"BETWEEN CAVEAT EMPTOR AND CAVEAT VENDITOR:
             THE MIDDLE GROUND OF LITIGATION REFORM"
                REMARKS BY CHAIRMAN ARTHUR LEVITT
        UNITED STATES SECURITIES AND EXCHANGE COMMISSION
           22ND ANNUAL SECURITIES REGULATION INSTITUTE
                      SAN DIEGO, CALIFORNIA
                        JANUARY 25, 1995

     I want to use this opportunity to continue the dialogue we
began a year ago about securities litigation.  Although I'm not a
lawyer, I do work in Washington, where -- as Justice Sandra Day
O'Connor once said -- there may actually be more lawyers than
people.  And I've sure learned a few things in the past year.

     Last January, I shared with you my views about litigation
reform.  Almost immediately, a blizzard of letters descended on
my office, some favoring my canonization, the vast majority
calling for my immediate resignation.  There's no denying that
the words "litigation reform" evoke the kind of passion usually
reserved for politics, religion, football, and stock option
accounting.  I wish we could coin another expression -- perhaps
"legal abuse abatement" -- that might get us past the flash
point. 

     Clearly, last year, I was staking out positions the SEC had
not embraced in its history.  What did I say that was so
controversial?  I said I was troubled by signs that our private
litigation system is flawed; I asserted that litigation imposes
tremendous unnecessary costs on issuers and other market
participants when it is abused; and I cited the common criticism
that the process often fails to distinguish between strong and
weak cases.  For this I was considered by some to be the single
greatest threat to the continued viability of private remedies
against fraud.

     But not for long.  Just a few months after I addressed the
Institute, the Supreme Court overturned several decades of
precedent and held that no private right of action exists against
persons who aid and abet violations of Section 10(b) of the
Exchange Act and Rule 10b-5.  At about the same time, Senators
Dodd and Domenici introduced comprehensive legislation to stem
abuses in private securities litigation.  A Congressional hearing
in July put a spotlight on reform legislation proposed by
Congressman Billy Tauzin.  In November, the Republican party
captured control of the House for the first time since the
Eisenhower administration, and earlier this month Representative
Chris Cox introduced litigation reform legislation that can
fairly be termed fundamental.  Congressman Markey then weighed in
with his own alternative.

     What a difference a year makes!  The tone of my mail has
certainly changed.  Last year, I was a bomb-thrower.  This year,
I'm the voice of reason.  Which shows just how polarized the
debate has become.  

     The truth is, my position hasn't changed -- nor did it ever
depart from the longtime SEC belief that 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.  In my judgment, draconian denials of the
right of private action represent as tangible a danger to our
markets as the status quo.  It would be difficult, not to say
unwise, to centralize all responsibility for the integrity of our
markets in Washington.  The Commission was not intended to be the
KGB of Capitalism -- we're not equipped to operate as an all-
pervasive agency.  Instead, over the decades, a structure has
been created in which, for the most part, market forces can solve
market problems, and investors reserve the right to protect
themselves.  The securities laws are not a call for market
participants to relinquish responsibility, but rather to take it.

     We've also remained squarely within the SEC tradition of
advancing the interests of investors.  The individual investor is
our touchstone -- the measure by which we appraise our every
action.  There should be no doubt that the Commission will
actively oppose measures that would eviscerate investors'
legitimate remedies against fraud.  But at the same time, there
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.  Let us not forget
that there are investors on both sides of this issue.  I want to
make it clear that there are provisions in the Cox bill, in the
Markey bill, and in the legislation reintroduced by Senators Dodd
and Domenici, that the Commission can and will endorse.

     The question is not, "Is there a crisis?"  That calls for a
value judgment, which isn't productive.  The real question is,
"Can the system be improved?  Can it serve our nation better?" 
The answer to that is a resounding "Yes."  The world has grown
much too competitive to hamper American companies with
unnecessary inefficiencies.

