a new take-no-prisoners sheriff in the corporate responsibility arena
in the United States. Class action lawyers who took $240 billion out
of the coffers of Big Tobacco (and silk lined their own pockets in
the process) are now turning their sights on the burgeoning corporate
scandals, taking dead aim at Wall Street.
Is this a good or bad turn of events?
It’s now axiomatic that corporations must implement tighter accounting
standards, reform governance practices and reexamine executive compensation
principles. But how do we get from here to there? And beyond the vague
generalities that such reforms promise, where exactly are we trying
The reforms proposed by the Business Roundtable and New York Stock
Exchange are sensible enough. But it’s hard to figure that any of
the high-profile corporate implosions would have been avoided if these
reforms had been previously implemented. And it’s dubious whether
the congressional legislation factory can generate anything of definitive
value. Corporate lobbyists are already working to limit the reach
of reform, and anything they miss will almost certainly face the wrath
of clever corporate lawyers.
If the carrot of reform seems of limited real value in reining in
corporate excess, perhaps the stick of fear might do it – not only
the fear of being carted away in handcuffs a la Daniel Kozlowski and
John Rigas, but of seeing your company, pay and future promised retirement
benefits included, dismantled. At least that’s the argument put forth
by a slew of lawyers who specialize in representing investors in securities
lawsuits. By recent count, Enron and its executives have been hit
by 45 securities lawsuits, Adelphia by 56 and Tyco by 60.
But these actions are not of the kind that heeled the tobacco industry.
For years, a class action was the litigation weapon of choice. Plaintiff
lawyers could simply allege fraud based on circumstantial evidence
and hope to find incriminating information – the smoking email – during
the discovery process. But by 1998, Congress all but closed down that
avenue. That’s led to some novel plaintiff strategies.
Wolf Haldenstein now pursues what are called “shareholder derivative
actions”. It recruits shareholders to in effect “stand in the shoes
of a corporation” by claiming what the company cannot or will not
otherwise assert because its officers and directors are allegedly
the wrongdoers against whom the derivative action is to be brought.
Earlier this year, it filed such a suit against Computer Associates,
asking for "tens of millions of dollars in damages” and charging that
it “double-counted” revenue, used a “secret” layoff to cut costs,
and devised an accounting method to disguise an “enormous decline
in revenue”. Wolf Haldenstein was among the firms that two years ago
successfully sued to force the return of a portion of a $1.1 billion
stock award to top CA executives.
To whose benefit?
Socially responsible investing advocates are cautious about embracing
these shareholder recovery actions. “There should be accountability
for gross negligence and fraud,” George Gay, CEO of First Affirmative
Financial Network told me. “But I’m not crazy about suing corporate
shareholders to pay back past shareholders.” Moreover, investors often
stand to recover very little if the target of their suit – for example,
WorldCom – goes under and they find themselves at the back of the
bankruptcy court queue.
Thomas Burt of Wolf Haldenstein says these issues are less of a concern.
Instead of going after the companies directly, firms now often litigate
against third parties – particularly directors and officers who have
lots of liability insurance. However, that still doesn’t remove the
fairness issue raised by Gay since targeting all board members undoubtedly
William Lerach of Milberg Weiss, point man in the tobacco suits, is
pursuing another new strategy by filing in state courts, and on behalf
individual investors, including major pension funds such as the California
state teachers pensions fund, known as Calpers, in its suit against
WorldCom. He’s focusing on supposedly miscreant enablers – financial
firms such as Citigroup, JP Morgan, Deutsche Bank, UBS Warburg and
others, rather than on the tottering companies, which may end up in
bankruptcy. “I told my clients that your chances of real recovery
of meaningful money is on the bonds,” Lerach has said. “It so outweighs
any speculative hope of recovery on the stock.” Defendants need not
be shown to have committed fraud, a tough standard to prove in court,
just that they issued misleading financial statements when they underwrote
$20 billion in WorldCom bonds.
These new litigation strategies are as welcome as castor oil by corporate
executives, who yet hold their collective tongues for fear of a public
backlash. But there are real questions whether such suits lead to
reform. “These lawsuits are a huge distraction [to corporations and
executives] when they hit,” says Michael L. Charlson, with Heller
Ehrman White & McAuliffe, which represents companies. Many able directors
have voiced concerns about serving for fear they will face liability
from events not of their own making. Insurance companies have quadrupled
some premiums on corporate director and officer policies.
So should corporate responsibility advocates embrace this new wave
of plaintiff litigation? Choose your poison. It’s certainly a messy
weapon driven more by money than ethics. Potential defendants represent
a potential goldmine for lawyers, who clearly will benefit far more
than individual shareholders. “There are efforts by the plaintiffs
to expand the number of deep pockets that can be held liable, and
[efforts] by the deep pockets to prevent themselves from becoming
enmeshed in litigation,” says Joseph Grundfest, a securities law expert
at Stanford University Law School. “All of these strategies can be
understood in terms of profit maximisation. That’s the way litigation
As crude as that conclusion may sound, however, it flows from a deeper
reality. Without real incentives – in this case fear of losing money
or the enticement of winning some – changes (or reforms) rarely happen.