"It's a situation basically directly out of a Kafka novel, and I can't think of anything more unjust."
That's how Lisa Rickard, president of the U.S. Chamber of Commerce's Institute of Legal Reform (ILR), framed the current state of securities class actions. When the Chamber talks, right-wing media listen -- which is why it matters when its representatives liken class action lawsuits to Kafkaesque hellscapes, worse than anything else in the world.
On February 28, the Chamber hosted "Erica P. John Fund & Beyond: The Past, Present, and Future of Securities Class Actions," an event where Chamber-selected panelists discussed the perils of the next big class action case before the Supreme Court, Halliburton Co v. Erica P. John Fund. At the heart of the case is the so-called "fraud on the market" theory, decades-old Supreme Court and legislative precedent that businesses interests are asking the conservative justices to overturn.
Legal expert Roger Parloff explained the theory in a recent CNNMoney report on the Halliburton case:
To prove a traditional fraud case, the plaintiff has to show not only that the defendant lied to him, but that he fell for that lie -- i.e., "relied" on it -- in a way that caused him injury. So in the securities fraud context, if a company's CEO publicly understates what he really thinks his company's asbestos liabilities are -- one of the frauds Halliburton stands accused of -- that lie might obviously lull an individual investor into purchasing the stock, believing it to be a safer bet than it really is. When the truth later emerges, and the stock falls precipitously -- 42% in Halliburton's case, after it got hit with a mammoth asbestos verdict in December 2001 -- that investor can credibly claim to have been injured.
But if that investor wants not just to sue on his own behalf but to bring a class action, how can he prove that the entire class of investors who bought Halliburton stock during the same time period attached the same importance as he did to the CEO's allegedly false statement -- or that, indeed, they ever even knew that the statement had been uttered?
One answer might be: He can't. In that case the investor couldn't bring a class action and, if he was just an individual, with only a few thousand bucks worth of stock losses at stake, it probably wouldn't make economic sense for him to bring suit of any kind.
The FOTM [fraud on the market] doctrine comes to that person's rescue. It theorizes that when there is an efficient market, in which stock analysts routinely pore over 10Qs, 8Ks, media reports, and, indeed, every passing rumor implicating the companies they cover, any material statement by a company's CEO quickly gets incorporated into the price of its shares. Every investor can then further be assumed to rely on the "integrity" of the share price -- i.e., the assumption that that price isn't being artificially depressed or inflated by fraudulent statements. With the benefit of the FOTM assumption, an investor can now bring a class action because the CEO's allegedly false statement can be assumed to have been incorporated into the share price, and all investors can be further assumed to have relied on the integrity of that price, whether or not they actually ever knew the statement had been made and attached any significance to it.
The Chamber -- a pro-business juggernaut that spends tens of millions of dollars a year on lobbying -- is hopeful that the conservative wing of the Court will gut this highly effective fraud on the market theory, thus shutting down another avenue for plaintiffs to access the justice system by immobilizing class action litigation even further. The New York Times' Supreme Court correspondent Adam Liptak and others have argued that this strategy is working: conservative justices and like-minded lower court judges push these targeted attacks on obscure rules of federal procedure to roll back protections for everyone.
Unsurprisingly, the Chamber's pro-business-to-a-fault point of view is popular among right-wing media outlets like The Wall Street Journal and National Review Online, among others. The WSJ editorial board has dependably relied on Chamber reports and expertise when it needs to support its anti-union views or to complain about "frivolous lawsuits." NRO has also carried water for the Chamber in the past, arguing in favor of forced arbitration clauses that are horrible for consumers but great for huge corporations.
Expect those outlets to do the same on March 5, when the Court hears oral arguments on Halliburton's request that it toss away stare decisis, the legal doctrine of respecting precedent that Chief Justice John Roberts claims to hold highly.
If the Chamber gets its way in Halliburton -- and it often does, about 80% of the time when it's involved in close cases in front of the similarly pro-business Roberts Court -- it could soon become more difficult for shareholder plaintiffs to file suits against large corporations that commit fraud to inflate the value of their stock price. But in Rickard's view, securities litigation, "instead of protecting investors, it's harming them. Instead of deterring fraud it often punishes honest businesses." The only winners in securities class actions, as far as Rickard and the Chamber are concerned, "are plaintiffs' lawyers that get huge windfall profits."
Attacking plaintiffs' lawyers and their clients is evidently a favorite hobby for the Chamber and the ILR, a practice that is then parroted by right-wing media. Last fall, the group hosted "Healing the U.S. Lawsuit System," an event dedicated to complaints about "judicial hellholes," "frivolous lawsuits," and "frequent filers" -- (non-corporate) plaintiffs who file multiple lawsuits. The Halliburton event was more of the same. Both Rickard and guest panelists argued that a decision in favor of Halliburton just wouldn't be a very big deal for plaintiffs. Rickard argued that the "investors would have other options" even in the absence of the fraud on the market theory, and that "it will help deter truly meritless cases ... and will be a meaningful step towards a better system."
