When Congress passed the Private Securities Litigation Reform Act of 1995 as part of Newt Gingrich’s Contract with America, it was to weed out frivolous lawsuits and tilt the legal scales a bit more in favor of CEOs and their companies.
There’s some debate over whether that has actually happened. There were 327 federal securities fraud classaction suits not related to initial public offerings filed in 2001, an increase of 60 percent over the year the reform act was passed, according to research from the Stanford Law School Securities Class Action Clearinghouse. However, lawyers for plaintiffs say this data is meaningless and argue that the number of cases dismissed by judges before settlement talks even begin has gone up markedly during the same period.
One unintended consequence of the reform act, though, that nobody among plaintiffs or defendants disagrees about is that the litigation is much more potent when it survives motions to dismiss the case in the first round.
The reason is that lawyers for the plaintiffs, fearful of having their cases tossed out, prepare themselves better, spend more on initial investigations and dig for any hint of dirt with much more ferocity than they did before the law was passed. As a result, since the legislation’s passage, the median dollar amount of securities fraud settlements has skyrocketed to $5.5 million for all post-reform cases versus $4 million for a large sample of pre-reform litigation, according to Stanford’s Securities Clearinghouse. While companies are facing higher payouts from securities fraud litigation and more dogged antagonists since the bill was passed, consumer advocate lawyers are also becoming more resolute. The best example: In 1998, after years of denying guilt, tobacco companies caved in to a team of tenacious lawyers and agreed to pay the states $240 billion to cover health care costs related to smoking.
What all of these cases have in common are aggressive, unyielding and extremely bright attorneys who view their careers as crusades to root out what they would describe as deception and fraud in corporate America. They are impressive foes for CEOs. To understand more about who these lawyers are, what motivates them and their litigation strategies, Chief Executive spoke to three of the nation’s most successful securities and consumer protection lawyers and to a company that fought back and won.
A new model for securities litigation
Milberg Weiss Bershad Hynes & Lerach
William Lerach says he has been handcuffed. It’s an image that many chief executives would relish seeing.
In the mid-1980s, Lerach, the best-known partner of Milberg Weiss Bershad Hynes & Lerach, a New York-based firm responsible for more than half of all shareholder suits against corporations, fashioned the model for a perfect securities complaint. Operating out of his San Diego offices, the 56-year-old Lerach used it against hundreds of Silicon Valley companies, usually when he saw a pattern that piqued his suspicions: unexpected bad news just months after optimistic forecasts, a large amount of insider selling and a plummeting stock. Over the years Lerach has taken on companies like Cisco, Apple, Quantum Computer and almost every other big name in the arena.
“I’m just about always right,” he says. “When this pattern is present, invariably someone has been lying.”
CEOs began to call these suits “getting Lerached” and their companies paid billions of dollars to settle. Lerach, himself, made well over $100 million and his firm has won more than $6 billion for its clients.
The good old days are gone, though, Lerach says. They ended when Congress passed the Private Securities Litigation Reform Act. It was the only piece of legislation to overcome a veto by President Clinton in his first term. Two key elements of the bill seemed to be aimed directly at Lerach’s tactics. No longer could a plaintiff’s lawyer simply allege fraud based on circumstantial evidence and hope to find incriminating information during the discovery phase of a legal proceeding.
Instead, the complaint had to include factual support-internal documents, eyewitness accounts, suspicious emails and the like-for a strong implication of deception. In addition, the legislation gave CEOs, other executives and their companies a so-called safe harbor from litigation if all projections contained a statement that these were forward-looking announcements and may not occur as predicted.
“This law tied my hands,” Lerach says, “but more important is its serious and devastating impact on investors. €˜€˜We’re probably just catching a small amount of the deception that’s going on because of the punitive standards that have been set for pleading a case in the first place.”
Lerach’s opponents-chief executives and corporate counsel-say that as a result of the reform act Lerach’s legal complaints are more fully developed and supported by real information, a point Lerach concedes. In fact, Lerach says, to meet the new requirements his firm has expanded its investigative capabilities, hiring a slew of private investigators and adding new teams of forensic analysts to dig up information on companies and executives.