     I've been in the corporate world for most of my life.  I
know the punishing costs of meritless lawsuits -- the time, the
money, the anxiety -- as well as some less obvious costs, such as
the stifling of much needed innovation and job formation when
accounting firms are unwilling to take on smaller entrepreneurial
clients, due to litigation fears. 

     I also know the value of well-founded litigation, not just
as recourse for victims of securities fraud, but also as a
deterrent against those who might otherwise be willing to cross
the line.  I believe that it's possible -- indeed, necessary --
to enact meaningful legislation that would eliminate the worst
abuses in private litigation, without eradicating its benefits. 
The ideas are there.  But for a consensus to be reached, all
parties to the debate need to stop shouting and start talking. 
All parties need to recognize the legitimate interests of their
adversaries.  And, perhaps more than anything else, all parties
need to be realistic in their expectations -- to measure new
proposals against today's realities, not against the world as
they would like it to be.  We must not allow the perfect to
become the enemy of the good.

     I've made it clear that the SEC will work with any group,
examine any idea, entertain any proposal, and consider any
perspective, if it will help resolve this contentious issue
without compromising investor protection.  In the last year, I've
conducted a form of shuttle diplomacy with all parties to the
debate -- the National Association of Manufacturers,
representatives of the plaintiffs' bar, the state securities
administrators, the AICPA, the AARP, investor rights groups,
federal judges, the SEC's Consumer Affairs Advisory Committee,
corporate executives, and countless others -- trying to move the
dialogue along.

     The Commission supports a number of measures designed to
eliminate abuses in class action lawsuits, and I'm more convinced
than ever that in these areas, a consensus can be reached. 
Virtually all parties seem to agree with us that lawyers should
not pay referral fees to brokers who refer clients; that named
plaintiffs should not receive bounty payments; that we need to
set a class organization period or some other method of
eliminating the "race to the courthouse"; that disclosure to
class members must be improved; and that private plaintiffs'
legal fees should not be paid out of SEC disgorgement pools. 
Most parties also concur that civil RICO charges in securities
fraud cases, and their treble damages, should be prohibited.  It
may be harder to reach agreement on other proposals, such as the
further involvement of institutional investors in class action
lawsuits.  

     The best solution of all would be to find ways to screen out
cases that lack merit early in the process, before the tremendous
costs associated with discovery have been incurred.  

     One idea that we will be considering is whether the
Commission should have explicit authority to exempt certain types
of disclosures or transactions from private liability under the
securities laws.  If a disclosure or transaction were subject to
this type of exemption, violations could be prosecuted by the
Commission, but could not be used as the basis for a private
lawsuit seeking damages.  Though we have yet to satisfy certain
concerns about this approach, it would allow the Commission to
act more quickly and flexibly to prevent meritless litigation,
while preserving its ability to respond to any who would take
improper advantage of the exemption.  

     Perhaps there's room also to consider ideas, such as that
contained in the Dodd/Domenici bill, for voluntary submission of
fraud claims to specialized tribunals or fact finders who know
the law and understand these cases.  This might eliminate some of
the uncertainties that cause meritorious cases to settle for too
little, and frivolous cases to settle for too much.

     The Commission's current focus on the safe harbor for
forward looking statements may have significant impact on
litigation practices.  The question is how to provide meaningful
protection to issuers acting in good faith, without also
insulating companies that intentionally hype their stock by
making unreasonable projections.  Finding an answer will not be
easy, but I assure you that we are committed to the task.  We
issued a concept release on this in October; we're now studying
the comments we've received; and in February we'll conduct public
hearings on the issue in Washington and in San Francisco.

     In my remarks last year, I said the SEC was willing to file
amicus briefs in support of motions to dismiss, or requests for
sanctions under Rule 11.  Three months ago, the Commission's
General Counsel provided a letter in a class action, Frank v.
Cooper, setting forth the Commission's view that the case should
be dismissed.  In an earlier case, the Prudential Securities
litigation, we presented a letter to the court addressing a fee
application submitted by class counsel.

