Mr. Chairman and Members of the Subcommittee, Sun Microsystems is honored to be invited to testify on an issue that is important to every American who works or invests in high technology companies.
I am Vice President and General Counsel of Sun Microsystems, Inc. of Mountain View, California. Founded only 16 years ago in 1982, analysts estimate that Sun's revenues will exceed $ 1 0 billion for the fiscal year ending June 3 0, 1998, and the Company employs over 22,000 people world-wide. We are one of the world's leading manufacturers of computer workstations and servers, and related software. In fact, approximately 50 percent of all our sales are exports. We enjoy the leading market share in our segment of the industry in Japan - Sun is the only American company enjoying market share leadership in any significant segment of the computer industry in that country. Sun has been a public company since 1986. We are proud of this record of success and determined to continue it.
Five years ago, our CEO, Scott McNealy, testified before the full Committee about securities class action lawsuits that had been brought against Sun and the lasting impact of that litigation on the Company and its investors. You and your colleagues heard us and responded. To address clear evidence of abuses in the system, Congress passed the Private Securities Litigation Reform Act of 1995 - landmark legislation intended to preserve a meaningful deterrent to fraud while eliminating the frivolous "strike suits" that had come to characterize the lOb-5 cause of action. We strongly supported that legislation and applauded its passage. Today I appear before you again on behalf of
Sun to urge you to address an unfinished part of the reform agenda that none of us could have fully anticipated five years ago.
The Unintended Effects of the Private Securities Litigation Reform Act
From the moment the 1995 Reform Act was passed, plans already were underway to subvert it. The securities bar's first effort was in the form of an initiative on the 1996 general election ballot in California, known as Proposition 21 1, that would have radically expanded the securities fraud cause of action in that state. By most assessments, the provisions of "Prop. 21 1 " would have exposed companies, their officers, directors and advisers to even greater liability than had existed under federal law prior to the passage of the Reform Act. The business community, investor organizations, pension funds, and many others mounted a massive effort to educate the public about the threat that "Prop. 21 1 " posed to the California economy. Notably, both presidential candidates - President Clinton and Senator Dole - also opposed the initiative. Fortunately, the voters ultimately rejected Proposition 211 by a three-to-one margin, sending yet another unmistakable signal that the American public was fed up with lawsuit abuses.
But even before this initiative was defeated, the securities bar was employing yet another tactic to circumvent the Reform Act's provisions; the filing of securities fraud class actions in state courts was already a well-established practice by November 1996. This development has been dismissed by some as unremarkable, noting that the number of cases filed in state court is relatively modest. But this "it's no big deal" attitude is not shared by those of us who have been the victims of class action abuses and who know of their lasting impact. On the contrary, from Sun's perspective, the migration of securities class action lawsuits to state court puts us and other growth companies in much the same posture as prior to 1995. As a business proposition, the real and viable
threat of securities class actions in state court forces us to act as if the Reform Act was never passed at all. This is true without regard to the number of cases in state court in any given year.
State court litigation of this type undermines virtually every objective Congress sought to achieve in the 1995 legislation, it particularly subverts the goal of increasing company disclosure of forward-looking information to investors. Congress correctly recognized that the release of corporate information is of enormous value in the marketplace. It can assist in capital formation, increase share prices and enhance shareholder values, reduce volatility and increase the liquidity of share prices, benefit investors by leading to more efficient pricing of shares, and equalize the availability of information to participants in the markets. To realize these benefits, Sun and other growth companies encouraged Congress to provide a "safe harbor" in federal law to encourage responsible forward-looking statements by corporate officials. But the advent of state class action litigation has foiled this provision for one simple yet compelling reason: we continue to be exposed to class action lawsuits in state courts for disclosures that would be protected by the federal safe harbor.
Put another way, until uniform standards make the safe harbor a true national standard, the safe harbor that Congress enacted in 1995 cannot have its intended effect.
Regretfully, Sun adopted a limited disclosure policy in response to being sued in federal and state court in the early 1990s - and that policy remains in effect today. We did not adopt this policy by choice; we adopted it by necessity.
The Impact of Securities Class Action Lawsuits: Limited Disclosure
Sun has had only one unnprofitable quarter in its history since point public in 1986 - and that was the quarter in which we were sued. A complaint was filed against Sun in federal court in May 1989 within a matter of days after issuing a special public advisory indicating that we would not meet Wall Street analysts' expectations and might suffer a loss. Three months later, when we released our results for the quarter in July 1989 showing the loss, two more class actions were filed. Eventually, all five cases were consolidated into a single matter in federal district court. In the September quarter of 1990, Sun reported earnings approximately 10 cents per share below the consensus of the analysts' estimates, but still showing a profitable quarter. Nevertheless, we once again were served within a matter of days with two federal class action lawsuits, which were consolidated into a single action.
