Reliance National
"Securities Laws and Corporate Governance: The Advent of a Meltdown?"
Panel Discussion and Q&A - May 13, 1999
World Trade Center - San Francisco, CA

NC:  Hello. Welcome to Securities Laws and Corporate Governance: The Advent of a Meltdown? This event is the first in a series of Internet broadcasts presented to you by Reliance National. My name is Nick Conca. I'm an attorney with Reliance National, and I'll be your moderator for this broadcast. In sponsoring events of this type, it's our goal at Reliance National to provide critical information to our policyholders and brokers on the issues that affect them the most.

     Today, we focus on the legal liabilities of corporate directors and officers under the federal securities laws. For the next 90 minutes, you'll be hearing from three of the nation's leading experts on corporate governance and securities class action litigation. They'll be addressing the critical issue of whether we are indeed approaching the advent of a meltdown. In other words, did the Private Securities Litigation Reform Act of 1995 fulfill its intended purpose of reducing the number of routinely filed class action suits, and if so, how come over 600 cases have been filed since that legislation's enactment, with a record number being filed in 1998?

     In that regard, is further legislative reform required? Conversely, have we seen an alarming decline in the quality of financial reporting by corporations? These and other issues will be addressed by our panel of experts.

     Let me introduce them to you. To my far left, we have William Lerach, who's a name partner and head of the San Diego office of Milberg Weiss Bershard Hynes & Lerach, the nation's largest law firm specializing in representing plaintiffs in class action litigation. Next, to my immediate left, we have Tower Snow who is chairman of Brobeck Phleger & Harrison, a law firm based here in San Francisco with offices nationwide. Tower is a leading defense counsel, representing corporations and their directors and officers in securities class action litigation.

     And the man in the middle, Professor Joseph Grundfest, who directs the Roberts Program for Law, Business, and Corporate Governance at the Stanford University School of Law. Joe has also been a commissioner of the Securities and Exchange Commission.

     All three of our panelists have testified before Congress on a wide variety of securities law issues. Welcome gentlemen, to all of you, and I would also like to extend a hearty welcome to our live audience here in San Francisco as well as those of you who are viewing this broadcast over the Internet. A special hello also goes out to those viewers watching this broadcast at town hall type meetings that we've set up in Denver, Chicago, Philadelphia, and at Ricker Auditorium in New York City.

     To make this program as educational as possible, we've provided for you on your computer screens a number of links to various web sites which contain information on the issues that we'll be discussing today, and you're certainly invited to visit those sites at your earliest convenience. You'll also find a link to a survey that we've prepared to solicit your feedback on today's presentation.

     A word about our format today. I'm going to pose a question or raise an issue with a member of our panel, and once our panelist responds, the other gentlemen will have a chance to comment. Additionally, you viewing this on the Internet will find a box immediately below this video which will allow you to e-mail your questions to our panelists. Finally, towards the end of this session, we're going to open the floor to questions from our live audience here in San Francisco.

     And with that, Professor Grundfest, I'm going to pose the first question to you. You heard the first statistics that I mentioned. I recently also read a statistic indicating that a corporation today has a 25% greater chance of being sued today under the Reform Act than it did before the Reform Act was enacted. Can you explain that?

JG:  No. (Laughs) Let's take a step back. There are numbers that we know and translating those numbers into statistics can be an exercise fraught with danger if it's not done with care. What we do know, pretty much for the first time in history - because of a provision of the Reform Act which requires public notice when litigation is actually filed, not merely when it's settled - we do know the number of companies that are being sued. And if we do a simple nose count, I think we can safely say that the number of companies being sued is now running at a record pace. We had more companies sued in 1998 than in any period prior to the passing of the '95 Reform Act. Now, that's a number. There are different ways to express that number. You can take it as a percentage of total publicly traded companies, you can express it in various forms of market capitalization, and any good statistician can honestly make that number go up and down from a variety of different perspectives. But I do think that it's fair to say that the one non-debatable point is that the total number of companies being sued is up relative to where it was prior to reform.

WL:  Of course, that comes at a time when we are probably in the 10th or 12th year of a huge IPO boom which has created a large number of new public companies, and oftentimes public companies that have the characteristics of rapid growth, dependence on one product, dependence upon stock option compensation of executives - that perhaps makes them more prone to getting in trouble under federal securities laws. I would like to see someone figure out as a percentage of existing public companies what number of companies are being sued today as compared to some years ago. My suspicion is it's probably flat or even somewhat less.

TS:  Yeah, I think people though should be careful about reading too much into the numbers. Joe is right, the number of filings is up, the number of companies sued is up. I actually think, though, that doesn't necessarily mean that this is a more hostile environment for public companies. If you really dig down deeper, one dynamic that's at work here is that more and more cases are being dismissed. Indeed, over 50 percent of all motions to dismiss that have been filed have been granted in whole or in part, and I would suggest that part of what is happening here is that the plaintiffs' bar is hedging its bets. They believe that fewer cases will survive, and as a result, they are filing more cases. And I think that's right. I think that as the cases go downstream, what we'll see is more and more cases will be thrown out early and fewer will go the whole road.

JG:  Well you know it's interesting. Bill and Tower's views are very interesting, but relative to what we know, they're forward-looking statements, they're forecasts, you know, they're speculation. (Laughter)

NC:  Do they get safe harbor proper protection?

JG:  Well, I don't know, what are you guys trying to sell? There are some things that we do know, all right, and that I think are non-debatable, and then Bill might be right and Tower might be right, spinning off of what we do know. One of the other things that we do know, which I think is an unassailable fact, the cases are taking much longer to resolve. There is an inventory that is building up in the federal judiciary of remarkable proportions. So Tower may well be right that some of these cases are getting dismissed out early on, but these cases may also be appealed up and they may be sitting in that inventory. There's a pig in the python.

     All right, we have more than 600 companies that have been sued, rough calculation suggests that about 100 of those cases have been settled or dismissed with prejudice and are out of the system. That leaves 500 cases still sitting somewhere in the federal judiciary waiting to be resolved. Now we can do a simple accounting exercise, and we can do what most companies have to do, and that is value the inventory. You've got an inventory of litigation sitting on the shelf in courts of appeals and in district courts around the country. What is the value of the 500 cases that are still sitting there?

TS:  Well the numbers are actually even more traumatic that what you suggest because the 600 cases are federal cases, and of course there are many state cases out there. There are actually 750 cases, federal and state, that have been filed in the post-reform era, and less than 50 have been settled. So we actually have nearly 700 cases in the pipeline post-reform, and of course there are still some pre-reform cases sitting out there.

NC:  I want to ask Bill a question. I mean, a lot of those cases in the pipeline are your cases. Why aren't they moving toward settlement? What is happening with these cases?

JG:  Well because you aren't offering enough money, that's why. (Laughter) Simple.

NC:  Aside from that fact?

WL:  Well I think Joe is right in one way that he says. It's very early on in the life of this new statute to really judge its ultimate impact. We were saying before the program began, we'll continue to sit here and predict, but year after year our predictions have proven to be wrong, and the situation will evolve as appellate decisions come down. But I do think it is true that currently, the combination of the discovery stay with the heightened motion to dismiss standard for plaintiffs to overcome has slowed the cases down dramatically. I don't know the number of cases, new PSLRA cases, that have settled - probably only 40 or 50 cases have settled.

     The slowdown is going to continue until the professionals on both sides of the cases get the information they need, the appellate direction they need, to adequately price the cases. If the plaintiffs win the first four or five appellate decisions, the price of the cases is going to be higher than if the plaintiffs lose. And if there is no externality driving a given company to settle a case now, why not just sit and wait and see what happens; I think that's part of what's going on.

TS:  Yeah, I think that the Reform Act really in many respects has been 'the law of unintended consequences.' It's done a lot of things certainly none of us foresaw it doing. And one thing is, it slowed how these cases move downstream because of the requirement for the court to consider who appropriately should be the lead plaintiff, who should be lead counsel, the discovery stay. But other things have changed too. The plaintiffs almost uniformly are asking for more money. The demand has gone up. In many cases, the demand to settle a case has gone up dramatically. What's happening on the defense side? On the defense side, the defendants are emboldened. Why are defendants emboldened? Because the defendants believe the Reform Act, long-term, is going to be much more beneficial to them than to the plaintiffs.

     What else is happening? The insurance industry, I think, is tired of paying out very, very significant claims, and the insurance industry is emboldened, and in fact, most insurance carriers would like to see more cases go to trial. And lastly, last year, three cases went to trial, for the first time in many, many years, three securities class actions went to trial in the United States. What happened? The defendants won all three. And when the jurors were polled in those cases, what did we learn? The jurors in fact get it. I think we're going to talk about this later, but jurors get it. They can sort through the facts in these cases and make intelligent decisions, so the plaintiffs are looking for more money, and the dynamic on the defense side is that people are digging their heels in more and are more willing to fight.

JG:  Tower, there was a decision yesterday in UDC, during a trial that was against Arthur Anderson, and there again, it was a victory on the defense side. So to the extent that we want to look at trends, the first thing you learn as a statistician, it's hard to extrapolate from four observations. But it's been a while since plaintiffs have had a big win at trial in a class action securities case.

