Decision ’96 : Under ‘Loser Pays,’ Loser Is You : Prop. 201 would disproportionately burden the small investor

Annoyed by what they call frivolous stockholder lawsuits, Silicon Valley companies and other business interests are spending millions championing the passage of Proposition 201. The “loser pays” initiative is the centerpiece of an antilawyer campaign promoted by the pro-business Alliance to Revitalize California.

If only Proposition 201 were truly about good corporate citizenship. In reality, the high-tech companies are looking out only for themselves as they throw money behind the measure. Billed as a way to discourage “meritless” actions, 201 would impose financial burdens on certain shareholder suits. Those burdens would be onerous and unfair, especially for small investors.

California high-tech firms ride the wild swings of a new and fast-changing industry and thus are vulnerable to shareholder class-action lawsuits when they fall short of performance projections and their stock prices plummet. A company often will settle to avoid high court costs.

Proposition 201 would apply to shareholder actions against corporations and to class-action suits based on violations of securities laws. The measure would require the loser to pay the winning party’s attorney fees and expenses, on a reasonable basis.

Unless the suing party owned or traded at least 5% of the company’s shares, he or she could be required to furnish bond for the defendant’s estimated fees and expenses. The plaintiff’s attorney could furnish the bond, although that’s likely only when the lawyer is confident the client will win.

The prospect of a loss to a deep-pockets corporation would discourage small investors’ legitimate claims. Few small investors, especially the elderly, could afford to take the risk.

With the explosion of investments in mutual funds, the stock market and new ventures, safeguards for investors against securities fraud need to be maintained--not cut back. This is especially true in light of the fact that the Securities and Exchange Commission, the federal watchdog over the industry, is stretched to its regulatory limits.

An effort to institute “loser pays” in federal law failed in Congress last year. But acting otherwise to curb frivolous lawsuits, Congress limited so-called bounty payments that lawyers make to investors who agree to sue. The law passed by Congress last year also gives companies safe harbor from liability when their business forecasts don’t prove accurate, so long as they warn investors that the projections are speculative and they do not engage in fraudulent practices.

The fear among proponents of Proposition 201 is that the new federal law will result in shareholder class actions being filed in state court instead of federal court. The proposition is a preemptive strike by California’s high-tech companies, which claim they are unduly targeted by shareholders. A high percentage of these businesses are indeed subject to such suits, but the statistics do not point to any dramatic rise of filings in federal courts, where the majority of shareholder class actions are brought. The Administrative Office of the U.S. courts recorded 290 securities class-action lawsuits filed in all federal courts (the preferred venue) in 1994, fewer than the 305 filed two decades earlier in 1974. The figures for California filings are not available. Securities class actions accounted for less than 1% of new federal civil cases in 1994.

There are some abuses, but Proposition 201 is too broad and could cost small investors plenty. Vote no.