CHANGING THE RULES
DECEMBER 22, 1995
The Securities Litigation Reform Act will make it harder for investors to sue companies for fraud. To discuss what the new law means, Paul Solman of WGBH-Boston talks with Joseph Auerbach, professor emeritus, Harvard Business School, and Ralph Nader, consumer advocate, and director of the Center for the Study of Responsive Law in Washington.
PAUL SOLMAN: Gentlemen, welcome to you both. Mr. Auerbach, very simply, what does this bill do, and why was it written?
JOSEPH AUERBACH: (Boston) Well, the bill had its thrust in preventing or reducing the number of suits brought, so-called plaintiff class actions, based on fraud, fraud that's claimed to have occurred. There's always company fraud in failure to disclose material facts concerning financial operations.
PAUL SOLMAN: Material meaning--
MR. AUERBACH: What an ordinary investor would consider important in making a decision.
PAUL SOLMAN: So financial projections, data about the company?
MR. AUERBACH: Projections or operations, or the contrary, the failure not just to disclose but the failure--but the actual misleading of an investor. So you have investors who would claim that they didn't buy the security because of the material, they did buy it because of the material, false information, or they kept the securities they wouldn't have kept if they'd been honestly told what was involved.
PAUL SOLMAN: Now, but security, you mean something like a stock, I mean, a share--
MR. AUERBACH: Stock. Generally speaking, it would be a common stock that we're speaking of, but it could be other forms of securities.
PAUL SOLMAN: So why--why was it written?
MR. AUERBACH: Well, over the years, over a number of years, there's been a number of suits brought in these plaintiff class action categories which many people, part of the bar, and certainly part of Congress, and certainly professions like accountants and bankers have considered were improperly bought--brought and only led to forced settlements by companies to avoid going through the litigation. And these settlements--generally they take the position--were for the benefit of the lawyers and not for the benefit of the security holders in any event, bearing in mind this is a federal cause of action that we're talking about.
PAUL SOLMAN: And you are very sympathetic with these people, I take it?
MR. AUERBACH: I'm sympathetic with the people. I'm also sympathetic with the investor. I have mixed feelings, but on balance, I'm in favor of the law.
PAUL SOLMAN: And, Mr. Nader, to you, what's the problem with the bill?
RALPH NADER: This bill is really a devastating blow to small savers, investors, people who have rights in pension funds, shareholders, and insurance policyholders, because in the midst of 15 years of financial corporate crime episodes documented in the "Wall Street Journal" and elsewhere, savings & loan debacle, Towers Financial scandal, equity fund scandal, I mean, these are all these huge rip-offs, it's hard enough now to win a suit in court against these corporations and their offices. Under this new law that President Clinton properly and principally vetoed but was overridden by the Senate today with the help of his party leader, Sen. Chris Dodd, it makes it extremely difficult to not only get into the court but to have a chance of prevailing. For example, if you file a complaint against a drug company or against a brokerage house or whatever, you have to plead knowing intent to deceive, which Senator Specter said requires the plaintiff, defrauded plaintiff, to be a mind reader. President Clinton wanted the recklessness standard; if you just pleaded reckless, you could get past a motion for summary judgment. And if you lose the case, you may have to pay the legal fees of the 400 [dollars] or 300 [dollars] an hour corporate defense lawyers, and that could intimidate anyone from bring a case. As one law professor said, John Sexton, he said, who in their right mind after losing part of their savings would go to court and risk losing their life savings by paying the other side's attorney fees?
PAUL SOLMAN: So is the small guy going to be intimidated, Mr. Auerbach?
MR. AUERBACH: The small guy has never been the one who was intimidated. There was a question of whether the lawyer for the small guy is going to be intimidated, and I disagree with Mr. Nader in the prior statement that costs are going to be assessed against that lawyer.
PAUL SOLMAN: He said they might be assessed.
MR. AUERBACH: Yeah. We have to give the reasons though. If it's a frivolous or abusive suit, the costs might be assessed against the plaintiff's lawyer, but if the suit gets by the initial stage before the judge and just a preliminary merit on the suit, that's not going to happen. It's going to go to the merits of the controversy. So we've always had fraud. The example that Mr. Nader gives or that are given by people who oppose the bill, of course, are legion, they occur. They're going to occur. But this is not going to prevent suits against people who are fraudulent.
