[Senate Report 104-98]
[From the U.S. Government Publishing Office]



                                                       Calendar No. 128
104th Congress                                                   Report
                                 SENATE
 1st Session                                                     104-98
_______________________________________________________________________




                     PRIVATE SECURITIES LITIGATION


                          REFORM ACT OF 1995

                               __________

                              R E P O R T

                                 of the

                     COMMITTEE ON BANKING, HOUSING,

                           AND URBAN AFFAIRS

                          UNITED STATES SENATE

                              to accompany

                                 S. 240

                             together with

                            ADDITIONAL VIEWS




                 June 19, 1995.--Ordered to be printed

                               __________

                    U.S. GOVERNMENT PRINTING OFFICE
99-010                     WASHINGTON : 1995
(Star Print)                                                            

                                                
            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                 ALFONSE M. D'AMATO, New York, Chairman
PHIL, GRAMM, Texas                   PAUL S. SARBANES, Maryland
RICHARD C. SHELBY, Alabama           CHRISTOPHER J. DODD, Connecticut
CHRISTOPHER S. BOND, Missouri        JOHN F. KERRY, Massachusetts
CONNIE MACK, Florida                 RICHARD H. BRYAN, Nevada
LAUCH FAIRCLOTH, North Carolina      BARBARA BOXER, California
ROBERT F. BENNETT, Utah              CAROL MOSELEY-BRAUN, Illinois
ROD GRAMS, Minnesota                 PATTY MURRAY, Washington
BILL FRIST, Tennessee
                    Howard A. Menell, Staff Director
                 Robert J. Giuffra, Jr., Chief Counsel
                Philip E. Bechtel, Deputy Staff Director
     Steven B. Harris, Democratic Staff Director and Chief Counsel
                                 ------                                

                       Subcommittee on Securities

                      PHIL GRAMM, Texas, Chairman
ROBERT F. BENNETT, Utah              CHRISTOPHER J. DODD, Connecticut
RICHARD C. SHELBY, Alabama           PATTY MURRAY, Washington
LAUCH FAIRCLOTH, North Carolina      BARBARA BOXER, California
ROD GRAMS, Minnesota                 RICHARD H. BRYAN, Nevada
                   Wayne A. Abernathy, Staff Director
                        Laura S. Unger, Counsel
          Courtney Ward, Democratic Professional Staff Member
                   Mitchell Feuer, Democratic Counsel
                            C O N T E N T S

                              ----------                              
                                                                   Page
History of the legislation.......................................     1
Purpose and summary..............................................     4
Purpose and scope of the legislation:
    Background...................................................     8
    Elimination of abusive practices in securities litigation....    10
    Removing the incentives to participate in abusive class 
      action litigation..........................................    10
    New rules relating to the settlement process.................    12
    Attorney Sanctions for pursuing meritless litigation.........    13
    Stay of discovery............................................    14
    A strong pleading requirement................................    15
    A safe harbor for forward-looking statements or projections..    15
    Written interrogatories......................................    18
    Limiting civil RICO actions..................................    19
    A grant of authority to the SEC to prosecute certain aiding 
      and abetting cases.........................................    19
    Limitation on damages........................................    19
    Modification of joint and several liability..................    20
    Loss Causation requirement for section 12(2) of the 1933 Act.    23
Auditor disclosure of corporate fraud............................    23
Section-by-section analysis of S. 240............................    24
    Title I--Reduction of Abusive Litigation:
        Section 101. Elimination of Certain Abusive Practices....    24
        Section 102. Securities Class Action Reform..............    24
        Section 103. Sanctions for Abusive Litigation............    26
        Section 104. Requirements for Securities Fraud Actions...    26
        Section 105. Safe Harbor for Forward-Looking Statements..    26
        Section 106. Written Interrogatories.....................    27
        Section 107. Amendment to Racketeer Influenced and 
          Corrupt Organizations Act..............................    28
        Section 108. Authority of Commission to Prosecute Aiding 
          and Abetting...........................................    28
        Section 109. Limitation on Rescission....................    28
        Section 110. Applicability...............................    28
    Title II--Reduction of Coercive Settlements:
        Section 201. Limitation on Damages.......................    28
        Section 202. Proportionate Liability.....................    29
        Section 203. Applicability...............................    29
    Title III--Auditor Disclosure of Corporate Fraud:
        Section 301. Fraud Detection and Disclosure..............    29
Regulatory impact statement......................................    30
Changes in existing law..........................................    30
Cost of the legislation..........................................    30
Additional views of Senators Gramm, Mack, Faircloth, Bennett, 
  Grams, and Frist...............................................    33
Additional views of Senators Sarbanes, Bryan, and Boxer..........    36
Additional views of Senator Dodd.................................    51

                                                       Calendar No. 128
104th Congress                                                   Report
                                 SENATE
 1st Session                                                     104-98

======================================================================



 
            PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

                                _______
                                

                 June 19, 1995.--Ordered to be printed

                                _______
                                

Mr. D'Amato, from the Committee on Banking, Housing, and Urban Affairs, 
                        submitted the following

                              R E P O R T

                             together with

                            ADDITIONAL VIEWS

                         [To accompany S. 240]

    The Committee on Banking, Housing and Urban Affairs, to 
which was referred the bill (S. 240), to amend the Securities 
Exchange Act of 1934 to establish a filing deadline and to 
provide certain safeguards to ensure that the interests of 
investors are well protected under the implied private action 
provisions of the Act, having considered the same, reports 
favorably thereon with an amendment in the nature of a 
substitute, and recommends that the bill as amended do pass.

                       history of the legislation

    On January 18, 1995, Senators Domenici and Dodd introduced 
S. 240, the ``Private Securities Litigation Reform Act of 
1995.'' This legislation, which was cosponsored by Senators 
Hatch, Mikulski, Bennett, Moseley-Braun, Lott, Murray, Mack, 
Johnston, Faircloth, Conrad, Burns, Chafee, Gorton, Helms, Kyl, 
Thomas, Hutchinson, Santorum, and Pell, contains provisions 
identical to those contained in S. 1976, which was introduced 
in the 103d Congress. Legislation to reform private litigation 
under the Federal securities laws, S. 3181, also was introduced 
in the 102d Congress.
    On June 17, 1993 and July 21, 1993, the Subcommittee on 
Securities held hearings on private securities litigation. 
Witnesses testifying on June 17 included Edward R. McCracken, 
President and

CEO, Silicon Graphics, Inc.; John G. Adler, President and CEO, 
Asaptec, Inc.; Richard J. Egan, Chairman, EMC Corp.; Thomas 
Dunlap, Jr., General Counsel, Intel Corp.; William R. McLucas, 
Director of the Division of Enforcement, Securities and 
Exchange Commission (``SEC''); Mark J. Griffin, Director, 
Securities Division of the Department of Commerce of the State 
of Utah, who testified on behalf of the North American 
Securities Administrators Association, Inc.; Joel Seligman, 
Professor, University of Michigan Law School; Patricia Reilly, 
an investor; Vincent E. O'Brien, Law and Economics Consulting 
Group, Inc.; William S. Lerach, Partner, Milberg Weiss Bershad 
Hynes & Lerach; Gordon K. Billipp, an investor; Russell E. 
Ramser, Jr., an investor; and Edward J. Radetich, President, 
Heffler & Co.
    Witnesses testifying on July 21 included Representative 
W.J. ``Billy'' Tauzin; Representative Ron Wyden; Jake L. 
Netterville, Managing Partner, Postlethwaite & Netterville, who 
testified on behalf of the American Institute of Certified 
Public Accountants; A.A. Sommer, Jr., Chairman, Public 
Oversight Board, American Institute of Certified Public 
Accountants; Ralph V. Whitworth, President, United Shareholders 
Association; Abraham J. Briloff, Professor, Baruch College, 
CUNY; Melvyn I. Weiss, Partner, Milberg Weiss Bershad Hynes & 
Lerach; Richard A. Bowman, Executive Vice President and CFO, 
ITT Corp., who testified on behalf of the Financial Executives 
Institute; Marc E. Lackritz, President, Securities Industry 
Association; Ralph Nader, Public Citizen; and Maryellen F. 
Andersen, Investor and Corporate Relations Director, 
Connecticut Retirement & Trust Funds and Treasurer of the 
Council of Institutional Investors. Additional material was 
supplied for the record by a large number of parties.
    On March 24, 1994, Senators Dodd, Domenici, Mikulski, 
Johnston, and Faircloth introduced S. 1976, the ``Private 
Securities Litigation Reform Act of 1994.''
    On May 12, 1994, the Subcommittee on Securities held a 
hearing on the Supreme Court's decision in Central Bank of 
Denver v. First Interstate Bank of Denver,\1\ which held that 
private parties could not bring suit under Section 10(b) of the 
Securities Exchange Act of 1934 (the ``1934 Act'') and SEC Rule 
10b-5 against alleged aiders and abettors of persons violating 
the Federal securities laws. Witnesses included Senator Howard 
Metzenbaum; Arthur Levitt, Chairman, SEC; Donald C. Langevoort, 
Professor, Vanderbilt Law School; Mark J. Griffin, Director, 
Securities Division of the Department of Commerce of the State 
of Utah, who testified on behalf of the North American 
Securities Administrators Association, Inc.; Stuart J. Kaswell, 
Senior Vice President and General Counsel, Securities Industry 
Association; Harvey J. Goldschmid, Professor, Columbia 
University School of Law; Eugene I. Goldman, Partner, 
McDermott, Will & Emery; and David S. Ruder, former Chairman, 
SEC, and Professor, Northwestern University School of Law. 
Harvey I. Pitt, Partner, Fried, Frank, Harris, Shriver & 
Jacobson, and Joel Seligman, Professor, University of Michigan 
Law School supplied additional material for the record.
---------------------------------------------------------------------------
    \1\ 114 S. Ct. 1439 (1994).
---------------------------------------------------------------------------
    On May 17, 1994, the Subcommittee on Securities issued a 
163 page Staff Report on private securities litigation.
    On March 2, and 22, 1995, and April 6, 1995, the 
Subcommittee on Securities held hearings on securities 
litigation reform legislation. Witnesses testifying on March 2 
included Senator Christopher J. Dodd; Senator Pete V. Domenici; 
Marc E. Lackritz, President, Securities Industry Association; 
J. Carter Beese, former Commissioner, SEC, and Chairman, 
Capital Markets Regulatory Reform Project of the Center for 
Strategic and International Studies; Nell Minow, Principal, 
LENS, Inc.; James F. Morgan, Founder and Chairman, Morgan, 
Holland Ventures, who testified on behalf of the National 
Venture Capital Association; Christopher J. Murphy III, 
President and CEO, 1st Source Corp., who testified on behalf of 
the Association of Publicly Traded Companies; and George 
Sollman, CEO, Centigram Communications Corp., who testified on 
behalf of the American Electronics Association.
    Witnesses testifying on March 22 included mark J. Griffin, 
Director, Securities Division of the Department of Commerce of 
the State of Utah, who testified on behalf of the North 
American Securities Administrators Association, Inc.; Joan R. 
Gallo, City Attorney, San Jose, California; Sheldon H. Elsen, 
who testified on behalf of The Association of the Bar of the 
City of New York; David Guin, Partner, Ritchie and Rediker, who 
testified on behalf of the National Association of Securities 
and Commercial Law Attorneys; and Bartlett Naylor, National 
Coordinator, Office of Corporate Affairs, International 
Brotherhood of Teamsters.
    Witnesses testifying on April 6 included Senator Barbara 
Mikulski; The Honorable Arthur Levitt, Chairman, SEC; Richard 
C. Breeden, former Chairman, SEC; and Charles Cox, former 
Commissioner and former Acting Chairman, SEC.
    On May 25, 1995, the Committee met in Executive Session to 
consider S. 240 and adopted an amendment in the nature of a 
substitute that was offered by Chairman Alfonse M. D'Amato and, 
by a vote of 11-4, ordered S. 240 favorably reported. Senators 
Shelby, Sarbanes, Bryan, and Boxer voted against this 
legislation. Senator Bond recused himself from voting. The 
Committee adopted by a voice vote an amendment offered by 
Senator Bennett to amend section 12(2) of the Securities Act of 
1933 (the ``1933 Act''). The Committee did not adopt amendments 
offered by Senator Bryan to extend the statute of limitations 
for private actions under the 1934 Act (6-9) (with Senators 
Shelby, Sarbanes, Dodd, Kerry, Bryan, and Boxer voting in favor 
of the amendment); by Senator Sarbanes to delegate promulgation 
of a safe harbor provision for forward looking statements to 
SEC rulemaking (5-10) (with Senators Sarbanes, Kerry, Bryan, 
Boxer and Murray voting in favor of the amendment); by Senator 
Sarbanes to revise the scienter language of the safe harbor 
provision adopted by the Committee (4-11) (with Senators 
Sarbanes, Kerry, Bryan and Boxer voting in favor of the 
amendment); by Senator Boxer to exempt from the statutory safe 
harbor retirement plans for senior citizens (4-11) (with 
Senators Sarbanes, Kerry, Bryan, and Boxer voting in favor of 
the amendment); and by Senator Bryan to revise the 
proportionate liability provision adopted by the Committee (5-
10) (with Senators Shelby,

Sarbanes, Kerry, Bryan, and Boxer voting in favor of the 
amendment).
    The Committee withheld consideration of two amendments 
pending further review: (i) to increase the uncollectible share 
provision for proportionate liability from 50% to 100%; and 
(ii) to provide for liability in private actions under Rule 
10b-5 for aiders and abettors of primary securities law 
violators.

                          purpose and summary

    During the Great Depression, Congress enacted the 1933 and 
1934 Acts to promote investor confidence in the United States 
securities markets and thereby to encourage the investment 
necessary for capital formation, economic growth, and job 
creation. The Committee heard substantial testimony that today 
certain lawyers file frivolous ``strike'' suits alleging 
violations of the Federal securities laws in the hope that 
defendants will quickly settle to avoid the expense of 
litigation. These suits, which unnecessarily increase the cost 
of raising capital and chill corporate disclosure, are often 
based on nothing more than a company's announcement of bad 
news, not evidence of fraud. All too often, the same 
``professional'' plaintiffs appear as name plaintiffs in suit 
after suit.
    S. 240, the ``Private Securities Litigation Reform Act of 
1995,'' is intended to lower the cost of raising capital by 
combatting these abuses, while maintaining the incentive for 
bringing meritorious actions. Specifically, S. 240 intends: (1) 
to encourage the voluntary disclosure of information by 
corporate issuers; (2) to empower investors so that they--not 
their lawyers--exercise primary control over private securities 
litigation; and (3) to encourage plaintiffs' lawyers to pursue 
valid claims and defendants to fight abusive claims. Senator 
Pete Domenici, one of two original co-sponsors of this 
legislation, expects that S. 240 ``will return some fairness 
and common sense to our broken securities class action 
litigation system, while continuing to provide the highest 
level of protection to investors in our capital markets.'' \2\
---------------------------------------------------------------------------
    \2\ Statement of Senator Pete Domenici, Hearing on Securities 
Litigation Reform Proposals: Subcommittee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs, March 2, 1995.
---------------------------------------------------------------------------
    The federal securities laws and SEC rules prohibit the 
making of false and misleading statements or omissions in 
connection with the purchase and sale of securities. Under 
these provisions, the SEC has broad regulatory and enforcement 
powers. In addition, investors may bring private actions for 
violations of the federal securities laws. These actions 
typically rest upon the so called ``catch-all'' fraud provision 
in Section 10(b) of the 1934 Act and SEC Rule 10b-5.
    Congress has never expressly provided for private rights of 
action when it enacted Section 10(b). Instead, courts have held 
that Congress impliedly authorized such actions. As a result, 
10(b) litigation has evolved out of judicial decisionmaking, 
not specific legislative action. The lack of congressional 
involvement has left judges free to develop conflicting legal 
standards, thereby creating substantial uncertainties and 
opportunities for abuses of investors, issuers, professional 
firms and others.
    The Committee has determined that now is the time for 
Congress to reassert its authority in this area. As Chairman 
D'Amato made clear: ``There is broad agreement on the need for 
reform. Shareholders' groups, Corporate America, the SEC, and 
even lawyers all want to curb abusive practices. Lawyers who 
bring meritorious suits do not benefit when strike suit artists 
wreak havoc on the Nation's boardrooms and courthouses. Our 
economy does not benefit when the threat of litigation deters 
capital formation.'' \3\ Senator Dodd similarly said: ``The 
flaws in the current private securities litigation system are 
simply too obvious to deny. The record is replete with examples 
of how the system is being abused and misused.'' \4\ SEC 
Chairman Arthur Levitt concurred: ``[T]here is no denying that 
there are real problems in the current system--problems that 
need to be addressed not just because of abstract rights and 
responsibilities, but because investors and markets are being 
hurt by litigation excesses.'' \5\
---------------------------------------------------------------------------
    \3\ Statement of Chairman Alfonse M. D'Amato, Hearing on Securities 
Litigation Reform Proposals: Subcommittee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs, March 2, 1995.
    \4\ Statement of Senator Christopher J. Dodd, Hearing on Securities 
Litigation Reform Proposals: Subcommittee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs, March 2, 1995.
    \5\ Arthur Levitt, ``Between Caveat Emptor and Caveat Vendor: The 
Middle Ground of Litigation Reform,'' Remarks at the 22nd Annual 
Securities Regulation Institute, San Diego, California (January 25, 
1995).
---------------------------------------------------------------------------
    The purposes of S. 240 are threefold.
    1.--S. 240 is intended to encourage the voluntary 
disclosure of information by issuers. The hallmark of our 
securities laws is broad, timely disclosure to investors of 
information about the financial condition of publicly traded 
companies. The mere specter of 10b-5 liability, however, has 
become more than a deterrent to fraud. Private securities class 
actions under 10b-5 inhibit free and open communication among 
management, analysts, and investors. This has caused corporate 
management to refrain from providing shareholders forward-
looking information about companies. According to the SEC: 
``the threat of mass shareholder litigation, whether real or 
perceived,'' has had adverse effects, especially in ``chilling 
* * * disclosure of forward-looking information.'' \6\ Public 
companies--particularly high-tech, bio-tech and other growth 
companies, which are sued disproportionately in 10b-5 
litigation--fear that releasing such information makes them 
even more vulnerable to attack. As a result, investors often 
receive less, not more, information, which makes investing more 
risky and increases the cost of raising capital.
---------------------------------------------------------------------------
    \6\ Safe Harbor for Forward-Looking Statements, Exchange Act Rel. 
No. 33-7107 (October 13, 1994).
---------------------------------------------------------------------------
    To reduce this chill on voluntary disclosures by issuers, 
S. 240 creates a carefully tailored safe harbor for forward-
looking statements. This safe harbor applies only to 
projections or estimates that are identified as forward-looking 
statements and that refer ``clearly'' and ``proximately'' to 
``the risk that actual results may differ materially from'' the 
projection or estimate. The safe harbor has several other 
important limitations. For example, the safe harbor would not 
apply to initial public offerings of securities. In addition, 
the SEC's enforcement authority would not be limited by the 
provisions in S. 240. To the contrary, S. 240 expands the SEC's 
enforce-