Sun litigated these two matters vigorously, spending over $2.5 million on attorney fees and expenses in the period from June 1989 through January 1993; our directors and officers liability carrier spent approximately $2 million more. These figures do not include the public relations costs, many hours of senior management time diverted to the litigation, and the uncertainty generated by the situation. Faced with an estimated $300 million of potential theoretical damages, only $35 million of which was insured, our Board regarded it as a matter of fiduciary duty to explore settlement seriously, even though the idea of settling was deeply offensive to us. But the grim prospect of a jury trial, with all of its inherent unpredictability, forced us to consider any kind of "reasonable" settlement that might be achieved. Accordingly, the Company agreed to settle the first matter for $25 million, half of which was paid by the insurance carrier; and the second matter for
$5 million, half of which also was paid by insurance. Of course, one-third of these settlements went to plaintiff's counsel, not to any shareholder.
Unbelievably, after settlement of these two matters had been announced, we were then served with a shareholder derivative complaint in state court putatively brought on behalf of the Corporation against the Company's board and officers. A derivative action attacking the settlement of a securities class action was unprecedented at that time. This state action claimed that the settlement of the class actions was too generous, the result of mismanagement and was improperly apportioned between the Company and the insurance carrier. In addition, plaintiffs' counsel also threatened to file a claim alleging insider trading for trades which occurred outside and, indeed, well after, the original class actions. This exposed our senior officers and directors to substantial risk under circumstances where neither the Company nor its insurance carrier could indemnify them in the event of an unfavorable judgment. Furthermore, the initial derivative action placed at risk the settlement in the federal cases that we had worked so long and hard to achieve. As a consequence, we settled the two derivative actions for an amount that was less than the expected cost of a jury trial (though morally outrageous), spending over $500,000 in legal fees and expenses in the process.
Prior to both the federal and state lawsuits, Sun's managers went to great lengths to describe risks and to acknowledge our inability to be precise in our estimates of Sun's future performance. But we were not perfect; we were not fortune tellers. Indeed, in an industry that is as fast-paced and volatile as the computer industry and with a company that was and is growing as rapidly as Sun, it is inevitable that management's estimates of quarterly results are, sooner or later, going to be inaccurate. In the litigation environment that existed in the early 1990s, our Board decided that the legal risks of providing earnings and revenue projections to Wall Street analysts simply were too high. Thus, the Board instructed management to adopt a policy of limited guidance - in effect "chilling" disclosure. This was to be the most lasting consequence of our litigation experience.
Since 1989, Sun has provided no revenue or earnings projections to Wall Street and has refused to comment on analysts' independent projections. The most we will do is give "tonal" guidance on the general state of the business. As you may imagine, the principal Wall Street analysts have never been happy with this policy. It requires them, to a significant extent, to "fly blind" - meaning that their estimates of Sun's future performance are bound to be less accurate than otherwise would be the case if we made more complete disclosures, and placing them at risk with respect to their clients and customers. Moreover, the estimates of the analysts who regularly follow the Company have a much broader range than would be the case if we could make fuller disclosure, which likely depresses the stock price since investor hate uncertainty. And our capital costs are higher.
Despite these real costs, we adopted this limited disclosure policy in 1989 because the potential liability exposure was even more onerous. Unfortunately, the migration of securities class actions to state courts leaves us in the same regrettable position today, despite passage of the Reform Act in 1995.
The Need For Uniform Standards Legislation
One of the primary reasons that Sun supports uniform standards legislation is to end this Hobson's choice between limiting liability and limiting shareholder value.
The value of greater corporate disclosure is simply beyond question. Members of Congress from both parties, the President, the Securities and Exchange Commission, and many of the nation's largest pension funds, among others, all endorsed provisions in the 1995 legislation to encourage
disclosure. Academic literature overwhelmingly endorses its value. And Sun's own experience confirms that policies of limited disclosure likely reduces shareholder values, among other effects. Absent uniform standards legislation to make the federal safe harbor truly effective, the benefits of the increased flow of information simply will not be realized.
While the disclosure impact is our overriding concern, uniform standards legislation also would reduce other burdens on America's growth companies. Despite competing in the international market place and listing our securities on national exchanges, we now have a litigation system that exposes every company - its investors, employees and management - to potentially enormous class action lawsuits in 50 states under 50 different legal and procedural standards. The disproportionate target of these state court suits continues to be high-technology and biotechnology companies - the very businesses that are driving our nation's economic revival and creating more new jobs than at any time in our history. The economic conditions that characterize high-growth companies, such as volatile stock prices and unpredictable sales results, are the very conditions that plaintiffs' lawyers seize upon to file abusive claims. In 1995, Congress recognized the benefits that securities litigation reform would bring to all investors and workers in the growth economy. Today, Congress has the opportunity to realize the full potential of those reforms by establishing uniform national standards to end the migration of securities class actions to. state courts.
On behalf of all of Sun's employees, investors, officers and directors, we thank the Subcommittee
for considering this important legislation.
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