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February 2007 Archives

By Walter Olson

(This piece appeared in the Times of London Online, 6-27-06)

In America, the entertainment business furnishes much fodder for lawsuits, which is only fair since the lawsuit business furnishes much fodder for entertainment. Case in point: now that Barbra Streisand has scheduled a back-from-retirement concert tour, some fans say they�re miffed at having paid top dollar for tickets during her previous "retirement" tour on the assumption that would be their last chance to hear her. And so they�re talking about tagging the singing legend with a class-action lawsuit.

Any fan who truly relied on a figure like Streisand to keep to her vow of retiring, of course, would have to be touchingly unacquainted with show business history. The beloved artist's multiply repeated farewell tour has been a standing joke since at least the days of Sarah Bernhardt and Nellie Melba. A host of Sixties and Seventies acts, notably The Who and KISS, have kept this less-than-dignified tradition going to the present day, while Cher pulled a variation by stretching out her farewell tour to three years' duration.

So would a lawsuit in such circumstances be legitimate? After all, most trade authorities frown on the furniture or rug store that claims to have been "going out of business" for years. In fact, as a commenter at pointed out, John Farnham, the Australian pop singer, was denounced to his country�s consumer protection commission by a supposed fan in 2004 when he took to the road again not long after a concert tour billed as "The Last Time". The complaint was rejected and later the supposed fan, a struck-off solicitor, admitted he'd never actually attended the original concerts.

One possibly relevant American precedent comes from, of all places, the automotive business. Years ago it appeared that convertible cars were going to vanish from production and some enthusiasts bought the only model remaining, from General Motors, on the strength of its buzz as "the last convertible built in America". Instead, fashions shifted, convertibles came back into production and lawyers sued GM for loss of the cars� specialness and associated resale value. Their claim fell short, however: they had trouble showing that the car maker had itself made any such promises, as opposed to standing by while others chattered about the cars being the last of their kind.

Such lawsuits thrive in the first place, of course, because American law is peculiarly welcoming toward the class action format. Recently, following the revelation that James Frey, the author, had invented whole episodes in his sensational autobiographical bestseller A Million Little Pieces, lawyers filed at least a dozen suits around the US asking to represent aggrieved readers. One suit demanded from publishers not only refunds for all book buyers but compensation for the lost time spent reading the book. When Sony was caught using a non-existent reviewer to blurb several of its movies, the resulting class-action suits resulted in a deal in which a grand total of 170 customers filed verified claims, resulting in an aggregate payout of $5,000 by the studio, while lawyers representing the class got $458,000.

A round of jokes at Barbra's expense, rather than a trip to court, would afford the best consumer protection here.

Walter Olson edits and and is a senior fellow at the Manhattan Institute. He is also the author of The Rule of Lawyers.

To shoot yourself in the foot is bad enough for U.S. capital markets; so why are we reloading and firing again?

By Jim Copland

(This piece appeared in the December 2006 issue of Chief Executive Magazine)

At the turn of the 20th century, most American companies were incorporated in the state of New Jersey. Today, of course, public companies are typically chartered in Delaware.

How did New Jersey lose the valuable corporate charter business to its southern neighbor? As New Jersey's governor, Woodrow Wilson led a crusade to "trust bust" big businesses through the state's unique position as the incorporation state of choice. Predictably, however, businesses chafed at the new restrictions and moved to Delaware, which had incorporation laws identical to New Jersey's old regime. Today, Delaware's low taxes are due in part to Wilson's folly; the state earns over 40 percent of its general revenues from incorporation fees.

This history lesson is apropos today, as the U.S. appears to be losing its long-established grip on the market for publicly traded securities. IPOs on European exchanges surged past those in the U.S. in 2005, in terms of both number (603 to 433) and the total offering value (51 billion euros to 28 billion euros)�marking the first time that the U.S. had not led at least one of the two categories Only two of the 20 largest IPOs in 2005 were listed in the U.S.

Although some weakening of the American position is inevitable as foreign capital markets grow more sophisticated, closer examination of 2005 numbers makes this reversal of fortune more ominous. Among overseas IPOs, in which a registrant listed in a non-home market, Europe placed 126 offerings worth 9.6 billion euros, as compared to America�s 23 offerings worth 3 billion euros. London has become the venue of choice for large Russian and Chinese IPOs. Even for venture-backed start-ups, European exchanges hosted 60 IPOs in 2005 versus 41 in the U.S.; nine of the 10 largest VC offerings went public in Europe.

