Fraud against US investors by companies listed on non-American exchanges is inevitable in a world of global financings in which all roads seem to lead to US pension funds and retirees. It is time for Congress to overturn a misguided, anti-consumer Supreme Court decision (Morrison v. National Australia Bank) that eliminated US investors' ability to take action in US courts against foreign companies that defraud them in the United States. Recent developments at Chinese-listed companies and a new Securities and Exchange Commissioner staff report underscore the need for Congress to take action now.
Persistent incidences of fraud and abuse in China, first evidenced in consumer products - think the seafood, pet food and children's toy scandals in recent years - exported to the United States seems to be a problem not only on farms and and factory floors but also in corporate board rooms. Yet, even as the Securities and Exchange Commission (SEC) has launched a serious and overdue investigation of sham Chinese "reverse listings" on US stock exchanges, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Citigroup seek to ramp up trading in stocks listed on Chinese stock exchange at their mainland China affiliates. And Credit Suisse wants in on the action.
"The SEC crackdown on Chinese reverse mergers doesn't surprise me. Everybody here knows that a Chinese company has four separate accounting books," a China-based British merchant banker told the Financial Times' emerging markets news service.
Another British investment manager based in Beijing told the FT, "I'm not surprised there's fraud in China; it's not whether it happens, but how to protect yourself against it."
Will Goldman or JPMorgan Chase Sell Americans Chinese Stocks?
So, on the one hand, we have America's largest investment banks happily trading in Chinese-listed stocks and even underwriting initial public offerings of Chinese companies on China's stock exchange. On the other hand, sources familiar with the industry clearly believe fraud within Chinese-listed companies is common, if not rampant. Now, when Morgan Stanley or Goldman Sachs underwrites a Chinese-listed company, who will they sell those freshly minted shares to? Think they'll flog them back home in the United States to pension funds and pensioners?
To paraphrase that British merchant banker: it's not whether it happens; it's how to protect yourself. But don't bother looking for protection under US law.
Because of the Supreme Court's Morrison decision, you'll need to take that sham Chinese company (whose shares you were likely bought from your US broker) to court in China, a problematic situation indeed.
Prior to June 2010, Americans had the right to protect themselves from foreign fraudsters by taking action against them in US courts. In taking away that right, the Supreme Court ignored briefs filed by the SEC, the US solicitor general and scores of American pension funds urging the Court to retain US investors' access to US courts.
SEC Staff: Commission Supports US Investors' Right of Private Action
In a recent study, the SEC staff said the commission stands by the views expressed in its pre-Morrison brief, which also recommended the court adopt a standard authorizing US private investor actions when the US component of the fraud directly causes investors' injuries. That April SEC study, which received little media attention, was required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The majority of public comments (44 of 72 respondents) on Morrison submitted to the SEC supported restoring Americans' right to take action in US courts against foreign-listed companies that defraud them. Indeed, all the letters to the SEC from investors and investor representatives - including 30 pension funds - support restoring the private right of action. To do so, however, will require Congressional action.
SEC Staff Found No Evidence That Private Actions Cause Economic Harm
There is no economic rationale for the Morrison decision, the SEC study found. Although the US Chamber of Commerce and other anti-consumer legal "reform" proponents have long claimed that supposedly "frivolous" lawsuits impose unfair economic burdens on companies and discourage foreign companies from listing on US securities exchanges, the SEC staff found no evidence backing such assertions. "Considering both the existing economic research and the results of our analysis, we are unable to document evidence of either economic costs or economic benefits that could be clearly and directly linked to extending a private right of action," the report maintains. [See appendix B, page B-1 of SEC Staff report].
SEC Staff Restates Importance of Private Actions in Law Enforcement
Moreover, on page one of its Morrison study, the SEC staff re-stated the commission's longstanding position (affirmed in several Supreme Court decisions) that meritorious private lawsuits are an important supplement to civil and criminal law enforcement actions. Such private actions are part of the superior US securities regulatory system that provides foreign companies who list here with an "investor protection premium." The SEC staff explained:
Another question raised ... is whether greater exposure to U.S. securities laws and regulations would cause an increase in firm value. The primary focus on whether a firm can increase value through bonding to U.S. securities laws has been [the subject of several] studies of cross-listings. Many of these studies have concluded that there is a valuation premium associated with cross-listing a foreign firm on a U.S. exchange.
Morrison Unnecessarily Restricts Investor Protection
Commenting on the SEC staff study and Morrison decision, Salvatore J. Graziano, Esq., a partner with Bernstein Litowitz Berger & Grossman, LLP and president of the National Association of Shareholder and Consumer Attorneys (NASCAT) said:
Congress should overturn Morrison to restore investors' full range of protection against fraud, enable investors to recover their losses, and to help deter fraud and other wrongdoing in the United States by corporations who operate or cause harm in the United States, but list their securities overseas. Restoration of investors' private right of action against such companies also would help United States pension funds comply with covenants directing them to reduce risk by diversifying portfolios geographically and by industry; but, at the same time, not limiting protections afforded by Unites States securities laws. Morrison unnecessarily limits those protections and the choices of pension funds.
Congress Should Overturn Morrison and Restore US Investors' Rights
As a matter of simple justice and investor protection, Congress should restore the right of American citizens to take action in US courts against foreign-listed companies who defraud them. The need for Congressional action is dramatized by increasing American investments in Chinese and other emerging-country securities - in markets that lack adequate regulation and accounting standards.
Will Congress have the backbone to stand up to multinational corporations (including our largest investment banks) and override the Supreme Court?