Still, Lerach’s frustration notwithstanding, he believes his two-decade broadside against Silicon Valley companies, which he describes as far from over, has had a positive impact. “My colleagues on the defense bar have told me privately that they have used the prospect of a suit prosecuted by our firm as a way to persuade executives to be more forthcoming in their disclosures,” Lerach says.
Perhaps the best news for CEOs is that Lerach is likely to be distracted for a while. After a whirlwind self-promotional campaign that included appearances on numerous major TV talk shows, Lerach won the plum assignment as the lead counsel in the shareholder class action against Enron. Upwards of 30 Enron executives are being sued for allegedly deceiving investors by purposely issuing false financial statements and artificially inflating the stock price with accounting gimmicks, even as the company was about to go bankrupt.
The case is on a fast track-for the legal profession-to open in late 2003. Lerach is elated to be involved. “It’s like old times,” he says. “A case where the gloves are off, obvious fraud exists and we can shine a light on how deceptive executives can be.”
When the math is on the lawyer’s side
Wolf Haldenstein Adler Freeman & Herz
Fred Isquith doesn’t grab headlines as deftly as Lerach. But as the lead securities litigation lawyer at the New York firm of Wolf Haldenstein Adler Freeman & Herz, Isquith is just as much a nuisance to CEOs-and certainly represents the dozens of lawyers who have quietly made class-action securities lawsuits a routine in corporate America.
“I am one of the luckiest people in America, because I am doing exactly what I want to do,” Isquith says. “When the system breaks down, people come to me for help and that’s satisfying. They have a right to get their money back if there was fraud and wrongdoing.”
Typical of Isquith’s recent victories is a class-action suit against MicroStrategy, a database software maker in McLean, Va., for having deceived shareholders about the company’s financial performance. It was surgically precise litigation.
In March 2000, MicroStrategy admitted to overstating revenue from 1997 to 1999. Its stock plunged from $313 to $17 within two months. Investors were furious, and Isquith sued on their behalf. MicroStrategy, reeling from slipping sales and an annual operating loss of $153 million, was too weak to fight back. By late 2000, a scant few months after Isquith filed the litigation, MicroStrategy agreed to a settlement. Under its terms, the company and its accountant, PricewaterhouseCoopers, were forced to pay shareholders more than $100 million over five years. Out of that, Isquith’s firm pocketed more than $20 million.
These high-stakes, high-profile cases are the last thing the 54-year-old Isquith expected when he began practicing in the early 1970s. At that time, securities law was an almost invisible corner of corporate litigation, mostly involving minutiae of stock and debt issues and antitrust or management disputes. But after Michael Milken’s junk-bond frenzy, the emergence of 401(k)s and Internet IPOs made trading and risk-taking an American obsession, Isquith’s practice lost the green eyeshades.
“There was so much money flowing around, you just knew that greed had to follow,” says Isquith. “Now when I see it, I attack it.”
Relentlessly. Isquith and his firm have filed upwards of 500 cases against companies as well as their chief executives and other top officers for securities fraud violations. These aren’t just failing startups. Enron, Merrill Lynch, Procter & Gamble and DaimlerChrysler AG are all on his hit list.
So is Lockheed Martin and its CEO, Vance Coffman, whom Wolf Haldenstein sued for harming investors by allegedly disseminating false information that would lift Lockheed’s stock price in early 1999 so that a merger with Comsat could be struck. In the summer of that year, Lockheed announced that its previously stated forecasts could not be met, sending the defense contractor’s shares tumbling. Lockheed Martin denies any wrongdoing.
“It’s not unusual for management to get themselves into trouble or to want to get some personal gain out of a merger, for instance, and then conceal things in order to make sure that the stock remains high,” Isquith says. “That has become as common as quarterly reports.”
Many CEOs might argue that Isquith’s logic is just a high-handed rationale for the dirty job he does. More to the point, they say, stocks fall because CEOs give an honest but negative assessment of the company’s performance. Then, Isquith attacks, scavenging for even a tidbit of prior positive information-put out by the company when management didn’t know any trouble was brewing-as evidence of fraud.
