Beyond Tort Reform
Philip K. Howard
New York Sun, February 5, 2007
The U.S. securities markets are on the way to losing their
pre-eminence. That's the conclusion reached by two recent reports,
one indirectly sponsored by Treasury Secretary Paulson and the other
by Mayor Bloomberg and Senator Chuck Schumer. The facts are indeed
alarming — the American share of global initial public offerings
declined to 5% from 50% in the last five years.
Foreign companies are being scared away in part, both reports
conclude, by soaring costs of American law. The highwater mark for
securities lawsuits was reached in 2005, with over $9 billion in
class action settlements. The zeal of American prosecutors in
corporate scandals is also of a different order of magnitude. In
2004, government fines in America totalled $4.74 billion, over 100
times more than in Britain, which had a total of $40.48 million.
Sarbanes-Oxley, the federal law that imposes higher accountability
standards on corporate boards, has almost tripled auditing costs for
small public companies.
But competitiveness is a complex phenomenon, critics correctly
observe. Yes, New York is losing its luster, but globalization is
inevitable in securities markets. Moreover, the "litigation tax,"
while large for companies that pay it, is only a drop in the bucket
in international markets.
What's largely missing in this debate is the critical role of
trust in the law. Perhaps the most chilling parts of the
Bloomberg-Schumer report are the surveys of foreign business leaders
who suggest, overwhelmingly, that they no longer trust American law.
For most of the last century, trust in American commercial and
securities law was one of our greatest competitive advantages.
Investors flocked to our markets because securities laws guaranteed
transparency and honesty. American contract law was the gold
standard for world business, in part because of a long tradition of
judges rigidly applying guidelines of liability and damages.
Economist Douglass North received a Nobel prize in part for his work
on the vital role of legal stability in economic prosperity.
An "essential element of the concept of justice," legal
philosopher H.L.A. Hart observed, "is the principle of treating like
cases alike." That's why law is the foundation of freedom — people
know where they stand. They can act freely instead of looking over
their shoulders all day long.
But that trust has now capsized. Companies are afraid that if a
few employees out of thousands do something wrong — even if not
material to the bottom line — the company faces the prospect of
ruin. An indictment, not a conviction, could put a company out of
business. Why roll the legal dice in America when legal systems in
Britain and elsewhere focus on punishing the individual wrongdoer,
not shooting everyone in sight?
We should have seen it coming. Over 20 years ago the dean of
Harvard Law School, Derek Bok, observed that "Foreign businessmen
express amazement at a system … that exposes the entrepreneur to
legal challenge so easily and on so many different fronts, a system
that lends itself so readily to harassment, obstruction, and
delay."
In those 20 years, foreign investors have witnessed litigation
that actually destroyed industries. The tragedy of asbestos, which
cries out for a legislative compensation plan, was instead handled
by class action litigation that, to date, has driven over 70
companies into bankruptcy — irrespective of whether there was any
causal link between the company and the victims.
Sarbanes-Oxley is a mixed blessing, improving oversight of
management by corporate boards, but also exposing executives to
personal liability for procedural errors. Business people tend to
rely on their instincts of right and wrong based on their general
understanding of law. If they might be personally liable for a
problem with internal controls in a remote subsidiary, they may do
business elsewhere.
The premise of American law in recent decades is that there can
never be too much accountability. If some litigation and fear of
prosecution for wrongdoing are good, then why not open the gates?
But a sword of Damocles approach to justice drives business away and
makes those who stay so paranoid that they cannot effectively
operate. Corporate board meetings have become an exercise in water
torture, a slow drip of formal reports designed not to uncover truth
but to cover everyone's backsides.
It's impossible to measure how much distrust of law has
contributed to declining competitiveness. But the evidence is all
around us. Just talk with foreign business leaders. The main victims
of this trend, however, are employees and their pension plans.
Drying up of markets means that countless people lose job
opportunities and that innovation moves offshore.
Trust, once lost, is hard to regain. Tort reforms limiting
damages don't get close to the heart of the problem. American
justice has a deeper flaw — it no longer reliably distinguishes
right from wrong. Instead, decisions are made on an ad hoc basis,
jury by jury, without predictable boundaries.
What's needed is not merely more tort reform, but also a
fundamental shift in goals, toward balance and predictability. Only
then can we rebuild the trust in law that used to be one of
America's greatest competitive assets.
Mr. Howard, a lawyer, is a partner at Covington & Burling
and chairman of Common Good, a nonpartisan legal reform group,
cgood.org.
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