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The Carlyle IPO

Years ago, Harvard Law professor Hal Scott suggested that New York financial markets could regain competitiveness by permitting securities issuers to opt out of the enormously wasteful securities litigation scam, whereby, on average, diversified shareholders had money transferred from the left-hand pocket to the right-hand pocket with enormous commissions taken by plaintiffs' and defense attorneys.

This year, privately-held Carlyle suggested it might make good on the idea with its IPO, which had a mandatory arbitration clause for such disputes. The SEC had previously, without much legal authority, blocked a less-restrictive arbitration clause in an IPO in the 1980s by Franklin First Financial, but Carlyle is deep-pocketed enough to have defended itself against the now Democratic-dominated regulators, which, indeed apparently opposed.

Shareholders who think class actions are good things can invest in one of the thousands of other securities out there; those who think class actions divert shareholder resources to attorneys now have a new, improved, investment option. Let the market decide which type of stock should trade at a premium and which at a discount. Even if trial-lawyer-controlled unions and pension funds boycotted the IPO, it shouldn't be enough by itself to depress the stock price, and would have had the side benefit of fewer frivolous proxy fights. (Moreover, Carlyle was to be a limited partnership, rather than a corporation, even further reducing the issue of fiduciary duties.)

Given that the DOJ's and SEC's criminal and civil penalties still applied, and such penalties are sufficiently draconian as to already create principal-agent problems between officers, directors, and shareholders, and given that well over 90% of meritorious civil securities litigation is simply piling on existing public disclosures, it's hard to say what permitting parasitical—or worse, meritless—civil litigation adds to investor benefit. One would thus expect Carlyle stock to trade at a premium: the boom in the Rule 144A private market suggests how beneficial it is for business entities to avoid the additional marginal litigation and regulation expense. See also Susan Beck.

But the litigation lobby was not satisfied with the simple possibility of letting investors have choice: only through monopoly power would investors willingly continue to let billions of dollars a year be unfairly siphoned into trial lawyers' pockets. Their water-carriers in Congress and the press spoke out loudly against the offering, and Carlyle has since backed down. AAJ declared victory, and Professor Stephen Bainbridge is understandably upset at being misquoted: but given that the trial-lawyer lobby was dishonest in getting the arbitration clause struck down, one can hardly be surprised that they continue to be dishonest afterwards.

Separately, strike another nail in the coffin for Professor Fitzpatrick's theory that the Supreme Court's recent jurisprudence will lead to the death of class actions.

It would be interesting to see which pension fund decision-makers with both ties to trial lawyers and fiduciary duties to fund participants lobbied against the clause; it would be entertaining if a fundholder brought a derivative suit on the issue. After all, such litigation is always a good, right?

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Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.