NC:  I want to focus on trials later. I want to ask you another question, Bill.

JG:  Real weird, I had Bill agreeing with me for a moment there. (Laughter)

TS:  Well, don't change the topic.

NC:  We can't have any agreement during this panel discussion. Let's assume for purposes of argument that I'm an associate at Milberg Weiss. Very well paid, obviously. (Laughter) I want to bring a case. I need your approval to bring this case. When I conference the case with you, what do you want to hear from me? In other words, what are the earmarks of a good case from your perspective?

WL:  Well first of all, not that it's directively responsive, associates don't start cases, certainly not in our firm, I don't know about other firms. The starting of a securities class action case is a very important decision. It involves a major financial commitment on the part of the firm, and in the new litigation environment, requires us to be very careful to make sure that the case, at least in our judgment, meets the heightened pleading bar. So just as a starting point, the cases are actually started by partners, often by myself, but by other experienced partners. We think that's important.

     What do we look at? There's no mechanical formula, notwithstanding some of the lore that surrounds the field. There's no magic button to be pushed, there is no magic formula that we utilize. We gather a great deal of information.

     We obviously look at the price action of the stock. If a stock has gone down 25 points in one day, upon a revelation of unknown news, that's one situation. If a stock's gone down 25 points over five weeks with a group of disclosures coming out, it's a different thing, so you look at the stock price action. We also looked very closely at the motive or the reason behind it. If you can't figure out a crisp, clear economic motive to deceive, the case is not going to have any appeal. But the motives can be all over the place. A company can be on a growth by acquisition spree, and therefore need a high common stock price. Insider trading is an obvious motive and something we look at, but it can be more subtle than that.

     A lot of companies pay their executives year-end or even quarterly bonuses for meeting pre-existing earnings-per-share targets, internal targets. If we see that and we see what looks to be an accounting fraud case, that can be a motive as well. We look at industry publications, we look at analysts' reports. In many of the cases, we spend weeks or months trying to analyze and synthesize that information. We have forensic accountants who review it, we have private investigators who go out. So I have a complaint that ... I wish I could tell the company, it's in my briefcase over there, they'll get it in a few days. (Laughter) They're going to get it about four days before the statute of limitations runs out, and I'm sure that they've probably even forgotten what they did at this point. But cases can take a long time to get ready.

JG:  It's interesting. You know, Bill suggests that there is no formula, but we've studied the patterns of allegations, we've done what we call textual analyses of complaints. And it appears that you can explain a very large percentage of plaintiffs' behavior with a couple of critical variables. Between 50 and 60 percent of the complaints being filed allege some form of trading by insiders during the period when the fraud is alive, and if this isn't consistent with your experience, I mean just ...

WL:  No, that is consistent.

JG:  And roughly 60 percent or so are also alleging some form of accounting problem, sometimes articulated as a violation of GAAP or GAAS, other times it's articulated in another way. But again, roughly 60 percent. Only about ten percent of the cases that we're seeing filed currently fail to allege either an accounting issue or trading by the insiders. So it's a pretty simple equation that if you've got a sufficient amount of market cap loss in a sufficiently short period of time, and if when you click on Yahoo and call up the call symbol, all right, and look at the insider trading, you find trading during the period that you think the fraud was alive, Bill probably says, "Let's get on file." That's probably enough to go.

WL:  But one could look at those facts and conclude that they are indicia of misbehavior by the insiders.

JG:  I'm not suggesting otherwise.

WL:  You know we filed a case the other day with an extraordinary amount of ... $189 million of insider trading by executives in about a six- or seven-week period before the stock went from high 40s to the low 20s, and it was a pretty spectacular reallocation of wealth between the public investors and the insiders.

TS:  Yeah, I think the plaintiffs really look at what I would call primary factors and secondary factors. The primary factors would be, as you suggest, Joe, insider trading and accounting restatement or something of that nature. Another thing could be the announcement of a SEC or DOJ investigation of the company. But you don't just start with trading, you've got to dig down. If, for example, the trading represents ten percent of an officer's or director's overall holdings, that's probably not going to excite Bill too much. If it represents 75 percent of the individual's holdings and the company's stock goes in the tank, 30 days later I'd say he's going to be real excited.

     He's also, I think, going to look at what I would call the secondary factors, and among them would be, does the company have good risk factor disclosure? He's going to look at the Qs, the Ks, other public documents the company puts out and see if the company is warning about the risks as well as talking about the upside. He's going to look at whether the company states the facts or tries to spin them and engages in a lot of self-congratulatory hype. He's going to look at whether the company is making projections.

     We were talking earlier that you see these really wild projections out there now where companies are predicting a 200- or 300-percent revenue increase for the next quarter or year. If they don't make that or come close to it and they're selling, that's going to excite Bill.

     And I think also he's going to look at what guidance the company is giving to the Street. And it's clear that if there's very extensive guidance, hard number guidance by a company, and other guidance by a company, particularly if it entangles the company with the analyst, it's going to interest him more. So you know there are a lot of things he looks at, and I don't think there's any formula as he's said, but what it does do actually for a company is, it gives you an idea of how you can take steps to proactively lower your litigation exposure.

NC:  Let me ask Bill a follow-up question. We've talked about accounting issues; we've talked about insider trading. My question pertains to the safe harbor. Has the safe harbor sort of taken out of the mix what I'll call the purely forward-looking statement cases?

WL:  It has not. The safe harbor is a very complex topic. It's a very complex part of the statute. I don't think it was really understood by those who wrote it, and I think people who are dealing with it on a counseling basis and on our basis, coming at it, find it to be somewhat of a Rube Goldberg device with the distinction between oral statements and written statements and I sort of sympathize with the executives. I think they find it impossible to comply with it. And my experience to date ... first of all, I thought it was going to be the worst thing in the world, and I think it may well turn out from a public policy standpoint to really debase the quality of public disclosure in the public company context. I mean, giving corporate officers a license to deliberately lie, if that's what it means, we're all going to rue the day that we did that. However, to date, it hasn't really seemed to have that impact, and plaintiffs have been able to plead their forecast cases.

JG:  Exactly. And I do think, I do think that this concern about executives going out and willfully lying, thinking that you can cover it by important cautionary language, I think that was speculative to begin with, and I put the challenge to you Bill. Can you think of one situation where you think that one executive has actually done that?

WL:  Well I have seen situations, Joe, where the following has occurred. Conference call, some poor stooge is put up at the beginning of the conference call to read a disclaimer that says, "We're going to make forward-looking statements, they may or may not be accurate. Read our SEC filings." We then see in the transcript corporate executives making rather bold and specific forecasts followed as soon as the trading window opens a couple of days later by significant insider trading, and those forecasts not being achieved in that quarter. Now, you tell me, did he lie or she lie, or not? Were they emboldened to be more specific with their false forecasts because of the comfort they got by the disclaimer that was read? I don't know the answer. I do see the conduct, and I don't know the answer.

TS:  Yeah, I actually can come to Bill's assistance. I do think there are cases, and I have seen cases in the post-reform environment where the executives are making hard-number projections and the evidence is pretty compelling that the executives knew there were very significant GAAP issues on the revenue recognition, which goes straight to what's going to the public domain at the same time. So I do think those cases are obviously out there. The SEC's, I mean, going downstream in a number of them.

JG:  But it's really very interesting. Again, you can devote an entire legal career to the safe harbor, but a safe harbor does not apply to GAAP. All right, so what you've just done is you've just described a situation that I would argue wouldn't be ...

TS:  Right, but the projection ...

WL:  It doesn't apply to GAAP, but see, in order for the projection to be credible, it has to build on a base of existing earnings, which are often 15 to 20 percent overstated due to preshipments or other ... So you can't ... I want to go back to what you said. You can't separate false forecasts from false financial reporting, they go hand in hand and build on one another.

TS:  Right, and the projections, Joe, are made independent of the financial statements themselves, so they are actionable. The other thing which I would just note in terms of the projections companies are using and the ways companies are trying to avail themselves of this safe harbor is that even today, four years after the Reform Act, many companies are doing it wrong, that they are making projections in writing and they are not including any risk factors in the writing which contains the projections. That does not bring you within the safe harbor. Similarly, companies are making oral projections and they're referring over to, you know, a document, a 10-Q or a 10-K. You go to the document, there's nothing in it. There are no risk factors, there's no safe harbor language.

     Or the other thing we see is companies who will issue a quarterly report. They'll try to avail themselves of the safe harbor by incorporating by reference another document which does contain risk disclosure. Again, that's invalid on its face. The document which contains a forward-looking statement must itself contain risk factors. So I would urge companies that want to avail themselves of this protective mechanism to understand it, because many companies do not.

WL:  There's another problem then that comes up, and this is a real outbreak of lawyer's disease when it comes to drafting the cautionary statements in the SEC filings. You know what? They never get shorter, they never get simpler, all they do is get longer and longer. It's like the growth of the indenture from one page in 1,500 to 1,700 pages 300 years later. And if you look at the annual reports or SEC filings of a number of major and well-represented public companies, they will now have three, four, five pages of, however well intentioned, nevertheless appearing to be boilerplate disclosure of every possible conceivable factor that could adversely affect their results.