ment authority with respect to forward-looking statements by 
authorizing the SEC to recover damages on behalf of investors 
injured by such statements.
    2.--S. 240 is intended to empower investors so that they, 
not their lawyers, control securities litigation. Under the 
current system, the initiative for filing 10b-5 suits comes 
almost entirely from the lawyers, not from genuine investors. 
Lawyers typically rely on repeat, or ``professional,'' 
plaintiffs who, because they own a token number of shares in 
many companies, regularly lend their names to lawsuits. Even 
worse, investors in the class usually have great difficulty 
exercising any meaningful direction over the case brought on 
their behalf. The lawyers can decide when to sue and when to 
settle, based largely on their own financial interests, not the 
interests of their purported clients.
    Numerous studies show that investors recover only 7 to 14 
cents for every dollar lost as a result of securities fraud. 
Indeed, a 1994 Securities Subcommittee Staff Report found 
``evidence * * * that plaintiffs' counsel in many instances 
litigate with a view toward ensuring payment for their services 
without sufficient regard to whether their clients are 
receiving adequate compensation in light of evidence of 
wrongdoing.'' \7\ The comment by one plaintiffs' lawyer--``I 
have the greatest practice of law in the world. I have no 
clients.'' \8\--aptly summarizes this flaw in the current 
system.
---------------------------------------------------------------------------
    \7\ ``Majority Staff of the Subcommittee on Securities of the 
Senate Committee on Banking, Housing, and Urban Affairs, Report on 
Private Securities Litigation,'' 103d Congress, 2d Session (1994).
    \8\ William P. Barrett, ``I Have No Clients,'' Forbes, October 11, 
1993.
---------------------------------------------------------------------------
    S. 240 contains several provisions to transfer primary 
control of private securities litigation from lawyers to 
investors. First, S. 240 creates a presumption, rebuttable 
under certain conditions, that the member of a purported class 
of investors with the largest financial interest in the case 
will serve as the lead plaintiff, thereby increasing the role 
of institutional investors in securities class actions. Second, 
S. 240 requires greater disclosure of settlement terms, 
including the reasons for a settlement, to class members, 
allowing them to object to, or raise questions about, the 
settlement. Third, S. 240 prohibits several abusive practices, 
such as the payment of bounties to named plaintiffs, that have 
enabled lawyers to exercise nearly total fiat over the course 
of private securities litigation.
    3.--S. 240 is intended to encourage plaintiffs' lawyers to 
pursue valid claims for securities fraud and to encourage 
defendants to fight abusive claims. The dynamics of private 
securities litigation create powerful incentives to settle, 
causing securities class actions to have a much higher 
settlement rate than other types of class actions. Many such 
actions are brought on the basis of their settlement value. The 
settlement value to defendants turns more on the expected costs 
of defense than the merits of the underlying claim. The Supreme 
Court has recognized that ``litigation under Rule 10b-5 
presents a danger of vexatiousness different in degree and in 
kind from that which accompanies litigation in general.'' \9\
---------------------------------------------------------------------------
    \9\ Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 185, 739 
(1975).
---------------------------------------------------------------------------
    As SEC Chairman Levitt explained, because class counsel 
usually advances the costs of litigation, ``counsel may have a 
greater
incentive than the members of the class to accept a settlement 
that provides a significant fee and eliminates any risk of 
failure to recoup funds already invested in the case.'' \10\ If 
a defendant cannot win an early dismissal of the case, ``the 
economics of litigation may dictate a settlement even if the 
defendant is relatively confident that it would prevail a 
trial.'' \11\
---------------------------------------------------------------------------
    \10\ ``Securities Litigation Reform: Hearings Before the 
Subcommittee on Telecommunications and Finance of the House Committee 
on Energy and Commerce,'' 103d Congress, 2d Session, 35-36 (1994).
    \11\ Id. at 36.
---------------------------------------------------------------------------
    This incentive to settle stems not only from legal fees 
incurred but also from the doctrine of joint and several 
liability, which requires a defendant to pay 100 percent of the 
damages even if the defendant is only one percent responsible. 
As Chairman D'Amato stressed: ``the threat of such liability 
often forces innocent `deep pocket' defendants to settle 
frivolous suits.'' \12\ Chairman Levitt similarly concluded: 
``Because the existing safeguards provided by the system are 
imperfect, there is a danger that weak claims may be 
overcompensated while strong claims are undercompensated.'' 
\13\
---------------------------------------------------------------------------
    \12\ D'Amato Statement, supra, note 3.
    \13\ House hearings, note 10, supra, at 36.
---------------------------------------------------------------------------
    S. 240 includes several provisions to reduce the settlement 
value of frivolous securities class actions. First, S. 240, 
while retaining joint and several liability for defendants who 
knowingly engage in securities fraud, adopts a modified 
proportionate liability standard for defendants found to be 
less culpable. In cases involving insolvent co-defendants who 
are found to be proportionately liable, a remaining defendant 
must pay the share reflecting his or her degree of 
responsibility plus all or part of the uncollectible amount but 
only up to 50 percent of its share of the original judgment. 
Joint and several liability is also retained for all small 
investors whose net worth is $200,000 or less and who lose more 
than ten percent of their net worth as a result of the fraud. 
Second, S. 240 clarifies the pleading requirements for bringing 
securities fraud claims by adopting a standard modelled on that 
currently applied by the United States Court of Appeals for the 
Second Circuit, the leading circuit court in this area. Third, 
S. 240 requires courts to make findings regarding compliance by 
all attorneys and all parties with Rule 11(b) of the Federal 
Rules of Civil Procedure, which authorizes the imposition of 
sanctions when a complaint is legally frivolous, lacks 
evidentiary support, or is otherwise abusive.
    S. 240 includes several other provisions intended to reduce 
the cost of raising capital. These provisions include 
establishing guidelines for calculating damages; codifying the 
requirement under current law that plaintiffs prove that the 
loss in the value of their stock was caused by the Section 
10(b) violation and not by other factors; requiring auditors to 
notify the SEC of illegal acts that management has not 
adequately addressed; prohibiting the use of conduct actionable 
as securities fraud as the basis of private treble damages 
actions under the Racketeer Influenced and Corrupt 
Organizations Act (``RICO''); and clarifying the ability of the 
SEC to bring aiding and abetting claims. None of the provisions 
in S. 240 affects the SEC's ability to bring enforcement 
actions.

                  Purpose and Scope of the Legislation


                               background

    The United States securities markets are the most liquid 
and deep in the world. In just the past ten years, capital 
raised has risen by 1,000%. Over the last three years, the U.S. 
securities industry has set new records in corporate 
underwriting and raising capital for new businesses.\14\ In 
1994, the industry raised $1 trillion for businesses, including 
$34 billion for small businesses making their first foray into 
the capital markets.\15\
---------------------------------------------------------------------------
    \14\ Through the U.S. securities markets, corporate issuers raised 
$76 billion in 1992, $102 billion in 1993, and $130 billion in 1994. 
Small businesses making initial public offerings of stock raised $40 
billion in 1992, $57 billion in 1993, and $34 billion in 1994. 
``Securities Industry Trends,'' Securities Industry Association 
Newsletter, April 5, 1995.
    \15\ Id. The $1 trillion figure includes private placements, 
underwriting and domestic medium-term note programs.
---------------------------------------------------------------------------
    The Nation's capital markets play a critical role in our 
domestic economy by creating jobs and expanding businesses. 
Small and emerging businesses now account for two-thirds of the 
new jobs in America.\16\ Strong capital markets enhance the 
United States' competitiveness in the global markets.
---------------------------------------------------------------------------
    \16\ Testimony of James F. Morgan on behalf of the National Venture 
Capital Association, Hearings on Securities Litigation Reform 
Proposals: Subcommittee on Securities, Senate Committee on Banking, 
Housing, and Urban Affairs, March 2, 1995.
---------------------------------------------------------------------------
    The success of the U.S. securities markets is largely the 
result of a high level of investor confidence in the integrity 
and efficiency of our markets. The SEC enforcement program and 
the availability of private rights of action together provide a 
means for defrauded investors to recover damages and a powerful 
deterrent against violations of the securities laws. As noted 
by SEC Chairman Levitt, ``private rights of action are not only 
fundamental to the success of our securities markets, they are 
an essential complement to the SEC's own enforcement program.'' 
\17\ The Supreme Court has also described private securities 
actions as a ``necessary supplement'' to the SEC's enforcement 
regime.\18\
---------------------------------------------------------------------------
    \17\ Arthur Levitt, ``Between Caveat Emptor and Caveat Vendor'' 
supra, note 5.
    \18\ Bateman Eichler, Hill Richards, Inc., v. Berner, 472 U.S. 299, 
310 (1985); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730 
(1975); J.I. Case Co. v. Barak, 377 U.S. 426, 432 (1964).
---------------------------------------------------------------------------
    Although private securities class actions can complement 
SEC enforcement actions, the evils flowing from abusive 
securities litigation start with the filing of the complaint 
and continue through to the final disposition of the action. A 
complaint alleging violations of the Federal securities laws is 
easy to craft and can be filed with little or no due diligence. 
A drop in a public company's stock price, a failed product 
development project, or even unpredictable adverse market 
conditions that affect earnings results for a quarter can 
trigger numerous securities fraud lawsuits against a company.
    One study concluded that, in the early 1980's every company 
in one business sector that suffered a market loss of $20 
million or more in its capitalization was sued.\19\ Another 
survey of venture-backed companies in existence for less than 
ten years revealed that one in six had been sued at least once, 
and that such lawsuits had already consumed an average of 1,055 
hours of management time and $692,000 in legal fees.\20\
---------------------------------------------------------------------------
    \19\ Janet Cooper Alexander, ``Do the Merits Matter? A Study of 
Settlements in Securities Class Actions,'' 43 Stan. L. Rev.  497, 551-
13 (1991).
    \20\ Many of these lawsuits are still pending. Testimony of James 
F. Morgan, supra, note 16.
---------------------------------------------------------------------------
    Most defendants in securities class action lawsuits choose 
to settle rather than face the enormous expense of discovery 
and trial. Of the approximately 300 securities lawsuits filed 
each year, almost 93% settle at an average settlement cost of 
$8.6 million.\21\ These cases are generally settled based not 
on the merits but on the size of the defendant's pocketbook.
---------------------------------------------------------------------------
    \21\ Testimony of George H. Sollman on behalf of the American 
Electronics Association: Hearings on Securities Litigation Reform 
Proposals: Subcommittee on Securities, Senate Committee on Banking, 
Housing, and Urban Affairs, March 2, 1995.
---------------------------------------------------------------------------
    The fact that many of these lawsuits are filed as class 
actions has had an in terrorem effect on Corporate America. A 
whole stable of ``professional plaintiffs,'' who own shares--or 
sometimes fractions of shares--in many companies, stand ready 
to lend their names to class action complaints. These lawsuits 
have added significantly to the cost of raising capital and 
represent a ``litigation tax'' on business.\22\ Smaller start-
up companies bear the brunt of abusive securities fraud 
lawsuits. Many of these companies are high-technology companies 
which, by their very nature, have unpredictable business 
prospects and, consequently, volatile stock prices.\23\
---------------------------------------------------------------------------
    \22\ Testimony of Marc E. Lackritz, on behalf of the Securities 
Industry Association: Hearings on Securities Litigation Reform 
Proposals: Subcommittee on Securities, Senate Committee on Banking, 
Housing, and Urban Affairs, March 2, 1995. Testimony of former SEC 
Commissioner J. Carter Beese, on behalf of the Center for Strategic and 
International Studies, Hearings on Securities Litigation Reform 
Proposals: Subcommittee on Securities, Senate Committee on Banking, 
Housing, and Urban Affairs, March 2, 1995.
    \23\ Testimony of Edward R. McCracken, President and Chief 
Executive Officer of Silicon Graphics, Inc. and Co-Chairman of the 
American Entrepreneurs for Economic Growth, Hearings on Private 
Litigation Under Federal Securities Laws: Subcommittee on Securities, 
Senate Committee on Banking, Housing, and Urban Affairs, June 17, 1993.
---------------------------------------------------------------------------
    This abusive litigation also threatens to undermine one of 
the underpinnings of the Federal securities laws--disclosure to 
investors. Risk-averse corporate management avoid discussions 
of future business plans. Many companies refuse to talk or 
write about future business plans, knowing that projections 
that fail to materialize will inevitably result in a 
lawsuit.\24\
---------------------------------------------------------------------------
    \24\ Testimony of George H. Sollman, supra, note 21.
---------------------------------------------------------------------------
    Underwriters, lawyers, accountants, and other professionals 
are prime targets of abusive securities lawsuits. The deeper 
the pocket, the greater the likelihood that a marginal party 
will be named as a defendant in a securities class action. The 
availability of insurance also drives these lawsuits. In 1994 
alone, $1.4 billion was paid out by corporations or their 
insurers to settle securities lawsuits.\25\
---------------------------------------------------------------------------
    \25\ ``GOP Targets Shareholder Suits,'' Investors Business Daily, 
February 26, 1995, p. A1.
---------------------------------------------------------------------------
    The ``victims'' on whose behalf these lawsuits are 
allegedly brought often receive only pennies on the dollar in 
damages.\26\ Even worse, long-term investors ultimately end up 
paying the costs associated with the lawsuits. As the Council 
for Institutional Investors advised: ``We are * * * hurt if a 
system allows someone to force us to spend huge sums of money 
in legal costs by merely paying ten dollars and filing a 
meritless cookie cutter complaint against a company or its 
accountants when that plaintiff is disappointed in his or her 
investment.'' \27\
---------------------------------------------------------------------------
    \26\ Testimony of Patricia Reilly, ``Hearing on Private Litigation 
Under Federal Securities Laws: Subcommittee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs,'' June 17, 1993; See, 
Majority Staff Report, supra, note 7.
    \27\ Testimony of Maryellen Andersen, Council of Institutional 
Investors, Hearing on Private Litigation Under Federal Securities Laws: 
Subcommittee on Securities, Senate Committee on Banking, Housing, and 
Urban Affairs, July 21, 1993.
---------------------------------------------------------------------------
    In crafting this legislation, the Committee has sought to 
strike the appropriate balance between protecting the rights of 
victims of securities fraud and the rights of public companies 
to avoid costly and meritless litigation. Our economy does not 
benefit when strike suit artists wreak havoc on our Nation's 
boardrooms and deter capital formation.

       elimination of abusive practices in securities litigation

Removing the incentives to participate in abusive class action 
        litigation

