American Enterprise Institute

October 5, 2007

[Edited transcript from audio tapes]

8:45 a.m.	Registration and Breakfast
9:00	Panelists:	Louis M. Bograd, Center for Constitutional Litigation
		Jonathan Cuneo, Cuneo Gilbert and LaDuca, LLP
		Theodore H. Frank, AEI
		Robert Gasaway, Kirkland & Ellis LLP
		Harvey Pitt, Kalorama Partners, LLC
	Moderator:	Michael S. Greve, AEI
11:00	Adjournment

Proceedings:

Michael S. Greve:  We’ll start with Ted Frank, who’s my colleague here at AEI and directs the AEI Legal Center for the Public Interest.  He is also, as he will tell you, probably, a nominal plaintiff in this particular case.  We’ll then go to Bograd, who’s a senior litigation council with the Center for Constitutional Litigation, and filed a brief for the American Association for Justice in the case.  Then we’ll go to – how do we do this?  We’ll go to Harvey Pitt next, former Chairman of the FCC, now the CEO of Kalorama Partners, and he’s one of the SEC officials, and other prominent law and finance experts who also filed a brief in this case.  Then we go to Jonathan Cuneo, who’s a founding member of Cuneo, Gilbert, and DeLuca.  Here in town, he drafted the AARP’s amicus brief, in the Stoneridge case.  And finally, Rob Gasaway, an AEI regular, but nominally, at least, a partner at Kirkland and Ellis, who filed a brief on behalf of the Washington Legal Foundation in Stoneridge.  Ted?

Theodore H. Frank:  Thank you, Michael, and thanks to everyone for coming.  As Michael mentions, I’m a plaintiff in this case, as a member of the punitive plaintiff class of charter shareholders allegedly damaged by Scientific-Atlanta’s and Motorola’s actions, and that’s, I think, one of my favorite disclosures ever, given that I’m frequently accused of conflicts of interest that I can tell you that, as a party to this case, I think the scheme liability, that plaintiff seek in Stoneridge would be disastrous. 

Let me start by giving some background to the case.  We’ll acknowledge straight up front that Charter Communications, the underlying cable company whose stock is at issue, their executives were naughty.  They engaged in accounting shenanigans that inflated revenues by close to half a billion dollars.  This was the Internet bubble heyday, where stock analysts were following revenues more closely than more conventional metrics, and the stock value was inflated by some seven billion dollars.  As a result, when the disclosures came in the early years of the Internet bust, the stock dropped by seven billion dollars.  Some executives went to jail, and, as always in this sort of situation, lawsuits followed.  Charter was sued, but more interestingly, a number of people with whom they did business were sued for allegedly participating in the scheme to inflate Charter’s revenues. 

What did Scientific-Atlanta, the respondent in this case, along with Motorola do?  They sell set-top boxes, the little boxes that sit on top of your television set to Charter, and, as part of the transaction, they agreed to what was essentially a wash, whereby the price of the set-top box was increased by twenty dollars, and Scientific-Atlanta would purchase twenty dollars of advertising from Charter Communications.  Charter then used that twenty dollars to raise its advertising revenues, and meet Wall Street targets in its own accounting, in part by lying to their accountants on how those deals were negotiated.

That those transactions increased revenues by about seventeen million dollars or so, which is a tiny fraction of the four hundred million-dollar exaggeration that Charter engaged in, and for this, the plaintiffs seek to hold Scientific-Atlanta jointly and separately liable for the entire seven billion- dollar stock market drop. 

You can see very quickly why this is the most important securities case before the court in a decade.  Lower courts threw this out in -- the Supreme Court had earlier ruled that this sort of aiding and abetting civil liability could not be countenanced, it’s secondary liability, and you can very quickly see why.  If simply doing business with someone, who then lies to their accountants, and then hides those numbers in their accounting records in such a way that the stock market is deceived about the true nature of the transaction, can then be sued, how can you account for that?  How can you police what your customers are doing in their accounting? 

The impact of this sort of case can be illustrated by both sides of the Enron case, which is also pending in a petition before the Supreme Court.  As you know, Enron collapsed, lost forty billion dollars in stock market value.  The investment banks that did business with them were sued under a similar theory of liability.  Now, these investment banks lost a lot of money dealing with Enron and holding Enron bonds and so forth, but they were sued for allegedly aiding and abetting the financial scheming by which Enron hid its losses, and many of these banks, faced with potential liability in the tens of billions of dollars, were given the opportunity to settle for five cents on the dollar. 

