The stock market is plunging, investors have lost more than $3 trillion, and every day a new company announces an unexpected disaster. So you might think that William S. Lerach, Melvyn I. Weiss, and other lawyers who make a living suing corporations that have suffered sudden stock price drops would be uncorking the champagne, tossing confetti, and putting on their party hats right about now.
Wrong. So far, the big market crash has not produced a tidal wave of shareholder fraud litigation. In fact, the number of federal class actions filed in 2000 was 195, down from 206 in 1999 and 234 in 1998, according to Stanford Law School's Securities Class Action Clearinghouse. And as of Mar. 13, only 23 new cases had been filed this year, well below last year's pace.
The main reason is the Private Securities Litigation Reform Act of 1995. Enacted after a long, intense, and expensive lobbying campaign by Silicon Valley, Wall Street, and the accounting industry, the law was intended to cut down on "strike suits." These were the widely despised securities-fraud class actions that plaintiffs' attorneys managed to file just hours after a company announced bad news--a practice that began to mushroom in the late 1980s.
Now that the market has melted down, the law is starting to repay its supporters in spades. Consider Yahoo! Inc. (YHOO) On Mar. 7, the company announced disappointing revenues, trimmed its profit forecast, and said it would be hiring a new CEO. The stock, already down more than 80% from its all-time high, plunged nearly 20%. "In the past, you would have had 20 complaints on file the next day," says veteran plaintiffs' attorney Richard D. Greenfield of Paoli, Pa. So far, Yahoo hasn't been sued at all--and Greenfield, like many of his ilk, is devoting more attention to other types of litigation.
The decline of securities-fraud class actions is a huge relief to the business community. While many cases are still filed, especially when companies are guilty of accounting irregularities, the law has clearly made plaintiffs' attorneys think twice before rushing to court with a barely researched case in hopes of digging out some damaging documents during pre-trial discovery. "I think we've gotten rid of some of the junk lawsuits," says Richard H. Koppes, a securities and business lawyer at Jones, Day, Reavis & Pogue in Los Angeles.
But while the Reform Act may be good news for the likes of Yahoo, not everybody is convinced it's so great for investors. The law has also made it harder for shareholders to recover money from companies that may have committed fraud. And at a time when many people are feeling victimized by seemingly irresponsible corporate and Wall Street hype, it could wind up protecting some executives who deliberately misled investors.
HARBOR HUBBUB. That's why some securities law experts are starting to question whether the law has gone too far. "Investors should be regretting it," says Philip A. Feigin, a Denver lawyer who used to be the Colorado securities commissioner and the executive director of the North American Securities Administrators Assn. He argues that Congress, on the basis of very little study, "just made a decision that there were more abusive lawsuits that were hurting investors than there were instances of fraud," he adds. Feigin doesn't believe that was the case then--or now.
The most controversial aspect of the Reform Act is a "safe harbor" provision protecting executives who make so-called forward-looking statements--predictions about a company's revenues, dividends, products, or liabilities. If the execs' remarks turn out to be untrue, corporations are generally shielded from liability as long as they surround the projections with a few sentences of legal boilerplate. Six years ago, this provision led President Clinton and former Securities & Exchange Commission Chairman Arthur Levitt Jr. to oppose the law, because they feared an increase in stock market hucksterism. But it passed nonetheless after Congress overrode the President's veto.
Forward-looking statements are especially important to technology companies, whose valuations are determined less by current earnings than by future prospects. Now that many of the more grandiose projections of the 1990s have fizzled, some people are wondering whether Congress gave Silicon Valley a little too much protection. "The big question is whether the safe harbor in the 1995 Act provided protection for baseless earnings projections," says Columbia Law School professor Harvey J. Goldschmid, a former SEC general counsel. "The present downturn may provide evidence of whether [there was] excessive protection."
SHENANIGANS. The safe harbor for forward-looking statements isn't the only part of the Reform Act that's under scrutiny. The law also requires plaintiffs to overcome a variety of new hurdles before any case can even come to trial. For instance, plaintiffs' lawyers have to supply specific details about the alleged securities fraud in their initial complaint. In the old days, they only had to prove that there was good reason to suspect that wrongdoing might have taken place.
As a result, securities-fraud litigation is not the easy path to riches it once was. Cases frequently take a year longer to get before a jury, and the cost of simply filing a suit has risen to more than $500,000 in some instances, plaintiffs' attorneys say. The odds of winning have also decreased. Before the passage of the Reform Act, 12% of all cases were dismissed outright by judges. That number has increased to 28% since the law was passed (table). Without the Reform Act, "I would say we could have brought twice as many cases," says Weiss, a key leader at securities class action powerhouse Milberg Weiss Bershad Hynes & Lerach.
What's more, he argues, the new law "is a disaster...at a time when fraud is proliferating, misinformation is rampant, [and] people in industry are using all kinds of shenanigans to artificially inflate stock prices." For now, plaintiffs' lawyers are the only ones griping. But if the market keeps falling, their anger could well spread to investors, too. By Mike France in New York