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Florida’s public employee pension system, overseen by pro-tort reform Republicans, has become the most litigious institutional investor in the country. The Florida State Board of Administration (FSBA), which manages $96 billion in retirement funds, is currently involved in nearly 300 securities fraud lawsuits against companies whose stock it has owned. Typically, the agency claims that management deception or other misbehavior drove down the price of the pension fund’s shares and lowered the value of its investments. But the agency also offers a moral rationale for its aggressive legal approach. “We have all seen an increasing number of corporate actions that border on criminal — and sometimes are criminal,” says FSBA executive director John T. “Tom” Herndon, the architect of the legal strategy. “Someone has to question the ethics of these business practices.” While there are no statistics ranking the most active plaintiffs in the shareholder fraud arena, experts say FSBA, a 217-employee agency that manages retirement funds for 750,000 state and county workers and retirees, leads the pack. FSBA currently serves as lead plaintiff or co-lead plaintiff in eight different actions, and has filed its own private lawsuits against 14 other companies. Just in the last two months, FSBA has won lead status in securities fraud class actions against Dollar General Corp. in U.S. District Court in Nashville, Tenn., and against Critical Path Inc. in federal district court in San Francisco. By comparison, CalPERS, the giant California public employees pension fund frequently cited as a model in the corporate governance monitoring arena, has acted as lead plaintiff in only one case and petitioned to lead one other. FSBA’s legal approach has begun to draw criticism from judges, securities attorneys, and even insiders in the institutional investor community. Some question whether the time and effort involved in prosecuting all these cases has yielded a worthwhile return to beneficiaries. “I am concerned with any frivolous litigation that in effect replaces productive employment and company profits with legal defense costs,” says Russell Bjorkman, a member of the FSBA’s six-member Investment Advisory Council and a former trustee and chairman of the Miami-Dade County police and firefighters’ pension fund. He plans to call for a review of the agency’s litigation policy. Several federal judges also have taken disapproving notice of FSBA’s activism. At least three times in the past two years, judges have turned down the agency’s request to lead a suit on grounds that the FSBA already had exceeded the limits set by the 1995 Private Securities Litigation Reform Act. In November 1999, Judge Donald Whyte of the U.S. District Court in San Francisco rejected the FSBA’s petition to serve as lead plaintiff in a securities fraud lawsuit against McKesson HBOC Inc. Whyte dubbed the FSBA a “professional plaintiff.” The FSBA’s litigation spree is more than a bit ironic. Its governing board is made up of three elected Republican officials — Gov. Jeb Bush, state Treasurer Tom Gallagher and state Comptroller Bob Milligan. One of their party’s most cherished goals has been to reduce the amount of securities fraud litigation and other suits directed at businesses. Early in his term, the governor pushed through strong tort reform legislation. Asked to comment, Gov. Bush issued a statement that it’s “the fiduciary responsibility of the state to protect participants of the Florida retirement system.” Milligan admitted that he was not aware of how many legal actions FSBA had launched or participated in. But if such aggressive litigation “is a necessary part of our whole fiduciary effort,” he said, “I have to support it.” Gallagher said that “when corporate governance doesn’t do the right thing” and stock prices fall as a result, FSBA has the right to take legal action. As a trustee, he said, he “will follow the recommendations of the executive director.” MAN WITH A MISSION Herndon, 55, has had a long career as a Florida public official under Democratic elected leaders. He previously served as chief of staff to Govs. Lawton Chiles and Bob Graham and as executive director of the state Department of Revenue. Prior to his appointment by Chiles to run the FSBA in November 1996, he headed his own governmental consulting firm. Herndon seems surprised that anyone would even ask questions about his agency’s activist legal stance. While “fiduciary responsibility” is FSBA’s main rationale for its aggressive litigation, Herndon takes a more expansive view of its duty. “We have to act in the best financial interest of our members,” he says. “But we have other obligations that go beyond that. … Is it OK to spend a million dollars to buy back the house of some CEO who leaves after a year? Who is going to ask these questions? Who stands in the place of the shareholders who don’t have the power to do it?” This moralistic approach was in evidence in 1998, when FSBA took the lead in suing UCAR International, based in Nashville, for securities fraud — even though FSBA’s losses were only $200,000 and the pension fund already had sold all its stock in the company. In its Annual Report on Corporate Governance for last year, the FSBA board of trustees declared that it had acted as a “private attorney general” in that case. UCAR, the report said, had conspired with its main competitor to fix the world price of carbon, and had made false statements in its annual report about how its business was highly price-competitive “when the opposite was true.” In its suit, FSBA charged that UCAR officers committed securities fraud when they lowered their previous earnings reports because of the government fines the company had to pay for price-fixing. But Herndon says that it was the officers’ federal criminal antitrust conviction — more than the financial losses to FSBA beneficiaries — that prompted his agency to sue UCAR. PUSHING OTHER PLAINTIFFS ASIDE A more typical FSBA fraud case is the one against Dollar General, in which FSBA is co-lead plaintiff. Dollar General operates 4,500 retail stores, which sell very low-priced merchandise. Despite its less than glamorous business line, the company attracted a great deal of investor attention from May 1998 until last April by releasing a series of highly positive news announcements that claimed record sales and earnings. Dollar General CEO Cal Turner also boasted of his company’s success in interviews on CNBC. The result of this media blitz, according to the lawsuit, was to drive up the price of Dollar General shares. That enabled the company to sell $200 million of notes at favorable interest rates, and allowed the Turner family to unload a substantial share of its controlling interest at highly favorable prices. But on April 30 of this year, Dollar General issued a press release that was not so glowing. It admitted that profits for 1998 and 1999 were lower than previously reported. That news sent the stock into a nosedive, plummeting 37 percent from its peak to $16.50 a share. That same day, the Pirelli Armstrong Tire retirees medical fund filed a suit accusing Dollar General executives of fraud for deliberately misleading shareholders about the firm’s financial condition. FSBA didn’t enter the case until June 29 — the filing deadline — when it moved to displace the original plaintiffs on grounds that its financial losses of $10.4 million were larger than those of the Pirelli Armstrong fund. That sort of last-minute takeover by larger investors and law firms is a common practice in securities fraud cases, says James Newman, executive director of the Securities Class Actions Services, a New York research group that tracks lawsuits for pension funds and other institutions. Not surprisingly, attorneys who are shoved aside don’t like it. One who faces that prospect is Jeffrey R. Krinsk, a partner at Finkelstein & Krinsk in San Diego. He alleges that the FSBA makes a habit of showing up at the last minute and demanding lead plaintiff status in cases that have already been developed by other plaintiffs. Krinsk filed a securities fraud complaint in May against Applied Micro Circuits Corp. of San Diego on behalf of two private investors. Since then, FSBA has filed a petition to act as lead plaintiff. But Krinsk says Barrack Rodos & Bacine of Philadelphia, which represents the FSBA, never even filed its own complaint on behalf of the pension agency. Krinsk calls the repeated use of such piggybacking tactics “an abuse of [the FSBA's] institutional status.” Steven Basser, a partner in Barrack Rodos’ San Diego office, declined to comment. Nevertheless, Herndon downplays his agency’s legal activism. For a fund that owns shares of nearly 2,000 companies, he says, 300 lawsuits is a relatively modest number. In 90 percent of those cases, he notes, the FSBA takes only a passive role. Besides, he adds, suing companies is not a new policy for his agency. “The board was active in corporate governance long before I became director — voting proxies, proposing guidelines, even filing lawsuits,” Herndon says. But, he concedes, “Maybe there has been an increase in the degree of intensity since I came in.” REFORM FAILURE Curbing securities fraud suits was a key part of the GOP’s “Contract with America” in the mid-90s. Overriding President Clinton’s veto, Congress passed the Private Securities Litigation Reform Act in 1995 to rein in what many lawmakers described as a glut of frivolous suits brought by opportunistic plaintiffs’ lawyers who claimed fraud every time the stock market took a tumble. Among its key provisions, the law compels plaintiffs to make a stronger showing of insider profiteering in order to initiate discovery proceedings, and it stays discovery until a judge rules on motions to dismiss the suit. As a result, the number of cases that are summarily dismissed before discovery has risen from 13 percent to 30 percent since the law was passed. But, to the surprise of the law’s sponsors, the number of securities fraud suits filed has gone up since it was passed. According to the Stanford Law School Securities Class Action Clearinghouse, there were 188 such suits