Now, even the most ardent advocates of our current liability system say, “Juries get it right about ninety percent of the time.”  So when you’re offered a five percent insurance policy against bankruptcy, after the court said that the case would proceed, you take it, even if it costs you two billion dollars if you’re at all risk adverse.  And banks such as City Bank and Bank of America were risk adverse, and they settled with Enron, with the Enron creditors, for a total of seven billion dollars, and settlements paid essentially as protection money, seven hundred-million of which went to lawyers such as Bill Lerach.  Merrill Lynch, appealed the district court’s ruling and actually won in front of the Fifth Circuit.  So, essentially valueless claims were settled for seven billion dollars simply because of the risk of this gigantic liability, and that sort of extortion at risk would be faced across the board by just about everybody who does business with corporations that are then turn out to be fraudsters. 

We have an interesting case.  There are only eight justices.  Justice Briar has recused himself.  Chief Justice Roberts had originally recused himself and appears to have sold his Cisco stock and preserved his capital gains without getting taxed on them under a nice law by which, if you’re selling stock to avoid a conflict of interest, you don’t have to pay taxes on it, and thus, Chief Justice Roberts has been unrecusing himself from a number of cases.

Male Voice:  It’s a great rule.

Theodore H. Frank:  And this is another one of them.  But we have eight justices who will be deciding this case, will be deciding the scope of the securities laws, and the original decision in 1994 was a five-four decision by Kennedy.  And if this goes five-three the other way, we could see a dramatic increase in the scope of the securities laws, which is of concern given new laws that have taken effect since 1994.  Congress has steadfastly refused to expand the security laws to undo the Supreme Court’s decision, and now petitioners seek to have that done in the judiciary what they couldn’t get done in the legislature, but the Sarbanes-Oxley Act has also been passed, and Section 44 of that requires an inclusion of internal control disclosures in every public corporation’s annual report.  And one can be held liable for the accounting of the companies you do business with. 

Well, how do you generate those sorts of internal controls to effectively supervise other companies’ accounting?  I think this is an underexplored issue, potentially a gigantic problem for the business community in terms of raising costs and just everyday contracting, and scheme liability plus Sarbanes-Oxley would put a huge drag on the economy and make international firms much less likely to want to do business with American firms.  Very dangerous case, and it’s one reason that, even though I am a plaintiff, and even though I was once subpoenaed by Scientific-Atlanta, I believe that the Supreme Court should affirm.

Michael S. Greve:  Thank you, Ted. 

Louis M. Bograd:  First of all, I’d like to say it’s good to be back in D.C.  I lived here for many years, but recently followed my spouse to Kentucky, and I’d like to thank AEI for flying me back for the occasion, and reminding me just how humid life is in Washington, D.C.  I’d like to begin by noting that we’re hearing lots of protestations of gloom and doom from the business community about this case.  Despite that, this should be an easy case.  If we accept the plaintiff’s allegations as true, and Ted just described them, Motorola and Scientific-Atlanta were far from your aiders and abettors; they were active and knowing participants in a fraudulent scheme.  Now, it may not have been the only fraudulent scheme Charter Communications was involved in, and maybe their liability should be limited to conduct related to – that grows out of their particular scheme to defraud, but they were active participants, knowing and active participants in the scheme to defraud. 

Back in the Central Bank case that everyone is describing as the grandfather of this case, when the court said there is no aiding and abetting liability, the Supreme Court made clear that there was liability when what our people like to call secondary actors commit primary violations of the securities laws.  The Court said the absence of 10b, aiding and abetting liability, does not mean that secondary actors in the securities markets are always free from liability under the Securities Act.  Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement or omission, on which a purchaser or seller of securities relies, may be liable as a primary violator under Section 10b.  That’s all the plaintiffs in this case are seeking, is to hold Motorola and Scientific-Atlanta liable as primary violators under the securities laws.  Both companies engaged in completely sham transactions to improve Charter Communications’ balance sheet, both fraudulently back-dated documents or created false documents to hide the sham nature of the transaction, and both knew, or certainly should have had every reason to suspect, that the reason Charter wanted to engage in these wash transactions was to improve their bottom line for purposes of convincing investors to raise the stock price. 

