.com/index.php?option=com-ilr-docs&issue-code= SLI&doc-type=STU (stating that large institutional investors are systematically overcompensated by securities-fraud litigation);
5. John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation, 106 COLUM. L. REV. 1534, 1545-50 (2006) (arguing that private litigation fails to achieve either compensation or deterrence objectives);
6. Alicia Davis Evans, The Investor Compensation Fund, 33 J. CORP. L. 223, 225-26 (2007) (identifying weaknesses in current litigation structure);
7. Donald C. Langevoort, On Leaving Corporate Executives "Naked, Homeless and Without Wheels": Corporate Fraud, Equitable Remedies, and the Debate over Entity Versus Individual Liability, 42 WAKE FOREST L. REV. 627, 650-52 (2007) (questioning whether enterprise liability should be pared back to increase the deterrent value of litigation).
8. Merritt B. Fox, Why Civil Liability for Disclosure Violations When Issuers Do Not Trade?, 2009 WISC. L. REV. 297.
9. Lawrence E. Mitchell, The "Innocent Shareholder": An Essay on Compensation and Deterrence in Securities Class-Action Lawsuits, 2009 WISC. L. REV. 243.
10. Professor Coffee appears to have coined this specific phrase. See Coffee, supra note 4, at 1556. Professor Cox used similar terminology ten years earlier. See James D. Cox, Making Securities Fraud Class Actions Virtuous, 39 ARIZ. L. REV. 497, 509 (1997) ("A reason that the securities class action poorly serves both a compensatory and a deterrent objective is the circuity problem that arises when the source of a settlement is the corporation that commits the misrepresentation.").
11. See, e.g., Brian G. Cartwright, Gen. Counsel, SEC, The Future of Securities Regulation, Speech at the University of Pennsylvania Law School Institute for Law and Economics (Oct. 24, 2007), available at http://sec.gov/news/speech/2007/spch102407bgc.htm (describing a reduction in the percentage of retail investors and exclusion of retail investors from some markets and asset classes as "deretailization");
12. see also Donald Langevoort, The SEC, Retail Investors, and the Institutionalization of the Securities Markets, U. VA. L. REV. (forthcoming 2009) (questioning whether increased institutionalization creates tension for the Commission's traditional approach to retail-investor protection).
13. See Jill E. Fisch, Cause for Concern: Causation and Federal Securities Fraud, IOWA L. REV. (forthcoming 2009) (identifying impairment of the investment decision as a distinct component of the fraud victim's harm).
14. See, e.g., STEPHANIE PLANCICH ET AL., NERA ECON. CONSULTING, 2008 TRENDS: SUBPRIME AND AUCTION-RATE CASES CONTINUE TO DRIVE FILINGS, AND LARGE SETTLEMENTS KEEP AVERAGES HIGH 14 (July 29, 2008), available at http://www.nera.com/image/BRO-Recent-Trends-8.5x11-0808.pdf (explaining that settlements are typically covered by D&O insurance, but that an adverse trial judgment may result in an insurer invoking the fraud exclusion of the policy).
15. See ANJAN V. THAKOR, THE UNINTENDED CONSEQUENCES OF SECURITIES LITIGATION 4-6 (Oct. 2005), available at http://www.instituteforlegalreform.org/issues. php?option=com-ilr-docs&issue-code=SLI&doc-type=STU (describing the costs of securities litigation, including decreases in issuer market capitalization and plaintiffs' attorneys fees).
16. See, e.g., A.C. Pritchard, Markets as Monitors: A Proposal to Replace Class Actions with Exchanges as Securities Fraud Enforcers, 85 VA. L. REV. 925, 929-30 (1999) (arguing that deterrence rather than compensation should be the primary goal in securities-fraud litigation).
17. Indeed, in other work Professor Fox argues that issuers not making a public offering of securities should not face civil damage liability; such liability should be reserved for individual wrongdoers and third-party actors, such as investment banks. See Merritt B. Fox, Civil Liability and Mandatory Disclosure, COLUM. L. REV. (forthcoming 2009).
18. Letter from Six Law Professors to Christopher Cox, Chairman, SEC (Aug. 2, 2007) [hereinafter Law Professor Letter], available at http://www.the10b- 5daily.com/archives/Chairman%20Cox%20SEC%20Letter.pdf;
19. see also Jesse Westbrook, SEC to Examine Effect of Investor Lawsuits on U.S. Competitiveness, INT'L HERALD TRIB., Sept. 24, 2007, available at http://www.iht.com/articles/2007/09/23/bloomberg/bxinvest.php (describing the letter).
