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John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia Law School and director of its Center on Corporate Governance. A major debate is opening over whether the U.S. capital markets are losing their competitiveness. As in most such debates, both sides tend to overstate and oversimplify. For many business critics of regulation, the cause of this new foreign disdain for the U.S. market is simple: the Sarbanes-Oxley Act of 2002, which arguably increased the regulatory burden on foreign issuers to an intolerable level. Exhibit A in their critique is the recent decline in initial public offerings (IPOs) by foreign issuers in the United States. According to the Financial Services Forum, as recently as 2000, nine out of 10 dollars raised by foreign issuers in IPOs were raised in the United States, but in 2005, nine out of 10 dollars in such offerings were instead raised outside the United States. But does such evidence prove its point? The problem is that the U.S. share of the worldwide IPO market began to decline in 1996 and hit rock bottom in 2001-the year before Sarbanes-Oxley passed Congress. Since then, the U.S. share has increased modestly. Conversely, for liberals, it is difficult to admit there is any problem. If foreign firms are no longer cross-listing in the United States at the same rate, they have suggested that greedy investment bankers are the cause, because the typical underwriting discount in the United States is nearly double what it is in the United Kingdom (7% versus 3% to 4%). Again, this is shallow. Cross-listing in the U.S. market has historically yielded a significant valuation premium for the foreign firm, and investment banking fees pale in comparison to increases in valuation from cross-listing that range as high as 37%. See C. Doidge, A. Karolyi and R. Stulz, “Why Are Foreign Firms Listed in the U.S. Worth More?,” 71 J. Fin. Econ. 205 (2004). Litigation risks and ‘legal imperialism’ are big factors To explain why foreign firms will forgo such premiums requires a more powerful motor force. The most likely answer is a combination of factors: Foreign firms fear both the United States’ litigation environment in which even a toehold presence can expose them to insolvency-threatening liabilities, and U.S. “legal imperialism,” under which the United States insists its law should control, even if it has only a tangential and remote relationship to a transaction. Yet any criticism of excessive litigation draws a stock response from liberal academics and journalists: The integrity of the U.S. markets depends on aggressive private enforcement of law through class actions. But can there be a point at which the U.S. securities laws can be overenforced? To suggest this to journalists-some of whom abide by the motto, “All the News that Fits My View”-is to provoke a shocked reaction and distorted reporting. Still, two examples will illustrate this possibility of overenforcement. First, suppose that a European firm decides to issue American Depositary Receipts (ADRs) in the United States and arranges with a U.S. bank to serve as its depositary. Typically, the ADR issue will be relatively small, perhaps only 1% of the European issuer’s total market capitalization. Next, assume further that this European issuer later experiences a sudden stock drop of, say, 25% or so-possibly caused by financial irregularities or possibly by macroeconomic conditions, or both. Predictably, the U.S. plaintiffs’ bar will bring not simply a securities class action on behalf of the 1% of the stock listed in the United States, but a worldwide class action on behalf of all shareholders who purchased during the period in which the market was affected by the alleged fraud. The result is a class action alleging damages in the billions of dollars, which, if successful, could cause the insolvency of the issuer. Of course, the case never proceeds to trial because it is settled by corporate managers who cannot afford to “roll the dice” with the corporation’s solvency at stake. Recently, several such worldwide classes have been certified. See, e.g., In re Royal Dutch/Shell Transp. Sec. Litig., 380 F. Supp. 2d 509 (D.N.J. 2005); In re Royal Ahold N.V. Inc. SEC & ERISA Litig., 2006 U.S. Dist. Lexis 1928 (D. Md. 2004). But see In re Australia Bank, No. 03 Civ. 6537 (BSJ) (S.D.N.Y. Oct. 26, 2006) (contra). Plaintiffs’ attorneys in these cases have been creative and ingenious; doctrinally, they must show some conduct in the United States by personnel of the foreign issuer that went beyond “mere preparations” and materially furthered the fraud. Yet, in an era of global corporations, the presence of issuer personnel in the United States is the rule, not the exception. As a result, foreign issuers, who do not face the threat of a class action abroad, can legitimately view even a toehold presence in the United States as inviting litigation involving astronomical damages and may conclude that this risk is not fully compensated for by a higher