    The Securities Subcommittee heard extensive testimony 
concerning certain areas of abuse involving class actions. 
These abuses include the use of professional plaintiffs and the 
race to the courthouse to be the first to file the 
complaint.\28\ State securities regulators testified that 
reform in both of these areas would ``create a more rational 
system for the filing of these cases.'' \29\
---------------------------------------------------------------------------
    \28\ See, Testimony of Arthur Levitt, Hearings on H.R. 10, the 
Common Sense Legal Reform Act of 1995, Subcommittee on 
Telecommunications and Finance, House Commerce Committee, February 10, 
1995.
    \29\ Testimony of Mark J. Griffin, Director of Utah Department of 
Commerce, Division of Securities, on behalf of the North American 
Securities Administrators Association, Hearings on Securities 
Litigation Reform Proposals: Subcommittee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs, March 22, 1995.
---------------------------------------------------------------------------
    The proliferation of ``professional'' plaintiffs has made 
it particularly easy for lawyers to find individuals willing to 
play the role of wronged investor for purposes of filing a 
class action lawsuit. Professional plaintiffs often are 
motivated by the payment of a ``bonus'' far in excess of their 
share of any recovery.
    The Committee believes that lead plaintiffs are not 
entitled to a bounty for their service. Thus, the lead 
plaintiff's share of any final judgment of any settlement 
should be calculated in the same manner as the shares of the 
other class members. Recognizing that service as the lead 
plaintiff may require court appearances or other duties 
involving time away from work, the Committee grants courts 
discretion to award the lead plaintiff reimbursement for 
``reasonable costs and expenses'' (including lost wages) 
directly relating to representation of the class.
    The Committee recognizes that certain basic information 
about the lead plaintiff should be provided at the outset of 
litigation. Accordingly, the Committee requires that the lead 
plaintiff file a sworn certified statement with the complaint. 
The plaintiff must certify that he or she: (a) reviewed and 
authorized the filing of the complaint; (b) did not purchase 
the securities at the direction of counsel or to participate in 
a lawsuit; and (c) is willing to serve on behalf of the class. 
To further deter professional plaintiffs, the plaintiff must 
also identify any transactions in the securities covered by the 
class period, and the other lawsuits in which the plaintiff has 
sought to serve as lead plaintiff in the last three years.
    The lead plaintiff should actively represent the class. The 
Committee believes that the lead plaintiff--not lawyers--should 
drive the litigation. As one witness testified: ``One way of 
addressing this problem is to restore lawyers and clients to 
their traditional roles by making it harder for lawyers to 
invent a suit and then attach a plaintiff.'' \30\
---------------------------------------------------------------------------
    \30\ Testimony of Mark E. Lackritz, supra, note 22.
---------------------------------------------------------------------------
    Courts traditionally appoint the lead plaintiff and lead 
counsel in class action lawsuits on a ``first come, first 
serve'' basis. Since no deference is given to the most 
thoroughly researched complaint, the lawyers spend minimal time 
preparing complaints in securities class actions. The first 
lawsuit filed also renders the lead plaintiff.
    The Committee believes that the selection of the lead 
plaintiff should rest on considerations other than a speedy 
filing of the complaint. The Committee establishes procedures 
for the appointment of the lead plaintiff in class actions 
brought under both the 1933 Act and 1934 Act. Within 20 days of 
filing a complaint, the plaintiff must publish in a widely 
circulated business publication notice of the complaint, and 
that members of the purported class may move the court to serve 
as lead plaintiff within 60 days. The Committee does not intend 
for the members of the purported class who seek to serve as 
lead plaintiff to file with this motion the certification 
described above. The Committee intends ``publication'' to 
encompass a variety of mediums, including wire, electronic, or 
computer services.
    The Committee intends to increase the likelihood that 
institutional investors will serve as lead plaintiffs by 
requiring the court to presume that the member of the purported 
class with the largest financial stake in the relief sought is 
the ``most adequate plaintiff.'' Institutional investors are 
America's largest shareholders, with about $9.5 trillion in 
assets, accounting for 51% of the equity market. Pension Funds 
total $4.5 trillion of institutional assets.\31\ The current 
system often works to prevent institutional investors from 
selecting counsel or serving as lead plaintiff in class 
actions.\32\
---------------------------------------------------------------------------
    \31\ The Brancato Report on Institutional Investment, ``Total 
Assets and Equity Holdings'' Volume 2, Edition 1.
    \32\ Elliott J. Weiss and John S. Beckerman, ``Let the Money Do the 
Monitoring: How Institutional Investors Can Reduce Agency Costs in 
Securities Class Actions' '' 104 The Yale Law Journal (1995). This 
article provided the basis for the ``most adequate plaintiff'' 
provision.
---------------------------------------------------------------------------
    The Committee believes that increasing the role of 
institutional investors in class actions will ultimately 
benefit the class and assist the courts. According to one 
representative of institutional investors: ``As the largest 
shareholders in most companies, we are the ones who have the 
most to gain from meritorious securities litigation.'' \33\
---------------------------------------------------------------------------
    \33\ Testimony of Maryellen Anderson, supra, note 27.
---------------------------------------------------------------------------
    Scholars predict that increasing the role of institutional 
investors will benefit both injured shareholders and courts: 
``Institutions with large stakes in class actions have much the 
same interests as the plaintiff class generally; thus, courts 
could be more confident settlements negotiated under the 
supervision of institutional plaintiffs were `fair and 
reasonable' than is the case with settlements negotiated by 
unsupervised plaintiffs' attorneys'' \34\ The Committee 
believes that an institutional investor acting as lead 
plaintiff can, consistent with its fiduciary obligations, 
balance the interests of the class with the long-term interests 
of the company and its public investors.
---------------------------------------------------------------------------
    \34\ ``Let the Money Do the Monitoring,'' supra, note 32.
---------------------------------------------------------------------------
    Finally, the Committee permits the lead plaintiff to choose 
the class counsel. This provision is intended to permit the 
plaintiff to choose counsel rather than have counsel choose the 
plaintiff. Although the Committee permits the most adequate 
plaintiff to

choose class counsel, the Committee does not intend to disturb 
the court's discretion under existing law to approve or 
disapprove the lead plaintiff's choice of counsel when 
necessary to protect the interests of the plaintiff class.

New rules relating to the settlement process

    The Securities Subcommittee also heard testimony that 
counsel in securities class actions receive a disproportionate 
share of the settlement award and that class members frequently 
lack meaningful information about the terms of the proposed 
settlement.\35\
---------------------------------------------------------------------------
    \35\ Testimony of Patricia Reilly, supra, note 26.
---------------------------------------------------------------------------
    Under current practice, courts generally award attorney's 
fees based on the so-called ``lodestar'' approach--i.e., the 
court multiplies the attorney's hours by a reasonable hourly 
fee, which may be increased by an additional amount based on 
risk or other relevant factors.\36\ As a result of this 
methodology, attorney's fees have exceeded 50% or more of the 
settlement awarded to the class. The Committee limits the award 
of attorney's fees and costs to a reasonable percentage of the 
amount of recovery awarded to the class. By not fixing the 
percentage of attorney's fees and costs that may be awarded, 
the Committee intends to give the court flexibility in 
determining what is reasonable on a case-by-case basis. The 
provision focuses on the final amount of damages awarded, not 
the means by which they are calculated.
---------------------------------------------------------------------------
    \36\ See generally, Majority Staff Report, supra note 7, at 81 et 
seq.
---------------------------------------------------------------------------
    Class members often receive insufficient notice of the 
terms of a proposed settlement and, thus, have little basis to 
evaluate the settlement. As one bar association advised, 
``settlement notices provided to class members are often obtuse 
and confusing, and should be written in plain English.'' \37\ 
The Committee received similar testimony from an investor who 
was a class member in two separate securities fraud lawsuits: 
``Nowhere in the settlement notices were the stockholders told 
of how much they could expect to recover of their losses. * * * 
I feel that the settlement offer should have told the 
stockholders how little of their losses will be recovered in 
the settlement, and that this is a material fact to the 
shareholder's decision to approve or disapprove the 
settlement.'' \38\
---------------------------------------------------------------------------
    \37\ NASCAT Analysis of Pending Legislation on Securities Fraud 
Litigation, hearing on Securities Litigation Reform Proposals: 
Subcommittee on Securities, Senate Committee on Banking, Housing, and 
Urban Affairs, March 2, 1995.
    \38\ Testimony of Patricia Reilly, supra, note 26.
---------------------------------------------------------------------------
    The Committee requires that certain information be included 
in any proposed or final settlement agreement disseminated to 
class members. To ensure that critical information is readily 
ascertainable to class members, the Committee requires that 
such information appear in summary form on the cover page of 
the notice. The notice must contain a statement of the average 
amount of damages per share that would be recoverable if the 
settling parties can agree on a figure, or a statement from 
each settling party on why there is disagreement. It must also 
explain the attorney's fees and costs sought. The name, 
telephone number, and address of counsel for the class must be 
provided, and such counsel must be reasonably available to 
answer class members' questions about the settlement. Perhaps 
most importantly, the notice must include a brief statement 
explaining the reason for the proposed settlement.
    Although generally barring the filing of settlement 
agreements under seal, the Committee recognizes that legitimate 
reasons may exist for the court to permit the entry of a 
settlement or portions of a settlement under seal. A party must 
show ``good cause,'' i.e., that the publication of a portion or 
portions of the settlement agreement would result in direct and 
substantial harm. The Committee intends that ``direct and 
substantial harm'' would include reputational injury to a 
party.

Attorney sanctions for pursuing meritless litigation

    The Securities Subcommittee heard ample testimony on the 
need to reduce the economic incentive to file meritless claims. 
Under Rule 11 of the Federal Rules of Civil Procedure, the 
courts may impose sanctions against an attorney or party for 
the filing of an abusive lawsuit.\39\ Many believe that Rule 11 
has not been an effective tool in limiting abusive litigation. 
Complaints about the current system include the high cost of 
making a Rule 11 motion, and the unwillingness of courts to 
impose sanctions, even when the rule is violated.\40\
---------------------------------------------------------------------------
    \39\ Rule 11 governs all pleadings, written motions and other 
papers filed with the court. Under Rule 11(b), the attorney's signature 
on such papers certifies that:
    (1) it is not being presented for an improper purpose, such as to 
harass or to cause unnecessary delay or needless increase in the cost 
of litigation;
    (2) the claims, defenses, and other legal contentions therein are 
warranted by existing law or by a non-frivolous argument for the 
extension, modification, or reversal of existing law or the 
establishment of new law;
    (3) the allegations and other factual contentions have evidentiary 
support or, if specifically so identified, are likely to have 
evidentiary support after a reasonable opportunity for further 
investigation or discovery; and
    (4) the denials of factual contentions are warranted on the 
evidence or, if specifically so identified are reasonably based on a 
lack of information or belief.
    \40\ See, response by Thomas Dunlap, Jr., General Counsel, Intel 
Corporation, to Written Questions of Senator Domenici, ``Private 
Litigation Under the Federal Securities Laws: Hearings Before the 
Subcommittee on Securities of the Senate Committee on Banking, Housing, 
and Urban Affairs,'' 103d Cong., 1st Session. S. Hrg. No. 103-431 
(1993) (noting that ``Rule 11 is rarely enforced in Federal Courts'').
---------------------------------------------------------------------------
    Several proposals have been advanced to reduce the economic 
incentive to file abusive securities fraud suits.\41\ The 
Committee recognizes the need to reduce significantly the 
economic incentive to file meritless lawsuits without hindering 
the ability of the victims of fraud to pursue legitimate 
claims.
---------------------------------------------------------------------------
    \41\ See, Majority Staff Report, 45-48, supra, note 7.
    The original S. 240 contained a provision allowed for fee shifting 
in cases where a party unreasonably refused to enter into Alternative 
Dispute Resolution (``ADR''), if that party pursued a claim or defense 
later deemed ``not substantially justified.'' Because the Committee has 
determined to retain the voluntary nature of ADR, it has not included 
the original S. 240's fee shifting mechanism in the final bill. The 
Committee, however, supports the increased use of ADR to reduce the 
time and expense associated with securities fraud litigation and 
encourages courts to explore new and innovative methods of ADR.
---------------------------------------------------------------------------
    Upon the final adjudication of an action, the Committee 
requires the court to include in the record specific findings 
as to whether all parties and all attorneys have complied with 
the requirements of Rule 11(b) of the Federal Rules of Civil 
Procedure. If the court finds that either a party or an 
attorney violated Rule 11(b), the court must impose sanctions. 
Section 103 adopts a rebuttable presumption that the 
appropriate sanction for the filing of a complaint in violation 
of Rule 11(b) is an award of attorney's fees and costs. A party 
may rebut this presumption by proof: (i) that the violation was 
de minimis, or (ii) that the imposition of fees and costs would 
impose an undue burden on that party. The Committee does not 
in-

tend the court to establish a specific income or other 
financial threshold that would automatically carve out a 
category of individuals for which imposing sanctions would 
always cause an ``undue burden.'' Rather, the Committee expects 
that the court will take into account the relevant 
circumstances of each case.
    If a party successfully rebuts the presumption, the court 
then must impose sanctions consistent with Rule 11(c)(2).\42\ 
The Committee intends for this provision to impose upon courts 
the affirmative duty to scrutinize closely filings and to 
sanction attorneys whenever their conduct violates Rule 11(b).
---------------------------------------------------------------------------
    \42\ Rule 11(c)(2) limits sanctions to ``what is sufficient to 
deter the repetition of such conduct or comparable conduct by others 
similarly situated.''
---------------------------------------------------------------------------

Stay of discovery

    The cost of discovery often forces defendants to settle 
abusive securities class actions. According to the general 
counsel of an investment bank, ``discovery costs account for 
roughly 80% of total litigation costs in securities fraud 
cases.'' \43\ In addition, the threat that the time of key 
employees will be spent responding to discovery requests, such 
as providing deposition testimony, may force coercive 
settlements.
---------------------------------------------------------------------------
    \43\ Testimony of former SEC Commissioner J. Carter Beese, Jr., 
Chairman of the Capital Markets Regulatory Reform Project Center for 
Strategic and International Studies, before the Securities Subcommittee 
of the Senate Committee on Banking, Housing, and Urban Affairs, March 
2, 1995 (citing testimony of Philip A. Lacovara, Hearing on H.R. 3185: 
Telecommunications and Finance Subcommittee of the House Committee on 
Energy and Commerce).
---------------------------------------------------------------------------
    The Securities Subcommittee heard testimony that discovery 
in securities class actions resembles a fishing expedition. As 
one corporate executive testified, ``once the suit is filed, 
the plaintiff's law firm proceeds to search through all of the 
company's documents and take endless depositions for the 
slightest positive comment which they can claim induced the 
plantiff to invest and any shred of evidence that the company 
knew a downturn was coming.'' \44\ Thus, plaintiffs sometimes 
file frivolous lawsuits in order to conduct discovery in the 
hopes of finding a sustainable claim not alleged in the 
complaint. Accordingly, the Committee has determined that 
discovery should be permitted in securities class actions only 
after the court has sustained the legal sufficiency of the 
complaint. Courts should stay all discovery pending a ruling on 
a motion to dismiss a securities class action, except in the 
exceptional circumstance where particularized discovery is 
necessary to preserve evidence or to prevent undue prejudice to 
a party. The Committee recognizes, for example, that a motion 
to dismiss may remain pending for a period of time, and that 
the terminal illness of an important witness may necessitate 
the deposition of the witness prior to ruling on the motion to 
dismiss.
---------------------------------------------------------------------------
    \44\ Testimony of Richard J. Egan, Chairman of the Board of EMC 
Corporation, Hearing on Private Litigation Under Federal Securities 
Laws: Subcommittee on Securities, Senate Committee on Banking, Housing, 
and Urban Affairs, June 17, 1993.
---------------------------------------------------------------------------
    Because the imposition of a stay of discovery may increase 
the likelihood that relevant evidence may be lost, the 
Committee makes it unlawful for any person, upon receiving 
actual notice that names that person as a defendant, to destroy 
or otherwise alter relevant evidence. The Committee intends 
this provision to prohibit only the willful alteration or 
destruction of evidence relevant to the allegations in the 
complaint. This provision does not impose liabil-

ity for the inadvertent or unintentional destruction of 
documents. Although this prohibition expressly applies only to 
defendants, the Committee believes that the willful destruction 
of evidence by a plaintiff would be equally improper, and that 
courts have ample authority to prevent such conduct or to apply 
sanctions as appropriate.

A strong pleading requirement

    The Securities Subcommittee has heard ample testimony on 
the need to establish a uniform and stringent pleading 
requirement to curtail the filing of abusive lawsuits. Rule 
9(b) of the Federal Rules of Civil Procedure requires a 
plaintiff to plead allegations of fraud with ``particularity.'' 
The courts of appeals have interpreted Rule 9(b) in different 
ways, creating distinctly different pleading standards among 
the circuits.
    The Committee does not adopt a new and untested pleading 
standard that would generate additional litigation. Instead, 
the Committee chose a uniform standard modeled upon the 
pleading standard of the Second Circuit. Regarded as the most 
stringent pleading standard,\45\ the Second Circuit requires 
that the plaintiff plead facts that give rise to a ``strong 
inference'' of defendant's fraudulent intent.\46\ The Committee 
does not intend to codify the Second Circuit's caselaw 
interpreting this pleading standard, although courts may find 
this body of law instructive.
---------------------------------------------------------------------------
    \45\ Testimony of Arthur Levitt, Chairman of the U.S. Securities 
and Exchange Commission: Hearing on Securities Litigation Reform 
Proposals: Subcommittee on Securities, Senate Committee on Banking, 
Housing, and Urban Affairs, April 6, 1995.
    \46\ In Re Time Warner, Inc. Securities Litigation, 9 F.3d 259, 268 
(2d Cir. 1993) (citations omitted).
---------------------------------------------------------------------------
    The plaintiff must also specifically identify each 
statement alleged to have been misleading, the reason or 
reasons why the statement is misleading, and, if the allegation 
is made on information and belief, the plaintiff must set forth 
all information in plaintiff's possession on which the belief 
is formed.
    The Committee also requires the plaintiff to show that the 
misstatement or loss alleged in the complaint caused the loss 
incurred by the plaintiff. For example, the plaintiff would 
have to prove that the price at which the plaintiff bought the 
stock was artificially inflated as the result of the 
misstatement or omission. The defendant would then have the 
opportunity to prove any mitigating circumstances, or that 
factors unrelated to the fraud contributed to the loss.

A safe harbor for forward-looking statements or projections

    Abusive litigation severely impacts the willingness of 
corporate managers to disclose information to the marketplace. 
Former SEC Chairman Richard Breeden testified: ``Shareholders 
are also damaged due to the chilling effect of the current 
system on the robustness and candor of disclosure. * * * 
Understanding a company's own assessment of its future 
potential would be among the

most valuable information shareholders and potential investors 
could have about a firm.'' \47\
---------------------------------------------------------------------------
    \47\ Testimony of Richard C. Breeden, Hearing on Securities 
Litigation Reform Proposals: Sub-committee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs, April 6, 1995.
---------------------------------------------------------------------------
    Fear that inaccurate projections will trigger the filing of 
a securities fraud lawsuit has muzzled corporate management. 
One study found that over two-thirds of venture capital firms 
were reluctant to discuss their performance with analysts or 
the public because of the threat of litigation.\48\ Anecdotal 
evidence similarly indicates company's counsel advises clients 
to say as little as possible, because ``legions of lawyers 
scrub required filings to ensure that disclosures are as 
milquetoast as possible, so as to provide no grist for the 
litigation mill.'' \49\
---------------------------------------------------------------------------
    \48\ Testimony of James F. Morgan supra, note 16.
    \49\ Testimony of J. Carter Beese, supra, note 43.
---------------------------------------------------------------------------
    Small, high-growth businesses--because of the volatility of 
their stock prices--are particularly vulnerable to securities 
fraud law-suits when projections do not materialize. If a 
company fails to satisfy its announced earnings projections--
perhaps because of changes in the business cycle or a change in 
the timing of an order or new product--the company is likely to 
face a lawsuit. In many cases, the discovery process is then 
used to look for evidence of fraud. One witness described the 
broad discovery requests that resulted in the company producing 
over 1,500 boxes of documents at an expense of $1.4 
million.\50\
---------------------------------------------------------------------------
    \50\ Testimony of John G. Adler, Hearing on Private Litigation 
Under Federal Securities Laws, Subcommittee on Securities, Senate 
Committee on Banking, Housing, and Urban Affairs, June 17, 1993.
---------------------------------------------------------------------------
    The Committee's statutory ``safe harbor'' is intended to 
enhance market efficiency by encouraging companies to disclose 
forward-looking information. This provision protects from 
liability certain ``forward-looking'' statements that are 
accompanied by sufficient cautionary language.
    The concept of a safe harbor for forward-looking statements 
made under certain conditions is not new. In 1979, the SEC 
promulgated Rule 175 to provide a safe harbor for certain 
forward-looking statements made with a ``reasonable basis'' and 
in ``good faith.'' This safe harbor has not provided companies 
meaningful protection from litigation. In a February 1995 
letter to the SEC, a leading pension fund stated: ``A major 
failing of the existing safe harbor is that while it may 
provide theoretical protection to issuers from liability when 
disclosing projections, it fails to prevent the threat of 
frivolous lawsuits that arises every time a legitimate 
projection is not realized.'' \51\
---------------------------------------------------------------------------
    \51\ February 14, 1995 letter from the California Public Employees' 
Retirement System to the SEC on SEC ``safe harbor'' proposal. See, note 
6, supra.
---------------------------------------------------------------------------
    Courts have also crafted a safe harbor for forward-looking 
statements or projections accompanied by sufficient cautionary 
language. At least five courts of appeals have recognized the 
so-called

``bespeaks caution.'' doctrine.\52\ In an oft-cited case,\53\ 
the Third Circuit articulated this doctrine as follows:
---------------------------------------------------------------------------
    \52\ The First, Second, Third, Sixth, and Ninth Circuits have 
adopted a version of the bespeaks caution doctrine. See e.g., In Re 
Worlds of Wonder Securities Litigation, 35 F.3d 1407 (9th Cir. 1994); 
Rubinstein v. Collins, 20 F.3d 160 (5th Cir. 1994); Kline v. First 
Western Government Securities, Inc., 24 F.3d 480 (3d Cir. 1994); Sinay 
v. Lamson & Sessions Company, 948 F.2d 1037 (6th Cir. 1991); I. Meyer 
Pincus & Associates v. Oppenheimer & Co., Inc., 936 F.2d 759 (2d Cir. 
1991); Romani v. Shearson Lehman Hutton, 929 F.2d 875 (1st Cir. 1991); 
Luce v. Edelstein, 802 F.2d 49 (2d Cir. 1986);
    \53\ In Re Donald J. Trump Casino, 7 F.3d 357 (3d Cir. 1993).

