Abstract:
     In the US, lawyers specializing in class-action fraud suits against the bosses of
     publicly-quoted companies whose share prices stumble are preparing for a bumper year.
     Ostensibly designed to help disgruntled investors, securities class-action suits pay their legal
     advisors handsomely. The lawsuits usually claim that the company in question knew before it
     went public about the problems affecting the share price - and that investors therefore paid
     an unfairly high price for their shares.

     Full Text:Copyright Economist Newspaper Group, Incorporated Mar 19, 1994

     Open season on small, high-tech firms America is about to start once more. Lawyers specialising in class-action
     fraud suits against the bosses of publicly-quoted companies whose share prices stumble are preparing for a
     bumper year. Few such cases, brought by some shareholders on behalf of all of them, make it to court, because
     small firms cannot afford protracted legal battles. Ostensibly designed to help disgruntled investors, securities
     class-action suits pay their legal advisers handsomely. According to National Economic Research Associates, a
     consultancy based in White Plains, New York, the average out-of-court settlement last year was worth $7.3m
     Plaintiffs' lawyers pocketed $2.1m in fees.

     They will make a killing in 1994, too, thanks to the growth of initial public offerings (IPOS) on American
     stockmarkets in the past few years. Many IPOS involve small, high-tech firms, whose quarterly profits are
     notoriously volatile. Their shares often trade at 20 or more times earnings, and are highly sensitive to bad news.

     That's the trouble. The moment these firms' share prices slip, their managers receive a pile of writs from
     shareholders accusing them, under Rule 10b-5 of the Securities Exchange Act of 1934, of perpetrating a fraud on
     the market (see chart). (Chart omitted) The lawsuits usually claim that the company in question knew, or should
     have known, before it went public, about the problems affecting the share price--and that investors therefore paid
     an unfairly high price for their shares.

     Consider Silicon Graphics, a small Californian computer manufacturer hit by four class-action fraud suits in the
     past three years. After racking up $500,000 in legal fees, the company has settled three of them rather than incur
     any more costs. Over the past five years, some $500m is said to have been paid out by firms in the San Francisco
     area to settle class-action suits.

     More companies could soon find themselves in the lawyers' sights. Montgomery Securities, a stockbroking firm in
     San Francisco, reckons that the money raised by small-firm IPOS rose from $3.6 billion in 1990 to $23.1 billion
     in 1993. Add in additional financings and some $40 billion was raised by small American firms last year. The
     typical firm raised $40m. A year or more into their expansion plans, many of these companies are ripe for some
     unpleasant surprises.

     The vast majority of accused managers will be innocent of intentional fraud; but some may be guilty of stupidity or
     of plain carelessness. A handful of firms are no doubt run by crooks out to fleece their shareholders. Because
     high-tech firms ten reward top managers with share options, not cash, there is more temptation to engage in insider
     trading. Yet the question exercising policy-makers' minds is whether class-action suits work in investors' best
     interests.

     One big snag is that fear of litigation has prompted many firms to tighten up the information they five to analysts
     and reporters. A study of 550 public companies, conducted by Baruch Lev of the University of California,
     Berkeley, found that firms were more likely to suppress good news than bad news. They fared that
     circumstances could change, leaving them vulnerable to lawsuits; safer, they reasoned, to be perpetually
     pessimistic.

     To the extent that Rule 10b-5 encourages managers to withhold crucial information, it does investors in general a
     disservice. The Securities and Exchange Commission (SEC) has repeatedly called on companies to publish more
     quantitative, forward-looking information. But while the fear of litigation continues, few will comply willingly.

     Some are fighting back. Nine business organisations including the Electronic Industries Association, the National
     Association of Manufacturers and the National Venture Capital Association--have spent the past three months
     lobbying Senators Christopher Dodd and Pete Domenici, who plan to introduce legislation to reform Rule 10b-5
     late this year. Their bill is expected to give judges discretion to award costs against the losing side--a variant of the
     so-called English rule--in the hope of deterring the more frivolous litigants. It could also require America's
     Securities and Exchange Commission to evaluate the legitimacy of claims before huge legal costs were incurred.

     Everyone agrees that tinkering with securities law is not something to be undertaken lightly. The first priority ought
     to be to protect investors' interests; only subject to that should legislators be trying to reduce the cost of litigation
     to defendant firms so as to stop it becoming a brake on capital formation. But the case for change is becoming
     increasingly strong. Jon Dickey, an attorney with a Californian law firm, Brobeck, Phleger & Harrison, now warns
     his clients that many investors are starting to consider litigation as a form of insurance against share prices ever
     falling.