Are the securities laws about to shrink?

Stephen Labaton writes in today's NYT about all the alarming moves that seem to be underfoot to undermine securities regulation and lawsuits. Spearheading these efforts is a U.S. Chamber of Commerce committee and the Hal Scott Harvard committee that seems to have heavy administration backing, including Treasury's Paulson. Labaton says that unnamed "critics. . . see the effort as part of a plan to cater to the most well-heeled constituents of the administration and insulate politically connected companies from prosecution at the expense of investors." Here I try to provide a more balanced perspective on the moves.

Basically the proposals are (1) to get Justice to stop forcing companies under investigation to stop advancing legal fees to executives under investigation; (2) send some investor lawsuits to arbitration panels; (3) revise SOX 404; and (4) eliminate private 10b-5 actions.

Although the NYT article is not always clear about which of these proposals it's attacking, the biggie is obviously the private remedy proposal. The article quotes Duke's Jim Cox as saying, basically, that securities class actions are not that much of a problem, and that without the private remedy “very few people would be prosecuted.” Harvey Goldschmid adds that “private enforcement is a necessary supplement to the work that the S.E.C. does. It is also a safety valve against the potential capture of the agency by industry."

As for SOX 404, the article says that "[m]embers of the two committees said that they had reached a consensus that Section 404, along with greater threat of investor lawsuits and government prosecutions, had discouraged foreign companies from issuing new stock on exchanges in the United States in recent months."

As the article points out, most of these changes could be done by rule rather than statutory amendment. So we wouldn't need Congress – which despite some mild Democrat noises, is unlikely to do much.

The bid to reform criminal prosecutions is inarguably necessary after the problems with the Thompson memorandum were so clearly revealed in the KPMG case.

As for the SOX reform, proponents of the move seem to be focusing on the international implications of SOX – that is, the effect on cross listings and foreign IPOs. This strategy seems designed to deflect NYT-type criticism that the changes are just to help fat cat defrauders. But it leaves the anti-SOX forces vulnerable to arguments that the decline in foreign listings is attributable to causes other than SOX, which has some plausibility.

Removing the private remedy is certainly an intriguing idea. There is, of course, some merit to the objection that public enforcement can't pick up the slack. The problem lies with the inherent limitations on public enforcement budgets, not that the SEC is some kind of a lapdog.  It is increasingly obvious that attacks by the Gretchen Morgenson and the NYT on the SEC's insider trading enforcement are a disingenuous move to beat back meaningful private remedy reform – i.e., by arguing that corrupt public enforcers won't pick up the slack.

I've argued that a possible solution to abusive federal and state litigation that would also preserve some private remedy deterrent to fraud is to let firms choose their securities regulation jurisdiction – that is, make state securities regulation subject to the internal affairs choice of law rule. The federal government could make that happen by explicitly exempting from preemption all state securities actions that are regulated under state corporate law, and therefore subject to the internal affairs choice of law rule.

Politically, the movement to delete the private remedy might be a threat to induce action on reform of SOX and criminal prosecutions.

Anyway, December should be interesting from a securities regulation standpoint.