Paul Sarbanes

Mr. SARBANES

Mr. SARBANES. Mr. President, I ask unanimous consent that the order for the quorum call be rescinded.

Mr. SARBANES. Mr. President, I think it is important at the outset of this debate to try to dispel three misconceptions that surround S. 1260. The first is that class-action lawsuits alleging securities fraud have migrated from Federal court to State court since 1995 and the enactment of the earlier legislation. In fact, as I will describe in some detail shortly, every study indicates that the number of securities fraud class actions brought in State courts, while it increased in 1996, then declined in 1997. So the numbers do not support that assertion. The next misconception is that this bill would preempt only class- action lawsuits from being brought in State court. In fact, this bill likely will deprive individual investors of their own opportunities to bring their actions in State courts separate and apart from class actions. The final misperception about this bill, which is suggested, is that it enjoys widespread support. In reality, a broad coalition of State and local officials, senior citizen groups, labor unions, academics, and consumer groups oppose this bill. They oppose it because it goes too far. It will deprive defrauded investors of remedies. Once again, we have this classic example of being able to sort of try to address a problem and, instead of narrowly dealing with the problem, swinging the pendulum well beyond the problem and taking the so-called corrective legislation so far out that in and of itself it creates additional problems. Let me turn to the first misperception, the notion that securities fraud class actions are being brought in State court in order to avoid the provisions of the Litigation Act of 1995. It is correct that the number of such cases went up in 1996, the first year the Litigation Act was effective, but every available study shows that the number declined in 1997. For example, a study done by the National Economic Research Associates, a consulting firm, found that the number of securities class-action suits filed in State courts during the first 10 months of 1996 increased to 79 from 48 filed during the same period in 1995. In an update released in the summer of 1997, however, NERA found that the number of securities class actions filed in State courts during the first 4 months of 1997 declined to 19, down from 40 in the same period in 1996. So the number actually declined very significantly by more than half the first 4 months of 1997. These numbers are cited in a report that was prepared by the Congressional Research Service. In July 1997, Professors Joseph Grundfest and Michael Perino of Stanford University Law School testified before the Securities Subcommittee, and in their testimony they show that the number of issuers sued only in State class actions declined from 33 in 1996 to an annualized rate of 18 in 1997. A Price Waterhouse securities litigation study posted by that accounting firm on its Internet site corroborated NERA's findings. Using data compiled by Securities Class Action Alert, based on the number of defendants sued, Price Waterhouse reported that the number of State court actions increased from 52 in 1995 to 66 in 1996 but then declined to 44 in 1997. That was lower than the number of such actions in 1991 or 1993. The study went on to find that the total number of cases filed in 1997 showed little or no change--little or no change--from the average number of lawsuits filed in the period 1991 through 1995. Data provided to the committee by Price Waterhouse on February 20, 1998, also demonstrated that State court filings declined in 1997. Measured by the number of cases filed, the number of State securities class actions declined from 71 in 1996 to 39 in 1997. So much for this assertion of a rising number of suits being brought in the State courts. This really is a piece of legislation in search of a problem. And when you look at the facts, when you look at the numbers, the problem is not there. Now let me turn to the notion that this bill addresses only class- action lawsuits. I think most people understand a class-action lawsuit to refer to lawsuits brought by one person on behalf of himself and all other people similarly situated, an anonymous and potentially large group of people. For class actions to be certified in Federal court, the Federal Rules of Civil Procedure require that the class be so numerous that joinder of all members is impracticable. In Federal court, a judge normally must find that common questions of law