To SEC and state securities regulators

From: RDShatt@aol.com

To: publicinfo@sec.gov, ri@nasaa.org, asc@asc.alabama.gov
CC: jmcpherson@naag.org, KDarcy@theecoa.org, pat@ethics.org, lrickard@uschamber.com, susan.reyes@shrm.org, tfrank@gmail.com
Sent: 10/13/2012 10:30:48 A.M. Central Daylight Time

Subj: Class action lawsuits that only shift losses around and that don't deter

Via email publicinfo@sec.gov

Mr. Mark D. Cahn, General Counsel
U.S. Securities and Exchange Commission

100 F Street, NE
Washington, DC 20549

Via email ri@nasaa.org

Mr. Russ Iuculano
Executive Director
North American Securities Administrators Association, Inc. (NASAA)
750 First Street, N.E., Suite 1140
Washington, D.C. 20002

Via email asc@asc.alabama.gov

Mr. Joseph P. Borg, Director

Alabama Securities Commission
P.O. Box 304700
Montgomery, AL 36130-4700

Dear Mr. Cahn, Mr. Iuculano, and Mr. Borg,

I am bothered by a certain type of large class action securities lawsuit that merely shifts shareholder losses around, that drains off huge amounts in attorneys fees, and that have little deterrent effect and may be counterproductive to achieving deterrence . The recently announced Bank of America $2.4 billion settlement regarding the Merrill Lynch acquisition is the latest example.

In this type of lawsuit, there is an accounting fraud or other failure to disclose adverse information, the stock price is "artificially inflated" and higher than what it would be if the fraud or other adverse information was known to the market, and there is buying and selling of shares on the open market prior to disclosure. In these transactions, the selling shareholders obtain the high "artificially inflated" price. After there is disclosure, the buyers, who have losses from paying the inflated price (which falls after there is disclosure), sue the corporation in a class action lawsuit. In the lawsuit against the corporation, the selling shareholders, who got the benefit of the wrongdoing that delayed disclosure and enabled them to get the "artificially inflated" price, are not parties in the lawsuit (so there is no recovery from those shareholders), and recovery of the losses is sought from the corporation. A recovery from the corporation is effectively out of the pockets of all the current shareholders, including the shareholders who bought the stock at the artificially inflated price and have experienced losses from the wrongdoing that delayed disclosure. As a result, such recovery against the corporation merely shifts losses around among various shareholders including those who experienced losses from buying at the inflated price. This shifting of losses around arbitrarily increases the losses of some of the shareholders who experienced losses from the wrongdoing (or shifts them to current shareholders who bought their shares before the wrongdoing occurred and did not either experience a loss or get a benefit from the wrongdoing) and reduces the losses of other shareholders who experienced losses.

In the arbitrary shifting around of losses, those losses are increased by huge amounts of attorneys fees that are paid in the class action lawsuit.

The failure of the class action to get recovery from parties who benefited from the wrongdoing in question and the arbitrary shifting of losses around among those who either experience losses or got no benefit from the wrongdoing largely makes the class action untenable as "doing justice" of compensating for losses.

That leaves a question of whether the class action lawsuit has a deterrent effect. I believe there is no deterrent effect where it is the corporation that pays the amount that shifts the losses around, and individual officers and employees who participated in the wrongdoing don't have to pay anything. Allowing these lawsuits may even be counterproductive to the goal of achieving deterrence.

Some examples of "circular payment" class action lawsuits

In 2007 Tyco was a particularly egregious example, and I tried to publish this: Tyco: On snookering clients out of $460 million.

n 2008 I was a member of the plaintiff class in a class action against Xerox and I wrote this letter to Judge Thompson and also corresponded with the Xerox Board of Directors and others, which correspondence can be found here. I think the unspoken sentiment of the Board of Direcotrs was, "we can't help the insanity of the law and the courts that this class action results in, but the (circular) payment is coming from Xerox and not out of our hides personally, so let Xerox pay the amount and let's move on."

Also in 2008, I was a member of the plaintiff class in a class action involving Monster, Inc. I wrote this to the lead plaintiff Middlesex County and then wrote this to various governmental retirement systems.

Deterrence

It is bad in these lawsuits that selling stockholders who benefited from the wrongdoing are not parties to the lawsuit and get to keep their benefit, and that the class action lawsuit against the corporation merely shifts losses around in an arbitrary way and further increases those losses by huge attorneys fees that are paid. Bad as that is, it needs to be considered whether there is nonetheless a deterrent effect that justifies these class action lawsuits.

