Don't Shorten The Deadline On Investors' LawsuitsDean Foust
Last summer, Corporate America heaved a collective sigh of relief. The Supreme Court in June drastically shortened the length of time private investors have to file securities-fraud suits. The court even applied its new standard retroactively to pending cases. But in its effort to forestall a tidal wave of litigation, the high court may have cut too deeply into some vital shareholder rights. Now, it's up to Congress to strike a new balance between wronged investors and companies beset by frivolous suits.
The court's goal was laudable: Impose uniformity on the disparate rulings by the lower courts on how long investors have to file suits. The justices chose a little-used federal standard that gives shareholders only one year from discovering fraud, but no more than three years from the deception, to file suit. That's less time than most courts had granted. In New York, for example, investors had up to seven years. The Supreme Court ruling forced lower-court judges to toss out $700 million in pending private claims against junk-bond behemoth Drexel Burnham Lambert Inc. and others.
LETHAL INTENT? With motions pending to dismiss another $4.6 billion in suits--including claims against junk-bond king Michael R. Milken and thrift executive Charles Keating--Congress scrambled before adjournment to approve a measure that reinstated cases filed before the high-court decision. But that's not enough. When lawmakers return, they should lengthen the statute of limitations beyond the Supreme Court's unreasonably short standard. The court "plunged a sword directly at the heart of victims of securities fraud," says Representative Edward J. Markey (D-Mass.). A better time frame: three years from discovery, but no more than five years after the fraudulent act, as proposed by Markey and Representative John D. Dingell (D-Mich.).
The time is needed because securities-fraud cases are often maddeningly complex. It takes time to discover that fraud occurred, let alone develop a case. Even the Securities & Exchange Commission, with its subpoena powers, needed more than three years from the time the alleged violations took place until it began proceedings against Drexel and E.F. Hutton, the latter on check-kiting charges. And under the high court's standard, notes Harvard Law professor Arthur R. Miller, suits that produced $600 million in settlements in the 1983 Washington Public Power Supply System scandal couldn't have been brought.
But the White House, conservative lawmakers, and business lobbyists worry that stretching the statute of limitations could fuel a litigation explosion. U.S. corporations complain that they already must mount a costly legal defense seemingly every time their stock price dips. Spurious litigation "has reached epidemic proportions in this country and is having massive, widespread, harmful effects," Philip A. Lacovara, general counsel for Morgan Stanley & Co., told Congress recently.
Sharing that belief, the White House will agree to extend the filing period only if legislation curbs frivolous suits. Among the proposals: requiring some losers to pay the victor's legal expenses, and placing sharp restrictions on pretrial maneuvers, perhaps by limiting access to documents.
But Congress should be wary of "reforms" whose hidden intent would be to insulate executives, Wall Street investment bankers, and other professionals from accountability. Investors shouldn't be discouraged from pursuing valid claims for fear of having to cover defendants' mammoth legal tabs. Who would have sued Drexel, for instance, knowing that the brokerage was prepared to spend $1 billion to defend charges that it manipulated the junk-bond market?
NO FISHING. The fact is, the number of private securities suits brought in federal court has declined 30% since 1985, according to the Administrative Office of U.S. Courts. The decline underlines the power that judges already have--and wield--to sanction lawyers who bring dubious suits just to extract a shakedown settlement. In November, for instance, a Boston federal appeals court threw out what the judges considered a "meretricious" shareholder suit claiming Digital Equipment Corp. gave inadequate warnings that its stock price might drop after the 1987 crash. The court ordered the plaintiff to pay double court costs plus DEC's legal fees. And federal judges appointed by Presidents Reagan and Bush already have issued a series of rulings that cut back on investors' ability to bring suits. They are not tolerating fishing expeditions by lawyers who want to rummage through a defendant's files for damaging evidence.
Unfortunately, the Supreme Court may now have created a catch-22: With less time to act, investors may feel compelled to bring suits before they've found the smoking gun. But then they run the risk of being sanctioned by the court for bringing a "frivolous" suit. Congress must save investors from having to walk such a tightrope.
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