and fact predominate over questions only affecting individual members. Class actions are a tool that allow plaintiffs to share the cost of a lawsuit when it might not be economical for any one of them to bring an action. But, because they can be brought on behalf of potentially an enormous class, they also carry with them the possibility of being misused to coerce defendants into settlement. This is the sort of situation that is ordinarily described by the proponents of such legislation as requiring a legislative enactment. But when you examine the legislation that comes in behind that assertion, you invariably find that the breadth of the legislation far exceeds this problem which they have identified, and which they constantly use in the discussion and the debate as the example of what they are trying to deal with. If we could limit the legislation to the examples that are cited, we might really come close to obtaining a consensus in this body about corrective measures. But the legislation goes far beyond the examples that are ordinarily used as constituting the basis for legislative enactment, and it is that expanded application of the legislative language, not the specific examples that are generally used, which creates the problem. This bill is another example of that. It addresses more than the type of class-action case which is ordinarily cited as constituting a potential abuse of the legal process. This bill contains a definition of class action broad enough to pick up individual investors against their will. The bill would amend the Federal Securities laws to include a new definition of class action. It would include as class action any group of lawsuits in which damages are sought on behalf of more than 50 persons if those lawsuits are pending in the same court, involve common questions of law or fact, and have been consolidated as a single action for any purpose. Even if the lawsuits are brought by separate lawyers without coordination--in other words, you have 50 different investors who feel they have been cheated and want to bring a lawsuit--there is no interplay or interaction amongst them, even if the common questions do not predominate-- which is a requirement in class-action suits, but weakened in this legislation--those lawsuits, under this legislation, may qualify as a class action and thus be preempted. So if an individual investor chooses to bring his own lawsuit in State court, to bear the expenses of litigation himself, he can be forced into Federal court. He can be made to abide by the Federal Rules if 50 other investors make the same decision about bringing a lawsuit, 50 other separate investors. Indeed, the bill provides an incentive for defendants to collude with parties to ensure that the preemption threshold is reached. Such a result goes well beyond ending abuses associated with class-action lawsuits. It deprives individual investors of their remedies. The definition of class action in the bill would preempt other types of lawsuits as well. It includes as a class action any lawsuit in which damages are sought on behalf of more than 50 persons and common questions of law or fact predominate. The bill specifies that the predomination inquiry be made without reference to issues of individualized reliance on an alleged misstatement or omission. This would ensure that the investor receives the worst of both worlds. While the investor could not bring a class action under State law, because each investor must prove his or her reliance, they nonetheless constitute a class action under the bill and their suit is preempted. Finally, let me turn to the assertion that there is little or no opposition to this bill. In fact, the bill is opposed by State and local officials very vigorously, as a matter of fact. I note there that Orange County has just begun the first of its recoveries, in terms of being defrauded. Senior citizens groups, labor unions, consumer groups, columnists and editors, legal practitioners and academics have all weighed in on this debate. The headline of a column by Ben Stein in USA Today on April 28, summarizes this opposition: ``Investors, beware: Last door to fight fraud could close.'' ``Investors, beware: Last door to fight fraud could close.'' He wrote of this bill, the legislation before us: State remedies would simply vanish, and anyone who wanted to sue would have to go into Federal court where impossible standards exist. He warns: This is serious business for the whole investing public. Mr. President, I ask unanimous consent that this entire column be printed in the Record.