I have done quite a bit of exploration of the deterrence question, with my primary focus being on the effectiveness of entity level liability versus individual officer and employee liability for deterring corporate wrongdoing. I have this ongoing project to find out what parties that have or should have an interest in the subject think. These include lawmakers, judges, regulators, state attorneys general, criminal prosecutors, corporate management, ethics and compliance officers, corporation lawyers, various academics, plaintiffs' lawyers, defense lawyers, tort reform organizations, and consumer protection organizations. I have written this Interim project report.

If you review the work I have done, I think you will have very serious questions raised for you about the deterrent value of these class action lawsuits and whether they are an enormous waste of resources and may even be counterproductive to business ethics.

Your role as securities regulators

The Securities and Exchange Commission and state securities regulators are charged with responsibility for protecting investors and preventing wrongdoing. The SEC and state regulators should have a sense about the justification for class action lawsuits where selling shareholders get benefit from the wrongdoing and the class action lawsuit merely shifts losses around arbitrarily among other shareholders and increases those losses by huge attorneys fees. The SEC and state regulators are also interested parties who should have views about the efficacy of entity level liability versus officer and employee liability for purposes of deterring corporate wrongdoing. In doing their job, the SEC and state regulators ought to provide lawmakers and judges the benefit of their knowledge and experience. This is particularly important if interested parties, such as corporate management and appendages of corporate management, probably do not want the issue of entity level liability versus individual liability to be delved into.

Amicus brief in Bank of America settlement

If these class action lawsuits are unjustified, one avenue for seeking correction is for securities regulators to approach lawmakers to seek corrective legislation.

Also the SEC and state securities regulators can and should endeavor to educate judges by filing amicus briefs, such as in the upcoming fairness hearing for the recent Bank of America settlement.

The brief should argue to the following effect:

In exercising its discretion as to approval of the settlement and attorney fees, the court is obligated under the law to be reasonable and not to approve something that has no reasonableness.

Reasonableness is properly determined with reference to doing loss compensation justice and to the deterrence value. If justice is not being done in compensating for losses and if there is no deterrence value to the litigation and it is wasteful of resources or even counterproductive to achieving deterrence, attorney fees that are approved should be correspondingly small.

First, this litigation does not promote an objective of the law to lessen corporate wrongdoing, and this litigation is in fact is counterproductive to that end and it undermines the fostering and inculcation of ethical business conduct. (For elaboration of this, see my article Does the civil liability system undermine business ethics?.)

Further this litigation does not serve the social utility of doing loss compensation justice. The selling shareholders who got the benefit from the wrongdoing are not parties in the lawsuit (so there is no recovery from those parties), and recovery of the losses is sought from the corporation. A recovery from the corporation is effectively out of the pockets of all the current shareholders, including the shareholders who bought the stock at the artificially inflated price and have experienced the losses Such a recovery against the corporation merely shifts losses around among shareholders who either experienced losses or were shareholders from before the wrongoing. This arbitrarily increases the losses of some of them (or shifts losses to current shareholders who did not experience loss from the wrongdoing or get a benefit) and reduces the losses of others. Further, the losses in question are increased by the huge amounts paid to the lawyers.

If this lawsuit is basically lacking in justification and purpose, for the court to approve the settlement, and the requested attorneys fees, the court will give incentive for more of these lawsuits that have no social utility to be filed.

The foregoing is a legitimate basis for the court not to approve the requested fees and to approve only very substantially reduced fees commensurate with the failure of the litigation to do loss compensation justice and with its very questionable deterrent effect.

Recipients of this email

I have included as recipients of this email the National Association of Attorneys General, and the Alabama attorney general (via Alabama AG contact form). I have furthered copied this email to the Ethics & Compliance Officer Association, the Ethics Resource Center, the U.S. Chamber of Commerce Institute for Legal Reform, and the Society for Human Resource Management, to offer those organizations an opportunity to express their views to you on this matter. The Center for Class Action Fairness is very active in court cases, and I am copying them on this email in case they would like to participate in an amicus brief in the Bank of America case. By separate correspondence I will contact law and ethics professors and other academics who have exhibited an interest in the subject matter, in order to solicit their participation in an amicus brief.

Thank you.

Sincerely,

Robert Shattuck

3812 Spring Valley Circle

Birmingham, AL 35223