That, my friends, is not aiding and abetting, it’s a primary violation of the securities laws.  Moreover, the only question on which the Supreme Court has granted cert in this case, which is the question of whether Section 10b covers deceptive conduct, as opposed to deceptive statements, should be a complete no brainer.  The statutory language is clear that the statute covers schemes and devices and artifices to defraud.  Rule 10b-5 is clear.  The Supreme Court precedent is clear, or as clear as it can be, that in a number of cases the Court has specifically stated that devices and acts and conduct are covered by the Securities Act. 

As we noted in the amicus brief we filed for the American Association for Justice, common law precedent, from the time when the Securities Act was passed, dictionary definitions from the time that the Securities Law was passed, commentary in the First Restatement of Torts, which was enacted at the time that the Securities Law was passed, all make clear that deceptive conduct is covered by the Act.  Indeed, even the Bush administration agrees with us on this point, and in the brief they filed in the Supreme Court, conceded that the Eighth Circuit got it wrong, and that deceptive conduct is covered by the Securities Act. 

So what is there interesting to say about this case?  Why all the hue and cry that would justify the outcry that we’re hearing from the business community?  I’m not really sure, but I’d like to make three general observations.  The first goes to this issue, the only one that speaks to a legal issue, which is the question of reliance, which, as I noted, is not even an issue on which the Court focused in its grant of cert. 

The Bush administration now says that this case was properly dismissed because there was no reliance.  The plaintiffs cannot prove reliance on the actions of Motorola and Scientific-Atlanta because Motorola and Scientific-Atlanta did not directly communicate with them, and therefore there’s no way the plaintiffs could’ve relied on their participation in this scheme to defraud.  This, despite the fact that the statute expressly speaks about schemes to defraud directly or indirectly, so that it clearly reaches conduct that is not directly linked to the securities purchasers or sellers. 

It’s important to note that the administration’s position on this reliance issue represents a complete about face from the position that the SEC took during the Bush administration in the Homestore litigation in the Ninth Circuit.  In that case, the SEC had this to say about reliance: “The reliance requirement is satisfied where a plaintiff relies on a material deception flowing from a defendant’s deceptive act even though the conduct of other participants in the fraudulent scheme may have been a subsequent link in the causal chain, leading to the plaintiff’s securities transaction.  The test is met where the plaintiff relies on a material deception that flows from a deceptive act committed by the defendant even though the conduct of others is a subsequent link in the chain of causation that injects the material deception into the securities markets.” 

And even somewhat more telling is the comment that the Bush SEC made about the contrary position that the Bush administration is now advocating in the Supreme Court.  “It is important that the Court reject the approach of defendants and their amici to reliance, as it would only invite gamesmanship on the part of wrongdoers.  Defendants and their amici essentially argue for a rule precluding reliance on parties that are one or more causal steps removed from the injured party.  But under such a rule, wrongdoers could structure their conduct so as to engage only in material deceptive activity, that is at least one causal step away from false statements to investors in the market and thereby escape liability in a private action.  This would be the case even though their actions caused the same injury to investors and the same deleterious effects on the markets as if they had committed fraud through their own false statements.” 

I don’t know whether the Supreme Court’s going to reach the reliance issue.  They could choose not to even get there, since it’s not encompassed in the scope.  If they do, I think it’s pretty clear where the law is, and it’s pretty clear that this case, on that point as well, should be straightforward. 

My second point.  How did the Bush administration get to this position?  Those of us on the plaintiff side were not exactly shocked when the Bush administration decided to come in on the side of Motorola and Scientific-Atlanta, despite the position that the SEC had taken in Homestore.  But we were surprised by this weirdly schizophrenic position, the reverse argument for the reversal of the Eighth Circuit on the deceptive conduct issue, but then for affirmance on this reliance ground. 

Now, it may just be that the administration found the Eighth Circuit’s position indefensible.  But, as we well know, this administration finds almost nothing indefensible, so it’s hard to imagine that that could be the explanation.  More likely, the explanation turns on the fact that unlike private plaintiffs, the SEC doesn’t need to prove reliance to bring civil enforcement action.  If I were a fly – if I could’ve been a fly on the wall, I imagine there was a fierce struggle inside the SG’s office between career lawyers at the SEC, who wanted very much to maintain strong protections against fraud, and political appointees in the administration who wanted to serve their corporate cronies.  Ultimately, they cut the baby in half, taking a position that protected the SEC institutional prerogatives while still managing to screw the little guy who’s been victimized by corporate wrongdoing. 