Mr. SARBANES. A number of groups representing State and Government officials, including the National League of Cities, the National Association of Counties, the Government Finance Officers Association, and the U.S. Conference of Mayors, oppose this bill, as do the National League of Cities National Association of Counties, Government Finance Officers Association, and the U.S. Conference of Mayors. I ask unanimous consent that a May 11, 1998, letter from these and other groups be printed in the Record.

Mr. SARBANES. Why are these public officials concerned about this bill? Why are these associations that represent public officials all across our Nation concerned about this bill? Because these public officials invest taxpayers' funds and public employees' pension funds in securities. And they fear they will be left without remedies if they are defrauded. Testifying before the Senate Banking Committee, Mayor Harry Smith of Greenwood, MS, warned: The most potent protection investors have is the private right of action. To remove that protection could have grave consequences. We oppose taking such a risk. We oppose preemption of traditional State and local rights created to protect our citizens and taxpayers. This bill is inconsistent with Congress' renewed commitment to the preservation of federalism, and reduces protections for our retirees, employees, and taxpayers. Over two dozen law professors, including such nationally recognized securities law experts as John Coffee, Jr., Joel Seligman and Marc Steinberg, expressed their opposition in a letter earlier this year. I ask unanimous consent that letter be printed in the Record.

Mr. SARBANES. These distinguished law professors stated: We . . . believe that Congress should wait to ascertain the effects of the 1995 Act, as well as the direction of state law, before enacting any legislation that would undercut the longstanding role that state law has had in protecting investors from securities fraud. These distinguished academics oppose any legislation that would deny investors their right to sue for securities fraud under State law. Similarly, the New York State Bar Association opposes this bill. A report prepared by the Bar Association Section on Commercial and Federal Litigation concluded: ``The existing data does not establish a need for the legislation,'' and, ``the proposed solution far exceeds any appropriate level of remedy for the perceived problem.'' Let me repeat that quote from the report prepared by the New York State Bar Association Section on Commercial and Federal Litigation: The proposed solution far exceeds any appropriate level of remedy for the perceived problem. The opposition goes on. As additional examples, I cite a March 30, 1998, editorial from the National Law Journal entitled ``What's the Rush?'' This editorial concludes: The Senate should pause before it neutralizes State laws that still stand as a bulwark protecting investors against flimflam artists. Mr. President, I ask unanimous consent that this editorial from the National Law Journal entitled ``What's the Rush?'' and concluding by saying, ``The Senate should pause before it neutralizes State laws that still stand as a bulwark protecting investors against flimflam artists,'' be printed in the Record.

Mr. SARBANES. Mr. President, I would like to point out also the opposition of the American Association of Retired Persons, the Consumer Federation of America, the AFL-CIO, the American Federation of State, County and Municipal Employees, and the United Mine Workers. I ask unanimous consent that letters from these groups expressing their opposition to this bill be printed in the Record.

Mr. SARBANES. Mr. President, much will be made during the debate on this bill of the support it is asserted it enjoys from the Securities and Exchange Commission. But it seems to me that citing the support of the SEC tells only part of the story--only part of the story. First, SEC Commissioner Norman Johnson has written to express his opposition to the bill. His March 24, 1998, letter concludes: I believe that much more conclusive evidence than currently exists should be required before state courthouse doors are closed to small investors through the preclusion of state class actions for securities fraud. I ask unanimous consent to have Commissioner Johnson's letter printed in the Record.

Mr. SARBANES. Secondly, the SEC supports changes to the Federal antifraud standard to make it more protective of investors. In other words, if the SEC is going to be cited, as the proponents of this legislation have done, in support of their position, surely then they ought to pay attention to the SEC position which has been asserted seeking changes in the Federal antifraud standard to make it more protective. Let me give you a few examples. The SEC supports a longer statute of limitations so that fraud artists do not escape liability by successfully concealing their frauds. The SEC supports the restoration of liability for aiders and abetters of securities fraud so that those who give substantial assistance to fraud artists do not escape liability. The SEC supports codification of liability--codification of liability--for reckless conduct to ensure that professionals, such as accountants and underwriters, carry out their responsibilities under the Federal securities laws. In fact, Chairman Levitt reiterated his support for these provisions as recently as 6 weeks ago when he appeared before the Banking Committee for his renomination hearing. Nonetheless, these provisions are nowhere to be found in this bill. The supporters of this legislation argue the desirability of a uniform antifraud standard for securities traded on national securities exchanges, but they fail to address directly the question which we need to ask, whether the current Federal antifraud standard, as reflected by the 1995 act, deserves to be the uniform standard. Is the current antifraud standard, which they are now going to use to bring cases up from the State courts and deny investors the remedies under the State systems, is that standard adequate to protect investors? I voted against the 1995 act because I was concerned that it did not establish an appropriate standard. I was worried that it did not strike the proper balance between deterring frivolous securities suits and protecting investors who are victimized by securities fraud. None of us is in favor of frivolous securities suits, these so-called strike suits. But at the same time, I, for one, at least, do not want to go so far in trying to deal with that problem that I cease to protect investors who are victimized by securities fraud. There is a line in between, actually, I have asserted many times, I think, on which a consensus can be reached, but the legislation that keeps coming forward always overreaches--it overreaches--and therefore, I think, jeopardizes the protections that are available to investors who are innocent victims of securities frauds. A number of securities law experts warn that the safe harbor for forward-looking statements enacted by that act could protect fraud. In addition, the proportionate liability provisions leave innocent victims suffering a loss while shielding those who participate in securities fraud. Of course, the 1995 act omitted the statute of limitations in aiding and abetting provisions recommended by the SEC, still recommended by the SEC, and, of course, not included in this legislation. Since the reform act was enacted, another concern has developed. Some district courts have relied on the legislative history of that act in concluding that the act's pleading standards eliminated liability for reckless conduct. Imagine, eliminating liability for reckless conduct. If that view prevails in the circuit courts, and if the Congress preempts, as this legislation proposes to do, causes of action under State laws, investors will be left with no remedies--I underscore that, with no remedies--against those whose reckless conduct makes a securities fraud possible. It is for these reasons that the associations and various commentators I have cited are opposing this bill. They oppose this bill both because of its overly broad reach--clearly because of its overly broad reach--and because its sponsors fail to take this opportunity to correct the flaws of the earlier legislation. If the sponsors are going to eliminate recourse in the State courts, it becomes even more incumbent upon them to correct the Federal standard with respect to the shortcomings which have been identified in it and continue to be identified by the Securities and Exchange Commission.

Mr. SARBANES. I yield to my colleague.

Mr. SARBANES. I say to my colleague, as I understand it, this is what transpired. The 1995 act was being interpreted at the district court level, the Federal district court level--the legislative history of it--that the act's pleading standards eliminated liability for reckless conduct. Now, the SEC has come to us and said we should codify a reckless conduct right of action into the Federal standard. The legislation before us does not have such a codification. Now, there is language in the report, but we do not have a codification. So you have the problem about the legislative history for the 1998 act. And it is not quite clear to me how it will supplant the legislative history for the 1995 act. A codification would do that but that is not in this bill.

Mr. SARBANES. That is right. If you want to talk about where you put the balance, how in the world would you drive the balance so far over that an investor who was the victim of reckless conduct would not have a remedy? It just defies any equitable striking of the balances with respect to, quote, ``frivolous'' lawsuits on the one hand, and investor protection on the other.

Mr. SARBANES. The Senator is correct. Currently, what happened is we set a Federal standard in the 1995 act in the Federal courts. That still left to an investor the option of going into a State court to seek remedy. Now the proponents of this bill said, ``Well, everyone who is going into Federal court bringing the so-called frivolous suits are now going to migrate into the State courts.'' The numbers show that has not happened. You have a little increase in 1996. The numbers came back down in 1997. The projected numbers are down. So you do not have that flood of litigation into the State courts, and yet investors had available to them State court remedies. Well, now what they are going to do is they are going to preempt the ability to bring the action in the State courts. Well, then, the proponents will say, ``Well, we are just preempting it for these class actions. If you are an individual investor and you want to hire your lawyer, you will still be able to go into State court.'' But they define a class action in this bill in such a way, so broadly that it will sweep up individual investors who are really not part of a class- action suit. Those individual investors will then discover--I mean, what is going to happen here, my prediction on this is that what is going to come before the Congress down the road, if this legislation passes, is small investors showing up in the Congress and saying, ``This happened to me. And now I discover, because of the legislation which you all enacted, I can't get any remedy. And this isn't right.'' And Members are going to be looking at that, and they are going to say it is not right. That is why we are urging Members to pause and take a careful look at this before they put it into law. You can have a situation in which an individual investor goes in under State law within the statute of limitations. Often you do not discover these things. They are concealed. That is what fraud is all about. So he is within the statute of limitations. Other investors do the same thing. So let us say it is New York or California or Illinois, and a whole wide group of people have been defrauded by some fraud artist. Well, if 50 of them come in and bring some kind of suit against this artist, they can be swept up into a class action, removed into the Federal court. They will go over to the Federal court, and then they say to them, ``Well, our statute of limitations is shorter than your State statute of limitations under which you filed this action,'' which was timely filed in the State court. They acted on their rights within the time limitation of the State court. They had no idea they were going to get swept up the way this bill permits. And so all of a sudden they are over in Federal court, and they say to them ``It's too bad. The statute of limitations has run. And you don't have an action. You don't have a cause of action.'' You are shut out of the courthouse. Now, where is the fairness in that? I defy anyone to show me the fairness in that process.

