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Though I have indulged in my share of plaintiffs’ lawyer-bashing, the current rash of accounting scandals is a salutary reminder that, in our adversarial system of justice, the coin always has two sides. As allegations of corporate misgovernance erupt all around us now, it is a good time to reassess the wisdom of the major judicial and legislative changes in the securities laws that occurred during the past decade, to see how they bear up in the harsh light of corporate meltdown. The picture isn’t pretty. As the 1990s began, this country was in the throes of a different set of accounting-related scandals — those that had helped conceal the financial woes of the savings and loan industry. (In one year, for instance, clean audits had been given to 25 separate S&Ls that failed within the year.) Nevertheless, all the major court rulings and legislative reforms of the 1990s tended to cut back on, rather than facilitate, the ability to pursue accounting-related securities fraud. In 1991, in a 5-to-4 ruling in Lampf v. Gilbertson, the U.S. Supreme Court ruled that federal securities actions should be governed by an unusually stingy federal statute of limitations: Cases would henceforth have to be brought within one year of discovery of the fraud and within three years after the fraud actually occurred. For most of the four decades preceding Lampf, federal courts had borrowed limitations periods from the states where federal securities actions were brought, and in most cases the state limitations periods for fraud were much more lenient — six years in New York, for instance. They were long for an obvious reason: Perpetrators of fraud try to cover their tracks, delaying victims’ discovery of their plight. Though the SEC had favored the adoption of a uniform federal rule, it had unsuccessfully urged the Court to adopt a five-year limitations period. Only in late July 2002 did it appear that Congress was finally reversing the anomalous result in Lampf. The Sarbanes-Oxley Act lengthens the limitations periods in securities fraud cases to five years from the date of the fraud and two from the date of discovery. As commonsensical as restoration of the longer period might seem — even the generally conservative Supreme Court Justices Anthony Kennedy and Sandra Day O’Connor had acknowledged in Lampf that the three-year limit was unfair — that provision of the original Sarbanes bill was at first reflexively assailed by Republican congressional leaders as encouraging “predatory” suits by trial lawyers. In fact, Lampf‘s unrealistically short limitations period had indiscriminately barred both frivolous and meritorious suits alike. Obviously, the goal of good-faith reformers should be to find ways to filter out only the former. In 1994 the Supreme Court followed Lampf with another surprising 5-to-4 ruling. In Central Bank of Denver v. First Interstate Bank, it found that federal law did not impose liability on those who knowingly aid and abet securities fraud. The ruling — which made it more difficult to hold accounting firms, law firms and investment banks responsible for facilitating clients’ securities frauds — ran contrary to at least 30 years of lower court precedent and the views of all 11 federal appellate courts that had ruled on the question. Even the majority justices conceded that “aiding and abetting a wrongdoer ought to be actionable in certain instances” (emphasis added), but ruled that it was up to Congress to say so specifically. Congress restored aiding and abetting liability in 1995 — but only for suits brought by the SEC, not for private actions. The illogical distinction continues to this day. Assume for the sake of argument that Citigroup and J.P. Morgan Chase officials really did, as has been alleged, knowingly disguise hundreds of millions of dollars in loans to Enron in a way that they knew would enable Enron to wrongfully conceal that debt from investors. To this day, the Central Bank of Denver case bars Enron investors from suing those banks for aiding and abetting securities fraud. Though the SEC can sue the banks, it can only win disgorgement of the banks’ profits; it cannot recover or distribute to bilked Enron investors the damages that they suffered. (Though plaintiffs can still try to sue banks, accounting firms and law firms as “primary violators,” rather than as “aiders and abettors,” their chances of success are much diminished. The Sarbanes-Oxley Act still does not restore language on aiding and abetting liability in private actions.) The year after the decision in Central Bank of Denver came down, Congress enacted the Private Securities Litigation Reform Act of 1995, which was designed to curb abusive filings of so-called strike suits — that is, baseless, cookie-cutter complaints that are calculated to extort nuisance-value settlements. Though class action plaintiffs’ lawyers protest that the PSLRA — like Lampf and Central Bank of Denver — also contributed to the proliferation of accounting frauds besetting us today, here I am more dubious. The main reforms enacted — stiffening pleading requirements and modifying joint and several liability — were sensible attempts to filter out frivolous filings and fishing expeditions. On the other hand, the 1995 act can be faulted for failing either to reverse the Lampf and Central Bank of Denver rulings, or to enact any of various prophylactic safeguards that were being urgently and cogently pressed at the time. As early as 1993 Melvyn Weiss, the co-founder of Milberg Weiss Bershad Hynes & Lerach, had testified before Congress about the need to establish government oversight of auditors, bar accounting firms from performing lucrative consulting services for companies they were auditing, and require public companies to rotate auditors every several years — suggestions that are now being belatedly heeded, in the Sarbanes-Oxley Act. It is, of course, impossible to disentangle the intertwined causes of the latest rash of scandals. Certainly the proliferating use of stock options as a form of executive compensation — which gave executives incentives to manipulate stock price — together with the accounting firms’ burgeoning businesses in nonaudit consulting services — which gave them incentives to render accommodating audits — were driving forces. But the one-sided judicial and legislative reforms of the 1990s could not have helped. “It’s very plausible that the incredible increase in corporate earnings restatements [in the late 1990s] has something to do with the liability costs for auditors going down,” says Professor John Coffee Jr. of Columbia Law School. (Such restatements, which averaged 49 a year from 1990 to 1997, jumped to 91 in 1998; 150 in 1999; 156 in 2000; and more than 200 last year.) “The message of the 1995 act was wrong,” says Joel Seligman, the dean of the Washington University School of Law in St. Louis. “It was, in effect, that the basic problem with securities law was avaricious plaintiffs’ lawyers. To put it simply, wise legislation requires better balance. There are also greedy corporate executives and ineffectual boards of directors, and that was lost in the 1995 analysis.” The Sarbanes-Oxley Act may begin the process of restoring that balance. Let’s hope so.

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