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Abstract:
This paper examines the overlap between SEC securities enforcement actions and private securities fraud class actions. We begin with an overview of data concerning all SEC enforcement actions from 1997 to 2002. We find that the volume of SEC enforcement proceedings is relatively modest. We next examine the scope of the recently enacted "Fair Fund" provision that authorizes the SEC to designate civil penalties it recovers from defendants to benefit defrauded private investors. We conclude that this provision offers only limited potential relief for private investors. We complete this part of the paper with an analysis of the serious resource limitations faced by the SEC.

The second portion of the paper contains an empirical analysis of the determinants of SEC enforcement actions and the overlap of private fraud suits and SEC enforcement proceedings. In bi-variate analysis, we find that: private suits with parallel SEC actions settle for significantly more than private suits without such proceedings; SEC enforcement actions target significantly smaller companies than private actions alone; private cases with parallel SEC actions take substantially less time to settle than other private cases; and private cases with parallel SEC actions have significantly longer class periods than other private actions. Finally, we create a model for estimating damages to compare settlement ratios in cases with parallel SEC actions to those in private actions. We find that one-fourth of all the private class action settlements occurring in suits that yield less than 10% of provable losses are settled for less than .02 percent of provable losses, but that there are no private actions with parallel SEC suits with such small settlements.

In the final part of the paper, we conduct a multivariate regression analysis of the determinants of when SEC enforcement actions are filed. We find that the most highly significant determinant of SEC actions is financial distress. Estimated losses do not appear to be a statistically significant factor in the SEC's decision to file these suits.

Abstract:
This article presents the results of an empirical investigation of the frequency with which financial institutions submit claims in settled securities class actions. We combine an empirical study of a large set of settlements with the results of a survey of institutional investors about their claims filing practices. Our sample for the first part of the analysis contains 118 settlements that were not included in our earlier study. We find that less than 30% of institutional investors with provable losses perfect their claims in these settlements.

We then explore the possible explanations for this widespread failure. We suggest a wide range of potential problems from mechanical failures in the notification and recordkeeping processes to more subtle issues such as portfolio managers' beliefs that only investment activities produce significant returns for their clients.

In order to determine which of these problems were the main culprits, we surveyed institutional investors about their claims filing practices, asking them who was responsible for this task, how they performed it, and what, if any, performance monitoring was done. We learned that most institutions relied on their custodian banks to file claims for them in securities fraud class action settlements, that many of these institutions did little monitoring of whether the custodian actually performed these services, and that custodians had financial disincentives to file claims on behalf of their clients.

We argue that any such failures should be evaluated as potential breaches of the duty of care consistent with the monitoring obligations embraced in Delaware's Caremark decision. Applying this standard to our problem, we believe that the trustees of institutional investors must, in good faith, insure that their fund has an adequate system in place to identify and process the fund's claims. Furthermore, they should create a monitoring mechanism to insure that this system is adequate, and if they learn it is inadequate they should take measures to fix the problem. Custodians that file claims on behalf of their institutional clients should perform the various aspects of this job with due care, too, or face potential liability for negligence. We then identify several discrete problems with the claims filing system that can be addressed to help remedy the current situation.

We conclude our article with two observations about the implications of our results for the goals of securities fraud litigation. Our survey results show a serious mismatch between the beneficiaries of the settlement and those that have been harmed by the securities violation that gave rise to the settlement. Simply stated, many defrauded beneficiaries are not compensated for their losses, while others are unjustly enriched. Given the enormous importance of institutional investors in the market, this mismatch raises serious doubts about whether securities fraud class actions can be justified as compensatory mechanisms. Moreover, the poor claims filing records of institutional investors exacerbates this mismatch, as many investors are systematically deprived of any benefits from these settlements. This raises more doubts about the compensatory function of securities fraud cases.

Rather we believe the more persuasive rational for these cases is the deterrence of fraud. But in order to accomplish that purpose, we think that the current process needs to undergo some changes. We therefore suggest targeting securities fraud litigation at the individual wrongdoers, and invoking vicarious liability only when the company benefits from the fraud.

