For investors worried about corporate mismanagement, the Securities and Exchange Commission is offering the proverbial ounce of prevention that is far better than the ton of cure that class-action lawsuits purport to provide.
In truth, investors and corporate officers alike will benefit from the SEC’s initiatives — and from a recent string of setbacks for the investor-plaintiffs’ bar. Those setbacks have included convictions of prominent lawyers, investigations of others, and a string of decisions both in trial courts and at the U.S. Supreme Court.
But lawsuits are far from an ideal means of redress for aggrieved investors anyway: In one respect, whatever money they gain from the suits comes straight out of their own pockets, because it devalues their own stock. Worse, the lawyers take as much as 30 percent off the top. It is the ordinary stockholder, the pensioner, the 401k owner, who effectively pays the millions or even billions of dollars that make up that percentage.
“There are many ways for investors to be injured,” SEC Chairman Chris Cox told me in a recent interview. “Among them are seeing their stock price collapse because of fraud and also seeing their stock price collapse because of the litigation that is the aftermath of the fraud. Oftentimes investors are doubly injured by the cost that the litigation process imposes on the business even after the original malefactors are gone.”
Far better it is to avoid grounds for suit in the first place. That’s where several of Cox’s initiatives should be of great assistance. These new measures make it easier for investors to access and understand all the financial data that companies must make public.
One measure requires reporting to be done in plainer English. Another, to be fully operational by 2009, involves interactive data using (quoting Cox) “hidden computer tags for each element of the financial information.” These tags will allow anybody to do simple “Google-type” research in “under 60 seconds” that previously may have taken hours to compile.
“Enron was able to hide its fraud because things were so complex,” Cox said. “Now, if you want an answer to the question as to why did a stock price drop suddenly, you can easily focus on the right question and you do not have to go through two years of ‘discovery’ [through a lawsuit] to find out.”
This setup should help companies as much as investors. For years, the plaintiffs’ firms have made an art of the massive fishing expedition where they file suit without any evidence of wrongdoing, hoping the discovery process will turn up actionable fraud.
Now, with much more information readily accessible, honest companies will be able to demonstrate much more easily that their actions are on the up-and-up, because it will be that much harder for plaintiffs’ lawyers to claim that companies are hiding something.
“To the extent that lawsuits are necessary to deal with fraud … the best way to avoid the whole mess is to prevent the fraud in the first place through greater transparency,” Cox said.
The new technology is inexpensive. Cox said that corporate giant United Technologies has been using it as a pilot project and “found that their total expense was less than $40,000. And even that was because they hired a consultant for $30,000 that they later determined they didn’t need.”
All those measures, of course, are preventive. If corporate malfeasance still occurs, there are avenues other than lawsuits by which investors can be made whole without lawyers taking their pounds of flesh.
First, the SEC itself vigorously polices such malfeasance. As Cox noted on Feb. 8 in a major speech outlining his 2008 agenda, “Over the past year, the SEC has distributed more than $2 billion in penalties and disgorgements to injured investors — and more than $3.5 billion since 2005.”
Meanwhile, last April, Cox asked his staff to study a new policy to allow companies to resolve shareholder complaints through arbitration, rather than lawsuits, in certain situations. The idea had been recommended in November 2006, by a blue-ribbon committee headed by Harvard Law professor Hal Scott. The SEC has not decided that issue yet.
Nobody suggests that lawsuits have no place. But if prevention or alternative means of resolution are available, everybody wins —except, of course, the lawyers.
Quin Hillyer is associate editorial page editor of The Washington Examiner. He can be reached at [email protected].