The keynote speaker for the event, former Securities Exchange Commissioner Troy Paredes, largely agreed with Rickard, dismissing the idea that shareholder litigation would "have less bite" in the absence of the fraud on the market presumption, and stating that "there are many other ways besides class actions to hold wrongdoers accountable. ... Scaling back class actions is by no means the end of accountability." Ultimately, said Paredes, the fraud on the market theory has made it "too easy" to bring class actions.
Other panelists like Hester Peirce, senior research fellow at George Mason University, lamented that securities lawsuits are unfair because plaintiffs are "really penalizing the shareholders ... you're making them pay themselves. It's a random distribution of money." Panelist Andrew Pincus, partner at Mayer Brown LLP, agreed, saying that securities litigation represents "one group of innocent investors who have to pay another group of innocent investors."
But these panelists ignore the fact that securities class actions actually play a significant role in administering civil justice to shareholder plaintiffs who have been the victims of fraud. According to a new report from Public Citizen, a nonpartisan consumer advocacy group, the Chamber's "criticisms of private securities lawsuits are overblown" and many of their claims about securities class actions are easily debunked. Moreover, many long-term investors actually support the fraud on the market theory. From the Public Citizen report:
The Chamber's description of securities class actions as abusive, lawyer-driven cases ignores that securities lawsuits are increasingly brought by large, professionally managed institutional investors.
Institutional investors contribute a substantial portion of the capital invested in the nation's securities markets, and 1995 legislation endorsed a leading role for them in securities litigation. In addition, Congress recognized that institutional investors have a long-term perspective that aligns their interests with those of the companies in which they invest. Institutional investors have no incentive to favor meritless securities litigation, which only harms their own investments, but they have a strong interest in policing fraud and enforcing the securities laws. Thus, it is telling that institutional investors strongly favor the Basic presumption [the fraud on the market theory] and that institutional investors representing millions of retirees and pension fund beneficiaries and trillions of dollars of assets under management filed two briefs in support of the fraud-on-the-market presumption in the Halliburton case.
Contrary to the Chamber's narrative, the Public Citizen report points out that "private securities lawsuits deter malfeasance, compensate investors, and help ensure the integrity of the markets, while simultaneously enabling individual consumers who have purchased stock to seek redress in a way that would not otherwise be possible." Although Rickard, Paredes, and other panelists at the Chamber event insisted that the end of the fraud on the market theory would still leave private rights of action intact, Public Citizen notes that "individual suits by institutional investors are rare," and suits brought by the SEC recover far less for shareholders than do class actions.
To that end, the current SEC doesn't agree with former Commissioner Paredes' take on securities class actions either. In fact, current Solicitor General Donald Verrilli filed a brief on behalf of both the SEC and the Department of Justice arguing in favor of leaving the fraud on the market presumption intact, because those agencies rely on private lawsuits to assist in policing fraud in the markets. According to the brief, "meritorious private securities-fraud actions, including class actions, are an essential supplement to criminal prosecutions and civil enforcement actions brought by the Department of Justice and the SEC," and without them, those agencies could be overwhelmed due to lack of investigative resources.
But perhaps most importantly, the Chamber's assertion that securities litigation does nothing more than distribute money from one group of "innocent investors" to another (the misnamed "circularity" argument) fails to acknowledge the common sense "incentive effects" of such suits. As the Public Citizen report explains:
The evidence shows that the Chamber's "circularity" argument -- the contention that private securities actions simply transfer money from one innocent investor to another -- is flawed because it ignores incentive effects. The threat of civil liability leads officers and directors (who are often shareholders themselves) as well as large investors to establish procedures to reduce the incidence of fraud in the first place. Long-term shareholders in particular, such as institutional investors, comprise an integral part of the mechanism that deters managerial fraud. Indeed, the fact that institutional investors support private securities lawsuits shows that the circularity argument is false.
The claim that securities lawsuits are abusive and meritless does not withstand scrutiny, either. The evidence shows that, even before legislative reforms enacted in 1995, securities lawsuits were generally meritorious. Since 1995, the meritorious nature of suits has only become clearer. Nearly two-thirds (64%) of class actions are resolved after a court has adjudicated a motion to dismiss, which is a preliminary legal indicator that the suit has some merit. If anything, the evidence is that "highly meritorious suits are brought, but settled for too little."
The Chamber has a history of advocating for so-called "tort reforms" like the current assault on all class actions -- not just those that deal with securities fraud -- that largely benefit large corporations by making it harder for injured defendants to sue. Its new attacks on securities litigation is just the group's most recent target in their crusade for such "reforms."
Don't be surprised if right-wing media takes note.