Institutional Investors, securities class action settlements, Caremark decision

Abstract:
The accounting and financial scandals the last few years not only produced the Sarbanes-Oxley Act, but have prompted a good deal of debate what forces led to so many dramatic reporting failures. This article is the only work to examine how the competitive structure of the accounting industry contributed to its movement from being a profession to a business that performed auditing. In the article we find not only documentation that the accounting profession is an oligopoly but a sound explanation of how its poor structure contributes significantly to negative social welfare. Throughout the article provides rich support of data to support explanations of the forces that have impacted the accounting profession as well as financial reporting. Most importantly, the article connects how the accounting profession's poor competitive structure likely contributed to the financial and accounting scandals of 2001 and 2002 by making it possible for the mangers of their audit clients to trade off better audits for consulting services. The article also provides insight into weaknesses that continue even after reforms such as those introduced by Sarbanes-Oxley. Several steps to strengthen the accounting industry so that it can return to being a zealous gatekeeper are also proposed in the article.

Abstract:
For most of the last one hundred years, the corporate approach toward related party transactions has been they can be managed, not prohibited. The most common approach toward managing conflicts of interests is review by the board's independent directors. The well-received monitoring role for directors of public companies envisions the outside directors carrying out their responsibilities to manage related party transactions, particularly pursuant to state conflict of interest statutes. This article makes the case that the ability of the outside directors to discharge this monitoring task in the case of related party transactions with senior managers is dependent upon their being assisted by "independent" counsel (counsel with no on-going relationship with the company or its senior management). Independent counsel is not now required for the board's review of conflict of interest transactions. However, we see that in analogous conflict situations that an independent counsel is an essential element for assessing the overall independence of the outside directors' actions. Thus, selectively injecting independent counsel is advanced as a modest extension of the law governing conflict of interest transactions that will significant impact in improving the quality of the outside directors' monitoring and managing related party transactions involving senior management.

Enron, Corporate Governance, Securities Law, Corporate Law, Sarbanes-Oxley

Abstract:
In this paper, we examine the role of institutional investors in securities fraud class actions. We begin by surveying the first five years of experience with the Lead Plaintiff provision of the Private Securities Litigation Reform Act (PSLRA). In particular, we look at those cases where the lead plaintiff position has been contested and the outcome of those disputes. We find that institutional investors have been very successful in obtaining the position of lead plaintiff where they have sought it, but that there are a number of cases where they were unsuccessful.

In part two of the paper, we dissect institutional investors' fiduciary obligations in petitioning to become lead plaintiffs and in filing claims in securities fraud settlements. For each major type of institution, we analyze their legal obligations under different legal standards in an effort to answer the question what obligation do they have to act in these areas. We conclude that institutional investors have a duty to file claims in settlements, except what we believe are rare instances where their cost-benefit calculations show filing to be unjustified. The case for becoming lead plaintiffs in securities fraud class actions is much more tenuous, though, as the costs of such a course of action may be substantial and the benefits are less certain.

The remainder of the paper focuses on the question of filing claims in settled securities fraud cases. Beginning with a discussion of the process of notifying claimants, we move to an empirical analysis of whether institutions actually file claims in these cases. We use a sample of 53 settlements. Our tentative findings are that only 25-33% of institutions that we can identify as having claims to file in these settlements are actually filing claims.The last section of the paper offers several theories as to why institutions are not filing claims. Among the theories proposed, we focus on three as the most likely candidates: first, that the institutions are making cost-benefit analyses of whether to file such claims, and concluding that they are not worth filing; second, that there are no internal personnel at the institutions that are responsible for filing the claims, and thus they never get made; and third, that the institutions may not be receiving notice of the settlements and claims forms from the banks and brokers that hold their shares for them. Each of these theories may explain some portion of the institutions' failure to file claims in securities fraud cases.