20. Law Professor Letter, supra note 21.
21. Congress rejected the explicit adoption of a federal corporation law when it adopted the federal securities law. See, e.g., JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET: A HISTORY OF THE SECURITIES AND EXCHANGE COMMISSION AND MODERN CORPORATE FINANCE 208-10 (1982) (describing the consideration of a federal corporation law);
22. Jill E. Fisch, From Legitimacy to Logic: Reconstructing Proxy Regulation, 46 VAND. L. REV. 1129, 1180-83 (1993) (describing reasons why Congress did not federalize corporate law). Nonetheless, as some authors have observed, federal securities litigation has largely supplanted state law as a mechanism for enforcing some traditional corporate-law principles such as fiduciary duties.
23. See Robert B. Thompson & Hillary A. Sale, Securities Fraud as Corporate Governance: Reflections Upon Federalism, 56 VAND. L. REV. 859, 860 (2003).
24. Indeed, a few vestiges of this responsibility remain. The New York Business Corporation Law, for example, imposes personal liability on the ten largest shareholders of a corporation for unpaid wages. See N.Y. BUS. CORP. LAW § 630(a) (2003). The provision does not apply to publicly traded corporations. Id.
25. See, e.g., Bernard S. Black, Agents Watching Agents: The Promise of Institutional Investor Voice, 39 UCLA L. REV. 811, 830-49 (1992) (describing the potential for increased monitoring by institutional investors).
26. But see Jill E. Fisch, Relationship Investing: Will It Happen? Will It Work?, 55 OHIO ST. L.J. 1009, 1025 (1994) (questioning whether institutional investors have the appropriate incentives to engage in activism).
27. See, e.g., Jill E. Fisch, The Transamerica Case, in THE ICONIC CASES IN CORPORATE LAW 46, 63-67 (Jonathan R. Macey ed., 2008) (describing shareholders' limited power to nominate directors).
28. See, e.g., Lawrence A. Hamermesh, Corporate Democracy and Stockholder-Adopted By-Laws: Taking Back the Street?, 73 TUL. L. REV. 409, 419 (1998) ("[S]tatutes creating general authority to adopt by-laws may not be construed to permit stockholders to adopt by-laws directly limiting the managerial power of the board of directors.").
29. See generally LUCIAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION (2004) (criticizing structure and amount of executive compensation);
30. Stephen Labaton, Four Years Later, Enron's Shadow Lingers as Change Comes Slowly, N.Y. TIMES, Jan. 5, 2006, at C2 (observing that, despite criticisms and reform proposals, executive compensation is poorly linked to performance).
31. See, e.g., Adriaen M. Morse, Jr., Breaking the Circle: The Problem of Independent Directors Policing Public Company Financial Disclosure Under the SEC's New Rules Governing Public Company Audit Committees, 23 ANN. REV. BANKING & FIN. L. 673, 717 (2004) (observing that, despite the new rules, including Sarbanes-Oxley, "[a]udit committees will still lack sufficient means to adequately look over management's shoulder").
32. In other work, Professor Fox has described the governance effects of mandatory disclosure. See, e.g., Merritt B. Fox, Required Disclosure and Corporate Governance, 62 LAW & CONTEMP. PROBS. 113, 114 (1999). He has also identified reasons why it may be necessary to mandate disclosure beyond the level voluntarily provided by issuers.
33. See, e.g., Merritt B. Fox, Retaining Mandatory Securities Disclosure: Why Issuer Choice Is Not Investor Empowerment, 85 VA. L. REV. 1335, 1394-95 (1999). These reasons include the positive externality of improved share-price accuracy. Mandated disclosure also enhances the ability of the issuer and its managers to credibly commit to continued transparency.
34. See Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices, 59 STAN. L. REV. 1465, 1541 (2007) ("[T]he rise of independent directors is partly explained by the increasing informativeness of stock prices over the 1950-2005 period.").
35. See, e.g., Randy E. Barnett, Foreword: Four Senses of the Public Law-Private Law Distinction, 9 HARV. J.L. & PUB. POL'Y 267, 267-72 (1986) (explaining the distinction between public law and private law);
36. Amir N. Licht, International Diversity in Securities Regulation: Roadblocks on the Way to Convergence, 20 CARDOZO L. REV. 227, 258 (1998) (explaining that, although the borders are not clear, the "public law/private law distinction between securities regulation and corporate law generally holds").
37. See, e.g., Jill E. Fisch & Caroline M. Gentile, The Qualified Legal Compliance Committee: Using the Attorney Conduct Rules to Restructure the Board of Directors, 53 DUKE. L.J. 517, 553-55 (2003) (describing the New York Stock Exchange and Nasdaq adoption of rules governing independent audit committees).
38. Steve Thel, The Genius of Section 16: Regulating the Management of Publicly Held Companies, 42 HASTINGS L.J. 391, 393 (1991).
