Settling for Reform

Call it good governance at gunpoint.

It's a phrase that Pat McGurn, director of corporate programs for proxy adviser Institutional Shareholder Services, has coined to describe corporate-governance reforms won in the settlements of shareholder lawsuits.

As a few recent cases demonstrate, it's a practice that is becoming increasingly common in this post-Enron era. Thanks to an 8-year-old law, more public funds are taking the lead in shareholder suits and demanding more corporate-governance reforms as part of their settlements.

In August alone, at least four companies -- Homestore(HOMS), DaimlerChrysler(DCX), Computer Associates(CA) and Siebel Systems(SEBL) -- settled significant shareholder suits. Of those, settlements in both the Siebel and Homestore cases included a raft of corporate-governance reforms.

"You're going to see even more of it in the future," says McGurn, whose firm advises institutional shareholders on proxy voting and corporate-governance matters. Whenever a large public fund is involved in a case, it's almost a guarantee the settlement will include some corporate-governance reform, he adds. And such funds have become increasingly willing to file shareholder suits ever since Congress passed the Private Securities Litigation Reform Act of 1995.

Ironically, that act was introduced in part to make it harder for trial lawyers -- and in particular the leading plaintiff firm Milberg Weiss Bershad Hynes & Lerach -- to sue companies. But the result seems to be higher monetary awards in such cases and a greater willingness of pension funds to sue.

The law changed the rules determining who would have control of a shareholder suit. Before its passage, control of a class-action suit went to whoever filed a suit first; after its passage, control went to the shareholder with the largest loss.

As a result, pension funds have been more willing to step up to the plate in such cases, because their large holdings generally mean they get control of the suit. And they place a greater emphasis on corporate governance than the individual shareholders who dominated the suits before the act passed.