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Securities and Exchange Chihuahua

20 December 2013 By Reynolds Holding

One of Wall Street’s major watchdogs is set to lose some of its sharpest teeth. The U.S. Supreme Court is poised to muzzle shareholder class action lawsuits. While not part of the Securities and Exchange Commission’s official arsenal, they help deter fraud. Congress may allow the regulator to levy stiffer fines, which could fill some gaps. Clamping down on private litigation, though, will remove serious bite.

Such suits are undeniably effective. They produce more and bigger settlements than SEC investigations do and force out more senior executives, according to recent New York University and University of Michigan research.

Most cases are based on the legal theory that investors assume stock prices reflect all public information about listed companies, including lies. That excuses individual shareholders from proving reliance on particular misrepresentations, allowing them to sue en masse.

In March, though, the Supreme Court is scheduled to hear Halliburton’s claim that this so-called “fraud on the market” theory is unfounded, or at least can be rebutted with evidence that an alleged lie didn’t affect share value. The argument probably appeals to the nation’s top court, whose justices recently made it easier to toss out class actions, shielded mutual fund managers from liability and blocked suits against third parties involved in fraudulent schemes.

If Halliburton wins, Congress may offer a partial remedy. Lawmakers are set to consider increasing by more than 10-fold the penalties that individuals and companies must pay for violations. The SEC would still have to prove its cases, of course, especially at trial, where steely new Chairman Mary Jo White should be able to improve its less than stellar record.

The outlook isn’t totally bleak for securities fraud class actions. The law provides investors’ lawyers plenty of wiggle room. No matter what happens at the Supreme Court next year, suing over an omission – the failure to reveal an important fact – still won’t require proof of reliance on any particular information. And shareholders could start recasting lies as failures to disclose the truth.

Forcing investors into such contortions is hardly ideal, though. Efforts to hold fraudsters accountable have been sporadic at best since the financial crisis. By now it ought to be easier to bring them to justice, not harder.

 

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