Abstract:
In this paper, we examine how those corporations that have been the targets of SEC enforcement efforts compare in terms of their size and financial health vis-a-vis firms that are targeted only by the private securities class action. We also ask whether the SEC or the private bar systematically proceeds against violators that cause the greatest loss to investors. In this regard, we are intrigued by the most basic question posed by private suits, whether settlements bear any relationship to the losses suffered by the class and whether those losses bear any relationship to the size of either the firm itself or the duration of the class action. Our data set consists of 389 securities class action settlements that occurred between 1990 and 2003.

Using multivariate regression analysis to examine the determinants of government litigation, we find a sharp change in the pattern of SEC enforcement actions after the end of 2001. We find that the SEC seems to have shifted its enforcement focus away from targeting frauds at firms in financial distress to seeking out frauds at companies where investors may have suffered larger losses, especially if they are smaller firms.

Again applying multivariate regression analysis, we look at settlement sizes in private class actions. We find that provable losses, total assets, class period and the presence of an SEC enforcement action, are all positively and significantly related to the dollar amount of the settlement obtained in a private action. These effects do not change over the time period of our sample. The fact that provable losses are such an important determinant of the size of actual recoveries supports the view that the "merits do matter."

SEC, Securities Laws, Enron6

Abstract:
In this paper, we examine the impact of the PSLRA and more particularly the impact the type of lead plaintiff on the size of settlements in securities fraud class actions. We thus provide insight into whether the type of plaintiff that heads the class action impacts the overall outcome of the case. Furthermore, we explore possible indicia that may explain why some suits settle for extremely small sums - small relative to the "provable losses" suffered by the class, small relative to the asset size of the defendant-company, and small relative to other settlements in our sample. This evidence bears heavily on the debate over "strike suits." Part I of this paper sets forth the contemporary debate surrounding the need for further reforms of securities class actions. In this section, we set forth the insights advanced in three prominent reports focused on the competitiveness of U.S. capital markets. In Part II we first provide descriptive statistics of our extensive data set, and then use multivariate regression analysis to explore the underlying relationships. In Part III, we closely examine small settlements for clues to whether they reflect evidence of strike suits. We conclude in Part IV with a set of policy recommendations based on our analysis of the data.

plaintiffs, securities, empirical class actions

Abstract:
This article links the growing income disparity in America to a possible metric that can be used to better assess the appropriate level of executive compensation. The article reviews the intellectual, commercial, cultural, and judicial forces that have each contributed toward the significant rise in executive compensation. Of particular note is the unqualified failure of courts and outside directors to provide meaningful supervision of executive compensation. This failure in part reflects the failure of society to develop guidance regarding what is the appropriate level of compensation for executives of public companies. The article concludes by reviewing evidence that income disparity within the firm, particularly the gap between executives and other employees within the organization are associated with firms that have high employee turnover, poor morale, and lower productivity levels than in firms where disparities are not as great. Herein lies the suggested standard that can be used for determining what is fair pay for CEOs and others.

Abstract:
In this paper, we provide an overview of the most significant empirical research that has been conducted in recent years on the public and private enforcement of the federal securities laws. The existing studies of the U.S. enforcement system provide a rich tapestry for assessing the value of enforcement, both private and public, as well as market penalties for fraudulent financial reporting practices. The relevance of the U.S. experience is made broader by the introduction through the PSLRA in late 1995 of new procedures for the conduct of private suits and the numerous efforts to evaluate the effects of those provisions.

We believe that the evidence reviewed here shows that the PSLRA's provisions have largely achieved their intended purposes. For example, many more private suits are headed by an institutional lead plaintiff, such plaintiffs appear to fulfill the desired role of monitoring the suit's prosecution and their presence is associated with suits yielding better settlements and lower attorneys' fees awards. SEC enforcement efforts, while significant, have tended to focus on weaker targets, suggesting that the big fish get away. Equally importantly, markets impose their own discipline on companies whose managers release false financial reports and, in turn, firms discipline the managers who are responsible for false misleading reporting, perhaps because of the presence of, or potential for, private enforcement actions.

