October 03, 2008
In the biggest securities fraud settlement ever reached, Enron shareholders will split $7.2 billion. The deal is part of a $40 billion lawsuit filed against investment banking giants such as Bank of America, Citigroup and JPMorgan Chase alleging that they abetted a fraudulent accounting scheme that helped drive down the one-time seventh largest corporation in the nation.
The distribution plan, announced in mid-September, caps off what had been the go-go era of the late 1990s. During that time span, a multitude of corporate scams transpired including one involving Worldcom, which had represented the biggest corporate securities litigation settlement at $6.1 billion. In the Enron case, $6.6 billion will go to investors and the rest to attorneys.
Securities suits are meant to deter instances in which companies deliberately hide or falsify valuable information. Enron typifies the kind of situation in which they are appropriately filed. But many times, those suits are registered by ravenous plaintiff lawyers with the clear intention of shaking down big companies.
Aggressive attorneys monitor individual stock performance relative to the Standard & Poor's 500 Index. When they detect a sharp divergence, they go in for the kill. To avoid costly legal battles, corporations and their directors and officers are all too willing to settle. While the number of federal securities fraud cases has been declining in recent years, the size of settlements has been getting bigger. And the present gyrating stock market creates the perfect condition for future suits.
The number of federal lawsuits peaked in 2001 at 497. But it fell to 166 at year-end 2007. Still, that is up from 116 in 2006, primarily the result of a stock option backdating scandal and the subprime financial mess, according to the Stanford University Law School. Large cases remain unresolved, it adds, noting that of the 2,218 securities class action cases filed in 1996, 19 percent are continuing. Among the 81 percent of cases that have been resolved, 41 percent were dismissed and 5! 9 percent settled.
"For the past two years, securities fraud class action litigation has been driven by market-wide events such as the 2006 backdating scandals and the 2007 subprime crisis," says Joseph Grundfest, director of the Stanford's Securities Class Action Clearinghouse. "If these systemic shocks are excluded from consideration, the 'core' litigation continues to be remarkably low."
For more than a year, the stock market indices have taken a wild ride. Prior to that and since about 2005, market conditions had been relatively stable, giving plaintiff lawyers little to work with. Beyond that, their team captain, Milberg Weiss and Bershad, is under indictment for fraud. But perhaps the most notably reason for the "change" in legal conditions is that companies are now under more regulatory scrutiny.
Self-Enrichment
In 1995, Congress garnered the necessary two-thirds it needed to override a presidential veto and set out to amend securities litigation laws. Both plaintiff and corporate lawyers say that the law has shortcomings, although for different reasons: The former says that too many hardships have been created while the latter says that the suits are now targeted at different stakeholders who also have deep pockets.
The 1995 law essentially tried to delay the gathering of any evidence until a court could decide if a suit had any merit -- an attempt to cut down on legal expenses that were strangling many companies but which may prevent some investors from pressing their cases. It also precluded companies from getting sued if they were open and forthright about their financial condition and where they might be headed in the future.
Trial lawyers argue that further changes to existing law would shield wrongdoers and reduce public confidence, thereby impairing capital formation. The reality, though, is that the big plaintiff firms have adapted to the new laws by joining forces with the major institutional investors. If their suits can withstand the scrutiny of the federal judges who must first surmise them, they stand a good chance of getting settled out of court.
Examples abound now in the financial world, but it is typically the technological sector that has been the target of many shareholder suits because of the inherent stock volatility. Take EnerNOC, a demand-response outfit, which was sued this year for making false and misleading statements as well as for failing to disclose material information. Company officials say that they will vigorously defend the suit that has been filed by Roy Jacobs & Associates by presenting "substantial legal and factual defenses."
Some companies, in fact, are fighting back. With respect to Enron, Barclays, Credit Suisse and Merrill Lynch have refused to settle. They have rejected the plaintiffs' legal argument that the banks are the primary reason why Enron failed. Their defiance could prevail as last year the U.S. Supreme Court ruled in a similar case to limit damages paid by third parties that do business with those accused of securities fraud.
"Seldom have I seen suits that I believe truly address an act of malfeasance on the part of a company," says Susan Fulton, with Wealth Trust in Washington, D.C., in a previous talk with this writer. "Personally, I think that the game of suing companies for not having stock prices fulfill a stock purchasers' expectation is a new lawyer tactic to get money. The reality is that stocks go down."
Enron's demise ended a sad chapter in American business history, but it will not likely signal a new beginning in the country's legal legacy. Securities fraud suits will continue. Some will be justified and many will not, which may serve the interest of a few but which will ultimately hurt national commerce.
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Ken Silverstein EnergyBiz Insider Editor-in-Chief
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