Finally, what will the Supreme Court do with this case?  It beats me.  I’d like to think that the Court will overturn the Eighth Circuit.  That’s the right thing to do on the law.  Plus, this Court has a strong history of interpreting Section 10b broadly and often doing so unanimously.  The Court regularly talks about the need to flexibly interpret the statute to protect the market and protect investors.  And Chief Justice Roberts still claims to favor narrow unanimous rulings.  So that might well argue for a reversal.  On the other hand, as many of the recent Supreme Court previews noted, this is undoubtedly the most pro-business Court we’ve had in decades, with few qualms about limiting claimants’ rights to sue.  So, as I said at the outset, this case should be easy. 

While I won’t make a prediction, I will make this observation.  If the Court sides with Motorola and Scientific-Atlanta, that would be a very dark cloud that would portend many bad days to come for the victims of corporate malfeasance, not just under Rule 10b, but in all kinds of business tort litigation.  Thank you.

Michael S. Greve:  Thanks so much.  Harvey.

Harvey Pitt:  Thank you, and it’s good to be here.  I think this is a very useful exercise, and I applaud the American Enterprise Institute for putting this on.  In some sense, for those of you who like burlesque, I kind of feel like the dog act following and preceding the strip tease.  I signed an amicus brief in this case that took a position.  I have no interest in rehashing what was in the brief, nor will I predict the outcome.  My epitaph will surely read, “Seldom right, but never in doubt.”  So I’m going to let that opportunity pass.  Rather, I’d like to do is talk to you about what I think some of the significant issues are, not from a legalistic point of view, but from a societal and economic point of view. 

We have a serious problem in this country, and it is trying to figure out how to balance the needs of investors and people who have been wronged, who deserve a forum to get recompense for improper conduct that has inflicted economic harm on them, with the need not to punish other innocent investors.  And this gets lost in the debate continually.  The shareholders of Motorola and Scientific did not do anything wrong.  Yet they will also be faced with a loss on their investment, and so much of today’s litigation seems to be an effort to shift the penalty for fraudulent misconduct from one set of innocent investors to another set of innocent investors.  The reason I raise this is because, to me, the principle reason why this case is significant is not because the outcome of this case is really going to be earth-shattering in a narrow sense, nor is it going to be a major beacon of light on the federal securities laws.  This really goes to what the roles of various institutions in our society are.  I thought Lou made some very impressive arguments as to why there might be a need for liability for so-called secondary actors.  The problem is that argument should be made to Congress.  Since 1995, it’s been made twice, and Congress has rejected it.  That doesn’t mean that that decision is correct.  It only means that that’s the right place for the issue to be raised. 

There are lots of issues that need to be considered when one takes up a question of liability like this, including what is the proper measure of damages?  What should the standards be?  Should there be a requirement for alliance or not?  We can all appear to debate those issues.  We’re all capable of doing that.  The point is that the debate should be had in Congress, and Congress should make a decision. 

Another major outpouring of this is U.S. competitiveness.  Now, I realize that for some, it’s no longer PC to worry about U.S. competitiveness.  I don’t approach this from simply a question of what’s good for business.  I really don’t think that’s the issue, and I think it demeans the major impact of these cases to try and put things in that light.  To me, the major issue really is whether we have a rational system of liability, and if we don’t, how do we fix that?  In my view, the worst place to try to fix that is in the courts.  The best place to try and fix it is in Congress, where everyone gets an opportunity to be heard, the various political factors are taken into account as well, and a resolution comes up. 

But U.S. competitiveness is suffering, and many people blame that on Sarbanes-Oxley.  I, frankly, discount that argument.  I think there was and may be some merit to some of the things, but I think we’re fixing a lot of those problems.  To me, the major impact on U.S. competitiveness is our litigation environment, and I go back to the fact that I believe we need strong rights for people who are defrauded.  The problem is we have to put them in a context, and we can’t do that in the context of the case, which has very interesting facts, but you have someone who had no duty to speak, who’s being held liable for never saying anything to the people who are now claiming relief.  Maybe that’s a good result, but I don’t think it should be one that’s judicially mandated.  I think that has to come from Congress.

The other issue, I think, is what is the role of precedent and what are the transactional costs that are implicated by a case like this?  To me, the role of precedent is fairly clear.  The Supreme Court said the statute that we’re looking at does not encompass secondary liability.  Maybe they got it wrong.  I don’t think so, but maybe they did.  And if they did, again, I think Congress should be the one to say, “We got it wrong”, or “We need to reverse our decision.” 