          We can state as a general matter that, when an 
        offering document's forecasts, opinions, or projections 
        are accompanied by meaningful cautionary statements, 
        the forward-looking statements will not form the basis 
        for a securities fraud claim if those statements did 
        not affect the ``total mix'' of information the 
        document provides investors. In other words, cautionary 
        language, if sufficient, renders the alleged omissions 
        or misrepresentations immaterial as a matter of 
        law.\54\
---------------------------------------------------------------------------
    \54\ Id. at 371.

    The Committee's safe harbor is based on aspects of SEC Rule 
175 and the bespeaks caution doctrine. This provision applies 
to both oral and written statements that describe, project or 
estimate future events. The Committee adopts the SEC's present 
definition as set forth in Rule 175, of forward-looking 
information. The SEC's definition covers: (i) certain financial 
items, including projections of revenues, income, and earnings, 
capital expenditures, dividends, and capital structure; (ii) 
management's statement of future business plans and objectives; 
and (iii) certain statements made in SEC required disclosures, 
including management's discussion and analysis and results of 
operations; and (iv) any statement disclosing the assumptions 
underlying the forward-looking statement.
    The safe harbor provision protects written and oral 
forward-looking statements made by issuers and certain persons 
retained or acting on behalf of the issuer. To come within the 
safe harbor, the statement must ``project, estimate, or 
describe'' future events and be accompanied by sufficient 
notice that the information is forward-looking and that actual 
results may be materially different from such projections. In 
the case of oral statements, the Committee expects that the 
notice will be provided at the outset of any general discussion 
of future events and that further notice will not be necessary 
during the course of that discussion.
    The Committee intends that the phrase ``a person acting on 
behalf of such issuer'' be construed in a manner that will 
promote the purposes of the safe harbor in accordance with 
securities industry practice. In this regard, the Committee 
intends that the safe harbor protect, not merely the statements 
of the issuer, but also those of employees of the issuer and of 
persons acting on the issuer's behalf.
    The Committee has determined that the statutory safe harbor 
should not apply to certain forward-looking statements Thus, 
the statutory safe harbor does not protect forward-looking 
statements: (1) included in financial statements prepared in 
accordance with generally accepted accounting principles; (2) 
contained in an initial public offering registration statement; 
(3) make in connection with

a tender offer; (4) made in connection with a partnership, 
limited liability corporation, or direct participation program 
offering; or (5) made in beneficial ownership disclosure 
statements filed with the SEC under Section 13(d) of the 1934 
Act. The Committee expressly authorizes the SEC to consider the 
adoption of a regulatory safe harbor for such statements.
    Moreover, the Committee has determined to extend the 
statutory safe harbor only to forward-looking information of 
certain established issuers subject to the reporting 
requirements of Section 15(d) of the 1934 Act. Except as 
provided by SEC rule or regulation, the safe harbor does not 
extend to an issuer who: (a) during the three year period 
preceding the date on which the statement was first made, has 
been convicted of a felony or misdemeanor described in clauses 
(i) through (iv) of Section 15(b)(4) of the 1934 Act or is the 
subject of a decree or order involving a violation of the 
federal securities laws; (b) makes the statement in connection 
with a ``blank check'' securities offering, ``rollup 
transaction,'' or ``going private'' transaction; or (c) issues 
penny stock.
    Although the Committee believes that market discipline will 
most likely provide sufficient disincentives for using the safe 
harbor as a ``license to lie,'' the safe harbor does not 
protect forward-looking statements ``knowingly made with the 
expectation, purpose, and actual intent of misleading 
investors.'' The Committee intends that the pleading 
requirements under new Section 36 of the 1934 Act will apply to 
a complaint alleging that a forward-looking statement is not 
within the safe harbor. Accordingly, the plaintiff would have 
to allege ``facts giving rise to a strong inference'' that the 
forward-looking statement was ``knowingly made with the 
expectation, purpose, and actual intent of misleading 
investors.'' ``Expectation,'' ``purpose,'' and ``actual 
intent'' are independent elements of the exclusion, and 
plaintiffs have the burden of pleading and proving each of 
these elements.
    The court must stay discovery (other than discovery that is 
specifically directed to the applicability of the safe harbor) 
when a defendant moves for summary judgment based on the ground 
that the safe harbor bars a claim for relief. Courts should, to 
the fullest extent possible, limit discovery to facts directly 
bearing upon the applicability of the safe harbor and not 
permit plaintiffs to engage in fishing expeditions. The 
Committee expects that the stay will significantly reduce the 
costs of discovery.
    The Committee intends for its statutory safe harbor 
provisions to serve as a starting point and fully expects the 
SEC to continue its rulemaking proceedings in this area. The 
SEC should, as appropriate, promulgate rules or regulations to 
expand the statutory safe harbor by providing additional 
exemptions from liability or extending its coverage to 
additional types of information.

Written interrogatories

    In an action to recover money damages, the Committee 
requires the court to submit written interrogatories to the 
jury on the issue of defendant's state of mind at the time of 
the violation. In expressly providing for certain 
interrogatories, the Committee does not intend to prohibit 
otherwise or discourage the submission of interrogatories 
concerning the mental state or relative fault of the

plaintiff and of persons who could have been joined as 
defendants. For example, interrogatories may be appropriate in 
contribution proceedings among defendants or in computing 
liability when some of the defendants have entered into 
settlement with the plaintiff prior to verdict or judgment.

Limiting civil RICO actions

    The SEC has supported removing securities fraud as a 
predicate act of racketeering in a civil action under the 
Racketeer Influenced and Corrupt Organizations Act (``RICO''). 
SEC Chairman Arthur Levitt testified: ``Because the securities 
laws generally provide adequate remedies for those injured by 
securities fraud, it is both unnecessary and unfair to expose 
defendants in securities cases to the threat of treble damages 
and other extraordinary remedies provided by RICO.'' \55\
---------------------------------------------------------------------------
    \55\ Testimony of Arthur Levitt, February 10, 1995, supra, note 28.
---------------------------------------------------------------------------
    The Committee amends Section 1964(c) of Title 18 of the 
U.S. Code to remove any conduct that would have been actionable 
as fraud in the purchase or sale of securities as a predicate 
act of racketeering under civil RICO. The Committee intends 
this amendment to eliminate securities fraud as a predicate act 
of racketeering in a civil RICO action. In addition, a 
plaintiff may not plead other specified offenses, such as mail 
or wire fraud, as predicate acts of racketeering under civil 
RICO if such offenses are based on conduct that would have been 
actionable as securities fraud.

A grant of authority to the SEC to prosecute certain aiding and 
        abetting cases

    Prior to the Supreme Court's decision in Central Bank of 
Denver v. First Interstate Bank of Denver,\56\ courts of 
appeals had recognized that private parties could bring actions 
against persons who ``aided and abetted'' primary violators of 
the securities laws. In Central Bank, the Court held that there 
was no aiding and abetting liability for private lawsuits 
involving violations of the securities antifraud provisions.
---------------------------------------------------------------------------
    \56\ 114 S. Ct. 1439 (1994).
---------------------------------------------------------------------------
    The Committee considered testimony endorsing the result in 
Central Bank and testimony seeking to overturn this decision. 
The committee believes that amending the 1934 Act to provide 
explicitly for private aiding and abetting liability actions 
under Section 10(b) would be contrary to S. 240's goal of 
reducing meritless securities ligation. The Committee does, 
however, grant the SEC express authority to bring actions 
seeking injunctive relief or money damages against persons who 
knowingly aid and abet primary violators of the securities 
laws.

Limitation on damages

    The current method of calculating damages in 1934 Act 
securities fraud cases is complex, with no statutory guidance 
to provide certainty. As a result, there are often substantial 
variations in the damages calculated by the defendants and the 
plaintiffs. Typically, in an action involving a fraudulent 
misstatement or omission, the investor's damages are presumed 
to be the difference between the

price he or she paid for the security and the price of the 
security on the date the corrective information is disseminated 
to the market.
    Between the time a misrepresentation is made and the time 
the market receives corrected information, however, the price 
of the security may rise or fall for reasons unrelated to the 
alleged fraud. According to an analysis provided to the 
Securities Subcommittee, damages in securities litigation 
amount to approximately 27.7% \57\ of an investor's market 
loss. Calculating damages based on the date corrective 
information is disclosed may substantially overestimate 
plaintiff's actual damages.\58\ The Committee intends a rectify 
the uncertainty in calculating damages by providing a ``bounce 
back'' period, thereby limiting damages to those losses caused 
by the fraud and not by other market conditions.
---------------------------------------------------------------------------
    \57\ The percentages of damages as market losses in the analysis 
ranged from 7.9% to 100%. See Princeton Venture Research, Inc., ``PVR 
Analysis, Securities Law Class Actions, Damages as a Percent of Market 
Losses,'' June 15, 1993.
    \58\ Lev and de Villers, ``Stock Price Crashes and 10b-5 Damages: A 
Legal, Economic and Policy Analysis,'' Stanford Law Review, 7, 9-11 
(1994).
---------------------------------------------------------------------------
    This provision requires that plaintiff's damages be 
calculated by taking into account the value of the security on 
the date plaintiff originally bought or sold the security and 
the median market value of the security during the 90-day 
period after dissemination of any information correcting the 
misleading statement or omission. If the plaintiff sells those 
securities or repurchases the subject securities during the 90-
day period, damages will be calculated based on the price of 
that transaction and the median market value of the security 
immediately after the dissemination of corrective information 
and ending with the plaintiff's sale or repurchase of the 
security.

Modification of joint and several liability

    The Committee heard considerable testimony about the impact 
of joint and several liability on private actions under the 
Federal securities laws. Under joint and several liability, 
each defendant is liable for all of the damages awarded to the 
plaintiff. Thus, a defendant found responsible for only 1% of 
the harm could be required to pay 100% of the damages.
    Former SEC Commissioner J. Carter Beese, Jr., observed that 
``[t]his principle has a legitimate public policy purpose, but, 
in practice, it encourages plaintiffs to name as many deep-
pocket defendants as possible, even though some of these 
defendants may bear very little responsibility for any injuries 
suffered by the plaintiff.'' \59\ He noted that ``[a]s a 
result, whenever a company is sued under Rule 10b-5, there is a 
strong likelihood that lawyers, accountants, underwriters and 
directors will be sued, as well.'' \60\ Several other 
witnesses, including former SEC Chairmen David S. Ruder and 
Richard C. Breeden and former SEC Commissioner Charles C. Cox, 
acknowledged this problem.\61\
---------------------------------------------------------------------------
    \59\ Testimony of J. Carter Beese, Jr., supra, note 43.
    \60\ Id.
    \61\ See, Testimony of Richard C. Breeden, supra, note 47; 
Testimony of David S. Ruder, Hearing on Securities Litigation: Impact 
of U.S. Supreme Court Decision: Central Bank of Denver v. First 
Interstate of Denver, Subcommittee on Securities, Senate Committee on 
Banking, Housing, and Urban Affairs, May 12, 1994. Testimony of Charles 
C. Cox, Hearing on Securities Litigation Reform Proposals: Subcommittee 
on Securities, Senate Committee on Banking, Housing, and Urban Affairs, 
April 6, 1995.
---------------------------------------------------------------------------
    When peripheral defendants are sued, the pressure to settle 
is overwhelming--regardless of the defendant's culpability. 
Former SEC Chairman Ruder stated that defendants are under 
``enormous pressure to settle'' because of ``the possibility 
that they will be required to pay the entire amount claimed.'' 
\62\ The exposure in securities fraud class actions is enormous 
because of the amount of total damages claimed. In one sample 
of cases the average claim was $40 million, with 10% of the 
cases seeking more than $100 million in damages.\63\ The cost 
of discovery also contributes to this pressure to settle.\64\ 
As a result, oftentimes peripheral defendants are joined simply 
to obtain a settlement. As Chairman D'Amato observed, ``[t]he 
threat of [joint and several] liability often forces innocent 
`deep pocket' defendants to settle frivolous suits.'' \65\
---------------------------------------------------------------------------
    \62\ Testimony of David Ruder, see id.
    \63\ Majority Report, supra. note 7.
    \64\ Testimony of Marc E. Lackritz, supra, note 22.
    \65\ Statement of Senator D'Amato supra, note 3.
---------------------------------------------------------------------------
    The resulting litigation burden--the combination of legal 
fees and settlement costs--on peripheral defendants has 
significant consequences. ``The fact that a director of a 
publicly-held company faces the prospect of being sued 
regardless of how well he or she performs is driving some 
directors off corporate boards, and precluding other companies 
from attracting qualified board members.'' \66\ Jean Head 
Sisco, testifying on behalf of the National Association of 
Corporate Directors, stated that ``the proliferation of abusive 
10b-5 securities suits is making it extremely difficult to 
attract qualified, independent people to sit on corporate 
boards.'' \67\ Several surveys have confirmed that directors 
are increasingly concerned about litigation risk and are 
reluctant to serve on boards of start-up and high-technology 
companies.\68\
---------------------------------------------------------------------------
    \66\ Testimony of J. Carter Beese, Jr., supra, note 43.
    \67\ Hearing Report, supra, note 40.
    \68\ Hearing Report, supra, note 40 at 104. Testimony of J. Carter 
Beese, Jr., supra, note 43 (discussing surveys).
---------------------------------------------------------------------------
    At a minimum, qualified individuals insist that the company 
obtain substantial D&O insurance coverage, SEC Chairman Levitt 
himself refused to serve on boards of companies with 
insufficient insurance.\69\ But that prerequisite imposes a 
high cost: D&O insurance premiums have increased seven-fold 
over the last decade,\70\ in large part because of the cost of 
this litigation. ``Within the past two years, several of the 
major D&O insurers have priced D&O insurance out of existence 
for many companies, or have stopped writing policies for 
companies in particular industries, such as the technology 
sector. All investors are at risk at these growing companies 
put increasingly large sums of money into D&O polices instead 
of into developing the long-term strength of the company.'' 
\71\
---------------------------------------------------------------------------
    \69\ Statement of Arthur Levitt, April 6, 1995, supra, note 45.
    \70\ See, Testimony of Marc E. Lackritz, supra, note 22. Nearly 
two-thirds of the companies responding in a 1994 survey reported 
substantial increases in D&O insurance premiums, with an average 
increase of 94%. Testimony of James Morgan, supra, note 16.
    \71\ Testimony of James Morgan, supra, note 16.
---------------------------------------------------------------------------
    Accounting firms particularly have been hard hit by 
securities litigation. The six largest firms face $10 billion 
in 10b-5 claims.\72\ Their gross audit-related litigation costs 
amounted to $783 million in 1992--more than 14% of their audit 
revenues for that year.\73\

---------------------------------------------------------------------------
    \72\ Hearing Report (statement of Jake L. Netterville), supra, note 
40.
    \73\ Id.
---------------------------------------------------------------------------
Former SEC Commissioner A.A. Sommer, who heads the Public 
Oversight Board, the independent body that oversees the 
accounting profession's self-regulatory efforts, testified 
that, in view of ``some recent judgments and the amounts being 
sought in pending cases, it is not beyond the pale to believe, 
and some responsible people do believe--that one or more major 
[accounting] firms may ultimately be bankrupted.\74\
---------------------------------------------------------------------------
    \74\ Id.
---------------------------------------------------------------------------
    Because of concern about the fairness of 10b-5 litigation 
and because of concern about the adverse consequences of joint 
and several liability, a number of witnesses, including SEC 
Chairman Levitt,\75\ former SEC Chairmen Ruder and Breeden,\76\ 
and former SEC Commissioners Beese and Sommer,\77\ advocated 
modification of the doctrine of joint and several liability in 
securities actions. For example, Ralph V. Whitworth, president 
of the United Shareholders Association, stated that in cases 
where there was no proof of actual fraud ``[e]liminating joint 
and several liability * * * will significantly reduce the 
number of strike suits brought against defendants who have done 
nothing wrong but are seen as having deep pockets.'' \78\ Marc 
Lackritz, President of the Securities Industry Association, 
identified proportionate liability as the most important 
provision to be included in securities litigation reform 
legislation.\79\
---------------------------------------------------------------------------
    \75\ Testimony of Arthur Levitt, supra, note 45.
    \76\ Testimony of Richard C. Breeden, supra, note 47. Testimony of 
David S. Ruder, supra, note 61.
    \77\ Testimony of J. Carter Beese, Jr., supra, note 43; Hearing 
Report (testimony of A.A. Sommer, Jr.), supra, note 40 at 353-4.
    \78\ Hearing Report, supra, note 40 at 465.
    \79\ Testimony of Marc Lackritz, supra, note 22.
---------------------------------------------------------------------------
    The Committee modifies joint and several liability to 
eliminate unfairness and to reconcile the conflicting interests 
of investors in a manner designed to best protect the interests 
of all investors--those who are plaintiffs in a particular 
case, those who are investors in the defendant company, and 
those who invest in other companies.
    The provision imposes full joint and several liability, as 
under current law, on all defendants who engage in knowing 
securities fraud. Defendants who are found liable but who did 
not engage in knowing securities fraud are liable only for 
their share of the judgment (based upon the fact finder's 
apportionment of responsibility), with two key exceptions. 
First, in the event some defendant is insolvent, and therefore 
cannot pay his or her share of the liability, and the jointly 
and severally liable defendants cannot make up the difference, 
each of the other proportionally liable defendants must make an 
additional payment--up to 50% of his or her own liability--to 
make up the shortfall in the plaintiff's recovery.
    Second, proportionally liable defendants will be liable for 
the uncollectible share if the plaintiff establishes that (i) 
the damages are more than 10% of the plaintiff's net worth, and 
(ii) the plaintiff's net financial worth is less than $200,000. 
In this scenario, there is no limitation on the amount 
proportionally liable defendants will be required to pay. The 
$200,000 financial net worth test does not reflect a judgment 
by the Committee that investors who fall below this standard 
are ``small,'' unsophisticated, or in need of,

or entitled to, special protection under the securities laws. 
The Committee intends ``financial net worth'' in include all of 
the plaintiff's financial assets including stocks, bonds, real 
estate, and jewelry.

