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By Nell Minow
Securities laws are designed to protect investors from misleading or inaccurate information. They recognize that corporate managers have an incentive to pass along only the good news, and that investors do not have access to enough information to evaluate managements statements about the company, either before or after making the decision to invest. So the law imposes a strict standard on CEOs and other corporate officers who talk about the companys future. They must share important news, whether good or bad, promptly and candidly. Plaintiffs attorneys abuse these protections by bringing automatic lawsuits, photocopying the last complaint filed, against any company whose stock moves in any direction other than precisely predicted by management. They even sue if it does not move. And if it does move as predicted, they sue again, arguing that it should have been predicted sooner. The recent announcement by Seagrams of a possible deal with MCA led to the inevitable flurry of lawsuits arguing that the announcement should have come earlier, for example.
The perverse consequence of this system is that there is money to be made in bringing these lawsuits, but the money is not taken from those who are guilty or paid to those who are harmed. Legitimate shareholders with legitimate claims get nothing, while professional plaintiffs and their lawyers get paid for filing and settling suits based on claims like the one a judge called helium weight.
Major Problems
Problem number one: It is cheaper and easier for the company to settle these suits than to fight them. The literally millions of documents that must be read, analyzed, and filed, the time demands on officers and directors, and, of course, the attorneys fees, impose astronomical costs. The inability to define with clarity just what information needs to be disclosed when makes going to trial risky and unpredictable. And the plaintiffs in the overwhelming majority of these cases are only too glad to settle. So are their lawyers.
Problem number two: These suits are most often brought by professional plaintiffs who hold only a few shares. Although they are considered by the court to represent their fellow shareholders, the lack of alignment with the interests of other shareholders is demonstrated by their settlements. As bad as the frivolous lawsuits are, I am more outraged by the legitimate suits settled for a tiny fraction of their value by class representatives who represent only their own pocketbooks. A classic example was the settlement of the lawsuit against Occidental Petroleum for using $120 million of the shareholders money to build an art museum for Dr. Armand Hammers collection. The museum was built, the money was spent, and the representatives extracted nothing more meaningful than a small Occidental Petroleum sign on the front of the museum building (and attorneys fees, of course) in exchange for dropping the suit.
Most shareholder lawsuits are brought by people who care little, if at all, for shareholders as a group. The plaintiffs and their lawyers make grand statements about the integrity of the markets, but the primary motivation -- and the primary outcome -- is their own returns. Typically, plaintiffs get a small award, and their lawyers get a large one. The rest of the shareholders get nothing.
Indeed, shareholders pay both sides of these lawsuits, with the costs of the defense and the settlement (including plaintiffs attorneys fees) coming out of their pockets.
Problem number three: The other perverse consequence of these suits is that less information is available to the marketplace. Corporate officers and directors are afraid to make any prediction about future performance. So shareholders lose again.
Changes Proposed
Despite the growing influence of large, fiduciary institutional investors in corporate governance over the past decade, they have been unable to address the abuses in securities litigation. For example, even the involvement of three of the largest institutional investors, with literally hundreds of millions of dollars invested in the company, could not prevent the settlement of the Occidental Petroleum suit described above. The litigation reform bill passed by the House would require courts to establish plaintiffs steering committees to make sure that the people who have the greatest interest in the company are the ones who determine the course of the litigation.
The House bill also includes a safe harbor provision to limit the potential liability for good faith efforts to provide investors with a companys best estimate for the future. Investors know that predictions of future performance are by their very nature speculative. Unless a shareholder can prove that a corporate official who made a statement to the press or a public filing deliberately provided misleading information or knowingly withheld relevant information, the shareholder should not be able to prevail.
The law should not encourage shareholders with microscopic stakes to file dozens, even hundreds, of nuisance suits and settle on terms that benefit the plaintiffs a little, their lawyers a lot, and their fellow shareholders not at all. Unfortunately, that is the current system. The law should encourage shareholders with a meaningful stake to file lawsuits to enforce limits on corporate directors and managers who have neglected or abused their obligation to be candid about the companys current status and prospects. Fortunately, the passage of the House bill and the seeming commitment by the Senate to enact similar reforms is a promising step in the right direction.