Chairman Gramm, Senator Dodd, Members of the Subcommittee: It is a pleasure to present the views of the National Venture Capital Association regarding the impact the Private Securities Litigation Reform Act ("Reform Act") has had on the venture capital and emerging company economic sector since its passage in December, 1995.
The NVCA is an association of over 240 professional venture capital organizations located throughout the United States. Professional venture capitalists have invested well over $40 billion in small and emerging companies across America in today's cutting-edge technologies. NVCA's affiliate, the American Entrepreneurs for Economic Growth, represents over 8,000 CEOs who run emerging growth companies and employ over 1.2 million Americans. Venture capitalists sit on the Boards of Directors of a large portion of these companies, and thus know firsthand the problems growing enterprises face in regard to the continuance of abusive securities class action suits.
I am Brian Dovey, President of the NVCA and General Partner of Domain Associates which is a Princeton, New Jersey and Costa Mesa, California based venture capital firm focused on providing venture capital to emerging growth companies in the life sciences (medical device and biotechnology) sector. I sit on the Boards of Directors of several biotechnology/pharmaceutical companies. I appear before you today as an investor and board director with personal experience of how deleterious these securities cases are to emerging companies.
EMERGING GROWTH COMPANIES IN THE NATION'S ECONOMY
The U.S. economy is undergoing a profound transformation. Our giant corporations, longtime leaders of the world economy, have lost their edge while emerging growth companies have expanded and prospered. In fact, the Fortune 500's share of non-farm employment is now under 10 percent of the American workforce, down from 20.1 percent in 1971.
To put this in perspective, NVCA recently completed its Seventh Annual Economic Impact of Venture Capital study which in part documents the employment generating power of venture-backed emerging growth companies. The study found that for the past decade as venture-backed companies have created jobs, Fortune 500 companies have cut them. In fact, from 1991 through 1995, venture-backed companies on average have grown jobs at an average of nearly 34 percent each year. This dynamic growth helps offset the average annual job decrease of almost 4 percent at Fortune 500 companies during the same time period.
As our companies mature, their workforce needs grow even more dramatically as demonstrated by the fact that venture-backed companies have consistently throughout the 1990's been a majority or near majority on both INC Magazine's and Fortune Magazine's annual list of its 100 fastest growing companies.
These very companies are truly the key to America's economic future not only because they are a primary source of U.S. job creation, but because they are significant exporters, innovators, taxpayers and international competitors. These companies play a critical role in discovering and opening new markets, in developing and accelerating technology and in producing goods faster and more efficiently than ever before. It is precisely because these venture-backed companies are so successful in such a short time that they are the prime candidates for securities class actions suits. Venture-backed companies traditionally go public faster than non-venture backed companies and once public are more successful than their non-venture financed counterparts. They immediately fall within the category as "likely to be sued".
For better or worse, these entrepreneurial businesses are shaped significantly by the policies and practices of all levels and branches of government. Since emerging growth companies are essential to economic growth, it is imperative for our Nation's policymakers to take the entrepreneurial viewpoint into serious account when discussing issues of national concern, such as abusive securities suits, and before enacting legislation to correct the situation.
This is the reason why NVCA is part of the Uniform Standards Coalition, a nationwide organization composed of high-tech companies, securities firms, accountants and venture capitalists who all have one thing in common: advocate a national, uniform set of legal rules governing private securities class action lawsuits. These entities never in the past combined their power to advocate a specific policy, but securities class actions and the impact of the 1995 Reform Act is so critical to our economic sector that we had no choice, but to unite in a cohesive manner.
THE RAMIFICATIONS OF THE 1995 REFORM ACT
Your invitation for NVCA to present testimony today is strong evidence of your concern to redress a serious "loophole" in the significant legislation your Committee worked so diligently to enact in 1995.
Mr. Chairman, you and the members of your Committee are all too familiar with the reasons why the Reform Act of 1995 was an absolutely essential piece of legislation for emerging growth companies and the investing public. By now you likely have grown weary of the stories of high growth companies unfairly burdened with abusive securities fraud suits. The leaders of these companies have had to turn their interest from growing a company to defending themselves in highly questionable legal proceedings at a huge financial cost to the company, its employees and its shareholders. I wish I could say that the 1995 Reform Act did what we all thought it would do: decease the number the abusive securities fraud suits, give the investing public more information about the companies they want to invest in and put entrepreneurs back in the business of doing what they do best: growing companies.
Unfortunately from the experiences of venture capitalists, I cannot declare the Reform Act a success for companies, investors or entrepreneurs. The work and the intent of the United States Congress has been seriously eroded by a small number of plaintiffs' lawyers. These lawyers have, in NVCA's opinion, decided on their own that the vote of two-thirds of the U.S. House and Senate, the peoples's elected officials, do not matter and are inconsequential in their pursuit of legal fees based on highly questionable "evidence". They also have ignored 75 percent of the California electorate who in November, 1996 voted overwhelmingly against expanding the ability of plaintiffs' lawyers to bring securities class actions in California state courts.