Mr. SARBANES. The Senator is exactly on point. That is exactly what would happen, which would be exactly what would be permitted to take place under this legislation. When the 1995 bill was passed, people said, ``Well, we are defining this Federal standard. People can still go into the State court, the individual investor, and get a remedy.'' Now they come along and they say, ``Well, we're going to preempt the State courts in quote, `class actions,''' but then they define class actions so broadly that it will sweep up individual investors. It can sweep up people who are not bringing what we traditionally recognize and know as a class action. So it is once again an example of overreaching, as this mayor indicated from Greenwood, MS, that removing these protections would have grave consequences. This thing goes beyond anything that is required to deal with--the New York State Bar Association quote, I think, is the best on this very point when they said, ``The proposed solution far exceeds any appropriate level of remedy for the perceived problem.'' I am saying to the opponents, look, let us examine what you assert as the problem. And we will hear examples of a problem that will be cited. Most of those examples, I am sure I would think something needs to be done about them. But the solution, the proposed solution here will far exceed the examples. What is going to happen is eventually--and that is why I think these people are opposing this legislation I have cited. I think Senators need to be cautious. This, in effect, is an investor's beware legislation--investors beware. I think in the future we are going to be petitioned or importuned in the Congress to correct this overreaching because innocent people will have been denied their remedy against fraud artists who have cheated them out of their life savings. Let me just note that we are at a time of record high in our Nation's stock market. The current bull market is the longest in history. Stocks are trading at a price-earnings ratio that exceed even those reported in the 1920s. The level of participation in the stock market by America's families is also at a record level, both directly through ownership of stocks and indirectly through pension funds and mutual funds. History suggests that at some point the bull market will end, and history also suggests that when that occurs is when securities fraud will be exposed. You don't get that much exposure in a rising market. Should this bill be enacted, at that time many investors will find their State court remedies eliminated. In too many cases investors will be left without any effective remedies at all. Such a result can only harm innocent investors, undermine public confidence in the securities market, and ultimately raise the cost of capital for deserving American businesses. I urge my colleagues to think long and hard about this legislation, to be very careful about it. It far exceeds what needs to be done in terms of addressing any perceived problem. I think we need to be extremely sensitive to it. I expect a number of amendments to be offered to this bill as we proceed with its consideration. I look forward to discussing those at the appropriate time as we seek to correct what I think are some of the more obvious and egregious flaws in this legislation. I yield the floor.

Mr. SARBANES. Will the Senator yield?

Mr. SARBANES. Would the Senator have any objection to codifying this standard?

Mr. SARBANES. Once an amendment is sent to the desk we can have time to proceed; is that correct?

Mr. SARBANES. I send an amendment to the desk for myself, Senator Bryan and Senator Johnson.

Mr. SARBANES. Mr. President, I ask unanimous consent reading of the amendment be dispensed with.

Mr. SARBANES. Mr. President, Senator Cleland has been here for some time on the floor. I know he wishes to speak to the bill, and in the course of those remarks would be speaking to this amendment, so I yield the floor. I hope that Senator Cleland will be recognized.

