In recent weeks, the agency has been publicly and noisily pressured by a congressman, a union leader and a Democratic presidential candidate, amid increasing consternation the agency is favoring business interests in its decision making. As a result, the SEC‘s decision about whether to weigh in on a Supreme Court case as well as on a similar case seeking the high court’s attention has become a test of its own motto: “investor protection.”
The cases revolve around a similar question: Can shareholders sue third parties, such as investment banks, for another company’s fraud? The SEC hasn’t been asked by the Supreme Court to file a “friend of the court,” or amicus brief, but lobbying by high-powered plaintiffs lawyer Bill Lerach, who represents shareholders in the Enron case, has boxed the agency into a corner. Unless it sides with shareholders, the SEC could be criticized as an ally of business for wanting to restrict the number of ways investors can sue.
Where the SEC comes down is “an absolute litmus test” of the agency’s leanings under Chairman Christopher Cox, said Ralph Ferrara, a former SEC general counsel who is now in private practice at LeBoeuf, Lamb, Greene & MacRae LLP. He thinks the agency should support the plaintiffs: “The SEC should be in there saying this is what’s best for small investors,” he said.
The SEC is under increasing pressure for what some see as several pro-business moves. Barney Frank, the Democratic chairman of the House of Representatives Financial Services Committee, has invited all five SEC commissioners to an oversight hearing next month. While Mr. Frank hasn’t been critical of the agency, the hearing will likely hear concerns expressed by unions and investor groups. Complaints include scaling back provisions of the Sarbanes-Oxley law, changing the process of deciding when to penalize a corporation engaged in a fraud and making a last-minute change to executive-compensation disclosure rules.
The SEC said streamlining the Sarbanes-Oxley provision will save investors money and allow managers to focus on risks that can affect financial performance. It said changes to the penalty process will result in stiffer penalties, and the new executive-compensation disclosures will give investors
more information. Mr. Cox told reporters he will be “waving the flag of investor protection” when testifying before Mr. Frank’s committee.
The current issue dates to 1994, when the Supreme Court ruled third parties that work with public companies can’t be sued by that company’s shareholders for “aiding and abetting” in a fraud. The new question before the court is whether these third parties can be sued as being directly liable for a company’s fraud. If the Supreme Court decides shareholders can sue on those grounds, it could pave the way for more suits.
A repeat performance would likely put the SEC on Mr. Lerach’s side, and Mr. Cox has previously resisted breaking with policy decisions made before he became chairman. But the tide appeared to change this year when the SEC filed a legal brief in a different Supreme Court case that was widely seen as pro-business. In the brief, the SEC said investors need to establish a “strong” inference that defendants acted with fraudulent intent compared with a standard of a “reasonable” inference that is being challenged.
In response to complaints that followed the brief, the SEC said its view is in line with a majority of courts. Mr. Cox, a former Republican congressman, himself championed a 1995 law aimed at preventing frivolous lawsuits.
One of the cases in question is before the Supreme Court. Shareholders of Charter Communications Inc. sued Scientific Atlanta, now a unit of Cisco Systems Inc., and Motorola Inc., for allegedly helping Charter inflate its financial performance. A Missouri district-court judge dismissed the case, citing the 1994 Supreme Court decision. Shareholders appealed, only to find the Eighth Circuit Court of Appeals in agreement with the lower court. They appealed to the Supreme Court.
The other case involves Mr. Lerach, who is representing former Enron shareholders in a case that raises similar legal questions. He has asked the Supreme Court to fold his case into the Charter review or hear it on its own merits. Mr. Lerach alleges that several Wall Street firms should be held liable for Enron‘s accounting fraud because they financed transactions the company used to inflate its results. A federal appeals court disagreed, arguing that because the bankers didn’t make any misleading statements, they couldn’t be held liable.
This year, Merrill Lynch & Co., one of the defendants in the lawsuit, asked the SEC to weigh in on its side. The agency declined. Meanwhile, a California nonprofit, the Foundation for Taxpayer and Consumer Rights, filed Freedom of Information Act requests to learn about the SEC meetings with Merrill Lynch.
Senate Banking Committee Chairman Christopher Dodd, a Democrat from Connecticut, sent a letter dated May 25 to Mr. Cox asking if the SEC would weigh in on the current case and, should it break from the “meritorious” position taken in the 2004 case, Mr. Dodd asks for the reasons supporting its decision.
Mr. Lerach launched a public-relations offensive. He won the support of aspiring Democratic presidential candidate and former plaintiffs lawyer John Edwards, who said: “I urge the SEC to fulfill its historic mission of protecting investors. Silence, or even worse, siding with fraud participants, would be a betrayal of that mission.” The plaintiffs bar has historically been a large source of funding for Democrats.
A few weeks earlier, Mr. Lerach was joined by Andy Stern, president of the Service Employees International Union, and several Enron investors at a news conference near Capitol Hill. One investor spoke of financial devastation he experienced at the hands of Enron‘s collapse. Hours later, Mr. Cox spent an hour with the investors, where he took pictures with them and gave them a tour of his office overlooking the Capitol building.