Market Watch : Shareholder Class-Action Suits Are a Growth Industry

Corporate managers may see them as Frankenstein monsters unleashed by the shareholders. And angry shareholders, in turn, may see them as frail weapons in a battle against management stonewalling and greed.

Whatever the view, shareholder class-action suits are becoming commonplace in corporate America. While class-action suits in general have staged a steady decline over the past 10 years, securities-related class actions filed in federal courts rose 9% in 1989, according to the federal court system.

Moreover, the anecdotal evidence supporting the recent surge in these suits is staggering.

In just the past two months, for example, at least three separate groups of shareholders have sued First Executive Corp. of Los Angeles, alleging that the company issued misleading statements about its financial health; Nordstrom was sued by shareholders who claimed that they were blindsided by the company’s labor woes; Pfizer Inc. shareholders accused the company of withholding information about fatal defects in one of its heart valves; Mercury Savings & Loan Assn. shareholders claimed that the company fraudulently misstated financial records; First Interstate Bancorp was sued for allegedly failing to recognize loan losses in a timely manner, and Genentech shareholders sued to block the company’s planned stock sale.

And the list goes on.

“It’s well known that any company that puts out a negative report is going to have a bunch of opportunistic lawyers on the doorstep,” complained one executive. “Things have gotten out of hand.”

Attorneys counter that company managers are really the ones that have gotten out of hand. If executives operated in the best interest of shareholders, none of these suits would be filed, they said.

“Both sides are right, and they likely deserve each other,” said Ian Mitroff, a professor of business policy at USC. “We have created a game where both sides try to profit at the other’s expense.”

Today’s burgeoning business of shareholder litigation primarily relies on 50-year-old securities laws. The laws, which were passed to protect the investing public after the 1929 stock market crash, require companies to issue detailed financial reports before they sell new shares to the public. These reports must disclose all “material” information to investors.

Putting out purposefully misleading reports is cause for suit, as is failing to disclose financial information on a regular basis, as required by the Securities and Exchange Commission. But the law is not completely clear on how much information must be disclosed after a public offering and between regular reporting periods.

One court decision said companies that don’t talk between reporting periods would not have to break silence to disclose bad news. But another said a corporation has a strict duty to talk--even between periods--if it knows that it’s likely to post a steep earnings decline or issue other bad news that would dramatically affect its stock price.

The laws, however, weren’t frequently applied until the late 1960s, when the U.S. Supreme Court held that individuals could sue on behalf of themselves and others “similarly situated,” which was the beginning of class-action suits.

Allowing investors to sue en masse is important because the suits are often complex and costly to bring to trial, said David Gold, a San Francisco attorney specializing in shareholder litigation. Generally, these suits take four to five years to complete, and individual shareholders rarely have enough at stake--or the financial wherewithal--to go it alone, he added.

Precious few shareholder suits make it that far. A good number are thrown out by judges early on and the vast majority are settled out of court, Gold added. However, when they do make it to trial, shareholders can often win big.

One case brought an award of $500 million to defrauded shareholders, said William Lerach, a partner with Milberg, Weiss, Bershad, Specthrie & Lerach in San Diego. Others judgments have ranged in size from hundreds of millions to just hundreds of dollars.

Richard Dannenberg, a New York securities lawyer, said he just settled a suit against Triangle Industries for $75 million. Each suing shareholder should receive about $5 a share, he said. Normally, however, attorneys are able to persuade firms to settle out of court for less than the damages claimed by shareholders, Gold said.

“We’ve never won on the RICO (Racketeer Influenced and Corrupt Organizations Act) side or gotten punitive damages, but we keep trying,” said Gold. Racketeering or punitive awards are often worth several times more than actual damage awards, which are merely meant to compensate injured parties for their losses.

While corporations generally take the stance that these suits are nothing but a nuisance, plaintiffs’ attorneys maintain that the litigation deters greedy managers from enriching themselves at the expense of shareholders.

But that’s debatable too.

Last year, for example, Occidental Petroleum agreed to settle a shareholder suit by limiting its spending on a controversial museum project in Westwood that would house the personal art collection of Armand Hammer, Occidental’s chief executive. But documents obtained by The Times indicated that the company may have skirted the spending restrictions by having Occidental entities billed for some museum-related construction expenses.

Occidental denied the charges in court documents. But the issue is sure to emerge in settlement hearings scheduled for next month.

And Mitroff believes that the suits--and the reasons behind them--will rage on until there are radical changes in the way Americans do business.

“The problem is systemic,” Mitroff said. Shareholders have financial incentives to sue--the big court awards--and company managers have incentives to act selfishly. “Society has created rules where you can get rich through this carnivorous behavior. Of course it will go on.”