     Now a couple of things come from this. They get themselves into the boilerplate language of the legislative history of the Reform Act. Secondly, there's a whole line of cases that say that cautionary language itself can be actionable because if you warn that a problem might occur when it is already occurring, that is deception. And so this sort of mindless repetition of "This may happen" or "That may happen" can all of a sudden turn into a liability-creating fact. Also, I just think that when you point this out to a judge, and you point out the fact that maybe the language of the risk factors hasn't changed at all in, like, six consecutive SEC filings in a rapidly changing world, in a rapidly changing economy, it might suggest that it's nothing but mindless boilerplate. It's a morass, the forward-looking statement situation.

TS:  But the risk factors clearly have to be thoughtful, and they absolutely must be updated quarter to quarter or more frequently if appropriate. But one thing I think we've learned from the cases that have gone to trial, and also from the dismissals, is that triers of fact, and by that I mean jurors or judges, are impressed with five or six or eight pages of risk disclosure. It's pretty hard to say that the company's trying to hide the ball when you can turn to page after page after page of disclosure which in effect says, "If this happens, we could be out of business, or we could be very materially injured." So you know, is carefully tailored, always updated disclosure best? Absolutely. But I'll tell you, boilerplate is a lot better than nothing at all, and that anything helps.

JG:  But as a practical matter, I think all this may be well and good with respect to the safe harbor, but it's not the driving force in the litigation environment today. Safe harbor debates, safe harbor arguments are of third- or fourth-order magnitude compared with other issues that are driving this engine.

NC:  All right, let's go to another issue, then. Oh, go ahead.

WL:  The fact of the matter is, if you don't tell the truth, your stock collapses, and the insiders have traded, investors are going to find a way to plead that case. I mean, the ultimate refuge is in the truth, however difficult that may be for corporate executives to cope with. (Laughter)

NC:  I want to switch gears. I want to talk about the pleading standard briefly, under the Reform Act. We've seen one Circuit Court decision out there on the Second Circuit on the pleading standard. Arguably that case was resolved in the plaintiff's favor, in that the case held that the motive and opportunity standard prevailing for years in the Second Circuit still prevails under the Reform Act. There are a number of Circuit Court decisions pending, oral arguments have been had. Tower, do you have any predictions of what the guiding rule might be across the country?

TS:  Well as you said, Nick, there has only been one decision so far under the Reform Act on these issues, and it came down the plaintiff side of the fence, where a lower standard was held sufficient. There are ways which a defense lawyer could argue that that case is distinguishable, but clearly that's a win for the plaintiff's side. There are a number of other cases pending. One always is wary of predicting what courts are going to do, but I think the reality is that if you look at the panels that have been drawn to date in the cases that have been argued, there were better panels for the plaintiffs than there were for the defendants. And if I'm a betting person, I would say that in the first half dozen or so cases, I think the plaintiffs I think are probably likely to do better than the defendants.

     Is that the end game? No, because the reality is that different panels and different Circuits are going to come down different ways, and some of the cases are going to go for the plaintiffs and some of the cases are going to be very pro-defense, and there will be others in the middle. So I think that we have years of appellate decisions before we'll really know the lay of the land.

JG:  And again, we're three and a half years from the adoption of the Act, we've just had our very first decision. The decision they sent was quite a surprise to everybody. It wasn't a case that people were really watching to be the trend-setter in this area, and the court comes out, adopts the Second Circuit standard, and more.

     There are ways to read the Second Circuit standard to make it stricter and there are ways to read it looser. The body language in this decision really goes for a pro-plaintiff, relatively low level of scrutiny in terms of the strong inference standard. There they let a case go forward on what the court called the thinnest of reeds, in terms of motive and opportunity. Weak motive, little ... weak motive and opportunities, and said, you know, enough to get you past motion to dismiss.

TS:  It's very important, I think, to remember though that these early appeals all involve pleading standards. They have nothing to do with the merits of the cases. And that again, even on this, I think, you know, it'll be at least two or three years before we have a better sense of where the appellate courts are going. But none of this has to do with the merits of the cases. And as the cases go downstream, I continue to believe we will see many, many cases thrown out as the cases develop.

WL:  I think that for those of us who practice in the field almost exclusively, even before the new Act was passed, there had been a clear shift in the judicial attitude and in the judicial landscape, in which there were an increasing number of dismissals of cases. And I think myself, and I would expect Tower would agree with me, that this reflected a certain judicial evolution that there were too many cases, it was too easy for the plaintiffs to get through the gate and get discovery and the judiciary was doing a very good job of dealing with what we agree are two magnificent statutes, the '33 and the '34 Acts. Now it's interesting, and these are magnificent statutes that are very important to our national economy and our national securities markets, and the courts know that. I wonder if the Press decision, which was the case that was being talked about a minute ago from the Second Circuit, the Stevelman case which came down from the second circuit a few days ago upholding another 10-b-5 case.

JG:  But pre-'95 Act.

WL:  Pre-'95, that, but applying theoretically the same standard. I wonder if we're not seeing the same judicial bent to tilt a little against the contemporary wind. Perhaps a concern that ... look, these Court of Appeal judges know what's happening in the district courts. Some of these decisions that have been the most adverse to the plaintiffs have been written up in every national periodical you could imagine. I wonder if there isn't just a little tilting back against ... to make sure that the playing field gets evened out again, which after all is the judicial role.

NC:  I've been asked to remind our viewing audience that you can still e-mail questions into our viewing panel. They've agreed to answer any and all questions that are put to us. I want to ask Bill about the lead plaintiff of selection process. It is no longer first filed, first dominating. It is no longer a situation where plaintiffs' attorneys themselves can choose who leads the plaintiff, the plaintiffs' class. There's a whole process you need to go through, there's a notice that needs to be provided. You've got to go to the judge to figure out who is going to be selected as the lead plaintiff and the lead counsel. Talk about how that's changed your practice over the last three years.

WL:  Well it clearly has changed the practice of everybody in the field. Everyone now has a shareholders relations department, a website and is very much attuned toward gathering shares as it's called after these cases are filed. There is no question that for better or worse, the lead plaintiff provision has a dramatic impact, because it impacts every single case at the very outset. It is mandatory. You have gone from a world where plaintiffs' lawyers, no matter what others may have thought, really were very careful about solicitation of clients and other overt activities for fear they would be criticized, to now where they operate under a congressional mandate to advertise their services and their cases. And it happened just like that, and the world changed.

     What are some of the impacts that are happening? Well, if it was meant to bring forth institutional investors to have them dominate the cases, it's had some impact, but not near what people would have expected. I think its most dramatic impact, Tower always steals my line about the 'law of unintended consequences'...

TS:  No, no, it was my line.

WL:  No, I thought of that line. (Laughter)

TS:  Wait a minute ... (Laughter)

WL:  But in any event, one really dramatically unintended consequence has been the equalization of knowledge between the companies and the victims, or the shareholders. Remember, when these kind of cases are normally started, the company has the benefit of knowing everything, the shareholder is on the outside looking in. Now when a case is filed, it's publicized nationwide, the technology exists for disgruntled present and former employees to anonymously provide the information instantly over the Internet, for competitors to contact you. And I do think that's having a dramatic impact, and don't think we don't go into those chat rooms, and we have a whole group of people who ... because there can be thousands and thousands of messages that have to be read through and analyzed, and there's a treasure trove of information. In fact, companies, I think, make a big mistake, sometimes get involved in a dialogue in those chat rooms.

TS:  It really is funny, you know, pre-reform, we would oftentimes see the same plaintiffs, the same shareholders, time and time again. I mean, Mr. William Weinberger, the most defrauded man on Earth; he'd been individually defrauded by 120 public companies. I mean, what an unfortunate investor that guy was. (Laughter) You know, but now, I mean, that whole argument and mode of attack has totally disappeared because they send out the press releases that go over the Dow Jones news wire, and they get literally, I think, in some of these cases, thousands of calls. And then they just simply go sort through the thousands, pick out the best people. Our line of attack is gone.

JG:  But what's happening is even more interesting than that, because what the statutes create is a presumption that the lead plaintiff shall be the plaintiff with the greatest financial interest. What that leads to is a process where ... which is akin to what happened in the Middle Ages. You know, in the Middle Ages, the aristocracy never actually fought, all right, you know, during these jousts. They would have their champions, and my champion would fight against your champion. So what's happening now is the law firms are all trying to get coalitions of investors so that the law firms are able to say, "My coalition is bigger than your coalition, therefore I'm going to ... you know, my guys are going to be lead plaintiff."

     And why is lead plaintiff important now? Lead plaintiff is important now because lead plaintiff then picks counsel, and you're going to get picked if your champion is the one selected to be lead plaintiff. That has the statutory process reversed. The way it was supposed to have worked was that the person with the greatest financial interest would have a presumption to be the lead plaintiff... wouldn't be a conclusive presumption. The lead plaintiff would then try to select the counsel most appropriate to represent the interests of the class in that environment. What's happened is the process has been reversed. The plaintiffs' law firms are putting forward the coalitions in an effort to take control of the case, and you get your coalition in, you get selected. I think that's something that may change in the future.

