Businessweek Archives

Bye, Fraud Suits. Hello, Fraud Suits


Legal Affairs: SECURITIES LAW

BYE, FRAUD SUITS. HELLO, FRAUD SUITS

New federal legislation isn't stopping class actions

The legislation was supposed to put an end, once and for all, to the plague of shareholder lawsuits pestering American companies. Where once plaintiffs' attorneys would fire off securities fraud nuisance suits just days after companies suffered large stock-price drops, now reason would prevail. In fact, the medicine contained in the Securities Litigation Reform Act of 1995 was supposedly so threatening to stock-fraud lawsuits that President Clinton vetoed the bill in December, fearing it could hinder even valid cases. But Congress handed Clinton his first override and rewarded the high-tech companies, securities firms, and accountants that had donated millions to see the law passed.

Now that the statute is in effect, executives no longer have to worry about securities fraud class actions, right? Wrong. That's not the case. In the six months since passage of the reform, the number of shareholder fraud cases is down little if at all, say securities attorneys. At least 35 companies have been hit with federal court suits, says Stanford University Law School Professor Joseph A. Grundfest. Targets include Silicon Graphics, Cephalon, SyQuest Technology, ValuJet Airlines, and AnnTaylor Stores. And to sidestep the statute, plaintiffs' attorneys have sued dozens more companies in state courts. Says former Securities & Exchange Commissioner Grundfest: "It is not clear that the corporations that wanted relief from this litigation have really won [what] they were looking for."

True, it's still early to judge fully the law's impact. Courts are only beginning to apply the statute, and many suits could ultimately be defeated. But already it is clear that the law has not forced plaintiffs' lawyers to abandon their cash cow. They're testing the limits of the new statute and enjoying some surprising early success.

The case of Touchstone Software Corp. shows just how lucrative bringing securities suits can still be. Plaintiffs' attorneys filed a case on Jan. 26 against Touchstone of Huntington Beach, Calif., for misleading investors. Touchstone's lawyers got preliminary indications that the judge considered the case against it to be weak and was leaning toward dismissal.

But the company was unsettled enough that it nonetheless agreed in May--without admitting guilt--to a settlement of $1.3 million in cash and stock. Touchstone attorney Tower C. Snow Jr. of Brobeck, Phleger & Harrison says the settlement cost less than fighting would have. And the final sum was only a fraction of the liability the company could have faced had the case gone to trial. Meanwhile, plaintiffs' lawyers in the case will probably get from $325,000 to $390,000, a handsome payoff for an apparently long-shot lawsuit.

LOOKING FOR DIRT. Plaintiffs' lawyers are also winning some skirmishes in court. Last month, Chantal Pharmaceutical Corp. tried to use the new statute to dismiss a securities fraud suit alleging that Chief Executive Chantal Burnison withheld damaging information from investors. But in the first major ruling interpreting the new law, a federal judge refused to toss out the case, holding that plaintiffs had raised serious issues. Because the suit was filed less than a month after the company stock nosedived, dropping by 62%, Chantal attorney William B. Campbell believed the law would offer his client more protection. "This is really the type of case the reform was aimed at. All of the earmarks of filing first and asking questions later are here," says Campbell. Opponent Alan Schulman responds that the suit is valid.

To adapt to the new landscape, plaintiffs' attorneys are deploying a variety of strategies. Now that they are required to provide more detail about an alleged fraud to get a judge to even hear a case, plaintiffs' lawyers are doing a bit more up-front work. For example, they are shelling out thousands of dollars for private detectives to dig up dirt about companies before filing initial court papers, a step that used to be delayed until later in litigation. In particular, they are sniffing out insider trading and improper accounting, since judges are less likely to toss such cases.

Plaintiffs' attorneys also are waging their battles in state courts. More than 20 securities fraud cases have been filed in California alone, a fivefold increase from previous years, according to Snow. It's a risky strategy, even though it avoids many technical restrictions in the federal statute. Because relatively few fraud suits have been filed in state courts, the law they will apply is unpredictable. For example, plaintiffs' lawyers may be forced to prove that each individual shareholder knew about the alleged misrepresentations--a nearly impossible task generally not required in federal courts. Moreover, state courts may not permit attorneys to represent victims in other states. Says plaintiffs' attorney Richard D. Greenfield of Ardmore, Pa.: "It is much more of a crapshoot in state court."

To create at least one welcoming state venue for securities fraud claimants, Milberg Weiss Bershad Hynes & Lerach along with other plaintiffs' firms are bankrolling an expensive ballot initiative intended to change the rules in California. Among other provisions, it would ensure that plaintiffs' attorneys do not have to prove that every alleged victim relied on the defendant's fraudulent statements. The ballot item is so pro-plaintiff that if the November measure prevails, any company with shareholders in California could face securities suits there.

SAFE HARBOR. Given these threats, corporate attorneys are urging their clients to be cautious about opening themselves up to lawsuits by discussing new products and future earnings. That's ironic, since one of the benefits of the legislation was supposed to be an improvement in investment information. In fact, lawmakers even gave companies a so-called safe harbor, insulating them from suits claiming that statements about the future were inaccurate. But because of the continued stream of securities fraud suits, many of the companies that had promised openness are releasing no more information about their operations than they had prior to the legislation.

That's frustrating to some investors. Says Philip Rueppel, a stock analyst at Alex. Brown & Sons Inc.: "I was hoping that the legislation would open up a freer conversation between me and management. Quite frankly, I've been disappointed that things haven't changed." In that sentiment, he's got plenty of company.By Mike France in New YorkReturn to top


Best LBO Ever
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus