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Mr. Stephen Schatz
February 6, 2002
Chairman Leahy, Senator Hatch, and Members of the Senate Judiciary Committee:
It is an honor to appear before you today and offer my thoughts on possible responses to the Enron debacle. As a former federal prosecutor, I urge you to bring swift and severe punishment to the wrong-doers who have apparently harmed so many innocent people. As an advisor to numerous honest companies that depend on the capital markets, however, I urge you to be sensitive to the indirect consequences your actions may have on those whom are frequently targets of frivolous litigation.
Today, I am a senior member of the law firm of Wilson Sonsini Goodrich & Rosati, P.C., located in Silicon Valley and numbering over 700 lawyers. We are proud to represent some of the most innovative, successful companies in the United States. Our clients include leaders in computers (Hewlett-Packard, Sun), semiconductors (Cypress, LSI Logic, Micron, VIA), disk drives (Seagate), electronics manufacturing (Solectron), software (Autodesk, Sybase), networking (3Com, Juniper, Broadcom), aviation (America West), and biotechnology (Genentech). We currently represent approximately 300 public companies. We also represent hundreds of start-ups that are working to become leaders of their industry sectors. Frankly, our clients depend on the availability of capital and the integrity of the financial markets, both of which the Enron scandal has jeopardized. I am heartened to know that you are considering measures to ameliorate these harms and protected against future abuses.
As a litigator, I have devoted a significant portion of the last seventeen years of my life to defending securities class action, representing clients such as Hewlett-Packard, Informix, Convergent Technologies, InfoSpace, Unisys, Cirrus Logic, Critical Path, Splash, Ventana Medical Systems, Robertson Stephens & Co., Santa Cruz Operations, MicroAge, Pyramid Technology, STAC Electronics, Ventritex, Laserscope and Continental Savings. In defending more than sixty securities class actions over the past two decades, I have personally witnessed the explosive growth of frivolous litigation, the measures Congress has taken to curb abusive litigation tactics, and the salutary effects those measures have had.
II. The Private Securities Litigation Reform Act
Recognizing this serious problem, Congress adopted the Reform Act with broad bipartisan support. The Act contains numerous provisions, but three are particularly crucial to protecting companies and their employees from frivolous and abusive litigation. Those three are: the Safe Harbor for forward-looking statements, the discovery stay, and the heightened pleading standard. None of these provisions facilitated Enron's accounting scandal, and none will shield Enron from the consequences of its fraudulent conduct. Let me very briefly consider each in turn.
A. Safe Harbor
This protection, in conjunction with Regulation FD, has allowed investors to benefit from increased information flow and to make more informed financial decisions, by making companies less nervous about disclosing their necessarily uncertain hopes for the future. The Safe Harbor often serves as an effective tool for companies unfairly accused of fraud-by-hindsight. It does not, however, provide any protection for perpetrators of accounting frauds such as Enron's. Indeed, the Safe Harbor expressly does not apply to audited financial statements. In short, the Enron scandal and the Safe Harbor have nothing to do with each other.
B. Discovery Stay
The Reform Act's express command not to destroy evidence strongly protects plaintiffs. More importantly, in cases such as Enron's, in which the fraud seems clear and the likelihood of surviving a motion to dismiss seems almost certain, the Reform Act ultimately does nothing to prevent plaintiffs from getting the evidence they need.
The key Reform Act provisions did not cause the Enron scandal and will not allow Enron to escape punishment. They do, however, protect companies from frivolous lawsuits, onerous discovery and exposure to extortionary settlements. The concerns which motivated Congress to enact the Reform Act in 1995 and the Securities Litigation Uniform Standards Act in 1998 are equally valid today, as demonstrated by the fact that the number of private securities class actions filed each year continues to rise. The Reform Act remains of vital importance in defending honest companies against these often meritless suits.
III. Reform Proposals
For example, one proposed bill would allow plaintiffs to add RICO claims to their securities class action complaints, and thereby seek treble damages. At first blush, it may seem appealing to increase penalties for wrong-doers. In actual fact, however, cases such as Enron's already involve damages beyond any defendant's ability to pay, even absent the addition of RICO penalties. Thus, this proposal would do little to inflict additional pain on those who commit fraud.
Rather, this provision would allow plaintiffs' counsel to reflexively include a RICO claim in every garden-variety securities class action complaint, providing additional - and typically unwarranted - leverage in settlement negotiations. By adopting this provision, Congress would simply increase the frequency with which "innocent parties are often forced to pay exorbitant 'settlements'" -- precisely the sort of abuse this body sought to deter in 1995. Indeed, no less than then-SEC Chairman Arthur Levitt testified in favor of the RICO exclusion, recognizing that "[b]ecause the securities laws generally provide adequate remedies for those injured by securities fraud, it is ... unfair to expose defendants in securities cases to the threat of treble damages and other extraordinary remedies provided by RICO."
Similar proposals involve efforts to impose aider and abettor liability and/or joint and several liability for securities violations. In weighing these proposals, it bears mentioning that the Reform Act (in a section titled "Reduction of Coercive Settlements") already imposes joint and several liability - without exception - for knowingly violating the securities laws; in addition, the Act already specifies that if a defendant cannot pay its share of the damages due to insolvency, each of the other defendants must make an additional payment - up to 50% of their own liability - to make up the shortfall in plaintiff's recovery. The Reform Act provides for even broader contributions to make whole certain small investors. Also, in evaluating aiding and abetting liability proposals, it should be recognized that courts have taken a broad view of direct liability. Undue expansion of these doctrines could become a tool allowing plaintiffs to expose tangential defendants to enormous risk even in frivolous cases.
Effectively, expanding the scope of liability would give plaintiffs an undeserved bargaining chip with which to compel settlement of meritless cases. Congress recognized this risk in the enactment of the Reform Act, criticizing plaintiffs' "targeting of deep pocket defendants ... without regard to their actual culpability." These concerns remain equally pressing today, and should be fully considered in any reforms. In addition, keep in mind that the SEC is authorized to investigate and pursue civilly and/or administratively anyone who violates the federal securities laws, whether directly or as an aider and abettor, and, where appropriate, can refer the matter for criminal prosecution.
Another proposal would allow immediate discovery in cases where a company's accountant is named as a defendant. No doubt this was drafted to prevent Arthur Anderson-type document destruction abuses. Unfortunately, it would also allow plaintiffs to gut the Reform Act's discovery stay simply by naming company auditors in every lawsuit. (Moreover, as I explained before, the Reform Act itself prohibits the destruction of documents and provides severe penalties for violations.) Congress must carefully consider whether it wishes to punish every honest company with onerous and costly discovery obligations in response to Enron's extreme misconduct, particularly when early discovery will serve little purpose.