Mr. SARBANES. Mr. President, this amendment, as the Senator from New York has indicated, goes to the question of the statute of limitations, and it seeks to preserve the State statutes of limitations. Let me quickly review the history. In the Lampf case, which my colleague referred to, the Supreme Court significantly shortened the period of time in which investors may bring securities fraud actions. On a 5 to 4 vote--in other words, in a very closely divided Court--the Supreme Court held that the applicable statute of limitations is 1 year after the plaintiff knew of a violation, and in no event more than 3 years after the violation occurred. In other words, once the violation occurs, if the plaintiff never finds out about it and 3 years pass, you can't do anything about it, even though, of course, one of the hallmarks of securities fraud is concealment and deception specifically designed to keep them from finding it out. The other aspect was 1 year after the plaintiff knew of the violation. Now, this is shorter--this statute of limitations --than those that exist in private securities actions in the law in 33 of the 50 States, as my distinguished colleague illustrated earlier with his map. Testifying before the Banking Committee in 1991, SEC Chairman Richard Breeden stated: The timeframe set forth in the Court's decision is unrealistically short and will do undue damage to the ability of private litigants to sue. Chairman Breeden went on to point out that many cases come to light only after the original distribution of securities. The Lampf cases could well mean that, by the time investors discover they have a case, they are already barred from the courthouse. The FDIC and the State securities regulators joined the SEC in 1991 in favor of overturning the Lampf decision. In fact, Chairman Levitt testified before the Securities Subcommittee of our committee in April of 1995: Extending the statute of limitations is warranted because many securities frauds are inherently complex and the law should not reward the perpetrator of a fraud who successfully conceals its existence for more than 3 years. Chairman Levitt reaffirmed his support for a longer statute of limitations before the committee as recently as March 25, 1998. I continue to believe that this time period in the Federal legislation does not allow individual investors adequate time to discover and pursue violations of securities law, but we raised that issue before and that issue was decided. So this amendment isn't trying to change the time period for securities fraud actions brought in Federal court. This amendment seeks to fix a related problem that will be created by this bill. Because of the overly broad definition of a class action, this bill creates a flaw; namely, that the Federal statute of limitations will now apply in an unfair manner to State cases. Cases that were timely filed under State statute of limitations may now be removed to Federal court and then dismissed under the shorter Federal statute of limitations.

Mr. SARBANES. I yield to my colleague.

Mr. SARBANES. Exactly.

Mr. SARBANES. Investors who file in a timely fashion under State law may find their lawsuits dismissed because, contrary to their intention, and in many instances unbeknownst to them that this would happen, they find themselves lifted out of a State court, put into the Federal court, and at that point the shorter statutes of limitations apply. So their suit is dismissed for failure to meet a shorter time requirement that they couldn't have known was going to be applied to them. This problem is created in part because of the broad definition of what is a class action that is in this legislation. So you could have an individual investor who finds himself classified as part of a group, although he was not part a group. He filed it on his own. He had his own lawyer, and he wasn't in collusion with anybody else in doing this. Or you could have 50 identified investors--say, school districts, or water and sewer districts--that get defrauded. If there are more than 50, they can be lifted out of the State court and put into the Federal court. When they went into the State court, they met the statute of limitations. But when they get lifted out of the State court and put in the Federal court, they then have to comply with this shorter statute of limitations, and they find themselves dismissed for failure to meet the shorter time requirement.

Mr. SARBANES

Mr. SARBANES. Will the Senator yield?

Mr. SARBANES. I am prompted by something the ranking member of the subcommittee said which leads me to put an inquiry to him and to Senator Grassley. There are a number of bankruptcy districts in the country that are facing very serious problems in handling their caseload. I have been in frequent communication with the subcommittee about this, and obviously my district is one of them. It has consistently now, for 4 or 5 years, ranked at the very top of case overload of all bankruptcy districts in the United States. Every study that has been made has recommended additional bankruptcy judges, and I note for a fact that the existing bankruptcy judges in my district are severely overworked. This is denying economic justice to both creditors and debtors. It is a matter which needs to be addressed. It is a pressing crisis. Now, the House sent over to us some time ago legislation providing for some additional judges based on comprehensive studies undertaken by the Administrative Office of the Courts and by others. This session is moving along. If we don't get some relief, we are going to continue to have this extraordinary situation which exists in quite a number of districts across the country in terms of reducing their backlog. It is a very severe problem in a number of districts. I am prompted by Senator Durbin's reference, and Senator Grassley's assent to it, as I understood it, there is more to follow. So I just put the inquiry whether this is one of the matters to follow. I would certainly hope so.