WL:  I want to ask you, lawyers are the ones who have to go to court and argue, Joe, I mean, you need a lawyer to approach the court and make any argument.

NC:  Bill, are institutional investors figuring into this mix at all?

WL:  A little bit, not much. I don't think it's been dramatic. I can think of only one or two cases where they have literally seized the case. I think another factor that I wondered if it was going to happen, I thought that institutional investors, whether they be labor union pension funds or public employee pension funds, coming forward and being plaintiffs might impress the courts who might realize that what they were dealing with were the lost life savings of workers who had been cheated, their pension funds had been cheated. Frankly, I find judges just as hostile to the cases in that environment as they were when the case was brought by William Weinberger or Rodney Shields or whoever it was. So I don't think the courts are impressed, if you will, by the fact that institutional investors are present at all, and in many instances, they haven't shown the institutional investors any deference in the leadership fights.

TS:  I think the institutions haven't really shown up in mass for a number of reasons. One is an institution can lose $50 million, but it's not particularly meaningful in a $10 billion portfolio. They have limited resources. Most institutions would rather have their people devoted to making investment decisions rather than running a lawsuit. If they show up as a class representative, all of a sudden the institution has assumed a fiduciary responsibility to all the other shareholders. Most institutions don't want that. And lastly, the reality, if an institution shows up as the plaintiff, they subject themselves to discovery, and I think a lot of institutions don't want companies probing into their proprietary trading strategies.

     So there's no big incentive for institutions to show up, and when they have, what is interesting is what Bill said. The courts haven't been particularly receptive to them. The SEC recently has come in with a number of amicus briefs urging the courts to appoint the institutions as the lead plaintiffs, and even with the SEC weighing in, and the courts haven't been particularly receptive to them, which is exactly the opposite of what one would think if you look at the manager's report for the Reform Act.

JG:  There's something else that's going on as well, and that is when an institution shows up and gives every indication that they don't intend to hire a particular law firm or what have you, that law firm gins it up and attacks that institution, about how they're incapable, inappropriate, they're not going to be adequate representatives of the class, their claims aren't characteristic. So they wind up in effect trying to litigate the entire case just to be able to get in as to be lead plaintiff. Now you take that same institution, you have them agree to pick that law firm, all of a sudden, they're exactly the institution that Congress had in mind that would be the appropriate lead plaintiff in the case. So let's keep our eye on the ball. What's going on here is not so much the lead plaintiff selection, but it's the counsel selection that's driving the game.

WL:  Well there is an issue that we're all concerned about with institutions. You can belittle the individual investor, and I understand the arguments that were made. But you know, a person who bought 1,000 shares of stock in a company and lost half his net worth or even ten percent of his net worth is angry, focused, and wants a remedy. A big institution has a huge portfolio of holdings, many of which conflict. What if that institution bought stock in XYZ Company, but XYZ Company's underwriter is ... I'm going to use a name, Goldman Sachs or Merrill Lynch or whatever, and they have a huge investment position in Merrill Lynch?

     Now is that employee pension fund willing to destroy Merrill Lynch and harm its huge investment in Merrill Lynch to get a $700 million recovery that it's got to share with a whole group of investors over here? Now I think that's a legitimate question to ask. What if the institution is audited by the same auditors that audited the company that committed the fraud? Are you so myopic that you believe that that's not going to affect their judgment and how vigorously they will prosecute the case? I guess it might be great that institutions are there, and they're wonderful in many ways, but they are not conflict-free, nor are they really different than the old professional plaintiffs.

     What is the difference with Bill Weinberger bringing 100 cases ... the man lived to be 100 years old, but we only sued once a year. (Laughter) He might have brought 100 cases, but the Louisiana Pension Funds have brought five or six cases in three or four years, the city of Philadelphia has brought cases well in excess of five, the Florida State Pension Fund seems to bring a case every couple of weeks. So, you know, are they any different than the old professional plaintiffs?

JG:  Bill, hold it there, this isn't on point, but if Weinberger filed 100 cases and lived to be 100, how many have you filed Bill?

WL:  I'm a lot younger than Weinberger is, I got a long way to go, too. (Laughter)

JG:  Let me tell you something, Methuselah had better watch out, because the filing is good for you that way.

NC:  A question. Do institutional investors have an affirmative obligation on behalf of their fundholders to file these suits?

WL:  They've been told universally that they do not. I don't think there's anyone who believes they do.

JG:  A brief was filed two days ago, I believe, by the Department of Labor suggesting that as part of fiduciary obligation of a ERISA fund, the fund should at least consider, all right, take a fiduciary look at whether they should move forward. The brief, and I read it relatively quickly, did not take a position that you are under any duty or obligation.

NC:  Let's switch gears, here, I want to go to you, Professor Grundfest. The SEC has been very vocal about accounting practices. Chairman Levitt, Lynn Turner, the Chief Accountant at the SEC, have been very vocal with respect to certain accounting practices. Revenue recognition practices, so-called big-bath reserving, accounting for in-process R&D. The SEC has also created this Blue Ribbon Committee on Improving the Effectiveness of Audit Committees. As far as I know, no real rule-making has come out of this. Could you give us a prediction in that regard?

JG:  I could, I won't. I think it's much better to observe that for perfectly understandable reasons, the SEC is worried about the quality of GAAP filed reports by United States issuers today. They are concerned primarily by revenue recognition issues, they're concerned by some of the practices described in Grace, some of these false reserves, some of these tin can accounts. And they are trying to force the audit firms and publicly traded companies to get religion, in the sense that just because GAAP may technically allow something to occur doesn't mean that it's good corporate practice to push GAAP to the very edge. And let's face it, pressure has been put on many of the big accounting firms, and they are backing away from prior positions. I'm hearing many companies in the Valley and in elsewhere saying, "Our accountants are now telling us this year we can't do what we were allowed to do last year." So the pressure is having an effect.

TS:  I think you're unlikely to see a lot of rules coming out. The SEC has probably doubled the number of on-staff accountants, but I think what we are likely to see is many more enforcement actions directed at companies and also directed at accounting firms, and I think the other dynamic you're going to see, and we're already seeing it, is the SEC going down the chain of command. Not just going at the top people, but going all the way down to in fact very junior people, and seeking to get a consent decree against them. And the signal they're trying to send is, you can't plead as a defense that you're a good soldier. You can't, from a junior position, say, "I was only following orders."

     And what they're trying to do is really, as Joe said, is scare people and put the fear of God in people from top to bottom so the people further down the chain of command that might have to execute certain things aren't going to do it, they're going to blow the whistle.

JG:  The SEC is and has to be a leveraged institution, and part of the dynamic of figuring out when you're at the SEC is whom to sue, how to sue them, and how to settle the case, because you can't afford to litigate most of your cases as well. So what you want to do is, you want to put the fear of God into as many people as possible. That can lead to some very interesting litigation patterns, but clearly that's the objective and it's not necessarily a dumb strategy, by a long shot, if you look at the objective and the resources.

TS:  The other thing is, also dealing with the SEC, what we're seeing pretty regularly is the SEC is less willing to compromise. It is tougher to do deals. It's more or less take it or leave it, and they're asking for more than they did in the past, and I think it's exactly because of what Joe said is, they're really trying to send a signal to the markets that, "If you cross the lines and we discover it, don't look for sympathy because there isn't going to be any."

WL:  Well I'll moderately dissent from this fanny-patting of the SEC. The fact of the matter is the SEC has been engaged in a lot more rhetoric than they have action. Now, part of that is understandable due to the resource difficulties that they have. But the fact is, so far there's been a lot more rhetoric and talk than there have been corporate executives or CFOs hauled to the dock for the fraudulent accounting. It also suggests that, little bit here, the SEC is engaging in that time-honored Washington custom of rushing to the aid of the victim. As Joe Grundfest's website pointed out very early on after the passage of the new Act and long before the SEC said "boo" about this, the private bar was beginning to allege in virtually all cases ... I don't know what your statistic is, but 60 percent or something accounting fraud, and this was viewed and hailed as a very major change in impact of the new Act.

     And not to be too high-tech, but we've got an article on the Milberg Weiss website if you want to look at it called "An Alarming Decline in the Quality of Financial Reporting," which details a great deal about this upsurge in fraudulent financial reporting by American companies and the reasons for it.

     So the point I want to make is, it's not a coincidence that after the private bar in '96 and '97 began to expose these accounting frauds through private litigations investigated and filed by them, that the SEC suddenly started to jump on the bandwagon, as whether it was the auditors or somebody was doing something inside these companies, because the number of accounting restatements and admitted irregularities have literally soared to beyond-record proportions. I mean, I've been in this field for 25 years, I can remember when if there were three accounting restatements a year it was a big deal. There are many times today when there are two or three accounting restatements a week and sometimes a day. There is something dramatically and horribly wrong with the financial accounting of public companies in America.