The other issue is transactional costs because our society is based on the predictability of legal outcomes.  When there’s no predictability, when you don’t know from one case to the next whether you might be held liable, one of the first things you do is you raise the costs of the transaction.  Lawyers, accountants, investment bankers, others have to raise the costs of transactional activity in order to ward against the possibility that they may somehow be held liable.  That goes back to my concern about U.S. competitiveness because when we do that, we put ourselves directly contrary to most of the rest of the free world.  We put ourselves in a situation where the costs of doing business become exceedingly high, and make it difficult. 

So in my view, the answer here is not whether the Court of Appeals got the decision right or wrong.  The answer really here is where should these issues be debated and how should they be resolved?  And in my view, much as I have great respect for the Supreme Court, I don’t think these issues should be resolved by the judiciary.  And my hope is that we can get a real debate going on in Congress instead of trying to deal with issues like this through the back door of litigation.

Michael S. Greve:  Thank you, Harvey.

Jonathan Cuneo:  I want to make clear that my law firm has played a variety of roles throughout this whole process, but that any remarks that I make are only mine, and not attributable to any of the people that we have in the past represented.

Now, I guess the first question I have is whether Sara Wexler is in the room.  And if she is, I want to thank her for her courteousness and promptness, efficiency, and politeness. Sara, I think that I’ve seen enough of life to know that if you continue that, you’ve got a job for life somewhere, that many companies will be delighted to have you. 

Now, this -- everyone who looks at this issue says this is an important case, it’s a Super Bowl, it’s Roe v. Wade, and it’s interesting, because our side feels the same way, but I think that there is really a disconnect in how we define the issues.  Ted sees disastrous consequences for naughty executives if this case proceeds, and he sees a tidal wave of litigation in the offing – something that will hurt American competitiveness.  And so his concern is about the volume of lawsuits, the effect on companies, and the effect on competitiveness.  Our concern – I’m going to address Ted’s in a second – is that this addresses a very small number of cases, but those cases are very, very significant.  Frequently, in the most egregious frauds, where there are criminal prosecutions – Enron comes to mind – there’s a whole network of financial professionals, investment bankers, lawyers, accountants, who assist actively in the perpetration of that fraud.  And at the end of the day, the main perpetrators are unable to answer any kind of a judgment from the defrauded victims.  And that means that either the insurance policies are depleted, there are no assets left, that any recovery has to come from people who schemed with the principal perpetrators to defraud the victims.  And if it doesn’t come from those schemers, then it won’t come at all. 

Ted noted that in the Enron case, for example, of the seven billion dollars in recovery, 6.6, I believe, came from banks.  Now, of course, he says that those were, in effect, nuisance suit settlements.  Those banks are represented by big, sophisticated, tough lawyers who are experienced in rock ‘em, sock ‘em litigation, and they settled because they felt that their clients had liability.  And I might say in that case, the Justice Department pursued -- and the SEC -- pursued a number of banks and bank executives for their activities with respect to Enron. 

Now, I think the rule, and I agree that the rule here shouldn’t be whether things are good for business, or whether they’re bad for business.  The question is what rule makes sense for all of us?  And I believe that the Supreme Court is capable of formulating a rule in which the guilty are held accountable, and fully accountable, and that, at the same time, the innocent have no fear of baseless lawsuits.  Now the basis for my conclusion goes something like this.  We have a laboratory for this, and that is years and years of American history.  For many years, the common law existed right alongside the Securities Acts.  As Lou noted, the common law rule is that people who scheme are liable. 

Since 1966, when the class action rules were revised, everybody believed, until 1994, that there was aiding and abetting liability.  There was RICO liability for people who participated in frauds.  Yet, between 1982 and 1994, the stock market experienced previously unparalleled gains.  So the fact of the matter is that there’s an experiment.  There’s an historical basis during which these rules, and more liberal rules than what are contemplated here, existed.  And there was no crisis, there was no problem, there was merely accountability. 