MR. NADER: But, you see, look, 150 newspapers, mainstream, "New York Times" to the "Miami Herald," called this legislation a protection of corporate fraud. The "Miami Herald" called it a license to steal or a liar's bill of rights. The major securities law professors from Arthur Miller to John Sexton to Joel Seligman in this country, no axe to grind, are furious about the devastating effect on the federal rules of civil procedure and how very difficult it makes it for ordinary people represented as a class to go after the security frauds or banks that rip 'em off, or other companies that give them deceptive information. And what's really shocking here is that this is going to split the Democratic Party even more than it's now split, because President Clinton was defeated today because of Sen. Dodd, who's the chairman of the Democratic Party. We should have laws to strengthen the remedies of defrauded people against corporate crime, fraud, and abuse, given the last 15 years of tens of billions of dollars of fraud. Instead, we have a legislation that weakens the right of pension fund administrators, insurance policy holders, labor unions, and ordinary investors and savers from having not just an opportunity to win in court but a chance to get into court. That's what this bill obstructs, and that bill now, unfortunately, is the law of the land.
PAUL SOLMAN: Mr. Auerbach, give us a concrete example in the face of what Mr. Nader's saying of something that this bill would do that we would all think was a good thing, as opposed to all the bad things it seems to hold up the possibility of.
MR. AUERBACH: Let me point out, I'm not addressing the politics of the situation. The politics, I don't think, enter into this. On both sides of this issue, we find people of goodwill. It's a question of "Are you depriving the small investor of an opportunity to seek redress for a fraud?" Now, there's common-law fraud and there's fraud under the Federal Securities Acts. Now, whether we talk about the common-law fraud is another matter entirely.
PAUL SOLMAN: Let's leave it out there.
MR. AUERBACH: What about the Federal Securities Act?
PAUL SOLMAN: Right.
MR. AUERBACH: Now, if you allege a crime, namely a fraud, because of the violation of those federal securities acts or rules, then your only point is that you show you're not just going on a fishing trip, that you actually got a cause of action. And the judge will decide whether that's a fishing trip or a real cause of action. If it's a real cause of action, you're going to get all the justice you ever had before and maybe more.
PAUL SOLMAN: Mr. Nader, isn't there such a thing as a frivolous lawsuit?
MR. NADER: Sure. And there's frivolous defenses, and the judges are in command of their courtroom. They don't read Karl Marx on their lunch break. Most of them are former business lawyers, and the judges are having their hands tied by this bill, because the judges are being told that if a defrauded investor files a complaint against a bank or a brokerage house or a corporation and doesn't show with particularity evidence on the knowing intent to deceive by the de-frauder, they can be thrown out of court. If they show evidence of recklessness, that isn't enough. So the judge's hands in going after corporate crime and fraud and abuse are being tied by, by this law. And that's why even pro-corporate law professors, Arthur Miller, Harvard Law School, he consults with corporations. He wrote a letter to President Clinton on December 19th that, that begged him to veto this bill because it wrecked the equitable federal civil procedures that gave people an opportunity to get justice in court.
PAUL SOLMAN: Mr. Auerbach, do we want corporations to be presumed innocent until they're proven guilty, which is I gather what Mr. Nader is claiming isn't going to happen now?
MR. AUERBACH: Corporations are citizens, just as you and I and Mr. Nader are citizens. They also have certain constitutional rights, including the right to attorney-client privilege, including the right to be deemed innocent till proven guilty. They don't have a privilege against self- incrimination, which makes it all the more difficult here. The important point is we have a federal agency, the Securities & Exchange Commission, that brings suit involving the misdealings of corporations on failures to disclose or misleading information all the time. I can't tell you offhand how many hundreds of suits have been brought by the FCC in that regard.
PAUL SOLMAN: And that won't be changed now?
MR. AUERBACH: That won't be changed one bit.
PAUL SOLMAN: Let me ask Mr. Nader. Is anybody in our audience going to get hurt by this? MR. NADER: Yes. If you are a saver, an insurance policyholder, a stockholder, or have a portion of a pension trust for your retirement, you're going to be affected by this. The Securities & Exchange Commission Chairman Arthur Levitt, himself, said that they can't handle more than a fraction of the fraud that private law enforcement brought in the courts are absolutely essential. He didn't like this bill, he was threatened with cutting of his budget, and that's why he wasn't that vociferous. What's really affecting this whole scene is if we are going to have public confidence in the financial markets, we've got to have strong law and order for these corporations that misbehave. We have got to have rights and remedies for people to get their money back when they're cheated in the court of law. And above all, I might add this, if people believe
what corporations tell them about their rosy prospects and how much they're going to sell and under this present law, they don't have to disclose some warning signs, like whether the FDA has turned down the drug application. They can just say, well, the FDA is delaying the drug application for approval, and that, of course, is going to scare off a lot of people, and it's going to be bad eventually for Wall Street if public confidence fails.
PAUL SOLMAN: And you've--very quickly now--but you've always been worried about this issue of financial markets and trusts, so you don't worry about what he's talking about?
MR. AUERBACH: Oh, I do worry about it, and what Mr. Nader has just referred to is the safe harbor provision, so called, but again, an intent to defraud takes away the safe harbor.
PAUL SOLMAN: All right. Well, we'll have to leave it there, gentlemen. Thank you both very much.
MR. NADER: Thank you.