Todd J. Zywicki is George Mason University Foundation professor of law at Antonin Scalia Law School.
U.S. public markets are quietly shrinking. Since the late 1990s, the number of publicly traded companies has fallen by more than half. Initial public offerings, once a reliable engine of economic dynamism that let ordinary Americans invest in tomorrow’s great companies, have plummeted.
Founders, executives and investors are doing the math and increasingly deciding that the risks of going public outweigh the rewards. Chief among those risks is a litigation environment so hostile to public companies that it has become a de facto tax on participation in America’s capital markets. It’s a situation that warrants judicial intervention.
As Securities and Exchange Commission Chairman Paul Atkins recently warned, a primary driver behind this liability risk is the explosion of securities class-action lawsuits.
Anyone who has seen “The Wolf of Wall Street” or “Boiler Room” will be familiar with pump-and-dump schemes, where insiders accumulate a company’s stock, spread pernicious rumors to inflate its value, then dump it when the truth comes out. One purpose of securities law is to compensate investors who have been wronged by such schemes. But in the past several decades, securities law has been twisted into a profit engine for lawyers manufacturing their own variation: stoking mounds of bad publicity about a company only to sue once the firm’s stock is affected.
Frequently referred to as “stock drop” lawsuits, these cases often materialize within days of a decline in a company’s market price, regardless of whether any fraud actually occurred.
Meritless securities suits have become a reliable way for trial lawyers to extract massive settlements from public companies, often with little connection to actual investor harm. In these cases, plaintiffs are not required to prove that an investor relied on or was influenced by any alleged misrepresentation or misstatement. Instead, they invoke what lawyers call the “inflation-maintenance theory” — where plaintiffs need not even show that prior false statements pumped up the stock at all, but only that it maintained an inflated stock price until the supposed truth came out through so-called corrective disclosures.
Worse still, it gives plaintiffs’ lawyers what amounts to two bites of the apple. A company accused of making a false statement may already face a direct fraud lawsuit over the underlying conduct. Then, when that allegation becomes public and the stock price falls, a separate class of shareholders, often represented by the same plaintiffs’ firm, files suit. This effectively allows trial lawyers to recycle the same allegation into a second round of litigation. If settled, the company pays twice for the same alleged wrong, irrespective of whether either claim was ever proved on the merits.
Allowing this to continue unabated serves one constituency: trial lawyers, who pocket exorbitant fees while companies, workers and consumers absorb the real costs.
The cumulative effect on public markets is staggering. This antibusiness litigation environment has contributed to a significant decline in publicly traded companies. Things have gotten so bad that the Wilshire 5000 index, founded in 1974 to track the performance of all U.S. publicly traded stocks, no longer has 5,000 public U.S. companies to include.
Since 2021, annual initial public offerings have declined by more than 66 percent and, over the past 30 years, the tally of U.S. public companies has dropped from more than 8,000 to just 3,700. Ultimately, this decline in public offerings limits Americans’ access to investment opportunities and shifts capital formation toward private markets that are largely inaccessible to ordinary investors.
The Supreme Court has the opportunity to help right this in a case it is set to consider later this month. Johnson & Johnson v. San Diego County Employees Retirement Association, which resulted in a split decision out of the U.S. Court of Appeals for the 3rd Circuit last year, loosened the standards for securities class actions even further by permitting investors to sue companies over alleged harms from stock price drops not related to new revelations but to recycled news stories and — incredibly — plaintiff-side press releases that repackaged already public information. Allowing this misapplied standard to go uncorrected will invite every forum-shopping, roll-the-dice class-action case into the circuit.
The lower court’s ruling also carries national implications for investors and the economy. Innovative and new companies — artificial intelligence companies, in particular — have become the latest cash cow for securities lawyers. In turn, economists have found that innovation and economic growth are being impeded by this rising threat of litigation.
The Supreme Court should end this trial lawyer tag-team that allows securities class actions to be bootstrapped from recycled news reports and the unproven allegations of product-liability lawyers. Permitting complaints to survive on such thin gruel invites abuse and distorts the purpose of securities law.
The court’s intervention is critical to preserving functional capital markets and curbing meritless lawfare against U.S. companies. The health of public markets — and the nation’s economy — depends on it.
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