FORUM COLUMN

By Mark Labaton
     
      Pressure from special-interest groups should not determine major public-policy decisions, but it could soon lead to the erosion of securities laws upon which investors rely - safeguards that ensure that corporate officers, directors and auditors act honestly and give harmed investors means of redress when they do not.
      Good economic times, fading memories of the Enron, WorldCom, Tyco and other scandals and a business backlash to the Sarbanes-Oxley Act of 2002 fuel this shortsighted drive to "fix" well-working securities laws.
      Two influential groups, the Committee on Capital Markets Regulation - which includes two former CEOs of major accounting firms and former Commerce Secretary Donald Evans, a close friend of President Bush - and the U.S. Chamber of Commerce, are pushing for barriers to class-action lawsuits, relaxed regulations for audits and restraints on state attorneys general. Such measures would reduce oversight of corporate conduct sharply and shield officers, directors and auditors from liability for misconduct that harms investors.
      Recognizing that the current Congress is less likely to be as sympathetic to their agenda as previous Congresses were, these groups are looking for changed administrative regulations to accomplish their goals. Both groups have ties to the administration's newly formed Working Group on Financial Markets and have begun to lobby for their desired regulatory changes.
      The capital-markets-regulation committee recently issued an interim report documenting certain of their proposed recommendations, and the Chamber of Commerce will release a detailed report of its own later this month.
      Signs of the administration's bias to limit investor protections include its recent decision to leave the $1 trillion hedge-fund industry largely unregulated and its filing last month of an amicus curiae in the U.S. Supreme Court case Tellabs Inc. v. Makor Issues & Rights, 437 F.3d.588 (7th Cir. 2006), certiorari granted, 127 S.Ct. 853 (2007).
      In Tellabs, the Securities and Exchange Commission advocates adoption of a rigorous pleading standard for securities class actions - more difficult for investors to overcome than the standard applied in most jurisdictions - that would stop many meritorious suits. The SEC position is inconsistent with its previous briefs, its role as the watchdog for investors and its historic position that class-action securities suits are "a necessary supplement to the commission's efforts."
      SEC Chairman Christopher Cox says the SEC took that position partly to safeguard the big-four accounting firms from further consolidation. His explanation is unconvincing because accounting firms rarely have been defendants in securities class actions since 1994, when the Supreme Court held in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), that there cannot be a claim in a private SEC Rule 10b-5 action for aiding and abetting liability. But such firms can be held liable when they are primary actors committing a securities fraud, which is the way it should be.
      (Incidentally, Arthur Andersen's 2002 collapse had nothing to do with a securities class-action suit; the company imploded following a criminal indictment.)
      Cox also contends that adoption of the SEC's position would help eliminate "fraudulent" suits, including actions by "professional plaintiffs." That is not persuasive because the Private Securities Litigation Reform Act of 1995 already deters such conduct by containing a heightened pleading standard, provisions to ensure that most actions are controlled by institutional investors, limits on a single party's ability to become a plaintiff multiple times and a mandatory stay of discovery until after a plaintiff overcomes a motion to dismiss.
      The capital-markets-regulation committee and the Chamber of Commerce contend that the SEC's enforcement of securities laws and class-action suits imposes excessive burdens on American public companies and forces more U.S. companies to go public overseas. But securities class actions and enforcement of security laws have not been the millstones around the neck of American corporations that these critics claim and are not the reason for more initial public offerings in foreign nations.
      During the past decade, American corporations have thrived. Stock trading reached a record volume in 2006, and U.S. markets remain, by far, the world's strongest. At the same time, the growth of overseas markets is attributable to several factors. One is a lack of analyst coverage for small U.S. companies; another is investment-banking fees - underwriting fees in the United States are nearly 7 percent of initial-public-offering costs, compared with half that amount in the United Kingdom and other foreign markets.
      Most significantly, the growth of overseas markets is a result of an expanding global economy. As Goldman Sachs observed last month, "[T]he growth of capital outside the U.S. is a natural consequence of economic growth and market maturation elsewhere," including Hong Kong, London, Tokyo and Frankfurt, Germany.
      Those bent on changing securities laws also disparage unfairly an exemplary system of regulation and enforcement. American markets derive their competitive strength largely from the protections they give investors; because of that, a foreign company's stock often is valued significantly higher on a U.S. exchange than it would be if sold abroad.
      Moreover, foreign nations have introduced legislation to permit class-action litigation and improve financial reporting. Their goal is to emulate U.S. securities laws - this is smart. Capital markets in which the watchword is "buyer beware" garner distrust, while currency flows to markets perceived as fair, honest and transparent.
      Efforts to restrict securities class actions - or replace them with mandatory arbitration, as some propose - are not justified. Moreover, the timing of this push to limit securities class actions reveals ulterior motives, especially because the number of securities class actions filed has dropped steadily from 226 in 2002, to 211 in 2004, to 110 in 2006.
      Sarbanes-Oxley, the post-Enron legislation designed to make such massive frauds less likely, is another target of those determined to undermine securities laws. But criticism of that legislation is largely unfounded.
      A recently released study by Thomson Financial, a public company providing information services to the financial community, demonstrates that Sarbanes-Oxley regulations have not stopped foreign companies from going public in the United States. In addition, the costs to corporations of complying with Sarbanes-Oxley pale when compared with the benefits. Sarbanes-Oxley requirements help companies identify faulty internal-audit controls that lead to lawsuits and foster more-accurate accounting practices. Foreign nations realize that and have adopted their own regulations patterned after Sarbanes-Oxley.
      Although Sarbanes-Oxley is not perfect, it should not be discarded haphazardly. Modest changes make sense. For example, the SEC has concluded that complying with some of Sarbanes-Oxley's internal-audit requirements has been expensive for smaller public companies and has taken common-sense steps to reduce the compliance requirements and much of the compliance expense for public companies with market capitalizations of less than $75 million.
      The Committee on Capital Markets Regulation - funded largely by a foundation controlled by Maurice "Hank" Greenberg, former CEO of insurance giant American International Group until being ousted because of an action by the New York attorney general charging him with using fraudulent accounting practices to hide the company's financial problems - strongly endorses strict limitations on the powers of state attorneys general.
      That would be a mistake: State attorneys general play an important role in protecting investors. In addition to exposing widespread fraudulent practices within the insurance industry after the SEC failed to act, the New York attorney general recently stepped forward to halt gross misconduct, misleading investors, committed by securities analysts for large investment banks including Merrill Lynch and Morgan Stanley.
      According to Lynn E. Turner, former chief accountant for the SEC, "in good times, memories are short." True enough, but it is perilous to ignore history and would be reckless to roll back securities laws to appease interest groups.
      In light of the recent and ongoing financial scandals, policy-makers should not bow to pressure and dismantle the foundations of effective corporate governance and market regulation that make U.S. capital markets a model for the rest of the world.
     
      Mark Labaton is a partner at Kreindler & Kreindler in Los Angeles, where he represents plaintiffs in securities and other complex litigation as well as whistle-blowers in False Claims Act cases.