The other day I mentioned that I think the threat of private securities litigation is vital for inducing compliance with the disclosure rules that apply to listed companies.
When people are sitting around a conference table deciding “do we disclose this or not?” there are many reasons not to disclose a piece of bad news.
Bad news can make shares harder to sell in an IPO or depress share prices (a problem that continues after the IPO, of course ). Executives own shares and options; they want a high share price. Bankers want to move product and earn fees; they don’t need bad news mucking up their pitches to institutional investors.
The lawyers sitting in the room will advise that disclosure offers insurance—that full disclosure deters SEC actions, criminal prosecution and shareholder litigation (or at least diminishes the chances of losing such litigation).
The odds of administrative or criminal enforcement may seem small and the upside of non-disclosure big, so often it is the fear of shareholder litigation that may tip the balance in favor of disclosure.
When share prices fall, it is shareholders that lose money, but if you own only a few shares in a company, it isn’t economically rational to pay a lawyer to sue to try to recover your losses. Enter the plaintiff’s bar, a group of aggressive, entrepreneurial lawyers who love to file class actions when a stock’s price goes down. They take cases on a contingency basis and can agglomerate lots of small claims (along with big ones) into massive class actions. Confronted with the prospect of staggering judgments (or, at best, long and expensive litigation), when sued companies often settle, admitting no wrong doing but making “nuisance” suits go away. The shareholders may get some money back, and the lawyers get paid. A lot.
Congress has sometimes stepped in to make it harder for lawyers to sue listed companies (particularly in the 1995 Private Securities Litigation Reform Act), but private shareholder litigation remains a big business in America.
If there is a face that personifies the threat of shareholder litigation, it is the face William Lerach, a fiery lawyer with Don King like hair. He has gotten very rich bringing private shareholder suits.
But now his former firm, Milberg Weiss, is reportedly imploding. And federal prosecutors have him in their sights.
This Fortune story details the saga.
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