Isquith concedes that some plaintiffs’ lawyers might operate that way, but Wolf Haldenstein, he holds, has a higher threshold. The firm always does a complete investigation before pursuing a case and wants to be reasonably certain that actual malfeasance has occurred before spending the hundreds of thousands of dollars it can cost to litigate, Isquith says. In fact, the lawyer says that more often than not, he will decide against bringing an action.
But he also knows that suing is a tempting course because the math is on his side. Upwards of 80 percent of all securities class actions he files are settled without going to court, Isquith says, costing companies that are already struggling tens of millions of dollars that they don’t have. To them it’s a better option than spending the same amount of money-as well as management hours-to fight, perhaps only to lose. That inequity, Isquith says, doesn’t disturb him at all: “They can’t blame me for putting themselves in a position to not be able to fight back. If the chief executive hadn’t lied in the first place, he would never have to even hear my name.”
Taking on companies and industries
Scruggs Law Firm
Richard “Dickie” Scruggs doesn’t have much good to say about plaintiffs’ lawyers who with knee-jerk predictability sue companies after their stocks have fallen, often alleging investor fraud by management even before there is clear evidence.
“Those are piggyback cases, not primary kills,” the 55-year-old native of Pascagoula, Miss., says. “I try to take on companies that have successfully avoided liability but shouldn’t have. I don’t want to get there after the antelope has been brought down. I’m not out to destroy corporations.”
No, just industries, Scruggs’ critics would argue. Scruggs’ first big score came in the early 1980s-a few years after hanging up his shingle in Pascagoula-when he began representing workers at Ingalls Shipbuilding in personal injury claims against asbestos manufacturers. A juror who liked Scruggs’ understated style on a case he lost went to see the attorney. “I sent him to a doctor to be tested,” Scruggs says. “Before I knew it, there were five shipyard workers, then 10, then dozens every day showing up in my office.”
Eventually, there were thousands, and by the time the last asbestos suits were settled in the early 1990s just a tiny minority went to court and fewer still ever ended in a verdict. Scruggs had won hundreds of millions of dollars for the victims and about a third of that for himself.
Without such resources, Scruggs would never have agreed to sue the tobacco industry for reimbursement of state Medicaid costs to treat sick smokers when his Ole Miss classmate, Attorney General Mike Moore of Mississippi, suggested the idea in 1995. To litigate and rally backing for this case, which included all 50 states as plaintiffs, Scruggs spent millions on a legal team that traveled the country in private planes speaking to witnesses, filing briefs and lobbying for government support. It took three years before the tobacco industry agreed to settle with the states for $240 billion over 26 years. Scruggs’ take: about $400 million.
That much money turned Scruggs into an idealist. “I now have the ability and credibility to take on corporate miscreants as a primary task. These resources weren’t given to me to have a good time. It’s a trust fund to fight negligent companies.”
His latest target is HMOs. Scruggs has filed class-action suits on behalf of the more than 30 million people enrolled in medical insurance programs run by companies like United Healthcare, Cigna, Pacific Care, Humana and Aetna. He asserts that they defraud consumers because they don’t deliver what they promise. “They claim that they will provide quality health care and they just don’t,” Scruggs says. “They never have any intention of providing that. They jack around their patients and they dictate to doctors how to treat patients by giving bonuses to undertreat patients.”
The case is wending slowly through the courts, mainly because Congress is considering a patient bill of rights that would guarantee HMO policy holders the option of getting a second opinion, going to specialists and suing when the medical care is substandard. If the legislation passes, Scruggs’ case would be moot. That would be fine with him, he says. In fact, Scruggs, who has excellent political instincts-his brother-in-law is the Senate Minority Leader, Trent Lott-has been lobbying on Capitol Hill to get the bill enacted. “This was never a case about money for me,” he says. “We were trying to reform business practices. The right patient bill of rights could do that.”
Scruggs switches sides
If CEOs have any reason for optimism regarding Scruggs, it could come from what he is working on while waiting for the HMO case to unwind. In a surprising switch, Scruggs is representing a company in its dealings with consumers-not the other way around. His client is Sulzer Orthopedics, an Austin, Tex.-based maker of musculoskeletal implants that in late 2000 recalled thousands of defective prosthetic hips because they were manufactured improperly. In many cases, people with these devices had to have a second operation to have them removed. Facing a mountain of litigation, Sulzer asked Scruggs to try to negotiate a global settlement for them that wouldn’t destroy the company.
