Chairman Gramm, Senator Dodd and Members of the Committee, thank you for this opportunity to speak before the Subcommittee on legislation to establish uniform standards for securities litigation cases. As you know, Representative Rick White and I have introduced H.R. 1689, a companion bill to S. 1260 currently pending before your committee. Both bills are focused to solve specific problems resulting from the passage of the 1995 Private Securities Litigation Reform Act.
In 1995, Congress passed the Private Securities Litigation Reform Act. The law represented a bipartisan attempt to deal with the problem of meritless strike suits filed against high growth . companies. In most instances, these cases were settled out of court because companies made the calculation that it was cheaper to pay off the strike suit lawyer than become engaged in a protracted legal fight.
These actions had a considerable impact on Silicon Valley which I represent. High technology companies account for 34 % of all the issuers sued last year, and 62 % of all cases are filed in California. It is ironic that the very companies that have contributed disproportionately to the economic health of our nation and have been a great source of wealth for investors are the ones being harassed. They are being penalized for success.
There have been some notable successes related to the 1995 Reform Act, including a slowdown on the rush to the courthouse. However, one significant problem has developed. In the wake of enactment of the federal law, cases which have historically been brought before federal courts have shifted to state courts, where it is much easier to file complaints without substantial cause. State courts lack tight federal standards in the areas of pleading, stay of discovery, and safe harbor for forward looking statements.
Two significant studies have been undertaken to examine the impact of the 1995 Reform Act. One by the staff at the Securities and Exchange Commission, and one by Professors Grundfest and Perino at Stanford Law School. Both have revealed a considerable shift to state courts of securities litigation cases involving nationally traded securities.
Professors Grundfest and Perino found the overall number of cases has not fallen off significantly from pre-Reform Act levels. Prior to the Reform Act an average of 176 issuers were sued per year. Last year 150 were sued and an estimated 194 will be sued this year. While the overall number of cases filed has remained roughly constant, there has been a dramatic increase in the number of cases filed in state courts. Prior to enactment of the 1995 Reform Act, the number of cases involving publicly traded securities was negligible, ranging from one to four. In the first 18 months since passage of the Reform Act, 94 issuers were sued in state courts.
Analysis also shows a clear motivation for this shift to state courts. The SEC staff report found that 53 % of the cases filed cited claims based on forward looking statements. Also, as Chairman Levitt pointed out in testimony last week before the House Commerce Committee, 55 % of the cases filed at the state level are essentially identical to those brought by the same law firm in federal court.
Migration to state courts is not a minor problem. It represents an undermining of core reforms implemented in the 1995 Reform Act. This is because the Reform Act relies on uniform application and enforcement of the law to be effective. Without this uniform standard the law is undermined, the strike suits continue and companies and investors are held hostage. This is particularly true for two key elements of the 1995 Reform Act: Safe Harbor and Stay of Discovery.
When companies refrain from disclosing information about their projected performance, investors are unable to make informed decisions. Under normal circumstances this would not be a problem since most companies would be eager to talk about what they are doing. But meritless suits place a chill on disclosure. This is because any Wall Street analyst's expectation can cause a company's stock to fluctuate, even if the company is growing at a rate of 20% or 30%. Those filing the strike suit then claim that any forward looking statement, even if it was clearly an estimate and not a promise of stock performance, is grounds for a civil action.
Companies responded by ceasing to make forward looking statements. In response, the 1995 Reform Act instituted a safe harbor for companies making forward looking statements as long as those statements were not false or misleading. However, because of the threat of state court action where there is no safe harbor, this provision still has yet to be implemented. I've received letters from hundreds of business leaders who say they will continue to refrain from making forward looking statements as long as the threat of litigation not covered by safe harbor remains. This means that the most investor and consumer friendly portion of the 1995 Reform Act is not being used.
The second key element of reform is the stay of discovery pending motions to dismiss. Discovery is often the most costly part of the litigation process. It is especially burdensome when plaintiff lawyers tie up executives' time and request literally millions of pages of documents. As long as this threat is present, companies will have more incentive to settle early and avoid the cost of discovery than fight, even if the case has no merit. To counter this problem we enacted a stay of discovery in the 1995 Act. This does not prohibit plaintiffs from filing their cases, nor does it prohibit cases that have merit from moving forward. It merely delays the discovery process until a judge can rule on a motion to dismiss.
Because of the shift to state courts, the stay of discovery is not in place. This means the threat of huge legal costs remains and the incentive to settle meritless cases continues. Even worse, plaintiff lawyers are able to file a case in state courts, go through a process of discovery basically a fishing expedition - and then take those documents into federal court.
It is this undermining of the federal law that prompted Representative White and I to introduce our bill. I would like to make clear that the bill is not a federal power grab. This is returning to federal courts cases which until the 1995 Reform Act had always been heard in federal courts. It is limited in scope, and only extends to private class action lawsuits involving nationally traded securities. State regulators and law enforcement officials maintain their full range of options to take both criminal and civil actions in state or federal court. It is a targeted approach to a specific problem.
I want to emphasize that this legislation is not premature. In some instances the impact of certain provisions of the Reform Act are not clear because the courts are just beginning to consider these cases. This may be true for cases involving the pleading standard or lead plaintiff reforms, but in the case of the stay of discovery and safe harbor it does not apply. For safe harbor, as long as the threat of state actions remains, the reform will never be implemented. Companies will refrain from making forward-looking statements and investors will be denied access to information. In short, there are no cases whose outcome we can wait for, because there are no cases.
The same is true for stay of discovery. It is the threat of costly discovery that motivates companies to settle. As long as that threat remains at the state court level, we will never know if the stay of discovery is able to weed out meritless cases.
Chairman Levitt raised concerns that both the Senate and House bills may extend into certain types of cases which have traditionally been heard in state courts, especially in the State of Delaware, such as when company directors advise shareholders on proxy votes. I know Senator Dodd has made a commitment to work with the SEC staff to find a solution to this problem. I want to make clear that it is not my intention to interfere with these cases, and I will also continue to work with Chairman Levitt and his staff to address his concerns.
I'd like to thank Senators Gramm, Dodd and Domenici for introducing the Senate companion
bill, and each Senator who has become a cosponsor. I thank you for the opportunity to appear
before you today, and am eager to answer any questions you may have.
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