ORAL STATEMENT BY CHAIRMAN ARTHUR LEVITT UNITED STATES SECURITIES AND EXCHANGE COMMISSION BEFORE THE SUBCOMMITTEE ON SECURITIES COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS UNITED STATES SENATE APRIL 6, 1995 Chairman Gramm and Members of the Subcommittee: I appreciate this opportunity to testify on behalf of the Securities and Exchange Commission regarding proposals to reform the system of private litigation under the federal securities laws. Mr. Chairman, I begin by noting that, although I find myself in the middle of one of the most contentious debates over legal remedies in our nation's history, I am not a lawyer. But in this case, that may be as much an asset as a liability. My background is in business, and while I cannot address the fine points of legal history and court decisions that end up providing much of the fodder for this debate, I can speak to the practical impact of our system of litigation. I've managed enterprises in fields as varied as finance, agriculture, and publishing. I've built small businesses into large companies. I know the punishing costs of meritless lawsuits -- the time, the money, the anxiety. My experience on the boards of more than a half-dozen major public companies may also be instructive. In each case, my procedure was to make sure that the company had sound management, the board members had good reputations, and the company insured its directors. These questions arose from a healthy concern about liability -- and indeed, the private right of action served those companies well by reinforcing the conscientiousness of their directors. But there's another side to the story: There's the dozen or so entrepreneurial firms whose invitations I had to turn down, because they could not adequately insure their directors. Some of these companies later turned out to be huge successes, and some of them failed. While I like to think I would have made some small contribution had I served those firms, countless colleagues in business have had the same experience, and the fact that so many qualified people have been unable to serve is, to me, among the most lamentable problems of all. Mr. Chairman, I've seen many charts that try to prove a point about our litigation system -- charts that show there is a crisis, charts that show there is no crisis; charts that show an explosion in litigation, and charts that show no explosion. But from a businessman's perspective, the most important chart of all is one we'll never see, and that is a chart of the opportunities missed, the knowledge and experience not applied, the companies whose growth was hindered, and the enterprises that folded or never were -- all because of the fears and flaws connected with our litigation system. These flaws are magnified in their effect on entrepreneurs and professionals. We've wasted too much time on the wrong question, "Is there a crisis?" The right question is, "Can the system serve our nation better?" The answer to that is a resounding "Yes." The SEC has a clear interest in this issue. Private rights of action are fundamental to the success of our markets; they are an essential complement to the SEC's enforcement program; and they play a significant role in helping to ensure full and complete disclosure. The Commission must oppose any measures that would eviscerate investors' legitimate remedies against fraud. But at the same time, there is no denying that there are problems in the current system -- and that investors, markets, and corporations are being hurt by these systemic flaws. We must do something to reduce the excessive costs of a litigation system that threatens the vitality and competitiveness of the U.S. economy. I've made it clear that the SEC will work with any group, examine any idea, entertain any proposal, and consider any perspective, if it will help resolve this contentious issue without compromising investor protection. Over the last year, I've conducted a form of shuttle diplomacy with all parties to the debate -- the National Association of Manufacturers, representatives of the plaintiffs' bar, the state securities administrators, the AICPA, the AARP, investor rights groups, federal judges, the SEC's Consumer Affairs Advisory Committee, corporate executives, and countless others -- trying to move the dialogue along. The Commission supports a number of measures designed to eliminate abuses in class action lawsuits, and I'm more convinced than ever that in these areas, a consensus can be reached. Virtually all parties seem to agree with us that lawyers should not pay referral fees to brokers who refer clients; that named plaintiffs should not receive bounty payments; that we need to set a class organization period or some other method of eliminating the "race to the courthouse"; that disclosure to class members must be improved; and that private plaintiffs' legal fees should not be paid out of SEC disgorgement pools. Most parties also concur that civil RICO charges in securities fraud cases, and their treble damages, should be prohibited. The Commission believes that meaningful improvement to the existing system can be accomplished through a combination of legislation, increased judicial activism in the case management process, and the Commission's use of its own rulemaking and interpretative authority. Any revisions of the law clearly should not apply to SEC enforcement actions, which, if anything, would rise in importance to the extent that private action is modified. In terms of our own rulemaking, the Commission is already in the process of reviewing the adequacy of the safe harbor protections we grant companies for their disclosure of forward- looking information. This action alone could have significant impact on litigation practices; we hope to issue a proposal soon. We will file amicus briefs in support of motions to dismiss, or requests for sanctions under Rule 11. We've also created a Litigation Analysis Unit in the Office of the General Counsel. Turning now to legislation, we were concerned with some of the provisions in H.R. 10, the first securities litigation reform measure introduced in this Congress. While H.R. 1058, the measure that passed the House, was an improvement, we still have significant concerns about some of its provisions. I view S. 240, the legislation introduced by Senators Domenici and Dodd, as a positive step toward improving the private litigation system. To a large degree, I am in accord with the objectives of S. 240, as well as a significant number of the measures chosen to accomplish them. I urge all of us to work together to make certain improvements in the bill, including: * the adoption of the Second Circuit's pleading requirement, that plaintiffs plead with particularity facts that give rise to a "strong inference" of fraudulent intent by the defendant; * the restoration of aiding and abetting liability; * the adoption of an expanded statute of limitations that is not limited by a "should have been discovered" clause; * the inclusion of specific language that confirms the Commission's authority to provide a "safe harbor" for forward-looking information; and, finally, * the adoption of the Sunstrand definition of recklessness. Let me add that I am aware of the bill introduced earlier this week by Senators Bryan and Shelby; while I have not yet been able to examine it in detail, it evidently represents a thoughtful approach to the problem. Commissioner Roberts, who has examined the bill, does endorse that legislation. Mr. Chairman, both the Commission and the Congress recognize the dangers that flaws in the existing system pose to investors, to companies, and to our nation. We've come a long way toward crafting thoughtful legislation to address the problem, and we're down to the last five yards. It would be a happy circumstance for the nation if the Commission and the legislative and executive branches moved together to achieve a bill that protects investors and corrects problems in the litigation system. For my part, I have no doubt that, if we continue to work together, we can and will score a victory for all Americans. # # #