Empirical Studies, Shareholder Litigation, PSLRA Provision, U.S. Securities Law

Abstract:
Notwithstanding cynicism to the contrary, data bears witness to the fact that government agencies come and go. There are multiple causes that give rise to their disappearance but among the most powerful is that conditions that first gave rise to the particular agency's creation no longer exist so that the regulatory needs that once prevailed are no longer present or that there is a better governmental response than Congress' earlier embraced when it initially created an independent regulatory agency to address the problems needing to be addressed. Certainly the more rigid the regulatory authority conferred on an agency has much to do with its ability to survive changes in the social, economic, commercial and scientific forces that shape its environment. One of the great illustrations of the vibrancy of the regulatory agency model, and particularly the notion of equipping such an agency with "quasi-legislative" authority through broad enabling statutes, is the Securities and Exchange Commission. But can an agency created and operating through most of its years in the internationally insulated environment of U.S. capital markets survive in a world that is light years away from the environment that existed a few years ago, not to mention 75 years ago when the SEC was created?

Abstract:
The PSLRA's lead plaintiff provision was adopted in order to encourage large shareholders with claims in a securities fraud class action to step forward to become the class' representative. Congress' expectation was that these investors would actively monitor the conduct of a securities fraud class action so as to reduce the litigation agency costs that may arise when class counsel's interests diverge from those of the shareholder class. Proponents of the provision claimed that there would be substantial benefits from having institutional investors serve as lead plaintiffs. Now, ten years later, the claim that the lead plaintiff is a more effective monitor of class counsel in securities fraud class actions continues to be intuitively appealing, but remains unproven.

In this paper, we inquire empirically whether the lead plaintiff provision has performed as projected. We break the lead plaintiffs into five categories: public pension funds; other institutional investors; single individual lead plaintiffs; aggregate groups of individual lead plaintiffs and groups containing both individuals and entities. Our data shows that courts fairly consistently favor financial institutions over other types of investors when there is a contest among them to be appointed lead plaintiff. We find that the public pension funds have much larger dollar claims than any of the other groups, and have the largest, or close to the largest, claims of any investors in the case in which they appear as lead plaintiffs.

We then analyze a sample of 388 securities fraud class action settlements to further investigate the effect of the lead plaintiff provision. Our first hypothesis is that PSLRA and the lead plaintiff provision have increased the dollar amount of settlements in securities fraud class actions. Our results show that after controlling for estimated losses, market capitalization of defendant firms, the length of class period and the presence of parallel SEC actions, the dollar amount of post-PSLRA settlements are not statistically significantly different from those in the pre-PSLRA cases in our sample. We also find that the ratio of settlement amounts to estimated provable losses - which is the most important indicator of whether investors are being compensated for their damages - was statistically significantly lower in the post-PSLRA period. In other words, the lead plaintiff provision and the PSLRA may have made investors worse off.

We next analyze the determinants of institutional investors' decision to become lead plaintiffs in the cases in our sample. Using a logit regression analysis, we find that institutions are more likely to become lead plaintiffs in cases involving larger provable losses, with longer class periods, with larger defendant firms, and when there is a parallel SEC enforcement action. Importantly, we find that the presence of an institutional lead plaintiff improves the securities fraud settlement, even holding constant estimated provable losses, firm market capitalization, the length of class period, and the presence of an SEC enforcement action.

Third, we examine whether recoveries are significantly different among settlements when a single (non-institutional) plaintiff represents the class compared with the lead plaintiff being either an aggregation of individuals or a group comprised of individuals and a non-institutional entity. We find that the single individual lead plaintiff does best in the smallest cases, and performs worst in the larger cases. Groups perform relatively better than individuals in larger cases.

Finally, we investigate press reports that institutions are aggressively lobbied by plaintiffs' law firms to appear as lead plaintiffs in "pay to play" schemes, with political contributions being made in exchange for institutional investors' agreement to become a lead plaintiff and select a preferred law firm as class counsel.

Lead Plaintiff, PSLRA

Abstract:
Federal appellate courts have promulgated divergent legal standards for pleading fraud in securities fraud class actions after the Private Securities Litigation Reform Act (PSLRA). Recently, the U.S. Supreme Court issued a decision in Tellabs v. Makor Issues & Rights that could have resolved these differences, but did not do so. This article provides two significant contributions. We first show that Tellabs avoids deciding the hard issues that confront courts and litigants daily in the wake of the PSLRA's heightened pleading standard. As a consequence, the opinion keeps very much alive the circuits' disparate interpretations of the PSLRA's fraud pleading standard. To be sure, Tellabs might ultimately be applied by lower courts to narrow the range of permissible approaches to satisfying the strong inference standard, but leaves a good deal of room within which wide variations in approach will continue.