valuation premium. Even outside the class action context, a U.S. capital markets presence brings substantial complications for the foreign issuer. Assume now that a foreign firm has a small amount of ADRs listed on a U.S. exchange. Assume further that it becomes the subject of a control fight, as two other foreign firms begin to acquire its shares. Both will be required to file a Schedule 13D with the Securities and Exchange Commission (SEC), and at least one recent decision subjects the adequacy of such disclosures to judicial review in the United States. From a European perspective, this prospect that a U.S. court could interfere in a corporate-control contest on European soil offends their sense of sovereignty. No wonder then that European issuers find some aspects of the U.S. market unattractive. But what can be done about these problems? Legislation is simply unlikely in an era of divided government, and the plaintiffs’ bar will have considerable influence with the new Congress. Still, there is an answer that to date has received little attention: Since 1997, the SEC has broad exemptive authority under � 36 of the Securities Exchange Act of 1934. This section authorizes the SEC to exempt any person, security or transaction, or any class of persons, securities or transactions, from any provision of, or rule under, the 1934 act if the SEC finds that “such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.” Many exemptions from Rule 10b-5 could be justified under � 36. For example, one could exempt securities held by foreign citizens that are not listed on a U.S. exchange or Nasdaq. This would allow holders of ADRs to sue in the United States, but not foreign citizens who held the ordinary shares of the same issuer. Would such an exemption be “consistent with the protection of investors?” Presumably, Congress meant U.S. investors when it wrote this language. Goal should be attracting foreign issuers to list in U.S. Is such an exemption also consistent with the “necessary and appropriate in the public interest” language in � 36? Here, the paramount public interest may lie in not deterring foreign issuers from offering or listing securities in the United States. Why? Securities markets work on a simple logic: Liquidity attracts liquidity. If foreign issuers instead list elsewhere, U.S. capital markets lose liquidity, and foreign markets could become stronger. Over time, U.S. issuers could also decide to list abroad, possibly to avoid litigation. If this seems a remote prospect today, it should be remembered that once the New York Stock Exchange completes its merger with Euronext N.V., it will have a foreign trading platform largely beyond the reach of the SEC. Nasdaq may join it in this dual-platform status if it can acquire the London Stock Exchange. At this point, the idea that U.S issuers could list abroad in preference to at home becomes at least a possibility. When federal courts originally permitted U.S. securities class actions to reach extraterritorially and include foreign holders of securities not listed on a U.S. exchange, they did so based on an inference about congressional intent. That inference was that Congress would not want the United States to be used as a “Barbary Coast, harboring international securities pirates.” See SEC v. Kasser, 548 F.2d 109, 116 (3d Cir. 1977) (quot-ing earlier decisions). But if a fraud-based U.S. securities class action included the foreign issuer’s securities that are listed in the United States, but not other securities of the same class that are listed only abroad, then adequate deterrence would be generated without the U.S. court serving as a policeman for the world. Liabilities often fall on ‘innocent’ shareholders Other proposals for reforming the securities class action through exemptive rules adopted under � 36 have recently been made by this author. See John C. Coffee Jr., “Reforming the Securities Class Action: An Essay on Deterrence And Its Implementation,” 106 Colum. L. Rev. 1534 (2006). Their premise is that when liabilities are imposed on the nontrading corporation, diversified shareholders are simply paying diversified shareholders in meaningless wealth transfers. Such proposals will predictably be greeted with the response that they would undermine private enforcement of the law through class actions. Used this broadly, such a response is less policy analysis and more a mantra chanted reflexively by those unable or unwilling to re-examine old dogma. The reality today is that plaintiffs’ attorneys and defendants often conspire to shift the costs of securities class actions onto an unrepresented third party: the shareholders. This problem was long ignored-until the magnitude of securities class actions settlements recently soared, with several surpassing the $1 billion threshold. At this point, private enforcers are employing not simply a deterrent threat, but a nuclear weapon. If we want others to play in our markets, greater accountability is needed.

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