filed in all of 1995. In the first six months of 2001, however, there already have been 261. One reason for the increase in suits, of course, is the sluggish performance of the stock market in recent months, which has prompted some investors to search for villains. But another is the generally increased litigiousness of institutional investors. Ironically, Congress encouraged big institutions like pension funds to take the lead in class actions, on the theory that they would be more restrained and responsible in securities litigation. But critics contend that some institutional investors, notably the FSBA, have taken the congressional encouragement too much to heart. The trend is beginning to create controversy. “Corporate litigation is becoming a bigger topic across the country, especially as stock market losses have grown,” Newman says. On the other hand, Newman’s group reported last month that many public and corporate pension plans are losing out on hundreds of millions of dollars in class action settlements by failing simply to file claims. Unlike CalPERS, the FSBA has no official policy on when to undertake litigation. “We don’t have any hard and fast rules on selecting suits to file,” Herndon says. “Our own staff suggests some cases. Others are brought to us by outside law firms, other institutions, corporate governance groups and by outside investment advisers.” In contrast, CalPERS has a written policy, with specific criteria for choosing when to participate in securities fraud litigation. For example, the potential damages must be more than $2 million, large enough to warrant the staff time devoted to the case. The written guidelines also pose the following question to guide decisions: “Would CalPERS’ involvement add value to the settlement?” Still, the Florida pension agency is hardly alone in its legal assaults on public companies. Other activist institutional litigants include the State of Wisconsin Investment Board and the Louisiana School Employees Retirement System — although neither is nearly as aggressive as FSBA. The public pension fund lawsuits, scattered around the country, have taken place below the radar screen of all but the most attentive observers. One reason is that the lead plaintiff often doesn’t emerge until long after the suit is filed. As a result, even political leaders with oversight responsibility often are unaware that public pension funds are involved. UNINTENDED CONSEQUENCES FSBA’s attorneys repeatedly have argued that the 1995 reform law’s limitation on “professional plaintiffs” does not apply to institutional investors. That claim is based on a statement in the House of Representatives’ conference report: “Institutional investors seeking to serve as lead plaintiff may need to exceed this limitation and do not represent the type of professional plaintiff this legislation seeks to restrict. As a result, the Conference Committee grants courts discretion to avoid the unintended consequences of disqualifying institutional investors from serving [as lead plaintiff] more than five times in three years.” Robert J. Giuffra, a partner at Sullivan & Cromwell in New York, who was the Senate Banking Committee’s chief counsel when the law was passed, says FSBA’s position on limitations is correct. “Congress wanted to put these cases in the hands of the adults,” he says, “and institutional investors are the adults.” The judges who have ruled against FSBA on the issue, he adds, “are just wrong.” But this arguable exemption for institutional investors is something that plaintiffs’ law firms can use to sidestep the reform law’s intended restrictions on assembling groups of small shareholders. Newman says some firms take cases initiated by an individual plaintiff to a big institutional investor like FSBA, and push the institutional client to seek lead plaintiff status, which means bigger legal fees for the law firms. Herndon, though, argues that it’s good public policy for institutional investors like the FSBA to take the lead. He says FSBA’s size and bargaining clout “could lead to a decrease in attorneys’ fees and thus a higher return to beneficiaries.” For all of the talk about protecting the retirees’ money, however, the returns from most securities fraud lawsuits are not that large. Across the country and for all cases, settlements average about $12 million, with legal fees and expenses eating up about a third of the total and the remainder of the spoils divided among thousands of shareholders, according to National Economic Research Associates, a consulting and analysis firm based in New York. The FSBA’s recoveries haven’t been huge so far this year. From Jan. 1 through Aug. 15, the FSBA reports that it recovered about $3.6 million in settlements from participating in various class action shareholder suits — a tiny fraction of the value of its $96 billion investment portfolio. Some observers inside the institutional investor community question the value of all this litigation. One veteran pension fund official, who didn’t want to be named, says his colleagues are increasingly critical of “investors who seem