Our second contribution is empirical in that we seek to answer the question: do plaintiffs' attorneys take advantage of the differences among the circuits' interpretation of the pleading standard to select more favorable venues to file their cases as some scholars have claimed? We find that 85% of the securities fraud class actions in our sample are filed in the home circuit of the defendant corporation. In the remainder of cases, those that are filed outside the defendant's home jurisdiction, our analysis shows that differences in the pleading standards do not explain a statistically significant amount of the reason for that decision.

While the differences in the circuits' pleading standards do not have a statistically significant impact on the plaintiffs' choice of venue, we find that plaintiffs are more likely to file low value cases in jurisdictions other than the one in which the defendants' headquarters is located. In particular, we find that cases with smaller provable losses and without an accompanying SEC investigation are statistically significantly more likely to be filed in circuits other than where the defendant's principal place of business is located. We interpret the former result as consistent with the hypothesis that in lower value cases, plaintiffs' counsel is more likely to select jurisdictions that are convenient to themselves rather than to the defendant. Conversely, when an SEC investigation is proceeding on the basis of the same operative facts, our results are consistent with the claim that plaintiffs' counsel will avoid filing outside of the defendant corporation's home jurisdiction to avoid procedural delays.

Securities, class actions, Tellabs, fraud, PSLRA

Abstract:
Mutual funds have enjoyed phenomenal growth with their numbers exceeding the number of public companies and their assets aggregating in excess of $9 trillion. Increasingly they are the investment instrument of choice by the proverbial widows, widowers and orphans, and a few school teachers are included as well. But how are best can that choice be one that is not only informed but informed in a way more likely to elicit a wise decision? This paper examines from a behavioral perspective how regulation can best disclose information related to two key factors for investors to compare competing mutual funds: fund returns and fund expenses. Our analysis reflects that the current disclosure process is deficient because it fails to reflect the insights of research on judgment and decision making, and particularly the need to distinguish between the availability of information and its processability by its user. The message of our article is straightforward: if regulators adhered to the insights provided by our paper, not only investors, but also the fund's directors, would be greatly empowered so that better returns and lower costs could be expected.

Abstract:
In October 2000 a hedge fund holding an unpaid debt claim won an enormous victory against the debtor, the Republic of Peru, through an opportunistic interpretation of the common pari passu clause by a Brussels court. This development was met by charges from policy makers and practitioners that the court's decision (its novel interpretation of the pari passu clause) would lead to a dramatic increase in the risks of holdout litigation faced by sovereign debtors. Over the ensuing years, multiple reform solutions were proposed including the revision of certain contractual terms, the filing of amicus briefs in a key case, and the imposition of an international bankruptcy regime for sovereigns. The question, looking back, that this Article empirically investigates is whether the capital markets actually perceived a significant increase in risk at the time of the October 2000 Brussels court decision. Equally important is whether markets discriminate among competing versions of the pari passu clause based on their relative risks for holdouts. And, to the extent the markets did react to the increase in legal risk, did any of the antidotes that were implemented to reduce the supposed increased holdout risk work? We offer evidence that bond prices did respond to this legal shock, that markets do discriminate based on the relative holdout risk posed by differing forms of the pari passu clause, and provide surprising evidence regarding the efficacy of the government-sponsored antidote, the advent of collective action clauses.

