I have kept a big secret for more than two years.
For twelve years, I was a founding partner of a law firm that filed over 300 securities-fraud class actions. I frequently worked directly with Bill Lerach and Mel Weiss, and worked with their firm, Milberg Weiss, at least a hundred times. I have turned down numerous opportunities to dish gossip about this controversial field, but I am now willing to let a secret out of the bag -- how to stay out of court and avoid this kind of trouble.
1. Fix Your Insider-Selling Policy
According to the Stanford Securities Class Action Clearinghouse, plaintiffs have alleged insider selling in 57 percent of securities cases filed after the Private Securities Litigation Reform Act of 1995 imposed limitations on investors suing for fraud. Against high-tech companies, insider selling is alleged 73 percent of the time. Insider selling arose in only 21 percent of pre-Act cases.
Insider selling is best way for plaintiffs to meet the Act's heightened requirement that they "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."
Larry Ellison trumpeting Oracle (ORCL, info) while selling $890 million of its stock, only to admit to internal weaknesses two months later, sounds like such an inference. Without the stock sale, the case - probably the most lucrative that the plaintiffs' bar has in inventory - would focus on Oracle's incorrect forward-looking statements, a weak, losing claim that forms the basis of only 6.5 percent of post-Act cases.
Companies can render plaintiffs' counsel impotent by cleaning this up. First, set up very limited periods (immediately after earnings announcements) during which insiders can sell. Second, require continuous selling during these periods. If Larry Ellison sold two million shares on a set day after every quarter, instead of selling none for three years then thirty million shares in ten days, the inference of fraud would disappear. Third, make the big guys announce their sales in advance.
2. Substitute Guerilla Tactics for the War of Attrition
Every company defends these suits the same way: (1) publicly disparage the case and the law firms; (2) file every possible procedural motion to dismiss the case; (3) threaten to seek sanctions; and (4) bicker endlessly over providing documents in pre-trial discovery. No wonder defendants claim the cost of litigation forces them into settlement; it costs a fortune.
IBM (IBM, info) once hired Milberg Weiss, the leading plaintiffs' firm, to defend and advise on a securities class action. Instead of spending millions in legal fees, IBM filed an immediate motion for a summary judgment - which is based on evidence, not allegations in a complaint - and pushed the court for a fast schedule to resolve it. IBM then made available all the millions of pages of documents sought in plaintiff's document request.
The plaintiff's firm got what it wished for, and regretted it. It has always amazed me that more companies have not tried this approach.
3. Get Off the Fast Track
If you refuse to consider class actions a cost of doing business, shut down the public relations machine that has come to dominate the high-tech corporate culture, especially at younger companies that are more frequently in the market for capital.
Limit contact with analysts and the media. Stop giving "guidance" and talking about "visibility." The illusion that the company's future can reliably be predicted increases a stock's PE ratio, its price, and its ability to raise money. If you don't want people to sue you when the stock price does down, simply stop trying to talk the stock up.
Discontinuing some controversial revenue-enhancing accounting practices can also drastically reduce the likelihood of being sued. Two-thirds of post-Act cases alleged accounting fraud, double the percentage making such allegations before the Act. The biggest culprit is revenue recognition.
So many high-tech companies goose sales by pushing through dubious transactions at the end of the quarter that a defense attorney at a settlement conference told me it was now the industry standard and therefore not actionable. (They soon settled that case.)
4. Lobby Better
The 1995 Act has been a disaster for defendants. This year is shaping up as the busiest ever for securities fraud suits. The additional burdens necessary to become lead counsel have ended up helping plaintiffs. Firms also had to clean up their client-gathering activities, an Achilles heel for the business and a productive area for defendants trying to derail a case.
The best feature of federal securities-fraud class actions has been judicial elimination of the need to prove that plaintiffs (and class members) relied on the defendants' misrepresentations. Courts have adopted a "fraud on the market" presumption, concluding that a stock's price on a recognized exchange incorporates all the information about a stock.
Private securities enforcement could disappear without this presumption. Plaintiffs would have to plead (and later prove) that they specifically relied on the information that later turned out to be false. In fact, every class member would have to prove this, making it doubtful that common issues could predominate, a requirement for a class action.
If you own an emerging company and you want to skirt all these ideas, just do the most obvious: discontinue your directors'-and-officers' liability insurance. Maybe it is scary operating without a net, but I can tell you from experience, that it is no fun suing a company with no money, no insurance, and a beat-up stock. No one will touch you.