     Read the article, and you'll see that it's driven by momentum investors who punish companies for missing by a penny, putting excruciating pressure on the managers to meet the numbers. It's driven by an evolution of stock option compensation of executives where they get their options every quarter with an expectation to sell, which only feeds into the pressure to keep the stock price up. One thing that made America's markets the envy of the world is, we have the world's most honest markets. If we lose that worldwide reputation of honesty and financial accounting, which efficiently allocates capital, we'll all pay a hell of a price for it in the long term.

JG:  Bill, two observations apropos of that. You know, first accounting seems very crisp and clear, but the reality is when you've got to put together the accounting statements, there are a bunch of judgment calls that get made, and it is possible for companies to work within GAAP and at the edges of GAAP. But within GAAP, and then to wind up in situations where there are restatements. Apropos of that, we are in a different economic environment. GAAP was structured to deal with a particular type of economy. It doesn't suit all companies as well today as it did in the past, and there are situations where these types of restatements and other accounting problems arise without it being fraud. Now that said, I have to agree with you entirely. The volume of restatements, the volume of these issues certainly is up. I think it's legitimate cause for debate and also for concern. The extent to which it's also a cause, should be a cause for litigation, is I think something that's open to discussion.

TS:  Yeah, just a data point on the SEC. The SEC at any given time has between 1,500 and 1,800 ongoing active investigations, and again, if you work on the defense side, many of these are non-public, so they don't show up anywhere in the public domain. But you know how active the SEC is, because you're all handling them in a private context. Each year, the SEC brings about 500 enforcement actions. I actually think those are remarkable statistics, given the staff of the SEC and given the domain that they have to police. I think that, you know, are they doing everything that maybe you would like to see them do? No. But I actually think they do a remarkable job, and boy, we certainly tell our clients, "You'd better expect they're going to show up at your doorstep if you cross certain lines," because I think they are.

JG:  I have to concur with that, and again, what you have to do is, you have to look at the shadow that they cast, not merely at the number of cases that they file.

WL:  It currently hasn't been a very threatening shadow recently, given the conduct of the corporate community. So, you know, I appreciate that they're a well-intentioned organization ...

JG:  They have to leave something for you to do. (Laughter)

WL:  There's plenty for us to do. The SEC is guilty, I think too often, of cherry-picking, easy cases, small companies, being driven by statistics, rather than challenging some of the so-called respectable companies that we know recently have been exposed to ... have been engaged in what I think even you would agree with were pretty dubious accounting practices.

NC:  In talking to ... I want to switch gears and talk about the discovery stay. In talking to some securities litigators about this, they have said to me that it is the provision of the Reform Act that had the greatest single impact on the way these cases are litigated. Do you agree with that?

WL:  Well sure, it keeps the evidence of the wrongdoing from the plaintiff. It has a very dramatic impact on the litigation as long as the discovery stays in effect.

TS:  Now what a company would say is that discovery is the lever which forces companies into settlement, because discovery totally disrupts the operations of the business, distracts management from being able to run the business, particularly for smaller companies, high-tech and emerging growth companies. The companies do not have the time to spend on discovery. Pre-reform management spent, on the average, 1,000 hours per securities class action. That's just an impossible position for companies to be in, so I happen to agree that the discovery stay has had a dramatic impact, and it's had a very good impact because what it does is, it takes away from the plaintiffs' bar the lever that forced companies that had not engaged in any wrongdoing whatever to settle the case.

NC:  Has the discovery stay, though, created this enormous inventory that we were talking about earlier? Is that really the single cause for the inventory?

WL:  It is a cause along with the fact that there's a lack of appellate guidance on how to process the cases in the district courts. There's no question a lot of district courts are just not deciding motions to dismiss, they're just sitting there waiting for appellate guidance, so it's a combination of the both.

JG:  And you know counsel, in many situations, I think that's perfectly reasonably behavior for the court. I mean, you know, why reach a decision only to find out that the Court of Appeals has some different view and you're going to have to deal with the case under a new standard?

NC:  Now as a practical matter, Bill, what exactly is going on in your offices during a discovery stay on a given case? Are you investigating the case, are you contacting employees at the company, are you interviewing securities analysts? What exactly is going on there?

TS:  They're filing new cases. (Laughter)

WL:  That too. (Laughter) Well, that actually is a legitimate point, Tower. The fact of the matter is, if you can't prosecute your existing cases, you might as well file new cases and, you know, get ready for the day when it comes that we know what the appellate rules are. I mean, there's nothing irrational or surprising about that. But we do continue to investigate and monitor the cases. You know, I wonder, sometimes the delay works in the plaintiff's benefit. I've seen situations where, while the case is held up, other information comes out that helps the plaintiff plead the case later on with a revised or amended pleading. Sometimes the passage of time, even if there's little overt action, can be beneficial to the plaintiff.

TS:  It's interesting that the passage of time can also help the defense. It can help it in a couple of respects. If the company rebounds, I think it dampens the plaintiff's appetite. And I also say, to the credit of the plaintiffs' bar, there have been a number of cases where additional information did come to light, and the plaintiffs' bar did the responsible thing, it walked away from the case. It voluntarily dropped the case and I give you credit for doing that. And, you know, the delays worked for the defense as well as for your side.

WL:  You know there is one sort of pernicious factor at work, and I wonder if you've seen it or you, Joe. The 90-day bounce-back provision, the provision that was meant to eliminate as damages in a securities case some portion of a steep decline in the stock, if during the succeeding 90 days the stock came back up. And it's a complex formula, but the long and short of it is that it eliminates some of the steep decline as damage. A) I don't think it's had too much impact on the cases, because the damages are normally so darn big it doesn't matter anyway. Companies don't seem to be able to get their stocks back up in 90 days very often.

     But I do ... I've seen a couple of situations where I thought companies sort of maybe got pretty aggressive during that 90 days on trying to talk the stock back up, and I wonder if they're not exposing themselves to danger in doing that, and in fact, I even believe that certain insurance companies may make money available to companies to crisis-manage those situations to push the stock back up, and I wonder what that implies.

TS:  Yeah, well I agree. I think that companies need to be very careful about what they say after their stock takes a hit, and the companies that engage in spin do so at their own peril and risk, and they could be making things worse, not better. I think you're right, Bill, that this provision really hasn't had much of an effect, and I think one reason is the market has been so punishing to companies that disappoint. It doesn't forgive in 90 days, the stock tends to stay depressed.

WL:  Also the stocks ... this is a point ... I give credit to Mel Goldman, who pointed this out to me recently. It's sort of obvious, but nevertheless a good point. Do you realize that virtually every day, if you watch the markets, a stock goes down 15, 18 points, not three or four points? I mean, there is a lot of air in this market, and if you stumble or miss or whatever term you want to use, the drop is A) dramatic. So it attracts attention and other things. Number two, it creates huge damages, and it makes it almost impossible to make it back in the 90 days. And that's a price the corporations are paying for dealing with these very, very high-priced securities.

JG:  And the bounce back role, just from an academic's perspective, never made much sense to me at all. I never found very much good that I could say about it. How and why it wound up in there, you know, it's one of the mysteries of legislation magic.

NC:  Well let's talk about the companies we're talking about ... and ask what advice you might have for ABC Corp. The headline reads "ABC Corp Agrees with Analysts' Views of 11 Cents per Quarter and a Dollar and Change for the Year." ABC Corp's Chief Financial Officer is quoted as saying that he is comfortable with the estimates because it reflects the guidance he has given to analysts. Now what advice might you give ABC Corporation?

JG:  Well, pay up your policy. (Laughs)

TS:  Yeah, right. I'm a pro-disclosure defense lawyer, and I think most members of the defense bar that are counsel companies are pro disclosure. The enemy of public companies is surprise, so I want companies talking to the financial community all the time. We want them to be releasing in a press release, over the wire, any material developments. But we also want them in a constant dialogue with the Street on immaterial information and a frank discussion about information in the public domain, competitive announcements and other things.

     As we said earlier, however, there are lines. One of the lines is that public companies and their CFOs shouldn't do the work of the analyst. Wall Street analysts get paid a lot of money. These are all MBAs. A lot of them make over a million bucks a year. They are totally capable of coming up with their own financial models. So the advice I would give to Company ABC is talk to the Street about your business, disclose material developments, point out what the operating dynamics are that can affect you. But don't be in the business of creating the analyst's financial model. Don't embrace hard number estimates by analysts because you've just then adopted them as your own, and you probably have a legal duty to update them if they change internally, and let the Street make its own evaluation of how you are likely to fair. A good way to think about this is a jigsaw puzzle. A company should provide the Street with all the pieces for the jigsaw puzzle, but let the Street put the pieces together.