Loss causation requirement for Section 12(2) of the 1933 Act

    Congress adopted Section 12(2) of the 1933 Act to deter 
material misrepresentations and omissions in the purchase or 
sale of securities. Some courts have held that a plaintiff 
suing under Section 12(2) need not prove that the misstatement 
or omission caused the loss.\80\ As a result, issuers have been 
put in the position of insuring shareholders and purchasers 
against normal market risk. An issuer that makes a material 
misstatement or omission in its prospectus can be liable for 
losses to shareholders--even if the losses have nothing to do 
with the misstatement or omission.
---------------------------------------------------------------------------
    \80\ See e.g., Wilson v. Saintine Exploration & Drilling Corp., 872 
F.2d 1124, 1126 (2d Cir. 1989).
---------------------------------------------------------------------------
    This interpretation of Section 12(2) provides an unfair 
windfall to shareholders who have not in any way been harmed by 
the misstatement or omission. For example, a company might fail 
to state in a public offering prospectus that it conducts 
business in a foreign country. Even if the company's foreign 
business is highly profitable, if its overall profits decline 
as the result of unrelated factors (such as a downturn in its 
domestic business), any purchaser of the securities in the 
offering could rescind his or her purchase.
    The Committee amends Section 12(2) to clarify that 
defendants may raise the absence of ``loss causation'' as an 
affirmative defense. If a defendant in a Section 12(2) action 
demonstrates that part or all of the decline in the value of 
the security was caused by factors other than the misstatement 
or omission alleged in the complaint, the plaintiff may not 
recover damages based on that portion of the decline. The 
defendant must bear the burden of affirmatively demonstrating 
the absence of loss causation. This provision does not place 
any additional burden on plaintiffs to demonstrate that loss 
causation existed, nor does it deprive investors of Section 
12(2) remedies when they have incurred losses caused by 
inadequate disclosure. The amendment to Section 12(2) is 
modeled after Section 11 of the Securities Act, which provides 
for a similar affirmative defense.

Auditor Disclosure of Corporate Fraud

    This provision requires independent public accountants to 
adopt certain procedures in connection with their audits and to 
inform the SEC of illegal acts of their auditing clients. These 
requirements should be carried out in accordance with generally 
accepted auditing standards for audits of SEC registrants--as 
modified from time to time by the Commission--on the detection 
of illegal acts, related party transactions and relationships, 
and evaluation of an issuer's ability to continue as a going 
concern.
    The Committee does not intend to affect the Commission's 
authority in areas not specifically addressed by this 
provision. The Committee expects that the SEC will continue its 
long-standing

practice of looking to the private sector to set and to improve 
auditing standards. The SEC should not act to ``modify'' or 
``supplement'' generally accepted auditing standards for SEC 
registrants until after it has determined that the private 
sector is unable or unwilling to do so on a timely basis. The 
Committee intends for the SEC to have discretion, however, to 
determine the appropriateness and timeliness of the private 
sector response. The SEC should act promptly if required by the 
public interest or for the protection of investors.

    Section-by-Section Analysis of S. 240, the ``Private Securities 
                    Litigation Reform Act of 1995''


Section 1. Short title; table of contents

    Section 1 provides that S. 240 may be cited as the 
``Private Securities Litigation Reform Act of 1995'' (the 
``Act'') and sets out a table of contents for the Act.

                title i--reduction of abusive litigation

Section 101. Elimination of certain abusive practices

    Section 101(a) amends the Securities Exchange Act of 1934 
(the ``1934 Act'') by adding a new paragraph (8) to Section 
15(c), prohibiting brokers or dealers or any associated persons 
from soliciting or receiving any type of fee or remuneration 
for assisting an attorney in obtaining representation of any 
person in private actions under the Securities Act of 1933 (the 
``1933 Act'') or the 1934 Act.
    Section 101(b) amends Section 20 of the 1933 Act by adding 
a new subsection (f) and Section 21 of the 1934 Act by adding a 
new subsection (i), requiring the court to determine whether a 
plaintiff's attorney who owns, or has a beneficial interest in, 
securities that are the subject of litigation has a 
disqualifying conflict of interest.
    Section 101(c) amends Section 20 of the 1933 Act by adding 
a new subsection (g) and Section 21(d) of the 1934 Act by 
adding new paragraph (4), prohibiting the payment of attorneys' 
fees or expenses incurred by private parties out of funds 
disgorged as the result of action by the Securities and 
Exchange Commission (the ``Commission'' or ``SEC''), except as 
otherwise ordered by the court upon motion by the Commission 
and, in the case of SEC administrative actions, by order of the 
Commission.

 Section 102. Securities class action reform

    Section 102(a) establishes five new recovery rules for 
private class actions under the 1933 and 1934 Acts. Section 
102(a)(1) of the Act amends Section 20 of the 1933 Act by 
adding a new subsection (h) and Section 102(a)(2) of the Act 
amends Section 21 of the 1934 Act by adding new subsection (j).
    The first rule requires every plaintiff seeking to serve as 
a representative party on behalf of a class to file a sworn 
certification with the complaint, stating: (i) the plaintiff 
reviewed the complaint and authorized its filing; (ii) the 
plaintiff did not purchase the securities at the direction of 
counsel or to participate in a lawsuit; (iii) the plaintiff is 
willing to serve as a representative party on behalf of the 
class; (iv) the plaintiff's transactions during the class 
period in the security that is the subject of the complaint; 
(v) other law-

suits in which the plaintiff has sought to serve as 
representative party in the prior three years; and (vi) the 
plaintiff will not receive any bonus for serving as the class 
representative. This certification will not be construed to 
waive the attorney-client privilege.
    The second rule limits the class representative's recovery 
to his or her pro rata share of the settlement or final 
judgment. The court may also reimburse the class representative 
for ``reasonable costs and expenses,'' including lost wages 
directly relating to the representation of the class.
    The third rule prohibits the filing of settlements under 
seal except if ``good cause'' is shown, i.e., publication of a 
portion or portions of the settlement agreement would result in 
direct and substantial harm to a party.
    The fourth rule limits the award of fees and expenses to 
counsel for a plaintiff class to a reasonable percentage of the 
amount of recovery awarded to the class.
    The fifth rule specifies the information that must be 
included in any proposed or final settlement agreement 
disseminated to the class. The rule requires the settling 
parties, if they can agree, to state the average amount of 
damages per share that would be recoverable if the plaintiff 
prevailed. If the parties cannot agree, each party must provide 
a statement on the issues on which they disagree. Such 
statements are inadmissible in any court action or 
administrative proceeding unless the action or proceeding 
concerns the statement itself. The rule also requires the 
parties or counsel who intend to seek an award of attorneys' 
fees or costs to state the amount sought--on an average per 
share basis--and to provide an explanation supporting the fees 
and costs sought. Any settlement agreement must also include 
the name, telephone number, and address of plaintiff class 
counsel who will answer questions from class members, and a 
brief statement explaining the reasons for the proposed 
settlement. The required information must appear, in summary 
form, on a cover page. The court may order disclosure of 
additional information.
    Section 102(b)(1) amends the 1933 Act by adding a new 
subsection (i) to Section 20, and Section 102(b)(2) amends the 
1934 Act by adding a new subsection (k) to Section 21; 
establishing procedures for the appointment of the lead 
plaintiff in class actions. A plaintiff filing a securities 
class action must, within 20 days of filing a complaint, 
provide notice to members of the purported class in a widely 
circulated business publication. This notice must: (i) identify 
the claims alleged in the lawsuit and the purported class 
period, and (ii) inform potential class members that, within 60 
days, they may move to serve as the lead plaintiff. The notice 
provisions in this subsection do not replace or supersede other 
notice provisions provided in the Federal Rules of Civil 
Procedure.
    Within 90 days of the published notice, the court must 
consider motions made under this section and appoint the lead 
plaintiff. If a motion has been filed to consolidate multiple 
class actions brought on behalf of the same class, the court 
shall not appoint a lead plaintiff until after consideration of 
any such motion. In appointing the lead plaintiff, the court 
shall presume that the ``most adequate plaintiff'' is the 
member of the purported class (who has moved for such 
appointment and otherwise satisfies Rule 23 of the

Federal Rules of Civil Procedure) with the largest financial 
interest in the relief sought by the class. This presumption 
may be rebutted by evidence that the plaintiff would not fairly 
and adequately represent the interests of the class or is 
subject to unique defenses.
    Members of the purported class may seek discovery into 
whether the presumptively most adequate plaintiff would not 
adequately represent the class. Subject to court approval, the 
most adequate plaintiff shall retain class counsel.

Section 103. Sanctions for abusive litigation

    Section 103(a) amends Section 20 of the 1933 Act by adding 
a new subsection (j) and Section 103(b) amends Section 21 of 
the 1934 Act by adding a new subsection (l), requiring the 
court (i) to make specific findings, upon adjudication of a 
private action, regarding compliance by all parties and all 
attorneys with each requirement of Rule 11(b), and (ii) to 
impose sanctions for any violations. In imposing sanctions for 
failure of the complaint to comply with Rule 11(b), the court 
will presume that the appropriate sanction is the reasonable 
attorneys' fees and expenses of the opposing party. This 
presumption may be rebutted by evidence that the imposition of 
sanctions would impose an undue burden on the violator or that 
the Rule 11 violation was de minimis.

Section 104. Requirements for securities fraud actions

    Section 104(a)(1) amends Section 20 of the 1933 Act by 
adding a new subsection (k) and (l) and adds a new Section 
36(c) to the 1934 Act, (i) requiring the court to stay 
discovery during the pendency of any motion to dismiss the 
complaint, unless particularized discovery is needed to 
preserve evidence or prevent undue prejudice, and (ii) 
prohibiting parties from willfully destroying or altering 
evidence they know is relevant to the allegations in the 
complaint.
    Section 104(b) amends the 1934 Act by adding a new Section 
36, establishing pleading standards for Section 10(b) actions 
alleging untrue statements or omissions of a material fact. The 
complaint must specifically identify each misleading statement 
and the reason or reasons why it is misleading. In any private 
action to recover money damages, the plaintiff must, for each 
misstatement or omission, specifically allege facts giving rise 
to a strong inference that the defendant acted with the 
required state of mind.
    This section also requires plaintiffs to show ``loss 
causation,'' i.e., that the alleged violation caused 
plaintiff's loss. The defendant may mitigate the damages 
arising from such loss by showing that unrelated factors 
contributed to the loss.

Section 105. Safe harbor for forward-looking statements

    Section 105 establishes a ``safe harbor'' protecting 
certain forward-looking statements from liability in private 
actions under the 1933 Act and the 1934 Act and grants the SEC 
authority to promulgate safe harbor rules under the Investment 
Company Act of 1940. Section 105(a) amends the 1933 Act by 
adding a new Section 13A; Section 105(b) amends the 1934 Act by 
adding a new Section 37; and Section 105(c) amends Section 24 
of the Investment Company Act by adding a new subsection (g).
    The safe harbor provision protects written and oral 
forward-looking statements that ``project, estimate, or 
describe'' future events made by issuers and certain persons 
retained or acting on behalf of issuers. To be protected, the 
statement must be accompanied by sufficient notice that the 
information is forward-looking and that actual results may be 
materially different from such projections, estimates, or 
descriptions.
    The definition of ``forward-looking'' information is the 
same as contained in the SEC's present Rule 175 safe harbor. 
The definition includes: (i) certain financial items, including 
projections of revenues, income, earnings, capital 
expenditures, dividends, and capital structure; (ii) 
management's statement of future business plans and objectives; 
(iii) certain statements made in required SEC disclosures, 
including managements's discussion and analysis and results of 
operations; and (iv) any disclosed statement of the assumptions 
underlying the forward-looking statement. The SEC may expand 
the definition by rule or regulation.
    The safe harbor does not protect forward-looking statements 
``knowingly made with the expectation, purpose, and actual 
intent of misleading investors.''
    In order to quality for the safe harbor, the issuer must be 
subject to the reporting requirements of Section 13(a) or 
Section 15(d) of the 1934 Act. Except as provided by SEC rule 
or regulation, the safe harbor does not extend to an issuer 
who: (a) during the three year period preceding the date on 
which the statement was first made, has been convicted of a 
felony or misdemeanor described in clauses (i) through (iv) of 
Section 15(b)(4) or is the subject of a decree or order 
involving a violation of the securities laws; (b) makes the 
statement in connection with a ``blank check'' securities 
offering, ``rollup transaction,'' or ``going private'' 
transaction; or (c) issues penny stock.
    The safe harbor does not cover certain statements that may 
otherwise qualify as forward-looking statements. Except as 
provided by SEC rule or regulation, the safe harbor does not 
cover forward-looking statements: (i) included in financial 
statements prepared in accordance with generally accepted 
accounting principles; (ii) contained in an initial public 
offering registration statement; (iii) made in connection with 
a tender offer; (iv) made in connection with a partnership, 
limited liability corporation or direct participation program 
offering; or (v) made in beneficial ownership disclosure 
statements filed with the SEC under Section 13(d) of the 1934 
Act.
    The court must stay discovery (other than discovery that is 
specifically directed to the applicability of the safe harbor) 
pending its decision on a motion for summary judgment based on 
the grounds that the statement or omission is protected by the 
safe harbor.
    The SEC may promulgate rules or regulations to expand the 
statutory safe harbor by providing additional exemptions from 
liability. This section also grants the SEC authority to 
recover damages on behalf of investors injured by reason of 
violations involving a forward-looking statement not protected 
by the safe harbor.

Section 106. Written interrogatories

    Section 106(a) amends Section 20 of the 1933 Act by adding 
a new subsection (m) and Section 21 of the 1934 Act by adding a 
new

subsection (m), requiring the court, in actions in which the 
plaintiff may recover money damages, to submit written 
interrogatories to the jury on the issue of defendant's state 
of mind at the time of the violation.

Section 107. Amendment to Racketeer Influenced and Corrupt 
        Organizations Act

    Section 107 amends Section 1964(c) of Title 18 of the U.S. 
Code to conduct that would have been actionable as fraud in the 
purchase or sale of a security as a predicate offense under 
civil RICO.

Section 108. Authority of Commission to prosecute aiding and abetting

    Section 108 amends Section 20 of the 1934 Act by adding a 
new subsection (e), authorizing the SEC to bring an action 
seeking injunctive relief or money penalties against persons 
who knowingly ``aid and abet'' primary violators of the 
securities laws.

Section 109. Limitation on rescission

    Section 109 amends Section 12 of the 1933 Act by adding a 
provision at the end of the section allowing a defendant to 
avoid the remedy of rescission under certain circumstances. In 
an action based on a misstatement or omission contained in a 
prospectus, a defendant may avoid rescissionary damages if the 
defendant proves that the depreciation in the value of the 
security resulted from factors unrelated to the alleged 
misstatement or omission. If the defendant shows there is no 
``loss causation'' the purchaser may recover damages only for 
the remaining portion of the depreciation in the security's 
value.

Section 110. Applicability

    The provisions included in Title I of this Act apply to any 
private action commenced after the date of enactment.

              TITLE II--REDUCTION OF COERCIVE SETTLEMENTS

Section 201. Limitation on damages

    Section 201 amends Section 36 of the 1934 Act by adding a 
new subsection (e), providing for a ``look back'' period in 
calculating damages in a private action involving a 
misstatement or omission under the 1934 Act. This provision is 
intended to limit damages to those losses caused by the fraud 
and not by other market conditions.
    Plaintiff's damages will be calculated by taking into 
account the value of the security on the date plaintiff 
originally bought or sold the security and the value of the 
security during the 90-day period after dissemination of any 
information correcting the misleading statement or omission. If 
the plaintiff sells those securities or repurchases the subject 
securities during the 90-day period, damages will be calculated 
based on the price of that transaction and the value of the 
security immediately after the dissemination of corrective 
information.

