Commentary: Why the Little Guy Can't Win

Supercop Spitzer may talk big about helping investors, but he can't deliver where it counts: Their wallets

By Dan Carney

Thomas O. Padgett would dearly love to see his former Enron Corp. bosses, Kenneth L. Lay and Jeffrey K. Skilling, in prison. "Let them sit there for 10 or 15 years and think about the mess they've made of peoples' lives," says the 59-year-old petrochemical lab technician. One of those lives is his own. Padgett's 401(k) lost $650,000, some 99% of its value, after the energy giant declared bankruptcy. But at least Padgett can channel his anger. He has joined a class action brought on behalf of Enron employees. "Realistically, I know I'm not going to get it all back," he says. "But I'd be satisfied if I got at least half."

Half? Don't bet on it. Padgett's case, built on a collection of novel legal theories, has some promise. Contrast that with a traditional shareholder class action, which collects, on average, only about 6 cents for every dollar lost. Meanwhile, ballyhooed efforts by state and federal prosecutors to build an investor restitution fund are more rhetoric than reality. And people who sue their brokers for pushing dog stocks have to buck a compulsory arbitration process that's tilted against them.

Law enforcers like New York State Attorney General Eliot Spitzer and Securities & Exchange Commission Chairman Harvey L. Pitt may talk big about protecting the small investor but the bottom line is that they don't deliver much where it counts: in the wallet. Despite the rush to prosecute alleged corporate criminals, the legal system ends up offering only meager assistance to their victims. Because of a long string of hostile court decisions and special-interest laws, the ordinary rules of civil procedure do not apply to defrauded investors. Instead, they must clear a series of unusual hurdles that would not apply if they were, say, suing a grocer for negligently leaving a banana peel on the floor. What's more, the law enforcers and plaintiffs' attorneys charged with representing the little guy have higher priorities than helping each individual victim recover his money.

One of the key culprits for this state of affairs is the U.S. Supreme Court. Starting in 1987, it has issued a string of wide-ranging rulings that has stymied shareholders hoping to recoup lost gains. That year, the court upheld mandatory arbitration, a practice that gives companies the power to make customers resolve complaints through a private dispute-resolution procedure.

The ruling has been a blessing for brokerages, which make new customers sign forms consenting to compulsory arbitration. It's a process that takes place out of public view and offers investors only limited investigatory powers. Many can't even get lawyers to bring claims. "We hear from a lot of investors," says Portland (Ore.) plaintiffs' attorney Bob Banks, who specializes in securities arbitration, "but most we don't take."

Then, in 1994, the high court granted a sweeping exemption from liability for people or companies that "aid and abet" securities fraud--that is, the auditors, lawyers, and bankers who help corporate crooks cook up their schemes. By removing potential "deep pockets," that ruling will make it much harder for people who put their money into companies like Enron and WorldCom, that later went belly-up, to recover any losses.

Investors haven't fared well in Congress, either. The Private Securities Litigation Reform Act (PSLRA), passed in 1995, put new limits on corporate liability. Among other things, the law requires judges to rule on motions to dismiss a case before plaintiffs' attorneys can get access to internal company documents. Without such evidence, many cases never get off the ground. Indeed, three months before WorldCom Inc. disclosed the accounting irregularities that would lead to its bankruptcy, a federal judge in Mississippi dismissed a fraud class action. In February, a judge dismissed 38 suits against Tyco International Ltd.

The legal abandonment of the small investor has emerged as a key theme in recent months for plaintiffs' lawyers, who would like to see PSLRA repealed. But while trial lawyers are casting themselves as defenders of the little guy, they're far more interested in their own fees than any damages they may collect for shareholders. Frequently, their "clients" only find out about a case long after it has been resolved, when an incomprehensible notice arrives in the mail announcing a class-action settlement. Many shareholders don't even bother to collect.

State and federal securities cops aren't that interested in helping investors recoup losses, either. Their main goal is deterrence: penalizing the bad guys to send out a lesson to others. Consider Attorney General Spitzer. Although he has posed as the champion of the small investor, none of his celebrated actions will put a penny directly in investors' pockets. One source close to his office, noting the staff had only 10 securities attorneys, figured that if they spent their time administering a fund for burned investors after tracking them down, "that would be all they did." Adds this source: "We can't run a piggy bank for millions of shareholders."

So, while victims' restitution funds may be a laudable idea, don't count on them to add up to much in most cases. The SEC has created a fund for Enron investors with the $12 million surrendered by former executive Michael Kopper. But the assets of corporate executives, while they may make for opulent lifestyles, don't go very far when divided up among shareholders. Kopper's contribution amounts to 1.4 cents per share. "These funds help," says Barbara Roper, director of investor protection at the Consumer Federation of America, "but only a little." Lose a dollar, get back a dime. Turns out that may just be the American way.

Carney writes about legal affairs from Washington.

    Before it's here, it's on the Bloomberg Terminal.