WL:  Yeah but, Tower, now in all honesty, let's be fair to the CFO of the company, okay? He's now had the conference call and let's say he has skillfully fended off all requests for specific information in the public part of the conference call. Now you know the first thing when he hangs up is the phone rings, and it's the Merrill Lynch semiconductor analyst who says, "Okay, let's go. How are we doing on the quarter? Here, I'm going to say, $1.21 for the year. How do you feel? Feeling good? Feeling comfortable?" Now that guy - and I'm sympathetic - he is in a tough spot. If he says, "I'm not going to tell you," the analyst is going to say, "Uh, something's wrong. They're clamming up. They're not giving us guidance." And the fact of the matter is, this market is so driven by momentum investors and earnings expectations, how can these companies not provide the information to the analysts?

TS:  Oh see, because I think the scenario you described is totally accurate. It happens to every public company in America and every CFO in America. But the name of the game is discipline. And the answer I think to that analyst that calls, and probably every other analyst that calls, is to say, "Look, I'll be happy to talk to you as long as you want about our company, but we're not in the business of making projections or doing your financial model." And you say it with a smile. Now what's interesting ...

WL:  Okay, I'll say, "Okay ...

TS:  Now let me finish.

WL:  ... but you know what I'm going to do? Then I'm going to recommend my clients buy DEF Company, because I've got a higher degree of confidence and visibility in their earnings than yours."

TS:  It doesn't happen, Bill, because, in fact, the analysts are smart and they can come up with their own models. And the way to test that is... My firm, for example, represents literally every investment bank in the country, and if you go and talk to the analyst individually or collectively, what they'll tell you is, "Look, I am always going to ask that question. I'm going to take any information I can get from the company. I'm going to love it if I get a hard endorsement or I'm told they're comfortable with my numbers. But am I going to get angry at the company if the company doesn't do that? No."

     As long as the company is giving me a lot of information, as long as the company has a frank dialogue - I'm a smart person, I can come up with my own projections. And that is what happens. So is a company going to be tested? Of course. Is an analyst going to probe? Of course. Does an analyst want that comfort? Of course. But does it mean a company has to give it? No. And many, many public companies say no with a smile.

NC:  The line we're talking about here, Tower, is the difference between guidance and entanglement. I was wondering, Joe, could you kind of flush that out for us and see if we can draw some kind of a line here for our audience?

JG:  Well, what I always tell my students is, you can't take a clear picture of a fuzzy object. And where you cross that line, it's not really a line. There's this gray zone and, you know, different judges will call the shots differently. You know, for example, Tower said that when you comment on the forecast, if you're internal forecast has changed, you could have a duty to update. Well, that would depend upon how you commented on the forecasts. Which magic words did you use? The way one court puts it is, if your words have a forward-looking connotation.

     So, you know, I can comment on a forecast with or without a forward-looking connotation. If we said, "Look, as of today, we're comfortable with those numbers, but this is a rapidly changing business, everything could be different tomorrow.

TS:  Yeah, I agree totally. That's why I used the word "may." As opposed to would have a duty to update, because it does vary. I agree.

JG:  Right. Exactly.

TS:  And nobody is suggesting this is easy. This is, and many people have said this, just like walking a tightrope. It is. But if CFOs really will take the time to understand the lines of selective disclosure and what gets companies in trouble and what does not, I would suggest to the audience that a company can just dramatically - and I mean dramatically - by 90 percent or more, reduce their litigation exposure by good disclosure approaches. But you have to take the time to really understand the environment and where the lines are.

JG:  To reduce the litigation by 90 percent or more, you have to do what Tower says, plus you've got to be really good about controlling insider selling. You've got to control the patterns of the sales. You know, the rule, no sudden moves. And you've got to be really crisp on your accounting practices.

TS:  And have good risk factors.

NC:  Let's talk for a bit about the convergence of this issue and the Internet. Several companies have ... most companies now have web sites where ... in which the companies will actually link the viewer to SEC documents, and analyst reports. Sometimes just links to favorable analyst reports. Is that a problem?

TS:  I think that's a huge problem. The risk is that if a company puts analyst reports on its web site, that a court is going to deem it to have incorporated their reports. The risk is, of course, even greater if they put on the good reports, but don't put on the bad reports. Because, obviously, they're only putting on what they like and what they want the market to believe. So there is a huge risk there.

WL:  How do you feel, though, if they include a disclaimer that we don't endorse, or blah, blah, blah?

TS:  A disclaimer, is better than no disclaimer. (Laughter) But the best policy is don't put other people's reports on your company on your web site. It's that your ... somebody that wants to learn about your company can go to the other sites and...

WL:  Yeah. What about just listing ... I'm sorry Joe. But what about just listing the firms that cover you and the analysts then giving the phone number, then giving the e-mail? Where do you step over the line?

TS:  Well, I think that's fine. I don't think there's risk in that. I think that a number of companies do that, and it just says, "If you want to learn more about us, here are people that follow us."

WL:  And, but again ...

TS:  Without comment.

WL:  And they list the five guys that are fed bulls and they don't list the three people who are...

JG:  Then they're in trouble. See, I mean, you can rank order these procedures in terms of, you know, safe to dangerous, safest to do nothing. All right? Next step, every analyst that you're aware of, all right, that covers, here's their name, address, e-mail, alphabetical order, you know, no selection in terms of who's favorable, who's positive. Plus cautionary language. These guys follow the companies. They've got their views. These aren't our views. You want to find out what they think? Call them.

WL:  I just want to prove that participating in panels is educational to the participants. We haven't done that check. (Laughter) We will. (Laughter)

JG:  That's a very interesting point.

WL:  That's very good.

NC:  Well, I have a question.

JG:  Bill, I'll send you a bill. Okay? (Laughter)

WL:  As he writes with his red pen. (Laughter)

NC:  I have a question here from the Internet. It comes from Phil Drake, an accounting professor at, it looks like, Thunderbird Graduate School. Predictably, it's for you Bill. If financial statement disclosure is poor, reads the question, why are accountants, i.e., independent auditors, not typically attached as defendants? Research shows that accountants are sued in less than 10 percent of lawsuits while financial statement fraud is asserted in over 50 percent of the cases.

WL:  Most of the financial statement fraud is in interim reports, and it's much more difficult to name the accountants as liable for the interim reports, because they don't express an independent opinion. With the curtailment of aiding and abetting, liability under ...

TS:  Central Bank.

WL:  ... Central Bank, it's tougher to get them in that situation. Number two, this concept of proportionate liability that's worked its way into the federal securities laws has made the accountants less attractive defendants. Number three, the accountants are very difficult customers to deal with in a litigation context. And I think those factors together lead to people naming accountants, probably only in the most egregious accounting fraud situations, where there is an opinion of the accountants that you can point to.

TS:  I would add one other thing as well. The percentage in the question is right, 10 percent or less. But in many cases, when the plaintiffs get discovery from the accounting firms, I think it is likely that in some of those cases they are going to name the accountants at a later date. What they're waiting to get are the accounting documents to see what they have.

WL:  And unfortunately, a one-year statute of limitations.

TS:  Statute of limitations.

WL:  And a discovery stay materially disadvantages the plaintiffs in that situation.

JG:  Well, you get into the one and three game. You know, when does the one start? How will the courts, you know, do this? So again, it's good business for people who litigate for a living.

WL:  And also there's a new Ninth Circuit opinion...I don't want to be too lawyerly, that might even suggest that actual knowledge is the test for the statute of limitations, which would help with that problem pretty significantly.

JG:  Right. More chapters to come.

NC:  Tower, I want to ask you a question about taking these cases to trial. Your firm is one of the few law firms to actually try a 10b-5 action recently. What lessons can you share with us that you took away from the trial?

TS:  Well, I think we've learned a lot of lessons. I didn't actually try the case. My partner Bob Varian, who in fact is here, tried it. And we learned an immense amount. We learned a lot in terms of tactics, of how to present a case successfully. But in terms of broad lessons that are beneficial, I think there were a number of them. The first was that jurors do understand that the federal securities laws are not investor insurance. That they're there to insure fair disclosure, and full and accurate disclosure, but they are not an insurance policy for investment losses. That's very important because the plaintiffs, of course, want to package these losses as investment insurance. Either you win with the market going up, or if the market goes down, hey, you just call on the federal securities laws and you get made whole anyway.

     Second, we learned clearly that jurors understand risk, that they understand that investing is very much a type of gambling. And that you roll the dice, and you're trying to make money. They also understand there are different types of risks. It was very clear that people understood that investing in IBM or General Electric is different from investing in an Internet company. Or that investing in a mutual fund is different from investing in some small high-flyer with "dot com" after their name. So they understand risk, that's also encouraging.

     Third, American jurors understand that our markets are competitive, that every business every day is an intensely competitive environment and there are going to be winners and there are going to losers. And by definition, if there are going to be losers, investors and shareholders are going to lose money. Not through any fraud, not through any wrongdoing, because that's the nature of competition.

     And then lastly, I think, in terms of general themes, one great advantage defendants have in going to trial is that the defense witnesses tend to be real live people who are there at the time. Officers, directors and employees, who oftentimes spent years building the company. Whereas the plaintiffs case tends to be based around experts who are brought in after the fact. And that for jurors to find a company liable, they oftentimes have to find a large number of people, not just people within the company, but accountants, underwriters and others, a large number of people that were there that lived it, that they lied. And most people actually have a hard time doing that. Most people are not so cynical. And they are going to be reluctant to hold that a large number of credible people are all in some conspiracy and all lied.