Section 202. Proportionate liability

    Section 202 amends the 1934 Act by adding a new Section 38, 
establishing a system for allocating damages in private actions 
brought under the 1934 Act. Under this section, a defendant who 
commits ``knowing'' securities fraud is jointly and severally 
liable for the full amount of the damages. To commit 
``knowing'' securities fraud, a defendant must make a 
``material representation or omission with actual knowledge 
that the information is false,'' and ``actually know that 
persons are likely to rely on'' the false information. Reckless 
conduct would not constitute knowing securities fraud.
    In cases involving multiple defendants, the court shall 
instruct the jury to determine (i) each defendant's percentage 
of responsibility, including any settling defendants, and (ii) 
whether each defendant committed knowing securities fraud. The 
defendants who did not commit knowing securities fraud will 
only be liable for the portion of damages attributable to their 
percentage of responsibility.
    If there are uncollectible shares because the defendants 
who have committed knowing securities fraud are ``judgment 
proof,'' the proportionally liable defendants may be liable for 
an additional amount of up to 50% of their total share of 
damages.
    In addition, proportionally liable defendants will be 
liable for the uncollectible share if, within six months of 
entry of final judgment, the plaintiff establishes that (i) the 
damages are more than 10% of the plaintiff's net worth, and 
(ii) the plaintiff's net financial worth is less than $200,000.
    Defendants who make an additional payment may, within six 
months of the date of the payment, seek contribution from other 
defendants in the action. A defendant who settles the action 
before verdict or judgment will not be subject to any claim of 
contribution. In determining the amount of the final judgment, 
the court will reduce the final judgment to take into account 
the settling party's percentage of responsibility and the 
amount the settling defendant paid to the plaintiff. A person 
who is liable for damages under this section may seek, within 
six months of entry of the final judgment, contribution from 
persons who were not parties to the lawsuit.

Section 203. Applicability

    The provisions included in Title II of this Act apply to 
any private action commenced after the date of enactment.

            title iii--auditor disclosure of corporate fraud

Section 301. Fraud detection and disclosure

    This section amends the 1934 Act by adding a new Section 
10A, requiring independent public accountants to institute 
certain procedures in connection with their activities. If an 
accountant learns of an illegal act that may be 
``consequential'' to the company, the accountant must provide 
this information to the company's management. If management 
fails to act, and the accountant determines that the illegal 
act would have a material effect on the issuer's financial 
statements, the accountant must report the information to the 
board of directors. If the board fails to notify the Commission

within one day, the accountant must notify the Commission the 
following day. Failure to provide this notification will 
subject the accountant to civil penalties.
    The provisions in this section apply to annual reports 
filed with the Commission after July 1, 1996 for registrants 
that file quarterly reports and January 1, 1997 for all other 
registrants.

                      REGULATORY IMPACT STATEMENT

    This legislation seeks to reform private securities 
litigation and thus it has limited regulatory impact. 
Generally, there is little or no requirement for regulatory 
implementation of the provisions of the bill.
    Some provisions, in fact, would reduce regulatory 
requirements. For example, the SEC is directed in Section 105 
of the legislation to provide by regulation safe harbors for 
forward-looking statements comprehended by the Investment 
Company Act of 1940, and is authorized to provide for statutory 
safe harbors for forward-looking statements under the 1933 and 
1934 Acts.
    Two provisions would, however, have some regulatory impact. 
First, Section 105 of the legislation would broaden the SEC's 
authority to seek and to obtain disgorgement under the 1933 and 
1934 Acts. This section authorizes the SEC to recover damages 
on behalf of investors involving a forward-looking statement 
not protected by the statutory safe harbor. Under current law, 
SEC disgorgement is generally limited to any ill-gotten gains. 
It is not possible to estimate the number of persons to whom 
this provision would apply. Second, Title III of this 
legislation would impose new reporting obligations on public 
accountants. Although these obligations will increase the costs 
of conducting audits, it is not possible to estimate precisely 
the extent of these new costs.

                        CHANGES IN EXISTING LAW

    In the opinion of the Committee, it is necessary to 
dispense with the requirement of subsection 12 of rule XXVI of 
the Standing Rules of the Senate in order to expedite the 
business of the Senate.

                        COST OF THE LEGISLATION

    The Committee has requested a cost estimate of this 
legislation under the provisions of Section 403 of the 
Congressional Budget Act of 1974. The cost estimate of the 
Congressional Budget Office follows.
                                     U.S. Congress,
                               Congressional Budget Office,
                                     Washington, DC, June 19, 1995.
Hon. Alfonse M. D'Amato,
Chairman, Committee on Banking, Housing, and Urban Affairs, U.S. 
        Senate, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
reviewed S. 240, the Private Securities Litigation Reform Act 
of 1995, as ordered reported by the Senate Committee on 
Banking, Housing, and Urban Affairs on May 25, 1995. CBO 
estimates that enacting S. 240 would cost the federal 
government between $125 million and

$250 million over the next five years, assuming appropriation 
of the necessary amounts. Because enacting S. 240 would affect 
receipts, pay-as-you-go procedures would apply to the bill. 
Enacting S. 240 would not affect the budgets of state or local 
governments.

Bill purpose

    Title I of S. 240 would require a court, when hearing class 
action litigation brought under the Securities Exchange Act of 
1934, to appoint a lead plaintiff for the class under certain 
circumstances. The bill would require the full disclosure of 
the terms of settlement for any such class action lawsuit and 
would prohibit the payment of attorneys' fees from certain 
funds. In addition, the bill would establish various procedures 
and restrictions to discourage litigation, restrict the 
liability of those persons who make forward-looking statements 
regarding securities or markets, and require the Securities and 
Exchange Commission (SEC) to promulgate rules establishing such 
limited liability. The bill would amend the Racketeer 
Influenced and Corrupt Organizations statute to exclude from 
its purview an action involving fraud in the sale of 
securities. Title II of S. 240 would limit the amount of 
damages that could be awarded in certain securities litigation 
cases, and would limit the application of joint and several 
liability in those cases. Title III would include certain 
procedures to be followed during a required audit of a 
securities issuer, and would provide civil penalties for 
violations of those procedures.

Federal budgetary impact

    CBO estimates that promulgating the rules required by the 
bill would result in increased costs to the federal government 
of approximately $300,000 in 1996, primarily for personnel 
costs, assuming appropriation of the necessary amounts.
    By discouraging private litigation under the Securities 
Exchange Act of 1934, enacting S. 240 would result in an 
increase in the number of enforcement actions brought by the 
SEC. In 1994, there were about 50 enforcement actions due to 
financial fraud, resulting in administrative costs to the 
federal government of approximately $24 million. Although the 
impact on the SEC's workload from enacting S. 240 is highly 
uncertain, CBO expects that financial fraud enforcement actions 
would number at least 100, and possibly up to 150. Therefore, 
CBO estimates that enactment of S. 240 would increase costs to 
the SEC for enforcement actions by $25 million to $50 million 
annually, or $125 million to $250 million over the next five 
years, assuming appropriation of the necessary amounts.

Pay-as-you-go impact

    S. 240 would require civil penalties for violations of 
certain of its provisions. These civil penalties would count as 
governmental receipts, and thus would be subject to pay-as-you-
go provisions. CBO estimates, however, that no significant 
additional amount of receipts would be collected.

Previous CBO estimate

    On February 23, 1995, CBO provided an estimate for Title II 
of H.R. 10, the Securities Litigation Reform Act, as ordered 
reported

by the House Committee on the Judiciary, to that committee. S. 
240 differs from that bill primarily in that S. 240 would 
require civil penalties for violations of the provisions of 
Title III, and it would require additional rulemakings by the 
SEC. In other respects the bills are substantially similar, and 
CBO's estimate of the SEC's enforcement costs under S. 240 is 
unchanged from our estimate for Title II of H.R. 10.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are John Webb 
and Melissa Sampson.
            Sincerely,
                                         June E. O'Neill, Director.

 ADDITIONAL VIEWS OF SENATORS GRAMM, MACK, FAIRCLOTH, BENNETT, GRAMS, 
                               AND FRIST

    The Hippocratic Oath begins with the admonition to do no 
harm. The bill reported by the Committee follows that mandate. 
Unlike much of the legislation of past Congresses, this bill is 
not ``two-steps-forward, one-step-back'' legislation. The 
improvements that the bill makes over current law are not 
eroded by new legislative injuries.
    While the bill provides significant incremental relief from 
abusive securities lawsuits, the costs of these lawsuits are so 
high that stronger reform is needed. Information presented to 
the Subcommittee on Securities indicates that approximately 300 
securities litigation cases are filed each year. Few of these 
cases are brought to trial. Instead, the high costs of 
litigation normally induce settlements of the cases, at an 
average amounting to $8.6 million per case, for a combined 
total of nearly $2.5 billion per year. Even with settlements, 
the legal costs for defendants average an additional $700,000 
per case.
    Perhaps the most destructive aspect of securities strike 
suits is the disruption that they cause to company operations. 
For example, defendant companies devote an average of 1,000 
management and employee hours to each case. This amounts to 
37,500 workdays each year consumed by securities lawsuits.
    Moreover, there seems to be a pattern of targeting high 
technology companies. A survey conducted by the American 
Electronics Association of their forty largest firms found that 
twenty-four had been sued for securities fraud, including nine 
out of the top ten. Either the securities litigation system is 
broken, or there is an enormous disrespect for the law in 
Silicon Valley. We believe that the problem lies with the 
system of litigation.
    We therefore recommend that the bill's provisions be 
strengthened. Among such changes, particular attention should 
be given to (1) strengthening the proportionate liability 
provisions of section 202, (2) strengthening the sanctions for 
abusive litigation provision of section 103, (3) strengthening 
the safe harbor for forward-looking statements in section 105, 
and (4) delineate more clearly the standard of liability 
provisions of section 104.

                 proportionate liability (section 202)

    No reform was more strongly supported by witnesses and 
members during subcommittee hearings than the concept of 
introducing proportionate liability for securities lawsuits. 
Currently, defendants have joint and several liability, which 
means that any person found to have any liability at all, 
regardless of how insignificant, can be liable for all of the 
damages awarded in these securities cases. The effect of this 
has been to add to the lawsuit ``deep-pocket'' plaintiffs who 
have at most a marginal involvement in the alleged wrongdoing, 
such as accounting firms, securities houses, banks, investment 
partners and others. Faced with (1) the risk of being jointly 
and severally liable for the entire settlement amount and (2) 
the high cost of litigation, such peripherally involved 
defendants frequently decide to settle the case rather than 
proceed to trial.
    The concept of proportionate liability is that no one 
should be required to compensate for injuries for which they 
are not responsible. Unfortunately, the bill's proportionate 
liability provisions contain exceptions that leave deep-pocket 
parties still within reach of the strike-suit attorneys. Under 
the bill's provisions, if a clearly guilty defendant's share of 
a court's judgment is not collectible, every other peripherally 
involved defendant is jointly and severally liable for the 
uncollectible share if the financial net worth of the plaintiff 
is $200,000 or less, that is, most individual investors.
    This exception to proportionate liability is open-ended, 
with no limitations on liability for defendants with minor 
fault, and no practical means of verifying the net worth or 
losses of those claiming to be such small investors. This is an 
exception with the potential for swallowing the rule and should 
be corrected.

         attorney sanctions for abusive lawsuits (section 103)

    The bill contains a very modest provision to penalize 
attorneys who promote abusive securities suits. Currently, 
strike suit attorneys face little cost or risk in filing 
lawsuits on flimsy pretexts. Rule 11 of the Federal Rules of 
Civil Procedure purportedly applies penalties against attorneys 
for abusive litigation. But investigation by the Congressional 
Research Service could find only three cases in history in 
which Rule 11 attorneys sanctions were ever actually applied in 
securities Rule 10b-5 cases. We advocated and support the 
directive in the bill that requires judges to review Rule 11 
issues in every case and provide a written statement regarding 
compliance with Rule 11, with mandatory sanctions in the case 
of a violation. However, we fear that this provision by itself 
will not be enough to end the ``winner pays'' reality of 
securities suits and alter the imbalance in the economics of 
securities litigation. This is particularly true, since the 
provision still relies upon the action of judges who have so 
far demonstrated little interest in imposing such sanctions. 
Innocent defendants will continue to be left in most cases to 
carry the expensive burden of proving their innocence.

        safe harbor for forward-looking statements (section 105)

    The safe-harbor provisions of the bill must be 
strengthened. Currently, there is impaired communication 
between investors and management regarding the forward-looking 
views and plans of corporations. Under the fear of costly 
abusive lawsuits filed when predictions of the future do not 
materialize, corporate representatives prefer to guard their 
silence or hide behind meaningless generic statements about the 
future. A statement from a recent securities filing by a 
financial services corporation is typical: ``The amount of 
future provisions will continue to be a function of regular 
quarterly review of the reserve for credit losses, based upon 
management's assessment of risk at that time, and, as such, 
there can be no assurance as to the level of future 
provisions.'' Investors and analysts are left wondering.
    While the provisions of the bill may allow for some degree 
of freer communication between corporate management and 
investors, we believe that the provisions have been so narrowly 
constrained and burdened with vague terms and standards that 
they are unlikely to provide in many cases adequate protection 
against abusive lawsuits. We are concerned that innocent 
corporations may still be subject to expensive and time-
consuming litigation and detailed fact-finding over the terms 
and restrictions of the safe harbor provisions and the extent 
of their application. In order to be effective, a safe harbor 
must have a bright line that is unmistakable to all parties. 
Otherwise, the utility of a safe harbor for obtaining early 
dismissal of abusive securities suits, or discouraging them 
entirely, may be elusive.

                  standard of liability (section 104)

    Curiously, under current law, it is often not clear just 
what constitutes a violation of Rule 10b-5. The current 
ambiguity is one of the contributing factors allowing for the 
filing of abusive, meritless, strike suits. Without a clear 
line as to what is and what is not a violation, the issue is 
left to the trial process. That is to say, meritless claims are 
given too long of a ride, all the while imposing costs on 
innocent defendants. Moreover, different courts in different 
judicial circuits have applied different interpretations of the 
standard of liability. A clear standard of liability would give 
greater protection to the innocent while allowing courts to 
focus on genuine cases of securities fraud.
    The legislation reported by the Committee would establish a 
single standard of liability. Unfortunately, it is still a 
vague standard that will require further judicial 
interpretation. Congress should provide clearer guidance to the 
courts than that provided in this bill. Otherwise, we will 
continue to provide too much legal confusion and too much room 
for the pursuit of meritless lawsuits. All of that imposes an 
unnecessary cost on the innocent and on our economy.

                          room for improvement

    While we support reporting this bill, we hope that in the 
remaining steps in the legislative process its provisions will 
be improved. At the same time, the legislation should remain 
free from provisions that take us backwards in the effort to 
eliminate abusive securities lawsuits.

                                   Phil Gramm.
                                   Connie Mack.
                                   Lauch Faircloth.
                                   Robert F. Bennett.
                                   Rod Grams.
                                   Bill Frist.

        ADDITIONAL VIEWS OF SENATORS SARBANES, BRYAN, AND BOXER

                              introduction

    We support the goal of deterring frivolous lawsuits and 
sanctioning appropriate parties when such lawsuits are filed. A 
number of the provisions in this bill are designed to achieve 
that goal. We support these provisions, and those that will 
improve class action procedures.
    This legislation, however, will affect far more than 
frivolous suits:
    The safe harbor provision will, for the first time, provide 
immunity under the Federal securities laws for fraudulent 
statements.
    The proportionate liability provision will, for the first 
time, transfer responsibility from participants in a fraud to 
innocent victims of that fraud. These provisions will make it 
more difficult for investors to bring fraud actions, and will 
reduce recoveries in such actions.
    The bill also fails to include provisions necessary to 
ensure that victims of securities fraud have adequate remedies:
    The bill does not extend the statute of limitations for 
securities fraud actions imposed by the Supreme Court in 1991, 
which the SEC and the State securities regulators believe is 
too short.
    Ignoring the recommendation of the securities regulators, 
the bill does not restore the ability of investors to sue 
individuals who aid and abet violations of the securities laws.
    This legislation threatens the capital formation process by 
undermining the confidence on which our markets depend. We are 
not alone in this conclusion. In a June 8, 1995 letter, the 
Government Finance Officers Association (``GFOA'') strongly 
agreed with this assessment. Consisting of more than 13,000 
state and local government financial officials, the GFOA's 
members both issue securities and invest billions of dollars of 
public pension and taxpayer funds. In its letter, the GFOA 
opposed S. 240 as reported:

          We support efforts to deter frivolous securities 
        lawsuits, but we believe that any legislation to 
        accomplish this must also maintain an appropriate 
        balance that ensures the rights of investors to seek 
        recovery against those who engage in fraud in the 
        securities markets. We believe that S. 240 does not 
        achieve this balance, but rather erodes the ability of 
        investors to seek recovery in cases of fraud.

Securities regulators, bar associations, consumer groups, and 
state and local government officials share this opinion, as 
discussed below. We reach the same conclusion, and accordingly 
voted against the legislation.

                    strength of u.s. capital markets

    By every measure, the United States capital markets are the 
largest and strongest in the world. In size, the U.S. markets 
remain preeminent: for 1993, U.S. equity market capitalization 
stood at $5.2 trillion, over one-third of the world 
total.1 The U.S. markets continue to grow: the 
combined total of equity and debt filings for 1994, over $810 
billion, was exceeded only by the record level set in 
1993.2 So attractive are the U.S. capital markets 
that more than 600 foreign companies from 41 different 
countries have tapped them, a level matched only in London, and 
more continue to come.3
---------------------------------------------------------------------------
    \1\ U.S. Securities and Exchange Commission 1994 Annual Report, at 
28.
    \2\ Id. at 53.
    \3\ Id.
---------------------------------------------------------------------------
    The growth of trading on our exchanges is a sign of the 
strength of our markets. Average daily trading volume on the 
New York Stock Exchange increased from 44.9 million shares in 
1980, to 156.8 million shares in 1990, to 291.4 million shares 
in 1994.4 The NASDAQ and American Stock Exchanges 
have experienced similar gains in trading volume.5
---------------------------------------------------------------------------
    \4\ Securities Industry TRENDS, Vol. XXI, No. 3, April 5, 1995.
    \5\ Id.
---------------------------------------------------------------------------
    Another sign of the strength of our markets is the rise of 
the mutual fund industry, one of the fastest-growing segments 
of the financial services industry. From 1980 to 1993, mutual 
fund assets increased by more than 10 times, to $1.9 
trillion.6 Approximately 38 million Americans, 
representing 27 percent of American households, own mutual 
funds.
---------------------------------------------------------------------------
    \6\ See Testimony of Arthur Levitt before the Senate Securities 
Subcommittee, November 10, 1993.
---------------------------------------------------------------------------

Role of the Federal Securities Laws

    Our securities markets have been operating under the 
Federal securities laws since those laws were enacted over 60 
years ago. As discussed above, our markets today are the 
largest and most vibrant in the world. This is so not in spite 
of the Federal securities laws, but in part because of the 
Federal securities laws. The Federal securities laws generally 
provide for sensible regulation, and self-regulation, of 
exchanges, brokers, dealers and issuers.
    Even more important to ensuring the success of our markets 
is investor confidence. That confidence is maintained because 
investors know they have effective remedies against persons who 
would defraud them. Both Republican and Democratic Chairmen of 
the Securities and Exchange Commission have stressed the 
integral role of the private right of action in maintaining 
investor confidence. In 1991, then-Chairman Richard Breeden 
testified before the Banking Committee:

          Private actions under Sections 10(b) and 14(a) of the 
        Exchange Act have long been recognized as a ``necessary 
        supplement'' to actions brought by the Commission and 
        as an ``essential tool'' in the enforcement of the 
        federal securities laws. Because the Commission does 
        not have adequate resources to detect and prosecute all 
        violations of the federal securities laws, private 
        actions perform a critical role in preserving the 
        integrity of our securities markets.

