Lawsuit-protection measure would allow too many bad guys to get away

STAYING AHEAD

June 19, 1995|By JANE BRYANT QUINN

NEW YORK -- A lawsuit-protection bill is speeding through Congress that will give freer rein to Wall Street's eternal desire to hype stocks.

It's cast as a law against frivolous lawsuits that unfairly torture corporations and their accountants. But the versions in both the House and Senate do far more than that. They effectively make it easier for corporations and stockbrokers to mislead investors. Class-action suits against the deceivers would be costly for small investors to file and incredibly difficult to win.

I'm against frivolous lawsuits. Who isn't? But these bills would choke meritorious lawsuits, too. They affect only claims filed in federal court, so bilked investors would still have the option of seeking justice in state courts. But the federal law would set a terrible precedent and leave the markets more open to fraud.

The congressional proposals started out as a way of protecting companies against so-called "strike suits" -- lawsuits filed against firms whose stock price unexpectedly plunges.

The firms complain that "vulture lawyers" lie in wait for these drops in price. When they occur, the lawyers find a willing plaintiff and immediately file suit. The usual charge: that the firm, its executives and accountants misled investors with falsely optimistic statements. That's not true, the companies say, but they tend to settle just to avoid the legal expense. If so, this represents a grave cost -- on corporations, shareholders and economic efficiency.

But are strike suits really overwhelming corporations? There's evidence on both sides of this issue, but most of it fails to document the executives' broad complaints.

Take the new study by Baruch Lev, a professor at the University of California at Berkeley. He looked at public companies whose share price dropped more than 20 percent in the five days around the time of a disappointing quarterly earnings report. There were 589 such cases, from 1988 through 1990. But related class-action suits were filed against only 20 of the firms.

Lev compared those 20 firms with similar firms where no lawsuit was filed. Among other things, the litigated firms tended to put out rosy statements -- in some cases, just before releasing the bad earnings report. By contrast, the firms that weren't sued tended to publish more sober statements and warn investors in advance that earnings would be lower than expected.

Lev warns that his sample is too small to reach statistical conclusions. But his basic data undermines the claim that companies are bombarded with lawsuits whenever their stock goes down.

The new bills contain many provisions to worry investors. For example, if you lost a class-action suit, you might have to pay the legal fees for the other side.

The bills also give excessive protection to so-called "forward statements," which are the business projections that corporations make.

Under current law, it's OK to make a reasonable projection, even if it doesn't come true. But a company can be held liable for an unreasonable projection that misleads investors. In many of the cases where lawsuits are brought, "executives are telling the public that everything is going to be great while they're bailing out and selling their own stock," Jonathan Cuneo, general counsel of the National Association of Securities and Commercial Law Attorneys, told my associate Louise Nameth.

If these bills become law, however, companies could get away with misleading, even reckless statements. To win a class-action lawsuit, you'd have to prove that a falsehood was uttered with a clear intent to deceive. That's incredibly tough to do.

This provision, in particular, troubles Arthur Levitt Jr., chairman of the Securities and Exchange Commission. "The law should not protect persons who make material statements they know to be false or misleading," he says, "nor should it protect offerings such as penny stocks, nor persons who have committed fraud in the past."

Baseless lawsuits do indeed exist. Lawyers may earn too much from a lawsuit, leaving defrauded investors too little. The incentives to sue should be reduced. But not with these bills. They'd let too many bad guys get away.

You can write to Jane Bryant Quinn at: Newsweek, 444 Madison Ave., 18th floor, New York, N.Y. 10022.

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