Too "Rich" to Recover -- A Securities Litigation Reform Parable
By Lawrence J. Fox
Chair, ABA Section of Litigation
"Boy, am I glad you voted for that securities reform bill, Jack. I'm tired of hearing my friends at the Palo Alto Club complain about how much these frivolous lawsuits cost. Damn plaintiffs' lawyers. You sure put them in their place," Milton observed, grabbing another canape.
How often over the next two years Milton Martin ruefully recalled those words, shared at a fundraiser to support Jack Holden's re-election to Congress. Milton had retired from a senior position at Unocal in 1994 and, shunning the advice of his stockbroker to put his retirement money in 30-year Treasuries, he had decided to make his investment decisions himself. "It'll give me something to do with my time and I understand hi-tech as well as those high-paid investment advisers."
One of Milton's best early selections turned out to be Integrated Solutions, the innovative Internet software supplier that provided the technology permitting scientific laboratories around the world to work together. Milton bought shortly after the initial public offering in 1995, and added more shares when the company predicted it would sustain triple digit growth for three years. Milton's original purchases were at $25, and his second group bought at $30-32 per share, providing Milton with a comfortable profit as the price quickly passed $50.
Then came black Tuesday, the day Integrated announced that it had overstated earnings for the last two years and that it was seeking Chapter XI protection "while it worked things out." Milton calculated his loss at over $75,000. So Milton cheered when he learned that the famous plaintiffs' lawyers, Culverhouse & Newton, had filed a class action against the company and its auditing firm, alleging violations of the federal securities laws. He read mail from the court with interest and followed the progress of the case as it was reported in the San Francisco Examiner. By the time of the trial, he had become so interested he attended opening arguments. Milton even took his wife Maggie out for a champagne dinner when the jury came in finding all defendants liable for $46,000,000 in damages. "The $75,000 will be back in our account, with interest, in short order," he proclaimed, feeling complete absolution from Maggie's criticism over the last year that Milton should have put their money in T-bills.
But when Milton's check finally arrived nine months later, his delight turned to dismay. "Only $22,500. That's all I get?" Milton was shouting at Alan Culverhouse, "I thought you won the case?"
"We did. We did. But there were five different defendants, and so, the jury divided the award equally among them, charging each with 20% responsibility," Culverhouse explained. "The problem is that since Integrated went bankrupt, four out of the five defendants have no money left. The only defendants with any money are the accountants, and they only owe you one and one half times 20%, or only 30%.
"But, if the accountants hadn't signed off on the overstated earnings for two years, the fraud would never have happened!"
"You are right, that's what the jury found."
"Then how come they get away with only paying 30%?" Milton pleaded.
"Good question. It's that new securities law Congress passed and the President signed. It says 'reckless wrongdoers'-- in this case, accountants -- don't have to pay all of the damages, even if the other wrongdoers are bankrupt or have fled the country."
"But how do you explain that my pal, John Schupper, collected 100% of his damages?" Milton was still shouting.
"John must come under the exception -- if the victim has lost more than 10% of his net worth and has a net worth under $200,000. You fail that test, so you get only 30% of your money back. If you had met the wealth test, you could have recovered all your losses."
"You mean I don't have the same rights as someone else simply because I own a house and a car that are worth more than $200,000? All my life I saved so I could afford my retirement, and now I learn that my efforts have reduced my rights as a citizen."
"Don't yell at me, my friend, call your Congressman. They're the ones that created this nightmare." "But I thought that legislation was directed at frivolous lawsuits. This one was the opposite of frivolous. We won."
"We won a fifth, just a fifth," Culverhouse replied. "At least it's in dollars, not scotch."
Is this what we want? Legislation that in its quest to curb frivolous lawsuits guts those with proven merit? Legislation that in choosing between innocent and injured plaintiffs and liable reckless defendants, places the entire risk of non-collection on the innocent and injured? Legislation that lets the ability to collect a judgment turn on how much other money the injured shareholder has in the bank? Of course not. Nowhere in American jurisprudence does a person's right to collect turn on an inquiry into the value of his house or his retirement account. But that is precisely what will happen if President Clinton does not veto the so-called securities litigation reform legislation, a proposal that will undermine the rights of the small investor, protect reckless and in some cases intentional conduct, and eviscerate our most effective tool for maintaining the integrity of the American markets. For the President, this should be an easy call.