Whither corporate accountability? - Providence Journal

Whither corporate accountability?

01:00 AM EDT on Monday, April 9, 2007

Lee drutman

BERKELEY, Calif.

LATE LAST MONTH, as the U.S. Supreme Court heard oral arguments in a pair of cases regarding the rights of investors to hold corporations and banks accountable for fraud, I was once again reminded of the puzzling (though, sadly, not shocking) fact that the very groups that benefit most from our current capital-formation system still don’t seem to understand that accountability matters. A lot.

In one case, Credit Suisse First Boston Ltd. v. Billing, 16 Wall Street banks (joined by the solicitor general of the United States, which filed an amicus brief) argued that they are immune from antitrust lawsuits when it comes to initial public offerings (IPOs). They claim that they are already capably regulated by the Securities and Exchange Commission (SEC), and to allow an investor antitrust suit to go forward would illegally undermine the SEC.

There is less doubt that the named banks successfully conspired to artificially drive up the price of about 900 IPOs during the 1990s technology bubble, engaging in a practice called “laddering” — essentially requiring that certain customers purchase the shares at steadily escalating prices to create the trompe l’oeil of a seductively rising stock. Banks also awarded hot IPO offerings to select clients in exchange for underwriting business. While the banks and their favored clients all made out quite well in all this, the resultant market bubble had real consequences. In expanding, it misallocated capital into firms that probably should have never been taken public in the first place. In bursting, it left less in-the-loop investors (i.e. you and me) holding the bag at a cost of billions of dollars (to us!). Wonder where that capable SEC was . . .

Now the banks and their attendant cheerleaders assert that to let investors hold banks accountable under antitrust law would undermine capital formation by increasing its costs. Funny, for all their great love of free markets, they don’t actually trust leaving IPO prices up to an open market. No, better to let investment banks conspire to self-servingly cheerlead investment dollars into worthless technology companies. After all, think of the lucrative underwriting business to be gained!

The second case, Tellabs Inc. v. Makor Issues & Rights Ltd., is about the proper threshold for investors to bring class-action lawsuits when a CEO makes false statements about company finances, as optical networking and broadband equipment firm Tellabs’s chief executive allegedly did in 2001. Tellabs (with supporting briefs from both the Securities and Exchange Commission and the U.S. Department of Justice) argues that under the proper interpretation of a 1995 law regarding such suits (The Private Securities Litigation Reform Act) it should be very difficult indeed for investors to bring such suits — that investors need to show that there was, in fact, a “high likelihood” that the executive was intending to deceive investors. But investors (with support from 32 states) argue that such a threshold is unnecessarily high. After all, how can investors ever gather enough evidence to show intention to deceive if they can’t even undertake legal discovery?

Again, the issue of accountability. One common explanation for the recent wave of corporate frauds was the 1995 law in question, which significantly limited the ability of investors to file suit when companies committed fraud. In doing so, it emboldened executives to be less than forthright about their company’s finances. Arguing for the strictest interpretation of the law is in essence an invitation for more fraud, telling companies: Go ahead, make it up as you go — ain’t nobody gonna be able to touch you on that one.

In all likelihood, the Supreme Court will resolve these legal ambiguities on behalf of the corporations, banks, and fellow travelers in the current administration who, ever since Sarbanes-Oxley, have been complaining loudly that all this accountability stuff does nothing but gum up the market by making everything more expensive.

They ought to be careful what they wish for. Free markets not only require rules, but also confidence that those rules will be followed and that those who don’t follow them will be punished. This confidence is the main reason that the U.S. has been the world’s preeminent stock market. And yet, piece by piece, the very groups that seem to benefit most from this system seem to stubbornly insist on undermining it. If this is what they mean by lowering the costs of capital formation, it’s worth remembering the old adage that you get what you pay for.

Lee Drutman, a frequent contributor, is the co-author of The People’s Business: Controlling Corporations and Restoring Democracy.

http://www.projo.com/opinion/contributors/content/CT_drut9_04-09-07_GD52JQQ.1d61b2e.html