But in the bigger picture, Lerach has clearly not been beaten. Even as judges whittle down his enormous inventory of cases, the number of new filings has not abated. In 1998 companies were sued at a rate of close to one a day, notes Joseph Grundfest, a former member of the Securities and Exchange Commission who now tracks securities litigation at Stanford University. Ironically, the very reforms for which Silicon Valley fought so hard have had the unintended effect of hastening the rush to the courthouse.
A requirement that lawyers post notice of pending securities complaints has, for example, functioned as a license to solicit disgruntled shareholders as clients. Posted on the Internet and with major wire services, the notices have drawn out thousands of small shareholders eager to join in a group effort to reclaim sudden losses -- almost before the lawyers have cobbled together a case. One law firm, Lerach competitor Weiss & Yourman, has even persuaded brokerage houses to send their clients letters describing stock-drop suits in the hope that traders will join complaints.
Shareholders' attorneys have also shifted the nature of a lot of their complaints. Whereas the reform act generally shields corporate management from fraud suits based on failed financial projections shared with analysts, it affords no such protection for alleged inaccuracies in routine financial statements. And that's where most of the action is now. According to data from PricewaterhouseCoopers, in 1995 only 25% of federal securities actions contained allegations of accounting fraud, as compared with 51% in 1999.
Of course, Lerach maintains that the shift toward claims of accounting fraud reflects nothing more than an increase in securities fraud, which he attributes partly to more public companies' linking executive compensation with quarterly earnings performance. "The dependence of corporate executives on stock-option trading and meeting short-term financial goals creates a powerful incentive to falsify results," he says, invoking an argument that has also recently found favor with senior staffers at the SEC.
A rash of major earnings restatements followed by gigantic settlements also supports Lerach's contention that securities fraud is at an all-time high. Traditionally, securities class-action suits have been settled for $5 million to $7 million; in the past two years the averages have been upset by several settlements in excess of $100 million. And last December, with investors claiming losses of more than $30 billion, Cendant Corp., together with its accountant Ernst & Young, set a record when it agreed to a joint settlement of $3 billion.
Such escalating settlement costs are, in part, another unanticipated outgrowth of reform. In an effort to eliminate lawyer-driven suits, the reform act called for courts to evaluate and appoint as lead plaintiffs the investors who had lost the most in an alleged fraud. Rather than allowing lawyers like Lerach to continue calling all the shots, the new law encouraged institutional investors to step to the front of the class, choose their own lawyers, and take charge of the case.
At first, institutional investors were leery of exposing themselves to the invasions and distractions of investigation. After all, every investor stands to collect a pro rata share of any recovery. Gradually, however, public financial institutions have come forward and assumed the position of court-appointed lead plaintiff, which ups the stakes for everyone. In the Cendant case, for example, the California Public Employees' Retirement System, the New York State Common Retirement Fund, and the New York City Pension Funds led the charge and obtained that unprecedented $3-billion recovery. Led by fund managers who are public servants, those institutions are now assuming an activist role in seeking to correct perceived wrongs in the market. "Institutional investors have lifted the bar on what they will accept in terms of settlement," says Alan Schulman, a former law partner of Lerach's, who anticipates that, down the road, private institutions such as mutual-fund companies may also jump into the fray. "That is something Silicon Valley didn't bargain for."
Owing in large part to his frequent vituperative attacks on corporate America, Lerach has so far not found much favor among institutional investors. "They're staying away from him in part because his attitude is insulting to them," comments Alan Salpeter, a partner with Mayer Brown & Platt in Chicago, who has defended accounting firms and other financial institutions.
Oddly, then, Lerach and his longtime adversaries in Silicon Valley now have cause to commiserate. "The megacases are going to be run by the big institutions, and the law firms that don't have large institutional clients are going to be out," says Schulman. Moreover, as financial institutions exert their newfound powers in securities-fraud complaints, public companies everywhere can expect stepped-up scrutiny from increasingly savvy investors -- and a steeper price to pay for missteps. With institutional investors in the mix, "it changes everything," worries Boris Feldman, who defends companies against securities complaints. "The institutions will kill us."
D.M. Osborne is a senior writer at Inc.
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