These are strong words, but warranted words. No one can suggest that prior to the enactment of the Reform Act that securities class action lawsuits of nationally traded securities were brought on the state level. They were virtually exclusively the domain of the federal courts, and for good reason : National class actions brought against companies which participate in the national securities markets should be brought in federal court. Federal courts have the expertise, resources and the duty to hear these cases to prevent overlapping and duplicative legal rules governing securities litigation that involve nationally-traded securities.
RAMIFICATIONS OF REFORM ACT ON VENTURE-BACKED COMPANIES
Since inception of the Reform Act venture capitalists have not seen a decline in the number of its companies being sued. In fact, some of our venture-backed companies are now being sued twice: once in state court and once in federal court on the same count. Rather than reducing the number of questionable securities class action suits, we have found that since the Reform Act companies are being burdened with two questionable cases thereby increasing legal and administrative expenses. In addition, it appears that those companies being sued since enactment of the Reform Act continue to be disproportionately venture-backed high technology and high growth companies.
An important element of the 1995 Reform Act was its anti-abuse provision designed to limit the ability of plaintiffs' lawyers to conduct expensive and burdensome discovery "fishing expeditions" of companies in the hopes that by rifling through a company's files a legal claim could be patched together which could form the basis for a forced settlement. Plaintiffs' lawyers are circumventing this critical provision by filing cases in state courts where the federal anti-abuse discovery reforms do not apply.
THE "SAFE HARBOR"
One of the most important provisions of the Reform Act for high technology companies is the "safe harbor" for forward-looking statements. The safe harbor provides protection from liability for certain forward-looking statements made by company management. By eliminating the threat of lawsuits if predictions fail to materialize, the safe harbor was intended to encourage companies to disclose more information to investors.
Venture capitalists have a unique perspective on this issue because we are both investors and often board directors in the companies in which we invest. This can put us at odds with ourselves. As board directors, in constant fear of meritless suits, we urge our companies never to make a forecast. As investors, we urge our companies to produce the most detailed and far reaching forecasts possible.
The safe harbor was intended to end our internal conflict because it allowed specific disclosures thereby increasing the flow of information to all investors without the Board of Directors' fear of unwarranted securities class action litigation. Particularly in today's highly volatile stock market, the safe harbor would have been a tremendous tool for all investors. However, most venture capitalists who sit on public boards continue to advice their CEOs to refrain from making forward looking statements that would be covered by the Reform Act's safe harbor. Why? As long as we continue to face securities class actions filed in state courts, which are beyond the reach of the federal safe harbor, we must urge our companies to remain silent or they will be exposed. Simply put, one of the most important objectives of the federal reforms is being undermined by the increase in securities class actions on the state level.
Thus, threat of state litigation now chills voluntary disclosure encouraged by federal law. As a result, investors are denied the information they need to make sound investment decisions. Fearful that financial forecasts will be thrown back at them in court, young companies are deciding, with our advice and consent, that it is better to say nothing. In this environment, projections about the future- - the very information most critical to investors - - seem particularly foolhardy. The lack of information, in turn, likely dilutes the enthusiasm of investors to invest in emerging businesses thereby making the capital markets less efficient.
WHAT CAN BE DONE?
NVCA, in conjunction with the Uniform Standards Coalition, believe that there is a simple way to make the Reform Act work. Legislation (H.R. 1689) introduced on May 21, 1997 in the House of Representatives would establish uniform standards governing private class actions involving companies issuing nationally-traded securities. It already has the support of two-thirds of the members of the House Commerce Committee, as well as numerous leaders in the House Republican and Democratic leadership. The proposal would require that securities class actions be litigated in federal court under a uniform federal law. The legislation is narrowly focused to reach only those types of claims that traditionally have been brought in federal court under federal law, while leaving undisturbed those claims that historically have been brought in state court under state law.
NVCA would like to see legislation like H.R. 1689 introduced and acted upon by the United States Senate as soon as possible. The proposed legislation would finish the job the Congress began in 1995. We believe this bill has been carefully and narrowly crafted to assure widespread bi-partisan support.
Investors, employee/shareholders, emerging growth CEOs and venture capitalists have lived with this odious problem for too long. We worked with you to obtain passage, after a very difficult fight, of the 1995 Reform Act. We fought and triumphed decisively against Proposition 211 in California, but only after spending too much time and too much money on the matter. We now look to you to end what can only be described as a blatant attempt to circumvent the will of Congress and the will of the citizens of the United States.
Last month, over 800 emerging growth company CEOs and venture capitalists wrote House Commerce Committee Chairman Bliley about the need to enact H.R. 1689 as expeditiously as possible. We strongly urge the United States Senate to do the same.
Meaningful national securities litigation reform which cannot be circumvented by state laws is an absolutely critical issue to emerging growth companies and those who invest in them. For years the very companies that have been creating the largest share of the Nation's jobs in some of the most far-reaching technological and medical fields have been victimized by abusive securities suits. These highly questionable legal challenges have dampened our ability to make even greater strides as we move into the 21st century. Uniform standards legislation will complete the commendable job Congress did through the enactment of the Reform Act in 1995.
Simply put, uniform standards legislation will help America's most important and
technologically advanced companies to grow while giving investors the information they deserve
to make prudent investment decisions.
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