It's a bear market for shareholder suits
Pending legislation, court ruling likely to add new barriers
By Tom Murphy, CBS MarketWatch
Last Update: 03:42 PM June 12, 1998
SAN FRANCISCO (CBS.MW) -- Pity Bill Lerach and his litigious
brethren.
The San Diego-based attorney has won fame
and fortune as one of the most active and
successful lawyers in the field of shareholder
lawsuits, particularly those alleging companies hid
bad news while insiders dumped shares.
His firm, Milberg Weiss Bershad Hynes &
Lerach, has sued more than 50 companies,
mostly technology companies that tend to have
volatile stock prices. But the times, they may be
a'changin -- for the first time since the 1929
market crash.
A federal appeals heard arguments this week to
make it tougher to file such suits. And a bill
wending through Congress would bar securities
suits from state courts, where legal standards
vary, forcing litigants to meet federal tests.
Lerach was on vacation and couldn't be reached
for comment, but the firm's senior trial attorney,
Patrick Coughlin, predicted the changes under
way will hurt individual investors and, eventually,
the market itself.
"It will make it tough across the country for the
average person to bring a suit against a company
that committed fraud," Coughlin said. "You'll
have less people in the market."
Reform act
Change has been in the air since 1995 when
Congress approved the Private Securities
Litigation Reform Act, overriding a presidential
veto. The act's stated intention was to raise the
bar for shareholder suits.
In a hearing before the 9th U.S. Circuit Court of
Appeals in San Francisco on Thursday, another
Milberg Weiss lawyer argued the standard
should rest on a relatively lax ruling by the 2nd
Court of Appeals before the act became law.
That standard allows plaintiffs to sue if they can
show a "strong inference" that defendants had
"motive and opportunity" to commit fraud. They
can also show "recklessness."
The case before the appeals court involved
Silicon Graphics (SGI). Early last year, the
company's shares tumbled after it said a shortage
of parts would hurt sales of its Indigo
workstations.
Upbeat forecasts
Before the news, the company had made several
upbeat predictions for the Indigo. They said the
new Indigo model could add $1 billion to sales.
That was big news, because company had $1.6
billion in revenue the prior year. Meanwhile,
several executives were quietly selling their
shares, the suit said.
But U.S. District Court Judge Fern Smith
dismissed the suit. She said the 1995 act
eliminated the "motive and opportunity" standard. Smith instead said the
plaintiffs had to show "specific facts" leading to circumstantial proof of
fraud in order to pursue a suit.
"These people sold $13.8 million worth of stock," attorney Leonard
Simon told the three-judge appeals panel now pondering the case. But the
judges, including two known for their conservative leanings, didn't show
much sympathy as they grilled Simon and two other attorneys who want
the case reinstated.
Judge Joseph Sneed suggested the company's problems with the Indigo
was simply a case of "bad business." Simon responded: "It's way more
than 'bad business' to say a product is shipping in volume when it doesn't
work."
Richard Walker, director of enforcement for the
SEC, told the court that members of Congress had
repeatedly referenced the 2nd Circuit Court's
standard as they reviewed the act. "The statutory
language is modeled directly after the 2nd Circuit's
standard," he said. But Judge John Rhodes noted
other lawmakers said the act's language was
"partly" based on the 2nd Court's ruling.
Attorney Paul Bennett, representing plaintiffs in a
related suit, complained Silicon Graphics initiated a
7 million share buy-back program while insiders
were quietly dumping their stock.
Sneed said: "Purchasing shares might help shareholders." Bennett shot
back, "Not if you're purchasing them at an artificially inflated price."
For the defense
By contrast, the judges listened intently as attorney Bruce Vanyo,
representing Silicon Graphics, noted the 2nd District's standards were
specifically thrown out by the House-Senate conference committee
considering the act. Instead, Congress said plaintiffs now must "state with
particularity" any facts that suggest illegal activities. The case brought
against Silicon Graphics didn't do that, he said. In fact, it didn't directly tie
any of the upbeat predictions to the allegations of insider trading.
Vanyo also noted that seven of the company's nine directors held onto all
their shares during the time covered by the suit. Even the executives who
sold some stock held onto their valuable stock options, he said.
Vanyo also noted Indigo machines were selling in healthy volumes during
the last quarter of 1996, so the statements made by the company were
true at the time, and that quarter's profits were in line with Wall Street
expectations. It wasn't until the following quarter that problems
developed, he said.
Although the hearing appeared to go in Vanyo's favor, he noted it's
difficult to predict how the judges will rule. "I think they leaned back and
forth," he told CBS.MarketWatch.com. "I don't know what they're
going to do."
Make a federal case of it
Meanwhile, a House subcommittee approved legislation Wednesday that
would plug a different loophole in the 1995 law by requiring investors to
file securities fraud suits in federal court rather than in state courts.
Some lawyers had reacted to the strong national standards for proving
stock fraud in the federal law by using state or local courts, where
different standards apply.
The bill passed by the finance and hazardous materials subcommittee of
the House Commerce Committee is similar to a bill passed by the Senate
on May 13. The full committee will consider the bill on June 24.
Coughlin, the Milberg Weiss attorney, said the bill's path is being greased
by political contributions, particularly from Silicon Valley companies. "It
kind of reminds me of the tobacco industry," he said. "The tobacco
industry used to get whatever they wanted in Congress."
He noted the securities laws have been left unchanged since the stock
market crash of 1929. "I don't know why -- when the market's never
been stronger -- we're changing the securities laws.
"It reminds me of the deregulation of the savings and loans in the 1980s,"
he said. "And the next thing that happened was the crash. I think that's
what we're setting ourselves up for."
Tom Murphy is managing editor of CBS MarketWatch. Washington
Bureau Chief Rex Nutting contributed to this article.
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