What explains the rush away from the U.S.? The biggest explanatory factor is the Sarbanes-Oxley Act of 2002. Its many new demands include greater reporting requirements for insider trading; firewalls to ensure auditor independence; bans on most personal loans to company officers and directors; and stiffer civil and criminal penalties.

Notable from the perspective of being publicly listed on U.S. exchanges is Section 404 of SOX, which requires an internal control report in each mandated annual 10-K filing. According to a survey of over 200 businesses with average revenue of over $5 billion, annual Section 404 compliance costs totaled over $4 million per company; analysts estimate a total direct compliance cost of $6 billion. Small-cap companies suffered a 22 percent rise in audit fees, versus 6 percent for mid-cap, and 4 percent for large-cap corporations.
What's more, SOX imposes huge indirect costs through what Professors Larry Ribstein and Henry Butler, authors of The Sarbanes-Oxley Debacle, characterize as "interference with business management, distraction of managers, risk aversion by independent directors, over-criminalization of agency costs, reduced access to capital markets, and the crippling of the dynamic federalism that has created the best corporate governance structure in the world." Ribstein and Butler estimate the total indirect costs of SOX to top $1 trillion and point to a "litigation time bomb" waiting to explode.

American businesses already suffer from an out-of-control legal system, which, even excluding securities litigation and the massive multistate tobacco settlement, costs more than twice as much as the legal systems of other developed nations as a percentage of the economy. Moreover, America's securities litigation industry imposes a direct tax on companies that enter the U.S. public equity markets. Though hailed as defending the small investor, securities litigation brings no direct benefit to most shareholders.

What�s more, though the threat of litigation clearly creates incentives that affect the behavior of corporate officers, the changes in behavior do not seem to be related to improving information relevant to market pricing. In part, this failing can be explained by the excessive cost of discovery in securities class action litigation, which enables plaintiffs' attorneys to extract substantial settlement values from defendant firms, regardless of case merits.

In 1995, Congress tried to reform securities litigation through the Private Securities Litigation Reform Act (PSLRA). First, the PSLRA tried to rein in "strike suits" in which securities lawsuits are filed whenever a stock price sees a rapid, major decline. Such stock price drops are regular occurrences in the technology sector, which naturally trade at high multiples of current earnings, if any, and are priced based on speculative assumptions about future earnings growth. The PSLRA sought to address the issue by requiring more in-depth pleading standards to support a securities claim and automatically staying discovery while a motion to dismiss is pending.
Second, the PSLRA tried to remedy what legal scholars call the "agency cost" problem inherent in any class action litigation. By definition, individual claims are small for class litigation, so no individual plaintiff typically has sufficient interest to monitor or control the class attorneys. As securities class action king Bill Lerach once boasted to Forbes, "I have the greatest practice in the world. I have no clients." To fix this issue, the PSLRA forced judges to select the investor most likely to protect the class of claimants' interests�typically the largest investor�as the lead plaintiff, rather than permitting the first plaintiff filing suit to control the litigation.

Unfortunately, the PSLRA did not, in general, work as intended. After an initial one-year decline, the number of securities lawsuits filed annually essentially returned to the pre-PSLRA level, and indeed increased slightly.

Enterprising plaintiffs' lawyers realized that the largest investors in the economy were none other than public employee pension funds, typically governed by politicians and state employee union heads. The securities lawyers cultivated these constituencies. Furthermore, if federal prosecutors' indictment against Milberg Weiss is to be believed, at least some securities lawyers skirted the PSLRA by offering kickbacks to individuals who filed bogus suits.

Meanwhile, SOX opens up new avenues of litigation by imposing hosts of new disclosure and monitoring requirements and thus theories of liability. It also gives firms strong incentives to develop more complex mechanized oversight systems, which will make public companies even more susceptible to onerous electronic discovery.
So what's a CEO to do? There may be some synergies created by acquiring smaller companies overburdened by the new requirements. But such savings should not be overstated �and are likely outweighed by greater exposure to securities litigation.

Clearly, the incentive to take one's company private, or to delist from U.S. markets and relist overseas, is now more compelling. But the preferable�and certainly the more patriotic�response is to encourage Congressional leaders to revisit SOX as part of a comprehensive securities law reform, closing the loopholes left open by the PSLRA. If not, U.S. markets may suffer New Jersey�s fate from a century ago.
Jim Copland is the director of the Manhattan Institute's Center for Legal Policy. This article is based on his testimony before the House Financial Services Subcommittee on Capital Markets, Insurance and Government- Sponsored Enterprises of International Tort Costs.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.