July 26, 2002

Corporate-Oversight Bill Passes, Smoothing Way for New Lawsuits

WASHINGTON -- By overwhelming majorities in both chambers, Congress approved sweeping legislation cracking down on corporate abuses, making it easier to sue companies and giving aggrieved shareholders a new way to get compensated.

The House passed the bill 423-3; hours later, the Senate cleared it 99 to 0. The bill sped toward President Bush, who called it "a good piece of legislation" and promised even before the Senate voted that he would sign it. The unusually quick action comes despite misgivings by many Republicans over the bill's tough line on business. But the GOP fears a voter backlash in November from continuing revelations about abusive accounting practices, which have helped trigger a dive in stock prices around the globe.

Overall, the legislation aims to stamp out deceptive accounting and management practices by beefing up criminal penalties for wrongdoers, setting up deeper oversight, holding top executives more directly responsible and requiring more-open books.

And it eases the path for injured parties to get compensation. The bill sets up a restitution fund for wronged shareholders, financed by fines from any ill-gotten gains that securities regulators squeeze from wayward executives. It also establishes a new regulatory scheme that offers new grounds for investors to go to court, and allows them more time to do so.

Those provisions come as securities-fraud suits are already booming, notwithstanding a 1995 law that Congress enacted to try to restrict such suits. And they put the president, despite his endorsement of the bill, in an uncomfortable position. Mr. Bush has spent much of his political career trying to rein in what he sees as abusive litigation. As president, he has repeatedly pushed Congress to curb class-action lawsuits.

Just Thursday Mr. Bush rolled out a new plan for limiting damages in medical-malpractice suits. "What we want is reasonable health care, not rich trial lawyers," the president said on a trip to North Carolina to promote a proposal to limit the amount of time for filing malpractice suits, cap punitive and noneconomic awards at $250,000 and encourage quick settlements.

White House spokesman Ari Fleischer said recent corporate abuses justified the bill's pro-litigation slant. He sought to draw a distinction with Mr. Bush's other message of the day. "Medical malpractice is overused," Mr. Fleischer said. "Corporate CEOs have created a new climate where more vigilance is needed. There is no simple rule."

The new legislation could spur an increase in lawsuits in several ways. It extends the amount of time investors have to file suits to two years from one after they discover an alleged fraud, and to five years from three after it occurs.

Authors of the bill did not intend for the legislation to encompass acts committed before the date it's enacted, but some plaintiffs' lawyers said they may even file new suits against companies such as Enron Corp. to cover investors who bought stock in the company as long as five years ago. "It is an open question," said a securities-industry official. "This is written imperfectly, and subject to what I think will be considerable dispute in the courts."

The longer time also increases the likelihood that attorneys will be able to unearth claims against auditors and bankers, not just against the companies themselves.

New Requirements

In addition, new requirements that corporate chieftains certify the authenticity of financial statements -- or face criminal sanctions -- increase the odds of companies restating their earnings, a frequent precursor to shareholder litigation.

Corporate lawyers, who have been largely exempt from securities suits since the savings and loan scandals of the 1980s, also face potential new liabilities. Those depend on the rules the SEC develops to meet the legislation's mandate that it establish new professional standards. And new enforcement powers and resources granted to the SEC will enhance its ability to unearth wrongdoing that could spur more suits.

"Obviously some lawsuits are going to spring up out of some of the regulatory provisions, but only time will tell if it's going to be a trickle or a torrent," said Patrick McGurn, a vice president at Institutional Shareholder Services, a proxy-advisory firm in Maryland. "Clearly, we're going to see more as a result, rather than less."

"It is more opportunities for the plaintiffs' lawyers," added Joseph Grundfest, a professor at Stanford University law school and former SEC commissioner. "There's no doubt about that."

Business groups and many Republicans agreed, calling the bill a potential boon for plaintiff's lawyers, who provide huge amounts of political and financial support to allies in the Democratic Party.

Yet the opposition didn't show up in the vote tallies. Sen. Phil Gramm of Texas, for example, had said earlier this week that he would oppose the final bill because he feared it would besiege companies with unjustified lawsuits. But he reversed course and voted for it. He still expressed serious concerns: "Provisions in the bill that expand the ability of people to sue may have a positive effect on making people pay attention to their business, but we all know based on our legal system that that is going to be abused," he said.

Gleeful Democrats, meanwhile, taunted House Republicans for finally accepting most of the tougher version of the bill that the Senate first approved last week. "Quite a change of heart," said Rep. John LaFalce of New York, the Financial Services Committee's top Democrat. "After a while the Republicans just got embarrassed."

Martin Regalia, an official of the U.S. Chamber of Commerce, predicted several provisions would fuel plaintiff lawsuits. He cited the statute-of-limitations increase on shareholder suits, which was fought by most major business lobbies. He also pointed to a mandate that "material" changes to a company's financial condition be disclosed quickly. Mr. Regalia said that provision would result in lawsuits that second-guess companies if they wait a bit too long to report a problem that takes a while to sort out. He also cited the mandate that top executives certify the truthfulness of company financial statements.

The legislation for the first time sets up a formal system for shareholders to recover some stock losses related to corporate executives' wrongdoing.

Restitution Fund

The bill directs the SEC to funnel into a new investor restitution fund all the fines and ill-gotten gains -- so-called disgorgement -- it recovers from executives whom the agency has accused of breaking securities laws. Currently, most of the money the SEC recovers goes to the U.S. Treasury, instead of aggrieved investors.

The fund would collect cash or securities from individuals and distribute them among identifiable shareholders who were specifically defrauded by a company executive's fraud. The message to executives: "You lose what you stole," said Rep. Richard Baker, a Louisiana Republican and an architect of the restitution clause.

Mr. Baker said the provision "is not as broad in scope as I would like." For instance, executives can shield assets, including real estate and retirement holdings, under state bankruptcy laws. He said the Financial Services Committee would examine early next year ways to carve out exceptions to state bankruptcy laws for securities fraud.

Until now, the SEC lacked resources to collect many fines from individuals. But the agency's budget is expected to get a boost of as much as $776 million next fiscal year from the bill, a 66% increase.

And the new restitution fund gives the SEC much more incentive to collect the largest amounts possible from executives, because the money goes to victims rather than the Treasury. With the enhanced penalties, "I would not be surprised to see this fund grow rather dramatically," Mr. Baker said.

In a recent study of the SEC's collection rate, the General Accounting Office, an independent research arm of Congress, found that the SEC recovered just $424 million, or 14%, of the $3.1 billion in fines and ill-gotten gains the agency ordered to be paid from 1995 to 2001. Collection usually falls to overworked SEC attorneys who try the cases. The agency has just three full-time collectors. Even after agreeing to pay, many violators still don't.

-- Kemba Dunham and Jeanne Cummings contributed to this article.

Write to Richard B. Schmitt at rick.schmitt@wsj.com⁷, Michael Schroeder at mike.schroeder@wsj.com⁸ and Shailagh Murray at shailagh.murray@wsj.com⁹

Updated July 26, 2002 11:59 p.m. EDT