WASHINGTON - Fraud litigation involving municipal bond issues is expected to increase as a result of the Securities and Exchange Commission's new rules requiring more openness in the industry, a senior SEC official said yesterday.
"It is bound to be true that as we get better standards [for disclosure], you are going to see people testing inadequate disclosures" in court, said Simon Lorne, the SEC's general counsel.
At least, Lorne Said he hoped that would be the case.
His comments came as the SEC's new advisory committee on consumer affairs agreed yesterday to develop recommendations on the reform of private securities litigation that could lead to greater investor participation in class actions.
The advisory panel, meeting for the first time, took up litigation reform first at the request of SEC chairman Arthur Levitt Jr.
"There is a problem that ought to be addressed" that involves excessive "frivolous and vexatious" fraud litigation, Lorne said. But "it's important to the SEC that private litigation be there for meritorious cases," he said. Private action "is an important adjunct to our enforcement program," he said.
The SEC formed the consumer committee to help the commission protect individual investors, "which is our focus, our mission, and our passion," Levitt said yesterday.
The commission has embarked on an ambitious investor education program and is looking at day-to-day operations to see how it can better meet the needs of individual investors, Levitt said. The commission will seek opinions from the advisory panel in such prominent areas as the new municipal bond industry disclosure rules, he said.
Typically, private securities fraud actions are brought as class actions in response to falling bond or stock prices and they allege related disclosure violations, panel members noted. There is increasing awareness that shareholders may be "badly served" by class action counsel in search of big fees, Barbara Roper, director of investor protection of the Consumer Federation of America, told the SEC advisory panel.
Courts are beginning to recognize there is an excessive litigation problem, but there is a tendency "to throw out whole areas of cases," including those with merit, Lorne said.
The SEC probably will file more friend-of-the-court briefs in the future in securities fraud cases at the trial court level, as it does now in appellate court proceedings, Lorne said. "It may be useful, when there are clear questions of law, for the SEC to file a brief expressing its view on the law and perhaps provide comfort to the judge ruling on a motion to dismiss a case ... that turns on a legal interpretation," he said.
Of particular concern, Lorne said, is litigation against aiders and abettors of fraud. Courts are dismissing private cases involving aiding and abetting in response to a recent Supreme Court ruling in Central Bank of Denver v. First Interstate Bank of Denver. The ruling removed aiding and abetting liability from private right of action under securities law, he said. The SEC is seeking legislation to restore that liability.
Federal judge Vaughn R. Walker, who serves on the U.S. District Court for the Northern District of California, told the advisory panel that much of the litigation reform debate has focused on "private motives" of plaintiff lawyers who bring class actions against security issuers.
Some suits "appear to have little or no merit" and have hurt capital formation by companies, especially high technology firms, Walker said. But "the judiciary as a whole has maintained a reasonably balanced approach" to handling fraud cases, Walker said, and he questioned the need for legislation.
"Class actions are different" from conventional litigation "because there is no real client," Walker said. Judges can do more to ensure that investors represented in such suits, but who do not participate in proceedings, are served by establishing compensation for lawyers at the beginning of a case, he said. this would spur more competition among lawyers and law firms and help keep fees down, he said.
Walker urged the commission and investor and consumer groups to intervene more in private suits on compensation questions. Investor interests also should get more involved in settlements, he said, noting there is little investor review of settlement documents.
"Judges are unlikely to take the initiative to implement these steps themselves; they need a push," Walker said. Judges need guidance from the commission and investors, he said. At this point, "No one is in charge.."
Advisory panel members include: David Hunter, chairman of Hunter Associates and former chairman of the National Association of Securities Dealers; Peter Lynch, vice chairman of Fidelity Management & Research Co.; Edward O'Brien, attorney and former president of the Securities Industry Association; William Ouchi, adviser to Los Angeles Mayor Richard Riordan and professor at the University of California-Los Angeles; and Nancy Smith, director of the securities division of the state of New Mexico.