     So I think the overall moral is that companies will do much better than many have thought in the past, going downstream when they believe that they're in the right. And as you said, Nick, there are two other cases that went to trial, the results were the same, the defense won. And Joe said yet another one. So there's four, four for the defendants, zero for the plaintiffs.

WL:  I agree with much of what Tower says and I think that lawyers who try cases for plaintiffs have to be very attuned to the risk issue. I think it's a very important issue. I think if you handle it properly you can win for the plaintiffs. I think there is a certain statistical skewing here that ... Tower, I think, will agree with me. It's the weak cases for the plaintiffs that get tried. The defendants, on the bad cases, pay. They can't take the risk. If there is a liability risk, a real liability risk, the cases are settled in most instances.

     Most of the cases that are tried ... you know, the case that you're mentioning, Arthur Andersen was the defendant, they're an institutional defendant, that's the way they are, they take cases to trial. Everex was not the strongest case in the world. So there's a statistical skewing. And plaintiffs have won cases too. I mean, it's not a one-way street.

TS:  Yeah, I very much agree with what Bill said and see, actually, the very important point is that it's critical if a company is sued, for the company and its lawyers and for its (insurance) carriers to accurately and honestly evaluate the case at the beginning. Because if it's a problematic case, the name of the game is dispose of it as quickly as you can, as cheaply as you can, and everybody does a lot better.

     If it's a strong case, and the company may well and probably should decide to take it downstream, and let's try to get it thrown out. The plaintiffs really have to do the same thing. And the danger to the defendants is where they misevaluate the case, and you go downstream with a weak case. Then you're put in an increasingly untenable position where you either have to try it or you have to pay an absolutely exorbitant amount of money. And that's a situation nobody wants to be in.

WL:  And I recall an instance where a company got extraordinarily cross-wise with its carrier, rather late in the game in a case. And it's just sort of a life experience story. There was a very, very, very bad document from the defendants, which the plaintiffs had, and as the case progressed, not only went a long way, big investment in the case, the plaintiffs began to bang on the table with this pretty incriminatory document. Well, it turned out that either through oversight or for some other reason, company counsel had not shared that document with the carrier. And I think the carrier was extraordinarily unhappy late in the game being told, you know, pay up $25 or $35 million, because of this document, when they felt the case could have been resolved earlier.

NC:  Let's talk about settlement dynamics. We talked about the fact that there are a great many cases in the pipeline waiting for something, either dismissal, trial, settlement, whatever. I'd like to ask you, Joe, of the cases that we've seen that have settled, the Reform Act cases that have settled, the 40 or 50 of them, do the settlement amounts appear to be rising, remaining static, falling?

JG:  Well again, you've got to be very careful about how you do the statistics. The median and the mean can be very different over here. The mean, for those of you who don't remember stats 101, the mean, the average, all right, is the average number weighted over all the cases. The median is the middle number. So if you have 99 cases settled for $1 million, and one case settled for $1 billion, all right, the average is going to be closer to a billion, the median is going to be closer to one.

     We have a skewed distribution, always have had a skewed distribution in the settlements of these cases. We had a larger number of cases settling for small amounts. And you get a small number of cases, you know, being the big homeruns. So in that kind of a distribution, what you see is the median number is going to be lower than the mean. All right? The mean, the average, is the number that's interesting to the insurer because that really describes the total amount you've got to pay out. And the average is also interesting to you because that's how you get paid.

     So if we look at the average, the average is currently running in excess of $10 million. All right? I've seen ... it depends upon which sample you look at, time periods. But generally the view is, the average is up over the pre-95 period. And again, you can find different averages depending on which time periods you look at. What we can do is value the inventory that we know is in the federal system. If we just take the federal cases, we know there are more than 600 of them, we would estimate roughly that 100 or fewer have been disposed of by settlement or otherwise. That leaves 500 cases, all right? And that number is growing on a daily basis.

     If you assume that the average settlement value is $10 million -- which is actually lower than ... which is roughly what we saw in '95 and lower than what we're seeing now -- and if you assume that 80 percent of the cases in the pipeline today will be settled -- and that's the percentage we saw pre-95 Act, all right -- you have a fascinating number. Eighty percent of 500 cases in inventory gives you 400 expected settlements. An average settlement of $10 million gives you a value on that inventory of $4 billion. All right?

     Plaintiffs' lawyers typically look to get on average about 30 percent. That's what you hope. There are larger cases where the numbers come in lower; when there is competition for the right to represent the class number, it comes in closer to 20 percent. But if we take that 30 percent number, subject to all the caveats I just described, cashflow to plaintiffs' counsel for inventory already in place is roughly $1.2 billion. This is a big business.

     I can tell you stories that would make those numbers higher. I can tell you stories that would make those numbers lower. But if you want a focal point, a place to start the discussion, it's not a bad number.

TS:  There's clearly a false sense of security, I think, out there with respect to the settlement of cases, because there haven't been that many settlements, less than 50 in the last four years. And that is not representative of what's going to happen. I don't think any of us know exactly when, but there are going to be some huge numbers coming down the pike in ugly cases.

JG:  The big bulk of it is still out there to settle.

TS:  Yeah, and you know you can pick up the (Wall Street) Journal any day and identify any number of companies who are ... there's absolutely, positively going to be a big ticket settlement. The FCC is going to bring an enforcement action. The DOJ is looking at some of these. There are going to be some big, big settlements. The ranges so far run from about $500,000 to $72.5 million. That just gives you a sense of the range of these 45 to 50 cases that have settled.

     One other thing we've seen is that there are fewer cases at the very bottom. That on pre-reform you would see cases going even below $2 million. You don't see very many of those anymore.

NC:  As our time is growing short, I'm going to invite our live audience to step up to the microphone, those of you who dare, to ask a question. If nobody steps up, I will certainly continue. Okay. Yes?

KK:  I'm Karsten Klehs with Woodruff-Sawyer and Company. The settlement statistics are very interesting. I have a further question. If the average settlement is 10 percent of damages, is it that defense is doing a great job? Or that the plaintiffs' bar is doing a bad job? Or is the investor who, Bill, you said is angry, are you doing a weak job for him?

WL:  The damages in these cases are very difficult to calculate. And to ascertain whether or not you're recovering 10 percent of the recoverable damages, or 50 percent, is a hard thing to do. The defense takes the position in the cases that the damages are very small, that factors other than the alleged misrepresentation led to the inflation of the stock or the decline of the stock. And I think it's really something that's proven to be very difficult to deal with on a statistical basis.

     There is a provision in the new Act that was meant to ... I don't know what it was meant to do. Maybe provide more information. I think it's been a complete nothing. It's just made class notices even more complicated and longer than they were before. I think the defense lawyers do a very good job for their clients in these cases. I think they have a very strong arsenal of weapons to use. And I think the plaintiffs do a pretty good job for their clients across the board in these cases as well. These are hard fought out cases.

TS:  I obviously am going to say the defendants are doing a great job. What Bill said, I agree with. You have to keep in mind that when the case is brought, the plaintiffs are going to come up with the biggest possible number they credibly can, it's in their interest to do that. And that what they're trying to do, of course, is to put leverage on everybody to come to the table and do a deal. So I've seen any number of reports that say, "Gee, the plaintiffs are only recovering 10 cents on the dollar, or five cents on the dollar." But nobody believes the initial number. It's not a real-world number. So in fact the recoveries of cases that are perceived by both sides to have merit are very significantly higher.

JG:  I'll give you another perspective. That is, if defendants can't get the case dismissed, either motion to dismiss or summary judgment, then given the way damages are calculated in after-market cases, it is an impossible financial risk for the company to take. All right? Because in many of these cases, you know, even if you give the defense all the arguments, the number that you come up with would bankrupt the company and everybody that's within a thousand miles of it. All right? The damage rules are nuts.

TS:  Right. And that's why early ...

JG:  You can't afford to litigate it. All right? So what you get is a very different bargaining dynamic. You look at how much is the insurance coverage, how strong is the case, how many other resources can we bring to the table, and that's the number that actually drives the ultimate size of the recovery. So calculating the numbers as a percentage of the final amount, it's a curious exercise, because the company can't afford to take that risk of taking it to trial, because the damage rules are so insane.

WL:  Plaintiffs can't really take the risk either, because the judge won't permit them to bankrupt a company. I mean, we all know that. The judges are going to protect the company at the end of the day.

JG:  So you're saying the damage rules are insane because you're not going to let them bankrupt the company. You're saying the damage rules are insane because the bank or the company could be bankrupted. I think we're all agreeing that the damage rules are insane.

WL:  Yeah, what Joe ... The damage rules are a function of the price of the stock, the volume of the stock. The insiders are the ones who benefit most from that, whether they're using the stock for acquisitions or for insider trading purposes. And I think for the ...

JG:  But here's the paradox, Bill.

WL:  ... company to then turn around and say, "Well, we're really sorry we drove the stock to 75. We're sorry it fell to 20. We're sorry that we have $189 of insider trading proceeds. But in order to provoke sanity in the process, we're going to cap the plaintiff's damages."