Abstract:
The metrics of generally accepted accounting principles is undergoing a debate in the wake of the accounting and financial scandals that began with Enron. Central to this debate is whether GAAP has become too rule based and needs to become more focused on principles. Sarbanes-Oxley calls on the SEC to undertake a study of the adoption of more principles-based reporting system for public companies. This article approaches the principles versus rules debate from the cultural perspective of the American boardroom with an emphasis on the monitoring model's dependence on not just the independence of directors but their outside advisor, the auditor. Extensive material is examined to explain the many forces that have caused auditors to be less independent on their audit clients. The principles-rules debate is also placed in the contemporary legal context where an overriding principle of liability and, hence, reporting continues to be that of fair presentation. We find that little has changed in the culture of auditing in the post-Enron era. Against this background the paper examines the likelihood that new requirements for the auditors and audit committee will lead to improved financial reporting, the objective sought by recent reform efforts. The paper concludes that many more reform steps are necessary to be undertaken by the Public Company Accounting Oversight Board if audit committees are to be able to strengthen the financial reporting process.

GAAP, PCAOB, Accounting Oversight, principles-based accounting, audit committee, Sarbanes-Oxley, SEC disclosure, accounting profession, non audit services

Abstract:
Due to globalization, the world is a much smaller place today than it was when the U.S. securities laws were enacted. In an era of global trading and offerings of securities disclosure policy for U.S. securities markets is formulated with a healthy respect for the rules, customs and practices of foreign markets. Thus, for policy makers, regulatory competition is as important a strategy as is harmonization. Theorists have long embraced the view that regulatory competition among markets will result in a regulatory hierarchy that is optimal for investors and the issuers of securities. In this article, Professor Cox takes the regulatory hierarchy paradigm to the next analytical level. He considers the policy implications of diverse regulatory standards within a single market, focusing much of his analysis on the significant issue presently confronting the SEC: Whether its registrants should be permitted to satisfy the mandatory disclosure requirements by using International Accounting Standards.

Abstract:
Corporate law is about norm management. Corporate statutes, the federal securities laws and judicial decisions erect standards for corporations, their officers and directors, and those that control the corporation must comply. Shareholder suits are is, theoretically at least, an important component in the management of corporate norms. Their success in achieving this goal, however, is dependent upon the expressive value of derivative suits and stockholder class actions. The initiation, prosecution and settlement of shareholder suit is more likely to reinforce the norms that are the subject of the suit?s allegations if shareholder suits enjoy a favorable reputation. This article examines the social meaning of shareholder suits; more particularly, the article evaluates the impact of certain procedural and substantive rules that govern shareholder suits. This examination is undertaken from the perspective of how its expressive value is impacted by the ambiguation of its objective, the tying of its mission to compensation instead of deterrence, the various procedural and substantive inhibitions that accompany shareholder suits, and rituals that attend the suits prosecution and settlement. The points developed in the article were delivered by Professor Cox at the Eighth Annual Abraham L. Pomerantz Lecture at the Brooklyn Law School in April, 1999.

Abstract:
In Part I of the essay (borrowing from Mark Twain, entitled "Lies, Damn Lies and Statistics") we examine the irrelevance of most of the data considered by the Congress during its hearings in 1993 and 1994 focused on securities fraud class actions. Part II responds to several commentators who argue against an entity-based sanction for market fraud; we argue that entity liability should be seen as a power disciplining force and not merely shifting money from one set of pockets to another. The final portion of the paper critques the Private Securities Litigation Reform Act. We conclude that the protector of the the class action's virtue lies with the superintending powers of the judiciary.

Abstract:
We argue that the only level of market efficiency that is significant in fulfilling the objectives of the Securities Act of 1933 informational efficiency (not fundamental or allocational efficiency) and that many commentators overstate the weaknesses in SEC regulatory initiatives by premising their criticism on funamental or even allocational efficiency arguments. We next argue that the major impediment to reforming the operation of the Securities Act is not shifting the focus to company registration as recommended by the Advisory Committee on Capital Formatin and Regulatory Processes, but the continual imposition of section 11 liability in the issuer's path as it speeds toward capital markets. We argue that so long as section 11 liability has such a focus the operation of the Securities Act will be transactional and will continue to stimulate many issuers to raise funds via Rule 144A or Regulation S. The paper concludes with a description of how section 11 liability could be shifted to a triennial review of Exchange Act filings with more limited "due diligence" standards applied to selected portions of the Securities Act registration statement.