Now, I want to address the policy issue, and the question, really, for people who are concerned about business, is whether honesty and accountability are good economic policy.  And I think that everyone agrees that they are.  Attorney General Gonzales delivered a speech last spring in which he said that.  He issued some very brave words on that point.  And if you look at the lineup of who’s before the Supreme Court, this isn’t a lawsuit about trial lawyers; it’s not even a lawsuit about victims.  This is a lawsuit in which the suppliers of capital, people who supply liquidity, and responsible voices are on one side, and the other side are essentially people who fear being defendants in lawsuits.  But if you look at who is on our side: the Council of Institutional Investors, that’s a very responsible group.  They have over three trillion dollars in assets.  The American Association of Retired Persons: thirty-eight million people, one of the great prides of the American economic system is that average people across the country, folks, invest in public markets: Members of Congress, former SEC chairs, including two, a chair and a commissioner, appointed by President Bush.  Retirement funds, thirty-two states, the state securities administrators, editors of major newspapers from across the country, people who are in touch with their communities have opined that the Supreme Court should uphold scheme liability, and the other side are very responsible voices, but essentially, they are the voices of the business community, who, in my judgment have an overstated fear of being sued in the financial community, and who don’t like lawsuits at all.

Now, I think that the court’s challenge, as it comes up, is to define a rule under which there won’t be a tidal wave of litigation, but on the other hand, there won’t be a safe harbor for fraud from people who essentially are clever enough to simply hide behind the curtain and not show themselves and issue public statements. 

And as to competitiveness, I’d like to leave you with this thought.  When I was in law school, a long time ago, I believed that the so-called multinational movement, as it was known then -- it shows you how old I really am -- would break down international competition laws.  But instead, cartel enforcement, anti-price- fixing-enforcement has been, like jazz, a great American export product.  And sophisticated countries around the world now have very, very advanced criminal cartel enforcement. 

And, of course, the same thing is now happening with the Foreign Corrupt Practices Act.  I’m not an expert in this area, but that was something that, at the beginning, American businesses claimed would put them and our economy at a competitive disadvantage.  But what we have now are a series of international agreements by which sophisticated economic governors around the world are adopting the American model.  They essentially alter it a little bit, but the fact of the matter is that these two developments have been enormous progress, and they’ve been export products.  These aren’t some soft values.  These are hard business values.  These are things that benefit American business.  They benefit us all.  And I think that we have the same opportunity here, and it’s the Supreme Court’s challenge to help define that.  Thank you.

Michael S. Greve:  Thank you.  Bob.

Robert Gasaway:  Thank you, Michael, and thank you to AEI for having me.  Like the others on the panel, I speak only for myself, not for my law firm or our clients or the business community, but just my own perceptions as a participant in the litigation process. 

The question here is not about liability for lawyers, it’s not about liability for accountants, it’s not about liability for capital providers or underwriters.  The question here has to do with arm’s length business partners.  Now, that’s significant, because the issue here is injustice, and the fundamental question is, is there a greater risk of real-world injustice if you vote one way on the Supreme Court or a greater risk of litigation injustice if you vote the other way? 

Our contention in our amicus brief is that the real risk here is one of litigation injustice.  The accusation against Motorola and against Scientific Atlanta is that they aided and abetted a fraudulent scheme.  The further accusation is that they gained about 3.5 million dollars in free advertising or underpriced advertising because of that. 

Because of that 3.5 million dollar gain, they are subject to losses that the plaintiffs compute at seven billion dollars.  Now that is litigation system injustice, and if you think of the characteristic cases that are hooted down, the characteristic cases that give our system of justice a bad name, both in this country and abroad, it’s not because there was no injustice committed, it’s because the injustice was over-exaggerated.  Think of the lost pants at the dry cleaners.  That may have been an injustice, but it wasn’t an injustice to the extent that the recovery was thought.  Think of the improper paint job by BMW that reached the Supreme Court.  Whatever the damages and harms from that paint job, it wasn’t the -- I think it was for six million dollars that the trial court held or the two million dollars that eventually reached the Supreme Court. 

The risk of our legal system is not so much that it finds injustices where they don’t exist, but it creates incentives on the parts of participants in the legal system to exaggerate those injustices and to get recoveries for them that are out of all proportion of any accusation of the injustice.  Now, the evidence of that here, again, is that there is a seven billion- dollar purported loss to the investors that was never once mentioned in the original briefing of the plaintiffs.  Never mentioned it.  If they were loud and proud on the fact that they were going to prevent a large fraud, they should have been trumpeting that fact.  “There are seven billion dollars of losses, and we’re going to see that justice is done.”  They never mentioned the seven billion-dollar figure, and on their reply brief, after it was mentioned in the briefs for the defendants, and for their amici, they came back and they did not trumpet the fact, but they diminished it.  “Well, it may be only 1.46 million dollars.  And we didn’t really mention that, but now we’re going to cut it and carve it down, and so it’s not really seven billion dollars, it’s only 1.46 million dollars.”  That’s why this is such a dangerous case, and that’s why it’s such an important case. 