39. See, e.g., John C. Coffee, Jr., No Exit?: Opting Out, the Contractual Theory of the Corporation, and the Special Case of Remedies, 53 BROOK. L. REV. 919, 954 (1988) ("Arguably, both the derivative action and some actions based on Rule 10b-5 could be either preempted or precluded by an agreement to arbitrate set forth in the corporation's certificate of incorporation and, in theory, accepted by shareholders when they acquired their shares.");
40. Myriam Gilles, Opting Out of Liability: The Forthcoming, Near-Total Demise of the Modern Class Action, 104 MICH. L. REV. 373, 424 (2005) (arguing that companies could opt out of securities class-action lawsuits through collective-action waivers);
41. A.C. Pritchard, Stoneridge Investment Partners v. Scientific-Atlanta: The Political Economy of Securities Class Action Reform, 2007-2008 CATO SUP. CT. REV. 217, 248 (suggesting that shareholders could modify the damage remedy in an SEC Rule 10b-5 claim through an appropriate charter provision).
42. See REPORT OF ROUNDTABLE DISCUSSIONS ON CLASS ACTION REFORM AT DUKE UNIVERSITY 13 (Feb. 2, 2007), available at http://ilep.info/pdf/Roundtable- 200702-Final-Report.pdf (identifying the question of whether such provisions would be enforceable against newly purchasing shareholders); Gilles, supra note 49, at 423-25 (noting concern about the enforceability of unilaterally adopted waivers against strangers who purchase on the secondary market).
43. See, e.g., Lucian Arye Bebchuk, The Debate on Contractual Freedom in Corporate Law, 89 COLUM. L. REV. 1395, 1396 (1989) (summarizing the literature arguing "that corporations should largely be free to opt out of corporate law rules").
44. See, e.g., Jonathan R. Macey, Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty, 15 CARDOZO L. REV. 909, 936 (1994) (explaining that investors can eliminate firm-specific risk through diversification).
45. See, e.g., Michael B. Dorff, Softening Pharaoh's Heart: Harnessing Altruistic Theory and Behavioral Law and Economics to Rein in Executive Salaries, 51 BUFF. L. REV. 811, 836 (2003) (explaining that indexing "eliminates the need for expensive research on individual corporations").
46. Although one might argue that, with mandated disclosure, the cost of acquiring firm-specific information is very low, the analysis of that information is more costly. Moreover, such analysis is fundamental to the corporate-governance story. For stock prices to facilitate monitoring through the mechanisms described above, they must be efficient, not merely in an information sense, but in terms of fundamental value - that is, information must be incorporated into stock prices properly. See, e.g., Jill E. Fisch, Picking A Winner, 20 J. CORP. L. 451, 464 (1995)
47. (reviewing ROBERTA ROMANO, THE GENIUS OF AMERICAN CORPORATE LAW (1993)) (explaining the difference between informational efficiency and fundamental-value efficiency).
48. But see Lawrence H. Summers, Does the Stock Market Rationally Reflect Fundamental Values?, 41 J. FIN. 591, 592 (1986) (citing evidence that the markets are not fundamentally efficient).
49. See, e.g., Marcel Kahan & Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 U. PA. L. REV. 1021, 1069-70 (2007) (explaining that a shareholder-activism strategy is feasible for hedge funds that take concentrated stakes in portfolio companies but not for diversified institutional investors).
50. It is a separate issue whether informed traders incur excessive information costs, either individually or collectively. See Stephen J. Choi & Jill E. Fisch, How to Fix Wall Street: A Voucher Financing Proposal for Securities Intermediaries, 113 YALE L.J. 269, 290-91 (2003) (considering the possibility that investors engage in excessive research).
51. See, e.g., Bernard S. Black, Shareholder Passivity Reexamined, 89 MICH. L. REV. 520, 568 (1990) ("Large stakes reduce liquidity⋯.").
52. See, e.g., Morris Mendelson & Junius W. Peake, Intermediaries' or Investors': Whose Market is it Anyway?, 19 J. CORP. L. 443, 458 (1994) ("Those who index do not buy or sell on news. Instead, they execute transactions to invest newly-received funds, to rebalance their portfolio keeping it closely weighted to track the particular index being followed, or to make changes in asset allocation formulas⋯.").
53. See, e.g., Jonathan R. Macey et al., Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson, 77 VA. L. REV. 1017 (1991).
54. For a more extensive analysis of Basic and its legacy, see Donald Langevoort, Basic at Twenty: Rethinking Fraud on the Market, 2009 WIS. L. REV. 151.
55. See, e.g., John C. Coffee Jr., Liquidity Versus Control: The Institutional Investor as Corporate Monitor, 91 COLUM. L. REV. 1277, 1326-27 (1991) (describing regulatory restrictions on investment-adviser compensation and resulting incentive problems).