The number of federal securities fraud lawsuits is steadily falling. Businesses are stepping up their assault on what they call frivolous litigation. Government investigations are chilling plaintiff’s attorneys. And last week, the U.S. Supreme Court heard arguments in a hotly debated case that may greatly narrow the scope of such lawsuits.
The legal climate has gotten so dicey that some securities fraud attorneys are seeking new revenue and pursuing litigation in antitrust, consumer products, subprime mortgages, employee pension plans and other areas, says James Cox, a law professor and securities fraud expert at Duke University.
“It’s getting harder for plaintiffs’ attorneys to make a living,” Cox says.
In the past decade or two, shareholders’ attorneys — representing public pension funds and other institutional investors — have sued hundreds of companies such as Enron, Tyco and WorldCom for accounting fraud, collecting billions of dollars in settlements and legal fees.
But the heady era of securities fraud class actions clearly has passed, according to attorneys and law professors. Among the key developments weakening the lawsuits:
Legal wins for businesses. Since the 1930s, Congress and the courts have strengthened shareholders’ rights in securities fraud lawsuits, says Mercer Bullard, a former SEC assistant general counsel now a University of Mississippi law professor.
In recent years, though, conservative judges have ruled against shareholders in key cases while siding with businesses. Bullard expects more of the same from the Supreme Court in “StoneRidge Investment v. Scientific-Atlanta,” the most important securities fraud case in decades.
“I’d put my money on Wall Street winning this one,” Bullard says.
The StoneRidge case could determine whether shareholders can sue a company’s auditors, lawyers and other third parties who know about securities fraud allegedly committed by the company.
The case arose after StoneRidge Investments and other shareholders of Charter Communications alleged that the cable TV firm and two suppliers, Scientific-Atlanta and Motorola, had schemed to defraud investors. The suppliers allegedly took part in “sham transactions” to inflate Charter Communication’s revenue.
An appeals court last year rejected shareholders’ arguments, agreeing with the trial court’s decision to boot the case. The trial court had found that the suppliers may have aided and abetted the alleged accounting fraud, but they did not violate federal securities law by misleading investors.
More than 30 advisory briefs from law professors, the Justice Department solicitor general, former SEC chairmen and commissioners and other legal heavyweights have been filed with the Supreme Court, arguing for one side or the other.
Among the interested observers are Enron shareholders who suffered massive losses in one of the worst corporate scandals in history. In a $40 billion lawsuit, they’ve sued Merrill Lynch, Credit Suisse First Boston and Barclays, citing their roles in Enron’s 2001 collapse.
Businesses argue that third parties should not be held liable under so-called “scheme liability,” and that current laws are strong enough to protect investors by nailing “primary violators” for fraud. Allowing broader liability also would hurt U.S. companies and spook overseas business partners.
“Plaintiffs’ attorneys are not empowered to sally forth beyond the law in an indiscriminate search for deep pockets,” says Quentin Riegel, deputy legal counsel for the National Association of Manufacturers, which filed a brief on the case.
Plaintiffs’ attorneys contend that third parties should be found as liable as key players in frauds. If not, auditors and bankers in financial scandals such as Enron will waltz away untouched. “If they can engage in that type of conduct, it would be a devastating blow to investors,” says attorney Patrick Coughlin at Coughlin Stoia Geller Rudman & Robbins, which represents the University of California Regents in a lawsuit against Enron’s bankers.
Fewer lawsuits. The number of shareholders’ lawsuits keeps falling, with court rulings and the hotly debated Private Securities Litigation Reform Act — passed by Congress in 1995 — toughening the legal standards to file such lawsuits.
From a record 240 lawsuits filed in 1998, the number dropped last year to 116 — the lowest figure in a decade, says Cornerstone Research and Stanford Law School’s Securities Class Action Clearinghouse.
“This is starting to look like a permanent shift, not a transitory phenomenon,” says Joseph Grundfest, a Stanford law professor and former SEC commissioner who heads the clearinghouse.
Another reason for the drop-off? Tougher enforcement by the SEC and Justice Department.
“If you put cameras at an intersection, fewer drivers will run red lights,” Grundfest says. “It’s the same thing in the corporate arena. Executives have gotten the message that it’s more dangerous to cheat.”