Now, like most dangerous cases, this is an easy case.  The doctrine is absolutely clear, it’s not about reliance, it’s not about scheme liability, it’s about whether or not Motorola and Scientific-Atlanta were participants in a scheme to purchase or sell securities of Charter Communications.  Did any fraud that they commit happen in connection with -- that’s legal language from both the statute and regulation –- the purchase or sale of Charter Securities?  Answer: no.  And on this issue the Eighth Circuit got it exactly right.  They did not directly buy or sell Charter Securities, and secondly, they had no financial interest in the purchase or sale of Charter Securities.  They never owned them; they didn’t get paid for their set-top boxes based on the performance of that stock; there were no derivatives, no nothing.  They sold set-top boxes in arm’s length transactions to Charter, and there was no purchase or sale in connection with any Charter securities on their part. 

That’s a clean rule, that’s an easy rule, and that’s a rule that prevents the type of over-liability in not only this transaction, but of a whole host of transactions.  Now, why is it so important that that rule be upheld?  Well, in terms of the equities of this case, it’s clear that, again, the plaintiffs are very uneasy about that fact.  The plaintiffs are very uneasy about the fact that Motorola and Scientific-Atlanta had no financial interest in this scheme.  At most, they were aiders and abettors of it.  And again, and again, and again in their brief, without really saying so, they use language and make statements that shows it’s very difficult for them to justify liability against people that did not purchase or sell securities and had no financial interests in the performance of those securities.  On page 15 of their brief they say they were partners in this fraud.  Well, they weren’t partners in the fraud.  They had nothing to gain from the fraud.  And then again, on page 12, page 14, page 32, again, none of these transactions was at arm’s length.  This is not a case involving an arm’s length transaction.  This case involves transactions that were anything but arm’s length. 

No, these were arm’s length transactions.  Motorola and Scientific-Atlanta were completely unrelated to Charter Communications, they had no ownership of Charter Communications securities, they were able to negotiate the terms of trade for their set-top boxes at arm’s length, they gained no profit from it, and because of that, as a legal matter, and as an equitable matter, and as a policy matter, it makes no sense to hold them liable for securities fraud.  They should be fully accountable for any other violations of law they committed.  If this was common law fraud, if this was wire fraud, if this was any other type of fraud, they should be held accountable. 

But unlike those other types of frauds, where the damages are going to be measured likely by some multiple of the gain they got, the 3.4 million dollars, securities law provides unique opportunities for abuse because of the outsize damages measures you can use.  Seven billion dollars, according to the defendants, about 146 million dollars, according to the plaintiffs, for a purported 3.5 million-dollar gain.  And that’s why this case is so important, and that’s why it’s so dangerous.  It’s easy as a legal matter, but it’s very, very dangerous if you get it wrong because it opens the door, not to liability where there should be no liability, but to exaggerations of liability, not just by ten times or a hundred times, but potentially up to thousands of times.  Thank you, Michael.

Michael S. Greve:  Thank you, Rob.  On behalf of the audience, and on my own behalf mostly, I want to thank all the participants for being so exceptionally disciplined as well as coherent.  I want to give all of you a chance to respond to each other.  I have some questions, but I’ll hold those back.  Why don’t we go just one more round – two minutes or so – starting with Ted?  In the same order?

Theodore H. Frank:  Very quickly, I kept hearing the words “safe harbor,” and it should be made very clear that, even if the Supreme Court rules in favor of the respondents here, there is no safe harbor.  There’s still government liability, there’s still government prosecutions if there’s actual wrongdoings, so that there’s not a question of defrauding executives getting off scot free. 

The question on whether the Enron suits are legitimate: if the claim is being made that these are legitimate suits for forty billion dollars, then one question is why the lawyers are setting them for pennies on the dollar.  And I think -- you look at the game theory of this, and you have a risk adverse general counsel being told, “You can continue to defend this case at ten million dollars a month, waste your executives’ time, have this giant sword of Damocles hanging over your company’s head for years while the case is tried, while it goes under appeal, even if you win, putting your entire company at risk, or you can get rid of it for pennies on the dollar.”  A lot of general counsels take the easy way out.  And the plaintiffs then get a free ride on the lottery ticket for those who aren’t willing to settle.

