The Wall Street Journal: The Initiative That Would Kill Silicon Valley | Cypress Semiconductor
The Wall Street Journal: The Initiative That Would Kill Silicon Valley
The Wall Street Journal: The Initiative That Would Kill Silicon Valley
Remember California's Proposition 13, the ballot initiative that started a nationwide landslide tax revolt? Proposition 211 is the latest Golden State innovation, but this one would bury American business in a landslide of lawsuits. Proposition 211 would make California the lawsuit capital of the U.S., giving trial lawyers more power to fleece companies with frivolous "strike suits," supposedly on behalf of defrauded shareholders.
And that isn't Proposition 211's most destructive aspect. The initiative would make it illegal for corporations to indemnify their directors against liability in such awards, forcing them to place their personal wealth at risk and making it much harder for firms to find qualified directors. Just a California problem? Hardly. Proposition 211 applies to any company with even a single shareholder in California -- that is, virtually every publicly held company in the U.S.
Frivolous lawsuits are already far too common. My company, Cypress Semiconductor Corp., was hit with one in 1992. The suit claimed we had defrauded our shareholders when we produced fourth-quarter 1991 earnings of 15 cents per share, compared with the Wall Street consensus of 20 cents. I was sued personally, as were several of our officers and directors.
The complaint was a joke. It claimed that some carefully selected quotes of mine, combined with the earnings shortfall and subsequent drop in the share price, constituted fraud. The plaintiffs' lawyers failed to acknowledge my cash purchase of 20,000 Cypress shares during the so-called class-action period, when they claimed Cypress insiders were dumping stock. One of the plaintiffs, Frederick Rand, was practically a professional litigant, having been involved in 17 previous class-action suits.
In June 1995 a judge granted our petition to throw the case out of court; the plaintiffs are appealing. We have been forced to spend $5 million on legal fees over four years, and to produce 750,000 pages of documents during the discovery phase of the case. That's how strike-suit lawyers try to wear down corporate defendants in order to force lucrative settlements.
Cypress refused on principle to settle, but less than 5% of high-tech companies fight it out, the American Electronics Association estimates. Instead, they opt to pay a few million dollars (about what their legal bill would be if they fought) to end the pain. According to the National Economic Research Associates, class-action lawyers pocketed $227 million in fees from 319 suits filed between 1991 and 1994 -- nearly a third of the $709 million awarded in settlements in these cases. One in three of these suits was brought against technology companies. More than half of the top 150 technology firms in Silicon Valley have faced class-action litigation, the AEA reports, including such powerhouses as Sun Microsystems, Silicon Graphics, and Apple Computer. Should we believe that 50% of America's high-tech CEOs are scam artists? Or that our legal system is out of control?
Congress restored balance last year by passing a bill that struck a compromise between shareholders' legitimate rights and the elimination of legal profiteering. President Clinton vetoed the bill, abandoning his 1992 campaign pledge to support Silicon Valley entrepreneurs, largely because of lobbying efforts led by White House dinner guest and Clinton fund-raiser William Lerach, a professional class-action lawyer who is Proposition 211's author and primary financial supporter. But congressional Democrats joined Republicans to override the veto, and the bill became law. Realizing that his veto had burned bridges in Silicon Valley, Mr. Clinton performed a double flip -- siding against Proposition 211 after a $50,000-a-plate Silicon Valley dinner.
Politics aside, Proposition 211 would kill 159,000 California jobs over the next decade, according to the Law and Economics Consulting Group, a private research company. It would penalize business by relaxing the controls on intrusive and expensive "fishing expeditions" in the discovery phase of class-action proceedings and by broadening the definition of "fraud," further inflating settlements and legal fees.
Of greatest concern to Silicon Valley entrepreneurs, the initiative would prohibit director and officer indemnification, making board members personally liable for damage awards and even barring companies from picking up copayments on directors' and officers' liability insurance. This would make it impossible for Silicon Valley companies to fill their boards with ex-CEO venture capitalists, a practice that has been highly successful.
Our company's start-up story is typical. At age 35, with a Stanford Ph.D. in electrical engineering and big aspirations, I formed the Cypress team. We snared $7.5 million from venture capitalists, but their human contribution to our board of directors proved even more valuable. Our original board members included L.J. Sevin, our first chairman, and Pierre Lamond, our current chairman, both founders of semiconductor companies and former CEOs.
They had the business experience that I lacked. (I remember the time when L.J. politely explained the nuances of a balance sheet to me in his living room.) Cypress might not have survived -- and certainly would not have been as successful -- without their guidance. Of course, Mr. Sevin and Mr. Lamond would never have joined our board of directors if their personal wealth had not been protected by the basic principle of limited corporate liability. This principle has been a cornerstone of the American economic miracle for two centuries: In 1800, America had only five million people but had more corporations than there were in all of Europe.
I'm now 48 years old and have enough scars and savvy to help other young Silicon Valley CEO-entrepreneurs. I am a board member of Vitesse Semiconductor Corp., America's largest producer of gallium-arsenide chips, and of C-Cube Microsystems, the nation's leading video-compression company. If Proposition 211 passed, would I be willing to expose my wealth -- the product of more than a decade's hard work building Cypress -- to class-action lawyers, one of whom might get a lucky jury on a long-shot case? Not a chance. I would have to resign both of my directorships -- as would the directors who guide my company.
If Proposition 211 passes, think about dismantling the Silicon Valley economic engine. Think about the demise of an entrepreneurial culture, which has bred three generations of businessmen and made America the world leader in semiconductors, so that self-interested trial lawyers can make California into a legal killing field. Californians should consider these possibilities as Election Day draws near.
Mr. Rodgers is president and CEO of Cypress Semiconductor Corp. This article appeared in The Wall Street Journal , in the "Manager's Journal" column on the editorial page, and is published here with permission.