JG:  Bill ...

WL:  And that's not right.

JG:  I'm not going to disagree with you about any of those facts, because the insanity lies elsewhere. But let's take a simple situation and, you know, it's a pure after-market fraud. All right? The stock is driven up by $5 a share for a month. Let's assume that there is no trading by the insiders, no sales by the corporation. Which right away makes it unrealistic from your perspective. And then we'll roll it back. You know, who are the plaintiffs in that case? It's anybody who bought during that month. All right? What damages they are going to claim? Five dollars a share, as long as they held through the period when there was a corrective disclosure. But where do these plaintiffs get the stock from?

WL:  They buy it from other investors.

JG:   The shareholders. And what was the effect of the fraud on those other shareholders?

WL:   Yes, but the other shareholders didn't perpetrate the fraud.

JG:  I agree.

WL:  If they benefited, it was ...

JG:  I agree.

WL:  ... innocent.

JG:  I agree. But what happened ... what we have here is, to my knowledge, a unique situation in the law. Where a dollar amount that economists would call a transfer payment, which does not wind up in the pocket of the perpetrator, winds up being called by the law damages.

WL:  That's because the law values honesty in the marketplace.

JG:  I agree, it does. I agree that the law should value honesty. I question whether this measure of damages is the appropriate measure in these cases. Because if there is no rational relationship, either to the harm that's done, or to the benefit, that those who perpetrated the fraud get.

TS:  I want to go back to something Joe said, because it's really important. That is the perspective of the board and what options a board has if the cases go downstream. Because this is just really critical. Companies must honestly evaluate their case early, because if they fail to do that, and if a company allows a weak case to go downstream because they're going to kill the plaintiffs, or because, you know, there is no way we're going to give up, and they get downstream and don't win on summary judgment, I would submit to you that there is no rational board in the country that is going to permit the case to go to trial where there are hundreds of millions, or now frequently billions, of dollars of potential damages.

     Particularly if there is insurance and if the company can get out for, you know, what might be an immaterial amount of cash, or a contribution of stock. And what early, accurate evaluation does is, it allows the company to avoid ever being put in a box from which there is no attractive exit and you can resolve the case early, go on with your business, and who cares. But boy, where companies get in trouble is they misevaluate the case or they let their egos get in the way of what should be a totally dispassionate business decision.

WL:  It seem to me that there is a disconnect here. If defendants with their D&O insurers are engaging in early case evaluation and then there's a stay of discovery, we wouldn't have a backlog because there would be more settlements, because defendants would know what their cases are worth, they'd be talking to the plaintiffs and we wouldn't have this backlog. I'm wondering what the disconnect is. Are defendants not evaluating these cases early on?

TS:  Well, there's a spectrum. I think some defense lawyers do and some don't. And some companies want to and some companies say let's not spend any money until we see how the motion does. I think the other really important dynamic is the plaintiffs oftentimes don't know how to value with their case shut. Because they don't know how the appellate courts are going to come down. And I don't blame them. They don't want to give away a good case for less than it's worth. I think that maybe they have more visibility now, but in the last couple of years, they were unsure how to price their cases ...

WL:  More importantly ...

TS:  ... so nobody was talking.

WL:  More importantly if the defendants won't turn over at least core evidentiary materials, the plaintiffs aren't in a position to evaluate the case. And defendants sort of find themselves betwixt and between. They might want to settle, but they don't want to let the plaintiffs look at the evidence. They're afraid if we get the evidence and they don't settle, they'll be disadvantaged. So that's been a negative dynamic for settlement, I believe.

TS:  But one dynamic that has worked in this environment is that in cases where the defendant may feel there is exposure, we've been able to negotiate settlements and then voluntarily produce what we both call confirmatory discovery. Where we do it on the side.

WL:  Well, that ... yeah, I respectfully disagree with that. I have not done that, and I do not believe in that practice.

TS:  Well your colleagues in the plaintiffs bar are doing it.

WL:  I can only speak for myself, and it is a practice that I do not favor, and I don't think is correct. I think if plaintiffs are going to settle ... if plaintiffs are being asked, as fiduciary litigants to settle a claim, they should insist at a minimum on disclosure of court evidentiary materials so they can evaluate the worth of the case before they settle it.

NC:  By court evidentiary material, are you referring to a complete document disclosure and the opportunity to interview witnesses? What kind of volume are you talking about?

WL:  No, I'm ... look, plaintiffs have to be realistic in this situation. It's not going to be appealing to the defendant to go through a complete litigate-driven document production. On the other hand, if plaintiffs believe themselves and believe what they say, we can give somebody a list of eight or 10 categories of key documents that are very easy to gather -- monthly financial packages, board minutes, forecasting annual plans, and the like -- and evaluate the case at that point.

NC:  Okay. We have a question from the audience here.

TS:  Well, on the Year 2000, there are Year 2000 cases, but frankly, the ones that have been filed so far are much ado about nothing. They really aren't going anywhere. And the ones that are going anywhere tend to be product cases, as opposed to securities cases. I mean, they're called securities cases, but they're really product cases. I think there will be real, Year 2000 cases. But I think we're likely to see them next year. And the reason why we're likely to see them next year is that there is a spectrum of disclosure with regard to year 2000.

     We're not going to know until next year who really was completely forthright and who wasn't, who had a problem and didn't disclose it and who had a problem and did. And I think that, you know, after the Year 2000, we're going to know who was compliant and who wasn't, who checked with their vendors and suppliers and who didn't, and who said what they should have said, and who didn't. So next year we'll see some real cases, and there will be some real cases because I think some companies are doing a lot and some companies aren't.

     To me the danger area is not whether American companies themselves are Year 2000 compliant. Because I think most American companies will be. The danger is they haven't checked other companies with whom they do business, particularly in Asia and in Latin America. They are way ... and in Eastern Europe, they are way, way behind the curve. And to the extent American companies are looking at companies in those areas as principal sources of supply, I think they have the exposure.

WL:  Huge disasters are very seldom widely and accurately predicted in advance or anticipated. In fact, by definition, disasters catch people by surprise and in an unprepared state. So if we do have a huge Year 2000 disaster, it will be the first time in history that such a disaster was so widely predicted and anticipated. (Laughter) I think there will be impact at the edges. And Tower is right, I think the problem is in Asia, with the subcontractors, the contract manufacturers. I think there will be some companies who suffer disappointments because something happens over in Asia. I just don't think it's going to be as big as people think.

NC:  Okay, and in our final moments, I'd like to ask our three panelists for some predictions as to where this type of litigation is going. Tower?

TS:  I actually believe we've already hit the high water mark on securities class actions, notwithstanding the increased number of filings. I believe that in the early '90s, the courts started to turn, that judges who had seen filing after filing after filing that looked pretty much the same became increasingly cynical. And that everybody is taking a closer look. And I believe that over time the filings will go down and will move more to a model which I think is the appropriate model. Cases that involve real wrongdoing will go for significant amounts of money, as they should. That the plain-vanilla cases, the cases built more on cosmetics than actual wrongdoing, either will not be filed or will be thrown out on the way. And I think this will take a number of years to play out. But my own belief is, we've passed the high water mark and that the environment steadily, not without, you know, bumps on the way, but steadily will improve for public companies and their (insurance) carriers.

JG:  I think it's a jump ball, still too soon to tell. But if you held a gun to my head and forced me to predict, I think at the end of the day the courts and the plaintiffs and the defendants will adjust and adapt in such a way that the '95 Reform Act will have only marginal impact on the net cashflows that run through the business. I could imagine, you know, weaker cases perhaps not being filed as often, being settled for less. But the bigger cases holding up for more. Bottom line, this is a business. If you analyze it like a business and understand the profit and loss, the risk, the cashflow effects, there's an equilibrium in the business. And I think people are going to adjust back to that equilibrium.

WL:  I think the securities laws, as I said before, two of the most important national laws that we have, had a tremendously beneficial impact on capital formation in the country. Private litigation is an indispensable part of that. Indeed, the preamble to the '95 Act, reemphasizes the importance that private litigation is expected to play in keeping our markets as honest as we can keep them. I think there's been a massive upsurge in public company creation in recent years. We've discussed the increase in fraudulent financial accounting. I think the courts will act to protect investors and privately enforce the '33 and '34 Acts. I think we will see more cases going forward, better cases, more thoroughly researched, more thoroughly investigated, larger recoveries for investors. Because, frankly, I think there's going to be more fraud in the marketplace going forward.

TS:  It sounds like my firm's going to have a lot of business. (Laughter)

WL:  I suspect it will. (Laughter)

NC:  Well thank you gentlemen very much. In closing, let me just say that Reliance National believes in the Internet, not only in terms of conducting e-commerce, but we believe it's a fabulous medium for bringing people together, exchanging ideas, as we've done today. It is indeed a great facilitator of communication. As I said before, we believe that this is going to be the first in a series of Internet broadcasts that we intend to put on. I'd like to thank our panel for being here, our live audience here in San Francisco, and those of you who have tuned in. Thank you.