     To my mind, the Commission must continue to do whatever it
can to assist the courts in assessing particular actions or
defenses, and in protecting the interests of class members. I've
asked our General Counsel, Sy Lorne, to devote more resources to
this effort, and I'm pleased to announce today the creation of a
Litigation Analysis Unit within the office of the General
Counsel.  These lawyers will evaluate the claims and the legal
support for private cases, and where appropriate, they will
provide our views to investors, corporations, lawyers, and
judges.  I encourage any of you who believe you're encountering
abuses on either side to bring them to the General Counsel's
immediate attention.

     The Commission will also consider asking Congress to enact a
provision that would allow us to appear and be heard on any issue
in a private action brought under the securities laws.  This
would be modelled on the provision that already exists in the
Bankruptcy Code, and would allow us to express our views in the
public interest.

     I've told you about some ideas we feel are worth examining. 
Let me now turn to the ideas we oppose, and explain why. 

     It's been suggested that plaintiffs be required to prove
that they read and relied upon a misleading statement by the
defendant in order to bring action.  This is antithetical to our
entire system of disclosure, which is premised on the notion that
when information is disclosed generally, it is incorporated into
market prices.  If that were not true, we'd have a system in
which all prospectuses and periodic disclosures had to be
distributed to all shareholders and prospective investors on a
continuous basis -- a tremendous, if not an impossible, burden on
business.  We allow a fair amount of information to be filed with
us, knowing that analysts will see just about everything.  When
someone buys stock at a price affected by misrepresentations, the
buyer has in effect bought the misrepresentations, whether or not
he or she actually read the statements in question -- and that
buyer simply must have recourse.  The proposal in question would
eliminate the notion of fraud on the market, and the need to
demonstrate actual reliance by each member of the class would
make it impossible to be certified as a class.  That's a cure far
worse than the disease -- not just for investors, nor only for
our disclosure system, but for the markets that depend on it.

     Like so many other catch-phrases, the concept of an "English
Rule," or "loser-pays-all," is neither as good nor as bad as its
proponents and detractors would have us believe.  Proponents
argue that the English Rule would screen out frivolous lawsuits,
and there's no question in my mind that it would have that
effect.  The problem is that, if it is applied in class actions,
it would also eliminate meritorious cases.   Imagine you're a
small investor whose nest egg of $10,000 loses its value
overnight, due to the sudden disclosure that a company has
withheld its true earnings.  Two hours after the meter has
started ticking at the law firm hired by the defendant, one
senior partner alone has already racked up $1,000 in fees. 
Within a month, you're weighing the possibility of paying
lawyers' fees that are dozens, if not hundreds of times larger
than your whole investment; that strikes me as a powerful
deterrent, no matter how legitimate your claim.

     This, too, is not just a question of investor interests --
it is a question of the market's interests.  Private securities
litigation plays a prominent role in checking market excesses. 
To change that, we'd need to recalibrate our entire system of
checks and balances.

     This is a crucial point.  Our markets are the best in the
world, partly because our securities laws are the best in the
world.  We tamper with the securities regulation system at our
peril, because you shouldn't fix what "ain't broke."  What is
"broke" is the litigation resolution system -- we must not
confuse the two.  Precipitous steps in one could lead to
structural damage in the other.  The race to the steps of the
courthouse should not be matched by a race to the steps of the
Capitol.

     There are more reasonable and measured reform proposals. 
One would be to give judges stronger authority to award fees when
cases clearly lack merit, as provided in Section 11(e) of the
Securities Act, and to make the attorney who files a frivolous
case responsible for the fees.  Last July, I testified before
Congress in support of this concept, and today I reaffirm that
support.  Congress might also consider a requirement that, where
cases are dismissed on the pleadings alone or in response to a
motion for summary judgment, the presumption is in favor of
awarding fees to the defendant.  Some proposals for alternate
dispute resolution (ADR), including one in the Dodd/Domenici
bill, suggest awarding fees to the winner if the parties fail to
accept an offer to resolve the case in an ADR forum.  This, too,
deserves close attention.

