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From the Pages of The Pomerantz Monitor: The Value of Private Enforcement of Securities Laws

By Carolyn Moskowitz

According to an article in the May/June issue of The Pomerantz Monitor, it has long been recognized that private enforcement is a necessary supplement to the enforcement capabilities of the Securities and Exchange Commission (?SEC?). This proposition is embodied in the idea of a ?private attorney general? to police violations of the securities laws, and was endorsed explicitly by the United States Supreme Court since the mid-1960s.

Private litigation often focuses on retroactive payments to damaged investors and corporate governance, while SEC enforcement actions result in injunctive relief, including ?cease and desist? orders or the barring of individuals from serving as officers or directors of public companies. More recently, the SEC has itself obtained monetary awards as restitution and sought to disseminate such awards to injured investors directly under the Fair Funds Act. Some commentators now question the need for private securities litigation at all, suggesting that the SEC should be the sole enforcement mechanism for violations of our securities laws. 

In light of this, it is legitimate to review the value of past private securities litigation in order to determine whether it should continue. An article by James D. Cox and Randall S. Thomas, ?Mapping the American Shareholder Litigation Experience: A Survey of Empirical Studies of the Enforcement of U.S. Securities Law,? Download Mapping the American Shareholder Experiencedoes just this. Professors Cox and Thomas are the authors of a number of papers on securities enforcement, including the influential ?Does the Plaintiff Matter? An Empirical Analysis of Lead Plaintiffs in Securities Class Actions,? Download Does the Plaintiff Matterpublished in the Columbia Law Review, noting that courts have overwhelmingly favored institutional investors as lead plaintiffs under the PSLRA, and the now-classic ?Leaving Money on the Table: Do Institutional Investors Fail to File Claims in Securities Class Actions?? Download Leaving Money on the Tablein which the answer, unfortunately, was ?yes.?

In their newest study, Cox and Thomas offer an overview of recent empirical research on SEC and private actions, precisely in order to determine ?if private securities fraud class actions are a necessary supplement to SEC enforcement actions.? Their findings are significant. A sample of private class actions filed from 1990 to 2001 reveals that only 15% overlapped with SEC enforcement actions. A subsequent sample of post-2001 private class actions showed that in less than 23% had the SEC filed a parallel enforcement action. Critically, the SEC has tended to focus its enforcement efforts on smaller targets, ?suggesting that the big fish get away,? and the authors suggest ? following the Madoff scandal ? that ?the SEC may be under-enforcing the securities laws.? 

The impact on the stock price of companies when an SEC enforcement action is disclosed is also greater. Combined with the fact that the monetary penalties extracted by the SEC tend to be smaller than those resulting from private litigation, companies facing an SEC enforcement action typically occur higher ?reputational costs? but lower monetary exposure. 

One of the major complaints among commentators against private securities litigation is that institutional investors who continue to hold shares in a defendant after a settlement do not benefit, since settlement amounts, when paid by a defendant, weigh down its stock price. It appears, however, that these even larger reputational costs ? which may depress stock prices even more ? have not been considered in their entirety. And while commentators have long emphasized the effect of attorneys? fee awards on the amount available to investors ? now addressed by the PSLRA ? they have ignored the effect of defense litigation costs that are often paid directly by the companies, and which the PSLRA did nothing to resolve.

Perhaps most significant are the findings that the SEC appears not to be the most important entity in detecting corporate fraud, and that class actions may lead to improvements in corporate governance. As the authors conclude: ?Good corporate governance practices should lead to better quality disclosures, better monitoring of management, a reduced incidence of fraudulent misconduct by corporate managers and an improved alignment of corporate managers? incentives with those of shareholders.?  

Full post as published by PomTalk on July 08, 2009 (boomark / email).