to be so eager to go into court. A lot of us think it makes more sense to do what CalPERS does and identify the companies that need to shape up before they become a problem, instead of spending so much time and energy suing the people who screw up.” But FSBA’s legal approach draws surprising praise from one of Florida’s leading critics of plaintiffs’ lawyers and anti-business litigation. Jon Shebel, president of Associated Industries of Florida, a powerful business lobbying group in Tallahassee, strongly defends the FSBA, which is overseen by his strong tort reform ally, Jeb Bush. For the FSBA to behave in any other way, Shebel insists, “would be an absolute dereliction of their duty.” MIXED RULINGS BY JUDGES Nevertheless, the FSBA’s frequent requests to act as lead plaintiff have drawn mixed reviews from federal judges around the country. In ruling on the FSBA’s petition to serve as lead plaintiff in the McKesson HBOC Inc. case, Judge Whyte noted that, by the agency’s own admission, it already was lead or co-lead plaintiff in six other shareholder fraud class action lawsuits. He rejected the argument that the public pension fund was exempt from the statutory limit on the number of times parties can serve as lead plaintiff. “The text of the statute,” he wrote, “contains no flat exemption for institutional investors.” Moreover, he added, “Congress also desired to increase client control over plaintiff’s counsel, and allowing simultaneous prosecution of six securities actions is inconsistent with that goal.” Three months earlier, a federal district judge in Cleveland also rejected FSBA’s petition to serve as lead plaintiff, in a class action shareholder fraud suit against Telxon Corp. He also said the FSBA had exceeded the statutory limitations. The reform law, wrote the judge, “places the burden on the FSBA to demonstrate why the bar should not be applied in this case.” And last March, a federal district judge in Erie, Pa., turned down FSBA’s bid to become lead plaintiff in a suit against Rent-Way Inc. Although the judge ruled that another plaintiff had a larger stake in the case, he also noted FSBA’s heavy workload in shareholder fraud cases. “It appears that, in addition to serving as lead plaintiff in a number of cases, FSBA is also a frequent nonlead plaintiff in securities actions,” he added. But these rebuffs hardly discouraged Tom Herndon. “I make it a practice never to disagree in public with a federal judge,” Herndon says, noting that other judges have set aside the statutory limits under the reform law and supported FSBA’s petitions to serve as lead plaintiff. Indeed, on June 28, U.S. District Judge William H. Orrick in San Francisco selected FSBA as lead plaintiff in a suit against Critical Path Inc., a California Internet messaging company. He said judges have the discretion to override the statute’s limits. Three weeks later, U.S. Magistrate Judge Joe D. Brown in Nashville approved FSBA’s petition to serve as co-lead plaintiff in the securities fraud suit against Dollar General. Brown made his decision even though the FSBA’s attorney acknowledged that during the previous three years, the agency had served as lead plaintiff in securities fraud lawsuits against DaimlerChrysler, Vesta Insurance Group, Northrop Grumman, Sykes Enterprises Inc., Pediatrix Medical Group, Parametric Technology Corp., UCAR International and Samsonite Securities. LEGALLY OVERSTRETCHED? Now FSBA faces bitter opposition to its request to act as lead plaintiff in a securities fraud suit against Applied Micro Circuits. In papers filed with the U.S. District Court in San Diego, Jeffrey Krinsk wrote, “FSBA is the embodiment of the professional plaintiff which the [1995 reform law] sought to eliminate.” Krinsk also asked whether FSBA has the resources and ability to handle so many class action cases simultaneously and fully protect other shareholders’ interests. “Can the FSBA possibly lend the oversight and involvement necessary to direct this [Applied Micro Circuits] action given its responsibility for directing dozens of other actions?” That seems a fair question. In addition to its other duties, FSBA’s seven-lawyer general counsel’s office currently is overseeing seven large law firms handling about two dozen shareholder fraud cases that the agency is actively litigating. But Herndon does not see this as a problem. “We have to keep in mind the best use of our resources and the time of our staff,” he says, “but we have tried to do that in a conscientious way.” Up to now, Herndon says, he’s received no criticism from his political bosses of the FSBA’s litigiousness. In response to Russell Bjorkman’s statement that he would seek a review of the FSBA’s litigation policies, Herndon says, “If they want to discuss litigation, we’ll be glad to do it.” But he expresses confidence that his legal approach would be upheld. “The trustees expect us to exercise good judgment, and apparently so far they believe we have,” he says. “We’ve had no indication that they think we’re too aggressive or not aggressive enough.”

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