The following guest post by Jay W. Eisenhofer, Roy Jones, and Gregg S. Levin, all of Grant & Eisenhofer, P.A., first appeared in the March 19, 2007 issue of Pensions Week.

For those of us whose job it is to help maintain and enhance capital market integrity, the last few months have been quite interesting. In November 2006, the Committee on Capital Markets Regulation (“CCMR”), a business led group, issued a report suggesting that the U.S. suffers from the “over-enforcement” of the country’s securities laws. In January 2007, McKinsey & Company (“McKinsey”) published a study positing that the American “legal environment” was responsible for “growing international concerns about participating in US financial markets.” Picking up on this same theme, Peter Montagnon of the Association of British Insurers wrote in the Financial Times (5 January 2007) that an “excessive zeal for regulation and litigation” has undermined the ability of the U.S. capital markets to compete. What these reports have in common is an overriding bias and a lack of factual analysis. Tellingly, several non-partisan reports on the same subject have reached the exact opposite conclusion.

We will leave it up to others, better qualified, to comment on the CCMR report. Richard Breeden, former SEC Chair, no less, stated that the interim report “is a bunch of warmed over, impracticable ideas, many of which have been around for a long-time. It is very elegant whining.” Eliot Spitzer, no stranger to confronting fraud in corporate America, opined: “the same old tired response from the defenders of the status quo.” Meanwhile, the Council of Institutional Investors reflected that “many of the panel’s recommendations, if adopted, would undermine the effectiveness of market watchdogs and weaken critical investor protections.. . . Rigorous U.S. investor protections are a boon, not a bust, for our capital markets.” And presciently, Duke University Law Professor, James D. Cox, adroitly commented that the proposals are “an escalation of the culture war against regulation,” which if adopted “would be a dark day for investors.”

Critics use the following “fact” to support their IPO thesis -- of the 25 largest IPOs (by dollar volume) that took place during 2005, 92% (or 23 of 25) listed on an exchange outside of the U.S. But, this ignores the fact that current IPO activity on the American securities’ exchanges is indeed robust. Last year, U.S. IPO volume was up 22% over 2005, and almost 170% over 2003. A recent Thomson Financial (“Thomson”) report concluded: that during 2006, initial public offerings involving foreign firms comprised 16% of the IPOs placed on the American capital markets – the highest level of such offerings over the last 20 years; that the number of foreign IPOs being placed on the American capital markets remained the same in 2006 relative to the prior year (34); and that that during 2006, foreign IPOs were responsible for 23% of all new capital raised on the U.S. exchanges -- the highest figure in well over a decade. Commenting on these results, Richard Peterson, Thomson’s Director of Capital Markets Research, stated that “[i]n terms of proceeds raised by foreign issuers and the number of deals by foreign issuers, the statistics show that things look rather healthy . . . there doesn't seem to be any really significant deterioration of the [U.S.] IPO market.”

Critics wholly ignore that any volatility in recent U.S. IPO activity can be explained by factors unrelated to the current securities litigation system, including: high American underwriting fees; and expanding economies elsewhere in the world. For example, underwriting fees for U.S. based IPO transactions commonly run from 6.5% to 7%, as against an average 3-4% for deals placed on European exchanges. Goldman Sachs recently found that America's share of global gross domestic product has fallen to 28% -- from 31% seven years ago, as other country’s shares have grown. Reflecting that Ernst & Young recently found that since 2006 the overwhelming majority of firms undertaking IPOs (90%) did so in their “home country.”, yet 65% of “competitive” IPO’s held during the first half of 2006 were placed in the U.S. These findings prompted Jim O'Neill, Head of Global Economic Research at Goldman Sachs, to opine that “[i]t seems to me that the New York intelligentsia are going through one of their occasional bouts of hysteria” and further that any so-called decline in the American capital markets “is probably in large part a simple reflection of the growth of the rest of the world.”

Apart from the foregoing, critics overlook the fact that companies that list in the U.S. enjoy a lower cost of capital (12.48% on average), and also enjoy a listing premium of about 16%, rising to 37% for firms that list on a major U.S. exchange. Interestingly, research confirms that the listing premium actually has grown larger since the enactment of the Sarbanes Oxley Act in 2002. These statistics hardly suggest a system that is in terminal decline, and we would argue that investor protection through litigation is a key determinant.

Rarely discussed is the quality of IPOs. As investors are finding, the granting of a U.K. capital market passport to foreign companies is not costless. Financial fraud there. increased by 40% in 2006, and many worry that this will only get worse, as ever more overseas companies with dubious backgrounds and governance systems list there. Regulatory arbitrage may give a short-term competitive advantage, but it will come back to haunt the U.K. authorities; and sadly cost investors dearly.

