AS Simple Proposal for Reducing Securities Fraud Suits

Article excerpt

Let's say you run a video game company. You've just been told that promised deliveries of this year's planned blockbuster, "Burn 'Em in Salem," will be delayed at least three months. The trouble is that the pitiful screams of the witches in the test version cannot be heard above the roar of the flames.

Who do you call first? Your ad agency? The big retail chains? Members of the corporate board? Ghostbusters?

More likely, the company's lawyers. For once the delay is announced, your stock is probably headed for a nose dive. And frequently _ arguably much too frequently _ securities fraud lawyers will be filing lawsuits on behalf of those who bought the stock (or chose not to sell it) on the implied promise that you were all set to send children to bed each night dreaming of incinerating witches.

Admittedly, not all cases in which a stock takes a sudden plunge lead to shareholder lawsuits. The law, after all, requires evidence of fraud or deceit to win a suit in federal court. But enough horror stories about frivolous lawsuits aimed more at extracting big settlements than proving malfeasance have made the rounds that many lawmakers are convinced something needs to be done to curb the practice.

Rep. Christopher Cox, R-Calif., wrote the original draft of what is now known as the Securities Litigation Reform Act and shepherded a modified version of the proposal through the House. It is now pending in the Senate, where it faces a tougher battle. "The bill addresses all the key concerns," he said.

But does it? Experts who are sympathetic to the need to rein in securities suits see the final House bill as an unwieldy patchwork that will require years of court tests before its impact becomes clear.

"Eventually," concluded Lester Brickman, a professor at the Benjamin Cardozo Law School in New York City, "we'd find out just how many angels can dance on the head of this pin."

Instead, Brickman just may have a better idea.

In recent years, stockholders' lawsuits have grown like weeds. Originally seen as a desirable way to encourage full and timely disclosure, many people now believe that such litigation on behalf of injured "classes" has taken on a life of its own.

The law has not changed, but the aggressiveness of the plaintiffs' bar has. Hundreds of class action suits on securities fraud are filed in federal court each year.

So what is wrong with that? Plenty. As Elliot Weiss of the University of Arizona Law School and John Beckerman of Cardozo Law School write in a forthcoming article in the Yale Law Journal, the market for such litigation responds to perverse incentives in which the cost of defending against these suits far exceeds the cost of pursuing them. …