     That brings us to the question of scienter.  Let me be clear
on this:  We are against any proposal to require a plaintiff to
prove that the defendant had actual knowledge that the relevant
statements were false.  The circuit courts have been unanimous in
holding that liability can be predicated on reckless conduct. 
The Commission has strongly supported these decisions because
such a standard is needed to protect the integrity of the
disclosure process -- which is to say the integrity of our
markets.  We want corporations to worry about the accuracy of
their disclosures, because that is the best way to assure the
markets of a continuous stream of accurate information.  Any
higher scienter standard threatens the process that has made our
markets what they are.  Indeed, an actual knowledge standard
could create a legal incentive to ignore indications of fraud. 
The phrase "ignorance is bliss" could take on new meaning.  

     The final question I want to examine is whether there should
be a change in the scope of private liability in fraud cases
brought under Rule 10b-5.  The accounting profession has argued
that joint and several liability is fundamentally unfair because
it sometimes forces parties that are only partially responsible
to pay more than their proportionate share of the damages.  We
acknowledge these fears, and we recognize the vital role
accountants play in the capital formation process.  We do not
want to see the profession weakened or hampered in its ability to
retain talent.  Many ideas have been offered, including liability
caps, one of the proposals of the Dodd/Domenici bill.  Even while
these ideas are being discussed, the Commission believes that
Congress should at least minimize the flaws in the existing
scheme by enacting a system of proportionate contribution, which
is also one of the features of the Dodd/Domenici bill.  We would
be prepared to support a rule providing that, where one defendant
settles a case, the liability of the co-defendants is reduced by
an amount equal to the greater of the amount paid or the settling
defendant's proportionate responsibility.  This could result in
some cases where defrauded investors are precluded from
recovering all of their damages, but it strikes me as a
reasonable compromise.

     Let me summarize, if I may, our position at the SEC:  We
want strong safe harbor protection for forward-looking statements
made in good faith.  We want to eliminate abuses in the
litigation of class actions.  We want to preserve antifraud
liability based on recklessness, and to have liability for aiding
and abetting reaffirmed, certainly for the Commission.  Finally,
we want to make it easier for courts to make awards against
plaintiffs' attorneys in meritless cases, and to implement a
system of proportionate contribution.  

     The bottom line is that we're in this together -- the
Congress, the SEC, the courts, the defendants' bar, the
plaintiffs' bar, the public accounting firms, and, most
importantly, the investors and the public companies that make
ours the deepest, richest capital markets in the world.  No
system can survive that is skewed to one side or another.  

     Imagine, if you will, a world in which the remedy against
fraud is too weak: companies will be able to say anything they
want about themselves or their expectations, but investors will
not want to risk their capital.  Imagine, on the other hand, a
world in which the remedy against fraud is too strong: any
mistake in any company statement will risk huge lawsuits alleging
fraud, so no company will be able to raise capital.  Either way,
our capitalist system is the loser.  What we need is a balance
between caveat emptor and caveat venditor -- between "buyer
beware" and "seller beware."

     It's in that spirit that I make this speech.  Most
reasonable people familiar with the issue feel the system must
change -- the debate is now about what form it will take.  The
fact that strongly opposing positions have been staked out may
actually be helpful, because they leave a lot of ground in
between.  That's where the Commission has made its camp -- and
that's where I ask you to join us -- in the middle.  The changes
we make must be profound, not drastic; they must be visionary,
not just revisionary; they must create something that's new and
right, not just destroy something that's old and wrong.  

     For my part, in the year ahead as in the year just past, I
will work with the Congress, and with any reasonable person
concerned about this issue, to find a fair and workable solution. 
I have no illusion that change will come overnight -- but by the
same token, I have no doubt that, if people of goodwill on all
sides work together, then by the time you meet again next year,
we can and will have an answer that improves the capital
formation process, reinforces investor confidence, and maintains
America's international leadership.

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