“They’ve been in business for 100-plus years, they make life-enhancing products and they had one screw-up, but there isn’t a legal mechanism for a company that makes an honest mistake to get out of the mess without going bankrupt,” Scruggs says. “It would be nice to fashion a vehicle that would allow a company in circumstances like this to earn its own way out.”
Cynics, noting the difference between this pro-corporate statement and the bitter language Scruggs has hurled at the tobacco industry and HMOs, would say this proves that even the most seemingly principled lawyer has never met a guilty client. Scruggs, of course, sees it differently: “It’s just another outlet for my idealism.”
How Silicon Graphics Beat William Lerach
McCracken probably shouldn’t have been baffled. Lerach, the bulldog partner at Milberg Weiss Bershad Hynes & Lerach-the firm that handled an astounding 83 percent of all securities class-action suits in California in 1996-has never shied away from a legal battle, and at the time was determined not to let the newly passed reform act get in his way. So when Silicon Graphics, which makes graphics workstations in Mountain View, Calif., announced in early 1996 that fourth-quarter revenues grew only 22 percent instead of the forecast 40 percent, the stock plunged 38 percent during the next couple of months, and Lerach pounced. The executives knew all along that sales wouldn’t reach projected levels, the attorney declared, but deceived investors to keep the stock price buoyed so they could make money by selling their shares before the earnings announcement.
Jerome Birn Jr. and his colleagues at Wilson Sonsini Goodrich & Rosati, the lead counsel on this case, knew they had to stymie Lerach from getting past the pleading stage to discovery with the limited amount of facts that he was offering to back up his allegations. Otherwise, it would be like every other pre-reform case, with months and months of depositions and document requests-“These were glorified fishing expeditions,” Birn says-that would require expensive legal resources and distract management.
“The purpose of the legislation was to not ever let a half-baked suit-one without a real factual basis-put an innocent company in that position anymore,” Birn says.
Wilson Sonsini’s gutsy strategy was to attack Lerach’s initial complaint, something that could not be done in the years before the reform bill. Birn and his partners offered information showing that the insider selling that Lerach was highlighting was not quite as extensive as his complaint contended. When Lerach asserted that there was an internal report at Silicon Graphics detailing inadequate chip supply to produce enough workstations to reach the $40 million revenue level, the company’s legal team demanded that he bring forth the source of his information.
Lerach was outraged by this tactic. As he saw it, if he had to back up every claim so completely at such an early stage, companies would essentially be immunized from fraud complaints.
In May 1997, nearly 18 months after the suit was filed, U.S. District Court Judge Fern Smith ruled in Silicon Graphics’ favor and dismissed the case. Her reasoning: Lerach had failed to comply with the reform act’s much higher requirements.
McCracken describes the Silicon Graphics suit as a watershed because it showed that the reform act had teeth and that unsubstantiated allegations weren’t enough anymore. “It helped change the attitude among boards in Silicon Valley and gave them confidence that there was an alternative to settling for millions of dollars.” What’s more, the Silicon Graphics case’s outcome appears to be dissuading plaintiff lawyers, who generally get paid only if they win, from taking on frivolous litigation.
And now that they’re more bulletproof, at least in court, CEOs are grappling with other aspects of the legislation and subsequent bills that have changed the way they are required to communicate with shareholders, Wall Street and the press. These include the so-called safe harbor that the reform act provides, which protects companies from being sued when forecasts go awry as long as they have stated that these are “forward-looking statements” and the company’s actual performance may be different.
“Companies have gotten good at putting this in press releases, but CEOs too often can’t be bothered with it when making public pronouncements,” says Birn. “I tell them to treat it like the Miranda warning: Carry it laminated in your pocket and read it before saying anything. It’s a get-out-of-jail-free card, if you’re innocent. That’s a big difference. Before the act, the innocent as well as the guilty were equally punished by the plaintiffs’ bar and the courts.”