Skip to main content

This story is part of a special series by investigating shareholders' reaction to corporate corruption on Wall Street. Click here to see a full listing of stories.

The villains in the scandals plaguing corporate America are many, and they include scheming executives, greedy bankers, lapdog accountants and obsequious attorneys.

But some big-time securities lawyers say federal lawmakers also must shoulder some of the blame for making it harder for shareholders to sue corporate wrongdoers.

Bill Lerach, the ubiquitous securities lawyer corporate America most loves to hate, says lawmakers all but gave corporate evildoers at companies like




a license to steal when they enacted the Private Securities Litigation Reform law of 1995.

The controversial law, enacted over a presidential veto, was supposed to deter frivolous shareholder suits by making it easier for federal judges to dismiss those actions. But according to Lerach, a partner with Milberg Weiss Bershad & Lerach in San Diego, the only thing the law has deterred is conscience.

"What's happened is that pro-corporate judges are using this law as a weapon to block valid cases and protect corporate malefactors," says Learch, the self-styled dean of shareholder litigation and the lead attorney on the multi-billion-dollar Enron shareholder class action. "There is no question that many good and thoroughly researched (lawsuits) are getting thrown out."

Center of the Storm

On one level, it's easy to dismiss Lerach's comments as self-serving hyperbole. After all, the 1995 law might never have been passed if not for Lerach's reputation of screaming fraud and running to the courthouse every time a company's stock fell.

But there's no denying the law has enacted some real barriers by prohibiting the plaintiffs' lawyers from conducting discovery in a case before a judge gets to rule on a motion to dismiss it. That means the lawyers can't depose any witness or gather any documents that might help support their allegations of securities fraud. And that prohibition can lead to cases getting tossed early.

Recent legal studies have shown that since the 1995 law, judges are granting 66% of the motions to dismiss, compared with a 40% dismissal rate prior to the law taking effect.

In a case like Enron, the bar on discovery is not such a big deal because there are hundreds of others lawyers doing Lerach's bidding and unearthing a mountain of evidence in both the massive bankruptcy proceeding and the criminal fraud investigation. For Lerach, all the free legal aid he's getting is like manna from heaven.

But it's a different story in a lesser-known case that doesn't generate much media publicity or spark the interest of securities regulators. And as the statistics show, that's where shareholders and their lawyer often find themselves caught in legal Catch-22.

"The discovery stay means (securities lawyers) don't get any more information until the case can survive a motion to dismiss," says Jill Fisch, a Fordham University School of Law securities professor. "But it's more difficult now for a plaintiffs' lawyer to put together a case that can survive."

TheStreet Recommends

On the other hand, the situation probably isn't as dire as Lerach and other critics make it out to be.

Police and Thieves

For starters, few believe the executives at Enron and WorldCom would have thought twice about committing a fraud if the 1995 law was never enacted.

"The fact that Congress amended the securities laws in 1995 has had little or no impact on the business practices that led us to where we are today," says William Allen, director of the New York University Center for Law and Business.

And there's even some evidence that a shareholder suit that survives a motion to dismiss will fare better today than a lawsuit brought prior to the 1995 law -- especially when it comes to the size of the settlements being negotiated.

Indeed, the law has done nothing about slowing the pace at which new lawsuits are filed. So far this year, the Securities Class Action Clearinghouse reports there have been 194 securities fraud class actions filed, compared with 188 in the last year under the old law.

"Some of the lawsuits being commenced today are less transparently frivolous than before the reform act," says Michael Young, a corporate lawyer with the New York law firm Willkie Farr & Gallagher. "But they are being replaced by more accounting lawsuits."

Legal observers say that even though there's an increased risk of a case being dismissed in the post-reform era, the lawsuits keep coming because the potential rewards are so great.

"The reform act made litigation riskier but it didn't change the fact that there's money to be made in these cases," says Michael Perino, a professor at St. John's University School of Law and a frequent commentator on the securities litigation reform measure. "I think the reform act worked, but not in the way Congress intended. What it has done is improve the overall quality of cases."

Pots of Gold

That may be one reason the dollar value of settlements has risen dramatically in the post-reform era.

In 2001, Institutional Shareholder Services reports that 162 class actions were settled for more than $2.3 billion. And the dollar value of the average settlement has jumped from $7.8 million in the period before the law's enactment to $25 million since its passage, according to Cornerstone Research, a class-action research group.

One of the biggest class-action settlements ever was



$3.5 billion deal in 1999 to settle allegations that the company cooked its books.

One reason shareholder suits are resulting in bigger settlements is the reform law's requirement that plaintiffs' attorneys compete to find institutional investors to serve as lead plaintiffs. Having a big institution serving as the named plaintiff can add some heft to the fraud allegations in a complaint, and it may put more pressure on the defendants to come up with an attractive offer.

An institutional plaintiff also sends a "signal to the court that this is a meritorious case," says Perino.

In the Cendant case, for instance, it didn't hurt shareholders' attorneys that Calpers, the big California state pension fund, was one of the lead plaintiffs.

Indeed, of the 10 biggest settlements in the post-reform era, large institutional investors were named as the lead plaintiffs in six of them, according to Cornerstone Research.

Tidal Pools

Still, it's difficult to draw too many conclusions from these statistics because the past two years have presented an unusually fertile breeding ground for securities fraud cases and to some extent may be exaggerating the statistics. With so many stocks getting crushed and corporations being investigated for accounting fraud, legal observers say the current climate is one that lends itself to more litigation and bigger settlements.

"It's very difficult to attribute the large settlements we've seen to the reform act because of the changed market conditions," says Laura Simmons, a senior manager with Cornerstone Research. "In order to draw a more rigid conclusion we may need a longer time horizon."

And it's worth remembering that shareholder litigation, both before and after the 1995 law, has never come close to making investors whole. Several studies have shown that the dollar value of settlements in securities fraud cases represent around 5% of the actual damages incurred by shareholders.