Critics fear SEC chief is seeking to limit investors’ ability to sue
As a Republican congressman from Orange County, Christopher Cox put his energies behind a bill that raised the bar for shareholder lawsuits, earning him kudos from private industry and brickbats from investor advocates.
Now Cox is chairman of the Securities and Exchange Commission, and critics again fear he is pushing for restrictions on investors’ ability to sue.
The SEC early this month filed a brief in a Supreme Court case arguing that a stricter standard should have been used to decide whether a manufacturer of fiber-optic equipment had knowingly broken the law. In addition, the SEC’s chief accountant, Conrad Hewitt, has been urging that accounting firms be given some protections from liability when they fail to uncover fraud.
These developments have raised questions about whether Cox, a free-enterprise enthusiast who has long assailed “frivolous lawsuits,” is using his SEC post to carry on the battle.
“This is an example of Cox using the SEC to fight for corporate America to the detriment of shareholders,” said Chris Mather, a spokeswoman for the American Assn. for Justice, which represents trial lawyers. She compared Cox to “the fox guarding the henhouse.”
In an interview last week, Cox said that the SEC merely had weighed in on a straightforward legal issue based on the 1995 law and that appropriate shareholder suits could be beneficial.
“Private litigation under SEC rules is an important complement to the commission’s enforcement program,” said Cox, who in public remarks often points to investors’ need for protection. At the same time, he added, the SEC had an interest in preventing “abusive litigation” that harmed shareholders and companies.
Interest in the matter is stirred by Cox’s personal link to the Public Securities Litigation Reform Act, a law ardently sought by Silicon Valley that was passed by Congress over the veto of then-President Clinton. The law made shareholder suits more difficult to pursue, increased disclosure requirements and strengthened the hand of judges to consider lawyers’ conflicts of interest.
The SEC and the Justice Department submitted their brief in a Supreme Court case involving Tellabs Inc., an Illinois-based communications equipment maker. They argued that the 7th Circuit Court of Appeals in Chicago had set too easy a standard for shareholders to sue.
The agencies said the 1995 law required “a strong inference” that the defendant company knowingly intended to break securities laws and deceive shareholders, rather than the weaker test that “a reasonable person could infer” that executives had such an intent.
Under the higher threshold supported by the SEC, judges have broad latitude to consider matters that exonerate the defendant company, lawyers said.
There is disagreement among the nation’s courts on the precise standard to apply, but most follow the “strong inference” guideline supported in the government brief, according to the SEC.
In the interview, Cox sought to play down the questions and maintained that the SEC was seeking a proper application of the law written more than a decade ago.
The weaker standard “would gut the law,” Cox said. “The SEC has sided with the largest number of courts that have reviewed the question.”
Cox said some of the criticism was reminiscent of the 1990s debate before the securities litigation law passed Congress. “The difference is this is now the law of the land,” he said.
Given Cox’s advocacy of the law -- and his role in writing it -- some observers feared the SEC was playing favorites, taking the side of corporate managers.
It was “more about appeasing the business community and pursuing their notions of greater competitiveness of our markets than about protecting investors,” said Beth Young, a senior research associate with the Corporate Library, a pro-investor research organization.
“I think that the SEC is for the first time in recent memory taking a biased view” against investors, maintained Joel H. Bernstein, an attorney with law firm Labaton Sucharow & Rudoff in New York.
But a lawyer who defends companies in white-collar cases expressed doubt that the SEC would tilt away from investor protection in the post-Enron era.
The spate of scandals symbolized by the Enron and WorldCom affairs brought a lasting change in public expectations -- along with stricter regulatory requirements embodied in the Sarbanes-Oxley law and a raft of new rules, said Roma Theus II, a former federal prosecutor and an official at the Defense Research Institute, an organization of trial lawyers and corporate counsel.
“They were watersheds,” he said of the corporate scandals. “We’re not turning back.”
The discussion of investor lawsuits is taking place at a time when the number of such cases has been falling steadily. According to Stanford University and Cornerstone Research, 110 cases were filed in 2006, down from 178 filings the year before. Overall, the 2006 figure was 43% below the 10-year average of 193 cases, researchers said last month.
Explaining the steady decline, the researchers cited stricter anti-fraud enforcement and the fact that a strong stock market typically reduces case filings.
“With the number of securities class actions falling, it’s hard to see a compelling need to raise the bar,” said Amy Borrus, deputy director of the Council of Institutional Investors.
“Where’s the evidence of a wave of frivolous lawsuits? I’d suggest there isn’t any,” she added.
Inside the SEC, officials don’t want to see the number of major accounting firms decline from the remaining Big Four: Deloitte Touche Tohmatsu, Ernst & Young, KPMG and PricewaterhouseCoopers. Their counterpart Arthur Andersen was convicted of obstruction of justice in the Enron scandal and never recovered, although the verdict was later overturned by the Supreme Court.
Hewitt, the SEC’s chief accountant, said during a Washington conference recently that U.S. auditors should consider proposing to Congress caps on their liability under securities laws, noting that the European Union was moving in that direction. He had expressed similar views earlier at a legal conference in San Diego.
Nonetheless, the SEC has no plans in the works to cap auditors’ liability, agency officials said.