Current Chairman Arthur Levitt reiterated that point in 
testimony before the House Subcommittee on Telecommunications 
and Finance on February 10, 1995:

          Besides serving as the primary vehicle for 
        compensating defrauded investors, private actions also 
        provide a ``necessary supplement'' to the Commission's 
        own enforcement activities by serving to deter 
        securities law violations. Private actions are crucial 
        to the integrity of our disclosure system because they 
        provide a direct incentive for issuers and other market 
        participants to meet their obligations under the 
        securities laws.

    The importance of the private right of action is likely to 
increase, given the budgetary constraints on SEC resources. 
Testifying in 1993, the Director of the SEC's Division of 
Enforcement noted,

          Given the continued growth in the size and complexity 
        of our securities markets, and the absolute certainty 
        that persons seeking to perpetrate financial fraud will 
        always be among us, private actions will continue to be 
        essential to the maintenance of investor protection.

State of the Securities Litigation System

    The Securities Subcommittee has held hearings over the past 
two years reviewing the health of the Federal securities 
litigation system. The Subcommittee received testimony from 
plaintiffs' lawyers, from corporate defendants, from 
accountants, academics, securities regulators and investors. 
There was sharp disagreement among the witnesses over how well 
the securities litigation system is functioning, and over what 
policy responses are appropriate.
    Some argue that American business, particularly younger 
companies in the high-tech area, face a rising tide of 
frivolous securities litigation. A number of corporate 
executives told the Securities Subcommittee of their 
experiences. The American Electronics Association decried what 
it described as the ``current practice of filing off-the-shelf 
legal complaints when a company announces a downturn in 
performance [that] amounts to an uncontrolled `tax on 
innovation.' ''
    Clearly some frivolous securities cases are filed, as 
indeed some frivolous cases of every sort are filed. However, 
frivolous securities litigation does not appear to be at the 
crisis levels which some assert. Presenting statistics obtained 
from the Administrative Office of the U.S. Courts, the Director 
of the SEC's Division of Enforcement testified in June 1993 
that:

          the approximate aggregate number of securities cases 
        (including Commission cases) filed in Federal district 
        courts does not appear to have increased over the past 
        two decades. Similarly, while the approximate number of 
        securities class actions filed during the past three 
        years is significantly higher than during the 1980's, 
        the numbers do not reveal the type of increase that 
        ordinarily would be characterized as an ``explosion.''

Professor Joel Seligman of the University of Michigan Law 
School, one of the leading experts on the Federal securities 
laws, testified at the same hearing, ``there is little 
objective data at this time that suggests there is a need for 
significant reform of the federal securities laws, either to 
benefit plaintiffs or defendants.''
    The Committee Report states that it is easy to craft 
complaints alleging violations of the Federal securities laws. 
However, the Committee received evidence that it is difficult 
to bring even a meritorious securities action under the current 
system. Rule 9 of Federal Rules of Civil Procedure requires 
fraud to be pled with specificity. Joan Gallo, City Attorney 
for the City of San Jose, testified on March 22, 1995 about the 
successful securities fraud suit that San Jose brought against 
a number of brokers in the 1980's. She said, ``[u]nder current 
law, despite the fact that the City had very experienced legal 
counsel, it was not until February 1986 that our third amended 
complaint was finally found sufficient by the Federal Court.''
    Some argue that securities fraud class actions are 
inhibiting the capital formation process. Marc Lackritz, 
President of the Securities Industry Association, testified on 
March 2, 1995 that ``new or innovative ventures are foregone 
because of the litigation risks involved in capital 
formation.'' James F. Morgan testified on behalf of the 
National Venture Capital Association that the big accounting 
firms are ``winnowing out'' growth companies because of their 
riskiness.
    In fact, initial public offerings have been setting records 
in recent years: the record $39 billion in initial public 
offerings in 1992 was in turn exceeded by a record $57 billion 
in IPO's in 1993.7 The $34 billion in IPO's in 1994 
was exceeded only by the records set in 1992 and 
1993.8 Less than one month ago, on May 22, 1995, the 
New York Times reported:
---------------------------------------------------------------------------
    \7\ ``Securities Industry TRENDS,'' Vol. XXI, No. 3, April 5, 1995 
(Source: Securities Data Company).
    \8\ Id.

          One of the great booms in initial public offerings is 
        now under way, providing hundreds of millions in new 
        capital for high-tech companies, windfalls for those 
        with good enough connections to get in on the offerings 
        and millions in profit for the Wall Street firms 
---------------------------------------------------------------------------
        underwriting the deals.

The Securities Industry Association's own publications describe 
the boom in initial public offerings:

          ``After years of weakness in the late 1980s, 
        investment in new securities and IPOs accelerated 
        dramatically from 1990-1993. During that time, the 
        securities industry raised a record $130 billion for 
        small business through IPOs. Again, this was more than 
        was raised in America's first two centuries!'' 
        9
---------------------------------------------------------------------------
    \9\ The Securities Industry Briefing Book, A Partnership with 
America (1994), at 11.
---------------------------------------------------------------------------

                          PROVISIONS OF S. 240

    To be sure, frivolous litigation should be deterred and 
sanctioned. Some of the provisions in S. 240 as reported appear 
to be directed toward this goal. The requirement that courts 
include specific findings in securities class actions regarding 
compliance by all parties and attorneys with Rule 11(b) of the 
Federal Rules of Civil Procedure should act as a powerful 
deterrent to frivolous cases. Should a court find a violation 
of Rule 11, the court is required to impose sanctions.
    The bill also prohibits payments to lead plaintiffs in 
class actions of additional compensation, other than 
``reasonable costs and expenses.'' This will help ensure that 
class actions are brought by real parties in interest, rather 
than ``professional plaintiffs.'' To the same end, the bill 
requires that the plaintiff file a sworn statement that he or 
she authorized the filing of the complaint and did not purchase 
the securities at the direction of counsel or to participate in 
a lawsuit. The bill also prohibits attorneys from paying 
brokers for referring clients.
    The bill also seeks to improve the procedures governing 
class action lawsuits. The new procedures contained in the bill 
for selecting a lead plaintiff in class actions are designed to 
encourage participation by institutional investors. We are 
pleased that this provision contains safeguards intended to 
ensure that a lead plaintiff must continue to represent the 
class fairly and adequately, as required under the Federal 
Rules of Civil Procedure.
    The bill also seeks to improve the quality of information 
provided to investors when a securities fraud action is 
settled. The bill requires that a notice of a proposed 
settlement provided to investors must include clear information 
to allow investors to make an informed decision on the 
settlement. The statement must include the reason for the 
proposed settlement, the average damages recoverable per share 
if the settling parties can agree, and the attorneys' fees and 
costs.

Provisions of S. 240 will hurt investors

    Other provisions in S. 240, however, are not tailored to 
deterring or sanctioning frivolous litigation. Instead, they 
will make it more difficult to bring all securities fraud 
suits, including meritorious cases, and reduce recoveries 
across the board.

Safe harbor provision will undermine market confidence by protecting 
        fraudulent statements

    Contrary to the advice of the SEC, the North American 
Securities Administrators Association, the Government Finance 
Officers Association and others, S. 240 as reported creates a 
statutory exemption from liability for certain ``forward 
looking statements.'' Not only will this provision immunize 
reckless statements, but Chairman Levitt has warned that as 
drafted it will immunize fraudulent statements as well. By 
undermining confidence in our markets, such a return to the 
pre-Federal securities laws days of ``buyer beware'' would not 
benefit investors or issuers.
    ``Forward looking statements'' are broadly defined in the 
bill, to include projections of financial items such as 
revenues, income and dividends as well as statements of future 
economic performance required in documents filed with the SEC. 
As with any attempt to foresee the future, such statements 
always have an element of risk to them, and prudent investors 
must be careful in relying on them. In fact, until 1979 the SEC 
prohibited disclosure of forward looking information. The SEC 
believed that forward looking information was inherently 
unreliable, and that investors would place too much emphasis on 
such information in making investment decisions.
    After reviewing the matter extensively in the 1970's, the 
SEC adopted a ``safe harbor'' regulation for forward looking 
statements.10 The regulation (known as ``Rule 175'') 
generally offers protection for specified forward looking 
statements when made in documents filed with the SEC. To 
sustain a fraud suit, the investor must show that the forward 
looking information lacked a reasonable basis and was not made 
in good faith.
---------------------------------------------------------------------------
    \10\ See Securities Act Release No. 6084 (June 25, 1979); 17 CFR 
230.175 (1994), 17 CFR 240.3b-6 (1994).
---------------------------------------------------------------------------
    There is a wide body of opinion that the current regulatory 
safe harbor does not provide sufficient protection for good 
faith corporate projections. In a May 19, 1995 letter to the 
members of the Senate Banking Committee, Chairman Levitt 
acknowledged ``a need for a stronger safe harbor than currently 
exists.'' Indeed, the SEC has been conducting a comprehensive 
review of its safe harbor regulation.11 Testifying 
before the Securities Subcommittee in April, Chairman Levitt 
said:
---------------------------------------------------------------------------
    \11\ See Securities Act Release No. 33-7101 (October 13, 1994).

        The Commission recently published a ``concept'' release 
        soliciting comments on current practices relating to 
        disclosure of forward-looking information, with a view 
        to developing a new safe harbor for projections that 
        provides issuers with meaningful protection but 
        continues to protect investors. The Commission has 
        received approximately 150 comment letters in response 
        to the release, and public hearings on the issue were 
        conducted in Washington, DC and San Francisco during 
---------------------------------------------------------------------------
        February.

    As originally introduced by Senators Domenici and Dodd, S. 
240 would have allowed the SEC to continue this regulatory 
effort. The bill as introduced required that the SEC consider 
adopting rules or making legislative recommendations 
identifying criteria for exempting ``forward-looking statements 
concerning * * * future economic performance'' from antifraud 
liability under the Federal securities laws. S. 240 provided 
that if the SEC adopted such a rule, a defendant could request 
a stay of discovery while the court considered a motion for 
summary judgment on the grounds that the forward looking 
statement was within the coverage of the rule.
    Chairman Levitt endorsed this approach in his April 1995 
testimony before the Securities Subcommittee:

          From the Commission's perspective, an appropriate 
        legislative approach is contained in the Domenici/Dodd 
        bill. This provision would allow the Commission to 
        complete its rulemaking proceeding and take appropriate 
        action after its evaluation of the extensive comments 
        and testimony already received. Based on the 
        Commission's experience with this issue to date, we 
        believe that there is considerable value in proceeding 
        with rulemaking, which can more efficiently be 
        administered, interpreted and, if needed, modified, 
        than can legislation.

In a May 23, 1995 letter, the North American Securities 
Administrators Association, the Government Finance Officers 
Association, the National League of Cities and nine other 
groups expressed the same view (``we believe the more 
appropriate response is SEC rulemaking in this area'').
    However, the Committee Print substitute to S. 240, unlike 
the bill as introduced, abandoned this approach in favor of 
enacting a statutory safe harbor. Like the bill passed by the 
House, S. 240 as reported will for the first time shield 
fraudulent statements from liability under the Federal 
securities laws. This provision constitutes an ill-advised 
break with 60 years experience under the Federal securities 
laws.
    Under the original Committee Print, forward looking 
statements were immunized from antifraud liability under the 
Federal securities laws unless they were ``knowingly made with 
the expectation, purpose, and actual intent of misleading 
investors,'' and unless an investor could prove that he or she 
``had actual knowledge of and actually relied on'' the 
statement.12
---------------------------------------------------------------------------
    \12\ In Basic, Inc. v. Levinson, 485 U.S. 224 (1988), the Supreme 
Court rejected this requirement of ``actual knowledge of and actual 
reliance on'' fraudulent statements in most circumstances. Instead, the 
Supreme Court recognized a doctrine called ``fraud on the market'' that 
had previously been adopted by a majority of Federal circuit courts. 
The Court held that:

      [a]n investor who buys or sells stock at the price set by 
      the market does so in reliance on the integrity of that 
      price. Because most publicly available information is 
      reflected in the market price, an investor's reliance on 
      any public material misrepresentations, therefore, may be 
---------------------------------------------------------------------------
      presumed for purposes of a[n antifraud] action.

485 U.S. at 247.
    In a May 19, 1995 letter to the members of the Senate 
Banking Committee, SEC Chairman Levitt expressed his ``personal 
views about a legislative approach to a safe harbor.'' He 
suggested that:

        [a] carefully crafted safe harbor protection from 
        meritless private lawsuits should encourage public 
        companies to make additional forward-looking disclosure 
        that would benefit investors. At the same time, it 
        should not compromise the integrity of such information 
        which is vital to both investor protection and the 
        efficiency of the capital markets--the two goals of the 
        federal securities laws.

He stated, ``[a] safe harbor must be thoughtful--so that it 
protects considered projections, but never fraudulent ones.'' 
He indicated he would support a safe harbor containing ``a 
scienter standard other than recklessness.''
    As explained above, the safe harbor provision in the 
original Committee Print did not adhere to Chairman Levitt's 
suggestions: the safe harbor in the original Committee Print 
would have protected fraudulent projections if an investor 
could not prove ``actual knowledge'' of and ``actual reliance'' 
on the projection. The substitute Committee Print offered at 
the Committee's May 25, 1995 mark up deleted the requirement 
that an investor prove he or she ``had actual knowledge of and 
actually relied on'' a fraudulent statement.
    As amended, however, the substitute Committee Print 
continued to exclude from the safe harbor protection only 
statements ``knowingly made with the expectation, purpose, and 
actual intent of misleading investors.'' The Committee Report 
states that ``expectation,'' ``purpose,'' and ``actual intent'' 
are separate elements, each of which must be proven by the 
investor. This language so troubled Chairman Levitt that he 
wrote to Committee members again, on May 25, 1995, the morning 
of the markup. He stressed that even the substitute Committee 
Print failed to adhere to his belief that a safe harbor should 
never protect fraudulent statements:

          I continue to have serious concerns about the safe 
        harbor fraud exclusion as it relates to the stringent 
        standard of proof that must be satisfied before a 
        private plaintiff can prevail. As Chairman of the 
        Securities and Exchange Commission, I cannot embrace 
        proposals which allow willful fraud to receive the 
        benefit of safe harbor protection. The scienter 
        standard in the amendment may be so high as to preclude 
        all but the most obvious frauds.

He warned that the bill's standard of ``knowingly made with the 
expectation, purpose and actual intent of misleading 
investors'' is a more stringent standard than currently used by 
the SEC and the courts. Given the broad definition of ``forward 
looking statement'' discussed above, it is crucial that the 
legislation not shield such statements from antifraud 
liability.
    The Committee Report states that the safe harbor provision 
in the bill is based on current Rule 175, and a legal doctrine 
known as ``bespeaks caution.'' Neither the SEC rule nor the 
court decisions cited, however, provide protection to 
fraudulent statements as the bill does.
    As discussed above, the SEC's Rule 175 does not immunize 
fraudulent statements. It requires forward looking statements 
to be reasonable and made in good faith.
    The courts have imposed a similar requirement on forward 
looking statements. The Third Circuit case cited by the 
majority, In re Donald J. Trump Casino Securities Litigation, 7 
F.3d 357 (3rd Cir. 1991), states:

          We have squarely held that opinions, predictions and 
        other forward-looking statements are not per se 
        inactionable under the securities laws. Rather, such 
        statements * * * may be actionable misrepresentations 
        if the speaker does not genuinely and reasonably 
        believe them.13
---------------------------------------------------------------------------
    \13\ 7 F.3d at 368.

Rubenstein v. Collins, 20 F.3d 160 (5th Cir. 1994), also cited 
in the Committee Report, reaches the same conclusion. The Fifth 
---------------------------------------------------------------------------
Circuit held that a forward looking statement

        contains at least three factual assertions that may be 
        actionable: (1) The speaker genuinely believes the 
        statement is accurate; (2) there is a reasonable basis 
        for that belief; and (3) the speaker is unaware of any 
        undisclosed facts that would tend seriously to 
        undermine the accuracy of the statement.14
---------------------------------------------------------------------------
    \14\ 20 F.3d at 166.

    The Third Circuit stated that to be immunized from 
liability the forward looking statements must be accompanied by 
cautionary statements ``substantive and tailored to the 
specific future projections estimates or opinions 
* * *.''15 The bill omits this requirement. Instead, 
it allows forward looking statements to be accompanied by 
general words of caution that will likely be boilerplate 
language, of little use to investors.
---------------------------------------------------------------------------
    \15\ 7 F.3d at 371-72.
---------------------------------------------------------------------------
    The Committee Report states that the safe harbor provision 
is intended to encourage disclosure of information by issuers. 
Encouraging companies to make fraudulent projections would hurt 
investors trying to make intelligent investment decisions and 
penalize companies trying to communicate honestly with their 
shareholders. We hope the majority of the Committee did not 
intend to achieve such a result. A safe harbor for fraudulent 
statements runs counter to the entire philosophy of the Federal 
securities laws, that fraud must be deterred and punished when 
it occurs. As described above, this philosophy has helped build 
the most vibrant securities markets in the world. While the 
majority of the Committee did not accept an amendment to this 
provision at the markup, we hope that the flaw in this 
provision identified by Chairman Levitt will be corrected.