According to Mr. Montagnon, liabilities from securities law class-action lawsuits have “ballooned” since 1995, bringing negative side effects. From that, Mr. Montagnon concludes that the securities class action system ought to be “repair[ed].” Once again context is essential. The size of the frauds themselves have ballooned since 1995, while their numbers have increased. Add to that, they are now more complex, and involve a broader range of actors. Reflecting that, the median investor loss for cases settling in 2006 reached $402 million – more than six times the 1996 median of $66 million. As regards settlements, 2006 brought six out of the ten largest settlements ever, with four of over $1 billion. Turning to the averages, both the mean and median settlement size have increased, again reflecting the size of the investor losses. Stripping out the mega-settlements still leaves an average settlement in 2006 of $34 million, a 37% increase over 2005. Including the billion dollar and over settlements pushes the average up to almost $87 million. As regards median settlement figures, 2006 saw a rise to $7.3 million.

Quite pointedly, after reviewing the data on settlements through the end of 2006, NERA Economic Consulting concluded that “while average settlements have been rising, there is no statistical evidence that this is the result of a more difficult litigation environment for defendants.”

Critics always disregard the dramatic changes that have taken place in our industry since the passage of the 1995 Private Securities Litigation Reform Act. Chief among these has been the rising number of institutional investors as class leaders, who take control of the litigation and use it to achieve positive, long-lasting governance reforms.

Many recent advances in shareholder rights and corporate governance have stemmed from this. The Delaware Supreme Court’s seminal decision in Smith v. Van Gorkom resulted in a host of procedural protections that we now take for granted such as fairness opinions, special committees of independent directors, and independent legal advisors. The Disney shareholder litigation over the payment of $140 million to Michael Ovitz heralded in a number of changes to corporate practices over the setting of executive compensation. In the wake of the WorldCom case, underwriters have been prompted to exercise a greater degree of care during the due diligence process. The superficial review that constituted due diligence before WorldCom apparently has now given way to real critical assessments of management’s representations.

Meanwhile, some critics assert that shareholder litigation is just shareholders suing themselves, since they are the actual owners of the defendant companies. In practice, shareholder suits reallocate funds to injured shareholder purchasers from current shareholders, as the former paid substantially more for a share of the corporation due to the fraud than did the current holders. Some overlap is inevitable here since institutional investors largely own all of corporate America. However, there are countless cases in which the overlap between “injured” and “current” shareholders is quite small. For example, in securities litigation involving Dynegy (settlement of $473 million), shareholders holding 127.23 million shares in the firm at the end the end of the class period (but not at settlement) owned only 5.49 million shares a year later.

Critics also fail to appreciate that private investor lawsuits are invaluable in ensuring that this country’s securities laws are vigorously enforced. Former SEC Chairman Arthur Levitt has stated that “private suits are the primary method for compensating defrauded investors.” The U.S. Supreme Court consistently has underscored that private actions “provide a most effective weapon in the enforcement of the securities laws and are a necessary supplement to Commission action.” This has never been more true than at present. While the number of enforcement actions commenced by the SEC is falling, corporate malfeasance is increasing. Financial restatements rose considerably during 2005, and over 100 companies currently are embroiled in the options-backdating scandal, just as questions are raised whether the SEC has adequate resources to investigate and prosecute these cases. Moreover, where corporate malfeasance has been the subject of both a private securities fraud class action and a parallel SEC investigation, the private action typically has resulted in a greater recovery for investors, with countless examples where the SEC’s efforts failed to achieve any financial compensation for aggrieved stockholders.

We share Peter Montagnon’s desire to see the U.S. initiate a system of corporate governance that makes corporate executives truly accountable to shareholders. However, vested business interests in the U.S. have successfully fought off every attempt to achieve our shared goal. Against that backdrop, we would welcome his support for the corporate governance changes that are being won through shareholder litigation. And once again, we have institutional investors to thank for their willingness to bring forward corporate governance based cases, known in the jargon as “derivative” actions. Our firm was honored to represent the international coalition of pension funds that won significant concessions from Rupert Murdoch and News Corp. Similarly, we helped the U.S. trade union, AFSCME, achieve the historic federal appeals court ruling against AIG that will enable proxy access for shareholders to nominate director candidates, long considered the “holy grail” for investor activists.

Our intention here has been to bring some balance back into the debate around the competitiveness of U.S., capital markets, and to give a different perspective on the reforms promulgated by the CCMR, among others. Shareholder litigation, far from being a drag on capital market competitiveness, promotes integrity by protecting investors. To alter the status quo now – in the wake of continued (and growing) corporate malfeasance – sends the message that accountability to shareholders is a goal not worth pursuing.