Silicon Valley companies thought an act of Congress would solve their problems with Bill Lerach and his shareholder lawsuits. But the reforms may end up backfiring.
On the Road
Silicon Valley companies thought an act of Congress would solve their problems with Bill Lerach and his shareholder lawsuits. But reforms can work in quirky ways.
Seven years ago Silicon Valley's power elite set out on a high-stakes mission to wipe out what they regarded as a scourge in the high-tech industry. Their target: Bill Lerach, who had hammered hundreds of high-tech companies with lawsuits accusing management of swindling shareholders. Owing in part to volatile stock prices, newly public technology companies in the Valley then stood about a 70% chance of being hit with such suits. And Lerach's law firm, Milberg Weiss Bershad Hynes & Lerach, had crafted more than half of all the complaints.
Fearing Lerach's wrath, those who plotted his downfall -- senior managers at companies such as Hewlett-Packard and Silicon Graphics -- started out in stealth mode, but by 1995 they had grown bolder: they began pushing money at Washington lobbyists. For legislative guidance they hired Lerach's archenemy, Bruce Vanyo from the Silicon Valley legal powerhouse Wilson Sonsini Goodrich & Rosati. In December 1995 they obtained nothing less than an act of Congress.
The committee that drafted the Private Securities Litigation Reform Act decided that Lerach and lawyers of his ilk had harmed the entire U.S. economy by routinely filing baseless, extortionate lawsuits, "whenever there is a significant change in an issuer's stock price, without regard to any underlying culpability of the issuer." Shareholders' attorneys had abused the legal system, Congress concluded, "to impose costs so burdensome that it is often economical for the victimized party to settle." As a remedy, it adopted the reform act, which was widely expected to rein in Lerach.
It has only been recently, though, that Silicon Valley has begun to see any results from its anti-Lerach campaign, and the picture is not entirely what the champions for reform had expected.
In one important respect, the reform act has dealt Lerach a major setback. It has made the jobs of shareholders' attorneys a lot more difficult, by requiring them to present hard-to-find facts that support their claims of corporate fraud. And increasingly, judges are tossing out fraud complaints that fall short of the new requirements. That trend threatens to topple a volume-driven business model that Lerach has successfully pursued for nearly two decades, in which his firm would swoop in on public companies at the least suspicion of foul play -- an earnings shortfall, for example, followed by a stock drop.
Indeed, in an interview in his sprawling San Diego office (picture a file room after a tornado), Lerach seems uncharacteristically daunted. Maybe the mayonnaise he heaped into his coleslaw at lunch hasn't sat right with him, but his usually rosy complexion is downright ashen. He reddens and roars only slightly even when asked about his critics, including the editorial board of the Wall Street Journal, which recently accused him and lawyers like him of "suing innocent companies with volatile share prices ... and extracting settlements from busy executives who can't afford to waste time in legal maneuvering." "I don't care what other people think about me, all right?" Lerach fumes. "It's that simple. I care about what I think of myself."
In the vast majority of cases he's pursued, Lerach has squeezed out settlements, which he has memorialized in a vast collection of Lucite cubes stacked around his office. He says he has long since lost count of the cubes, noting that "a lot of them have fallen behind the furniture." But his take from the settlements they represent is memorable: he has personally pocketed more than $100 million of the money handed over by companies and their insurers. His law firm, meanwhile, has soaked up nearly $700 million.
The biggest source of those gains has been from technology companies based in California. So when Lerach was abruptly shut out of court in a closely watched case there, in 1997, he was predictably apoplectic. The case was against Silicon Graphics (an active player in the reform movement), and the charges were practically identical to hundreds of complaints that had survived court challenges before the reform act was passed. Senior executives at Silicon Graphics had allegedly made false financial forecasts, concealed unfavorable internal developments, and wrongly profited from selling millions of dollars' worth of shares at artificially inflated prices just before disclosing disappointing earnings that caused the company's stock value to plummet.
In a major upset, federal judge Fern Smith threw out the suit, explaining that it failed to fulfill what she regarded as a new mandate of the reform act. Smith concluded that disgruntled investors faced a higher burden of showing not mere recklessness by corporate executives (as had been the case before) but specific facts suggesting that the executives deliberately intended to dupe the market. For Lerach the decision was devastating. He fretted at the time that if it was upheld on appeal, "private enforcement of the securities laws in this country will be mortally wounded."
Not only was Judge Smith's decision upheld, but last October it was also affirmed by judges in the Ninth Circuit -- the final hurdle before the U.S. Supreme Court. "It means that companies that simply miss their earnings expectations are not going to be hit with these lawsuits," predicts Bruce Vanyo, who defended Silicon Graphics.
Ironically, the very reforms for which Silicon Valley fought so hard have had the unintended effect of hastening the rush to the courthouse. Settlement costs have escalated as well.
Clearly, the Silicon Graphics ruling has transformed the nation's largest federal circuit -- encompassing nine western states -- from the easiest place to proceed with fraud suits into the hardest. And Lerach says he has reluctantly resigned himself to abiding by the "egregiously wrong" decision. In every other securities-fraud case that has made its way through the appeals process, the courts have followed the lead of the Silicon Graphics ruling in siding with company management. "You could look at the appellate decisions and conclude that we're getting slaughtered," Lerach admits.
