House subcommittee hears litigation reform debate.

In hearings on private securities litigation reform, corporate, investor, consumer and academic representatives testified before the House Energy and Commerce Telecommunications and Finance Subcommittee. The subcommittee, chaired by Congressman Edward Markey (D-Mass.), heard testimony on litigation abuse under section 10(b) of the Securities Exchange Act of 1934 and on the Securities Private Enforcement Reform Act (HR 417). The bill, subject of a House hearing for the first time, is sponsored by Congressman Billy Tauzin (D-La.).

HR 417 calls for a proportionate liability standard to replace the joint and several liability standard under Securities and Exchange Commission rule 10b-5. Tauzin called rule 10b-5, which was written to ensure that investors are compensated for losses due to securities fraud, a tool used by speculators to recoup losses from risky investments. The Louisiana representative said speculators' attorneys file frivolous class-action suits against companies whose only crime is a drop or gain in the price of their stock.

Speaking for the six largest accounting firms, J. Michael Cook, the chairman and chief executive officer of Deloitte & Touche, Wilton, Connecticut, argued that joint and several liability promotes "market incentives" for plaintiffs' lawyers to pursue cases "without regard to the merits of the underlying claims." Cook said proportionate liability can reverse the liability burden by changing incentives so as to force plaintiffs' attorneys to focus on cases with merit.

Opposing HR 417, Arthur Miller, Bruce Bromley Professor of Law at Harvard University, Boston, emphasized that there is no real explosion of securities fraud cases. Joel Seligman, professor of law at the University of Michigan, said studies show that securities class actions are "not primarily a vehicle for enriching lawyers." However, Seligman agreed that "bounty payments" to professional plaintiffs should be outlawed, as proposed in the Tauzin bill. And consumer advocate Ralph Nader, representing the Center for Study of Responsive Law, accused the accounting profession of seeking more limitations on liability, more privilege and more immunity.

But Cook countered the opposition, saying more than 90% of U.S. public companies are facing a severe litigation crisis and the largest CPA firms pay nearly 12% of their audit revenues on settlements as a result of lawyers targeting accounting firms as "deep pocket" defendants.

Said Cook, "Too often each year I must decide between risking the future of my firm in a trial involving complex auditing issues or capitulating to the coercive tactics of a plaintiffs' lawyers." Although his firm may not be responsible for the calamity that befell a company or its shareholders, said Cook, "the plaintiff's lawyers know I am reluctant to authorize the expenditure of several million more dollars in attorneys' fees and expenses to go to trial, running the risk of having to pay the full amount of damages that could destroy my firm."

Warning of the pitfalls to clients of excessive litigation, Cook said accounting firms increasingly are engaging in aggressive risk management, declining to provide services to potential clients, such as new companies and high-growth companies, that present high litigation risk. "As a result," said Cook, "newer and smaller companies may find it difficult to obtain advice from professionals." He also said that litigation risk is making it increasingly difficult for accounting firms to attract and retain high-quality personnel, and he cited a study that suggests one-third of departing managers and half of all partners leave CPA firms because of the fear of legal liability.

The SEC has yet to take an official position on HR 417, but SEC Chairman Arthur Levitt said, "The SEC certainly supports a number of the proposed measures that would enhance investor protection while deterring frivolous and abusive litigation." However, the chairman did express reservations about proportionate liability proposals, saying that they would deny investors certain protections that are "our fundamental right to preserve and protect."

Because of a full legislative schedule, which includes health care debates, it is not likely Congress will address private securities litigation legislation again before the October adjournment.

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