Proportionate liability provision transfers losses from fraud 
        perpetrators to fraud victims

    Predating the Federal securities laws, courts have 
traditionally held parties who commit fraud to be ``jointly and 
severally'' liable. Under joint and several liability, each 
person who participates in a fraud is liable for the entire 
amount of the victim's damages. Mark Griffin, Securities 
Commissioner for the State of Utah, testified before the 
Securities Subcommittee on March 22, 1995 on behalf of the 50 
State securities commissioners. He explained why the law 
currently holds all parties who participate in a securities 
fraud jointly and severally liable:

          Under current law, each defendant who conspires to 
        commit a violation of the securities law is jointly and 
        severally liable for all the damages resulting from the 
        violation. The underlying rationale of this concept is 
        that a fraud will fail if one of the participants 
        reveals its existence and, as a result, all wrongdoers 
        are held equally culpable if the fraud achieves its 
        aims. (emphasis in original)

    In Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), the 
Supreme Court held that a defendant is liable under the Federal 
securities antifraud provision only if he or she possesses a 
state of mind known in the law as ``scienter.'' Conduct 
intended to deceive or mislead investors satisfies the scienter 
requirement.
    While the Supreme Court did not decide the question in 
Hochfelder, courts in every Federal circuit have held that 
reckless conduct also satisfies the scienter requirement. These 
courts have followed the guidance of hundreds of years of court 
decisions in fraud cases. As the Restatement of Torts, states, 
``The common law has long recognized recklessness as a form of 
scienter for purposes of proving fraud.''16
---------------------------------------------------------------------------
    \16\ See Restatement (Second) of Torts, Sec. 526(b), comment e; 
Prosser and Keeton, Law of Torts, Sec. 107.
---------------------------------------------------------------------------
    The most commonly accepted definition of reckless conduct 
that constitutes securities fraud was enunciated by the Seventh 
Circuit in Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 
1033 (7th Cir. 1977), cert. denied, 434 U.S. 875. This 
demanding standard defines reckless conduct as:

          Highly unreasonable [conduct], involving not merely 
        simple, or even gross negligence, but an extreme 
        departure from the standards of ordinary care, and 
        which present a danger of misleading buyers or sellers 
        that is either known to the defendant or is so obvious 
        that the actor must have been aware of it.

Under current law, then, individuals who participate in a fraud 
through their reckless conduct are fully liable to the victims. 
Recklessness liability is generally applied to an issuer's 
professional advisers, such as accountants, attorneys and 
underwriters.
    The bill limits joint and several liability under the 
Federal securities laws to persons who committed ``knowing 
securities fraud.'' All other violators will generally be 
liable only for their proportionate share of the fraud victim's 
losses. ``Knowing securities fraud'' is defined in the 
legislation specifically to exclude reckless conduct. S. 240 
thus reduces the liability for reckless violators from joint 
and several liability to proportionate liability.
    When investors' damages can be paid by a violator who is 
jointly and severally liable, this change will not affect the 
recovery available to investors. In cases where the architect 
of the fraud is bankrupt, has fled, or otherwise cannot pay the 
investors' damages, though, this change will harm investors. In 
those cases, innocent victims of fraud will be denied full 
recovery of their damages. Testifying before the Securities 
Subcommittee on April 6, 1995, Chairman Levitt said:

          Proportionate liability would inevitably have the 
        greatest effect on investors in the most serious cases 
        (e.g., where an issuer becomes bankrupt after a fraud 
        is exposed). It is for this reason that the Commission 
        has recommended that Congress focus on measures 
        directly targeted at meritless litigation before 
        considering any changes to the liability rules.

    Perhaps recognizing this unfairness to investors, S. 240 
would require violators who are proportionately liable to pay 
more than their proportionate share in two circumstances. 
Neither provision, however, goes very far toward making fraud 
victims whole. First, if part of the judgment is uncollectible, 
defendants who are proportionately liable would be jointly and 
severally liable to investors whose net worths are each under 
$200,000 and who each lost more than 10 percent of that net 
worth in the fraud. In our view, this will protect only a tiny 
number of investors. In many parts of the country, few 
investors who own their own homes will have net worths under 
$200,000. Further, very few such investors will invest 10 
percent of their net worth in a single stock or bond issue. 
Second, if part of the judgment is uncollectible, defendants 
who are proportionately liable would also be liable for an 
additional amount, not to exceed 50 percent of their 
proportionate share. For example, a defendant found to be 10 
percent responsible for the commission of a fraud would be 
liable for up to 15 percent of the investors' losses. This 
provision therefore will likely increase the recovery of 
defrauded victims only marginally, leaving the balance of 
losses uncollectible.
    In a February 23, 1995 letter to House Commerce Committee 
Chairman Thomas J. Bliley, Jr., Chairman Levitt wrote, ``[t]he 
Commission has consistently opposed proportionate liability.'' 
The Association of the Bar of the City of New York agreed ``it 
is critical that all defendants remain jointly and severally 
liable to the plaintiff when a wrongdoer is unable to pay his 
or her share of any judgment.'' In their June 8, 1995 letter, 
the Government Finance Officers Association also identified the 
restriction of joint and several liability as a reason for 
their opposition to the bill.
    Accountants are the class of defendants most likely to be 
affected by a change to proportionate liability. Dr. Abraham J. 
Briloff, CPA, the Emanuel Saxe Distinguished Professor Emeritus 
of Baruch College, City University of New York and a respected 
authority on accounting, testified before the Banking 
Committee. He stressed the crucial role accountants play in 
preventing fraudulent financial statements from reaching the 
investing public. He stated that the accountant

        is presumed to stand as the ``sentinel at the gates''; 
        it is he who holds the passkey required for the history 
        of the enterprise's management and accountability, its 
        financial statements, to become acceptable for the 
        purposes of the securities laws.
          If * * * he has permitted the passkey to be used 
        irresponsibly, then he should be held fully liable for 
        any resultant harm to those who relied on his 
        professional undertaking.
          To the extent he may identify those who overtly 
        created the underlying quagmire, well, then, the 
        auditor should have the right of subrogation. But 
        again, as in negotiable instruments law, if you cannot 
        find the ``maker'', you proceed against the ``last 
        endorser''--in the circumstances before us that ``last 
        endorser'' is presumed to be the certified public 
        accountant who has undertaken the independent audit 
        function.

The bill would undermine the independent auditor's role as the 
last line of defense against fraud.
    The legislation reported provides that defendants who meet 
the Sundstrand definition of recklessness, that is, who know of 
a fraud but in an extreme departure from the standards of 
ordinary care do nothing about it, will no longer be 
responsible for the result of their conduct. Instead, innocent 
investors--individuals, pension funds, county governments--will 
have to make up the loss. This legislation would, for the first 
time in our legal history, transfer responsibility for bearing 
the results of a fraud from participants in the fraud to 
innocent victims of the fraud. Such a change would be neither 
fair to investors nor beneficial to our markets, and is opposed 
by a host of consumer groups, labor unions, and government 
officials.17
---------------------------------------------------------------------------
    \17\ See May 23, 1995 letter to Committee Members from American 
Council on Education, California Labor Federation--AFL-CIO, Congress of 
California Seniors--LA County, Consumer Federation of America, 
Consumers for Civil Justice, International Brotherhood of Teamsters, 
Government Finance Officers Association, Gray Panthers, National League 
of Cities, New York State Council of Senior Citizens, North American 
Securities Administrators Association, and U.S. Public Interest 
Research Group (``primary concerns with respect to the provisions of S. 
240 * * * include * * * Limits on joint and several liability. * * 
*''); May 24, 1995 letter to Committee Members from Citizen Action, 
Consumer Federation of America, Consumers Union, Public Citizen, U.S. 
Public Interest Research Group, Violence Policy Center (``Abrogation of 
joint and several liability * * * would effectively immunize 
professional wrongdoers.'').
---------------------------------------------------------------------------

     S. 240 DOES NOT CONTAIN PROVISIONS NEEDED TO PROTECT INVESTORS

    We are concerned about the provisions of S. 240 described 
above, which in our view will harm investors bringing 
meritorious suits. We also are disappointed that S. 240 as 
reported does not contain provisions that would aid investors 
bringing meritorious suits.

Failure to extend the statute of limitations

    Chairman Levitt's May 25, 1995 letter to the members of the 
Banking Committee stated, ``[i]n addition to my concerns about 
the safe harbor, there is not complete resolution of two 
important issues for the Commission. First, there is no 
extension of the statute of limitations for private fraud 
actions from three to five years.''
    For over 40 years, courts held that the statute of 
limitations for private rights of action under Section 10(b) of 
the Securities Exchange Act of 1934, the principal antifraud 
provision of the Federal securities laws, was the statute of 
limitations determined by applicable State law. While these 
statutes varied, they generally afforded securities fraud 
victims sufficient time to discover and bring suit. Indeed, 13 
States recognize the concept of equitable tolling, under which 
the statute of limitations does not begin to run until the 
fraud is discovered, for private securities fraud 
cases.18
---------------------------------------------------------------------------
    \18\ See June 14, 1995 letter from the North American Securities 
Administrators Association.
---------------------------------------------------------------------------
    In Lampf v. Gilbertson, 501 U.S. 350 (1991), the Supreme 
Court significantly shortened the period of time in which 
investors may bring such securities fraud actions. By a five to 
four vote, the Court held that the applicable statute of 
limitations is one year after the plaintiff knew of the 
violation and in no event more than three years after the 
violation occurred. This is shorter than the statute of 
limitations for private securities actions under the law of 31 
of the 50 States.19
---------------------------------------------------------------------------
    \19\ Id.
---------------------------------------------------------------------------
    Lampf 's shorter period does not allow individual investors 
adequate time to discover and pursue violations of securities 
laws. Testifying before the Banking Committee in 1991, SEC 
Chairman Richard Breeden stated ``the timeframes set forth in 
the [Supreme] Court's decision is unrealistically short and 
will do undue damage to the ability of private litigants to 
sue.'' Chairman Breeden pointed out that in many cases,

          Events only come to light years after the original 
        distribution of securities and 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 
favor of overturning the Lampf decision.
    On this basis, the Banking Committee in 1991 without 
opposition adopted an amendment to the bill later enacted as 
the FDIC Improvement Act (``FDICIA''). The amendment lengthened 
the statute of limitations for all Section 10(b) rights of 
action to two years after the plaintiff knew of the securities 
law violation, but in no event more than five years after the 
violation occurred. In a letter to Senator Bryan, Chairman 
Breeden stated that ``[a]doption of these measures would give 
private litigants a more realistic time frame in which to 
discover that they have been defrauded, while also 
accommodating legitimate interests in providing finality to 
business transactions and avoiding stale claims.''
    When FDICIA reached the Senate floor in November 1991, some 
Senators indicated they would seek to attach additional 
provisions relating to securities litigation. They argued that 
the statute of limitations should not be lengthened without 
additional reform of the litigation system. No arguments were 
raised specifically against the extension of the statute of 
limitations. In order to expedite consideration of FDICIA, the 
extension of the statute of limitations was dropped. Senators 
Domenici and Dodd included the extended statute of limitations 
in their comprehensive securities litigation reform bill, 
introduced as S. 1976 in the 103rd Congress and as S. 240 in 
this Congress.
    Now that the Congress is acting on comprehensive changes to 
the securities litigation system, it should include the longer 
statute of limitations in keeping with the 1991 agreement. 
Chairman Levitt testified before the Securities Subcommittee in 
April 1995, ``[e]xtending 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 
three years.''
    We are deeply disappointed that the Committee did not 
include the extension of the statute of limitations in S. 240 
as reported, and consider it imperative that the full Senate 
restore some balance to the legislation by voting to adopt the 
extension.

Failure to restore aiding and abetting liability

    Chairman Levitt's May 25, 1995 letter to Banking Committee 
Members stated that, in addition to his concerns about the safe 
harbor, the Committee Print substitute did not resolve two 
important issues for the Commission. The first of these, 
discussed above, was the statute of limitations; the second was 
aiding and abetting liability. Chairman Levitt expressed his 
disappointment that ``the draft bill does not fully restore the 
aiding and abetting liability eliminated in the Supreme Court's 
Central Bank of Denver opinion.''
    Prior to 1994, courts in every circuit in the country had 
recognized the ability of investors to sue aiders and abettors 
of securities frauds. The courts derived aiding and abetting 
liability from traditional principles of common law and 
criminal law. The notion attaches liability to those who 
provide assistance to the unlawful acts of others. To be held 
liable, most courts required that an investor show that a 
securities fraud was committed, that the aider and abettor gave 
substantial assistance to the fraud, and that the aider and 
abettor had some degree of scienter (intent to deceive or 
recklessness toward the fraud).\20\
---------------------------------------------------------------------------
    \20\ See, e.g., IIT v. Cornfeld, 619 F.2d 909, 992 (2nd Cir. 1980).
---------------------------------------------------------------------------
    In Central Bank of Denver v. First Interstate Bank of 
Denver, 114 S. Ct. 1439 (1994), the Supreme Court eliminated 
the right of investors to sue aiders and abettors of securities 
fraud. Writing for four dissenters, Justice Stevens criticized 
the five member majority for ``reach[ing] out to overturn a 
most considerable body of precedent.'' While the issue was not 
directly before the Court, Justice Stevens warned that the 
decision would also eliminate the SEC's ability to pursue 
aiders and abettors of securities fraud.
    As Senator Dodd stated at a May 12, 1994 Securities 
Subcommittee hearing, ``aiding and abetting liability has been 
critically important in deterring individuals from assisting 
possible fraudulent acts by others.'' Testifying at that 
hearing, Chairman Levitt stressed the importance of restoring 
aiding and abetting liability for private investors:

          Persons who knowingly or recklessly assist the 
        perpetration of a fraud may be insulated from liability 
        to private parties if they act behind the scenes and do 
        not themselves make statements, directly or indirectly, 
        that are relied upon by investors. Because this is 
        conduct that should be deterred, Congress should enact 
        legislation to restore aiding and abetting liability in 
        private actions.

The North American Securities Administrators Association and 
the Association of the Bar of the City of New York also 
endorsed restoration of aiding and abetting liability in 
private actions.
    The bill reported by the Committee restores, in part, the 
SEC's ability to sue parties who aid and abet violations of the 
securities laws. The provision in the bill is limited to 
violations of Section 10(b) of the Securities Exchange Act, and 
to individuals who act ``knowingly.'' It ignores the 
recommendation made by the SEC, the State securities regulators 
and the bar association that aiding and abetting liability be 
fully restored for the SEC and private litigants as well. While 
the provision in the bill is of some help, the deterrent effect 
of the securities laws would be strengthened if aiding and 
abetting liability were restored in private actions as well.

                               CONCLUSION

    Our capital markets depend on investor confidence. 
Individuals and institutions are motivated to place their funds 
in our markets, in part because they believe in the efficiency 
and fairness of those markets. Their confidence depends also on 
the existence of effective remedies against persons who commit 
securities fraud.
    While we support the goal of deterring and sanctioning 
frivolous securities litigation, provisions in this bill will 
deter meritorious fraud actions as well. By protecting 
fraudulent forward looking statements, and by restricting the 
application of joint and several liability, this bill may 
undermine investor confidence. These changes are likely to fall 
hardest on the elderly, who often are targeted as fraud 
victims.\21\ Further, it fails to include provisions that are 
needed to ensure that investors have adequate time and means to 
pursue securities fraud actions.
---------------------------------------------------------------------------
    \21\ See ``If the Hair is Gray, Con Artists See Green,'' The New 
York Times, May 21, 1995.
---------------------------------------------------------------------------
    The securities markets are crucial to our economic 
performance as a nation; we should evaluate efforts to tamper 
with them very carefully. Because this legislation may reduce 
investor confidence in the capital formation process it seeks 
to promote, we oppose it and hope it will be improved by the 
full Senate.

                                   Paul Sarbanes.
                                   Barbara Boxer.
                                   Richard Bryan.

                    ADDITIONAL VIEWS OF SENATOR DODD

    I share the view of the Committee majority that this bill 
carefully addresses the flaws in the current securities 
litigation system, without limiting the rights of investors to 
bring actions to recover damages. Striking the balance between 
protecting the rights of victims of securities fraud and the 
rights of public companies to avoid costly and meritless 
lawsuits was difficult, but on balance, I believe the Committee 
has succeeded.
    The measure adopted by the Committee is based on a bill 
that Senator Domenici and I introduced in the past two 
Congresses. The bill, as reported, contains several substantial 
improvements to S. 240 as introduced this year in the Senate. 
However, there are several provisions of the original bill that 
I wish had also been included, although I understand the need 
to produce a consensus document.
    Specifically, I have pressed for an extension of the 
current statute of limitations for private actions under the 
Securities Exchange Act of 1934. The Committee rejected an 
amendment to do that, and I expect this issue will be raised 
again when this bill is considered by the entire Senate.
    Another issue of concern to me involves liability in 
private actions under 10b-5 for aiders and abettors of primary 
securities law violators. As chairman of the Subcommittee on 
Securities, I held a hearing on this issue in May 1994, after 
the Supreme Court ruled that private parties could not bring 
suit against alleged aiders and abettors. I am pleased that the 
Committee bill grants the Securities and Exchange Commission 
explicit authority to bring actions against those who knowingly 
aid and abet primary violators. However, I remain concerned 
about liability in private actions and will continue to work 
with other Committee members on this issue as we move to floor 
consideration.
    A final provision, which would have created a self-
disciplinary organization for auditors, is also not part of the 
bill.
    I favor all three of these provisions because of my belief 
that as we properly make it more difficult to bring meritless 
lawsuits, we must do all that we can to ensure that legitimate 
victims can continue to sue and can recover damages quickly. It 
is appropriate to ``raise the bar,'' but we must provide the 
careful balance that is needed to protect the rights of fraud 
victims.

                                                        Chris Dodd.