Whether or not this case went to trial, whether or not Lerach won the case, he was going to make a huge profit simply because he was able to sue everybody and the kitchen sink, he was able to get a significant number of them to settle, and extract seven hundred million dollars from investors, and I think that’s an important point, too.  You see the press describing this as investors versus business, but I think, as Harvey correctly pointed out, there are investors on both sides of the equation here, and it’s really investors versus lawyers.

Michael S. Greve:  Thanks.  Lou?

Louis M. Bograd:  Thank you, Mike.  Let me just quickly respond to a couple of points that Harvey made.  Yes, there are investors on both sides, and there are investors on the defense side every time a business or a corporation gets sued.  They may well be innocent.  We have never figured out a system that allows us to go after wrongdoing corporations without some adverse consequences for investors, but I would say that Economics 101 says that we want to place the incentive on the investors of the companies engaging in fraud to police their executives and make sure that their executives engage in proper behavior, and the way to place that incentive on them is by making them suffer the costs of litigation judgments as opposed to the injured purchasers of the stock who were the victims of the fraud. 

But there’s no question that innocent investors get hurt either way; it’s just a question of where we place the incentives.  Harvey also suggested that we’re in the wrong forum, that if plaintiffs are concerned about secondary liability, we should be going to Congress.  I think he’s got that exactly backwards.  We’re not talking about secondary liability; we’re talking about primary liability for what the Supreme Court has labeled secondary actors who engage in fraud. It’s very clear that the statute does cover that, has covered that, and will continue to cover that if the business community is of a view that the statute reaches too far, and that we should have some clear delineation, then they should be the ones going to Congress and saying – they’ve done it before -  “Let’s limit the liabilities to anyone other than...

[gap in recording]

... transaction costs and legal predictability.  I think there’s a very clear rule here, and it’s a very clear rule that the Supreme Court set out in the Central Bank case.  If you commit fraud, if you knowingly and actively participate in a scheme to defraud, you are liable under the securities laws.  If you merely aid and abet by negligently not doing sufficient due diligence in reviewing the books of the company, or missing something, but you’re not an active participant in the fraud, you are not liable under the securities laws.  That’s a pretty bright line.  It may well be that in any particular factual scenario, we’re going to have a fight about whether the plaintiffs can prove actual fraud on the part of the defendants.  This case is up on the pleadings, it -- we don’t know whether that will succeed.  But the allegations are allegations of direct fraud, and I think there’s a clear, bright line rule.  Thank you.

Harvey Pitt:  Thanks, I’m reminded – there’s a wonderful book, it may be out of print now, but I recommend it to you, it’s called The Uncommon Law.  It was written by an itinerant Englishman who conjures up sixty-six fictitious cases to show all of the foibles of the legal system.  There’s a case in there, and time won’t permit me to relay it, called “chicken against ham.”  But it is very, very apt.  As I hear my colleagues up here telling me this case is easy -– easy is obviously in the eyes of the beholder. 

I really think that the concerns that have been expressed on both sides are real.  There is no question that legitimate fraudulent misconduct needs to be redressed.  But I am reminded, when I was General Counsel of the SEC, the Supreme Court handed down a very -- what was thought to be a very damaging case called Ernst & Ernst v. Hochfelder, in which it said you can’t have any liability unless there’s scienter, a mental state embracing an intent to manipulate, deceive, and defraud.  And my colleague, who is head of the enforcement division at that time, Stanley Sporkin, uttered famous words.  He said, “Okay, if they want scienter, we’ll give them scienter.”  My problem isn’t that there may be bona fide cases that deserve a remedy.  My problem is that trying to do this by skewing allegations in a complaint is very much like saying, “All right, if they want a primary violation, we’ll give them a primary violation.”  I think the facts of this case are even more remote than the facts of Central Bank. 

But the critical thing is, should people who never said anything, who had no interaction with investors, who didn’t do anything to induce them to trade or not to trade, be potentially liable for billions of dollars in damages, and the answer I submit can’t be either yes or no.  It has to be, “Well, let’s think about all of these wonderful arguments we’re hearing, and let’s make some societal judgments about that.”  But the wrong place to make those judgments, as I said earlier, is in a federal court.  The right place is to make it in Congress and have a statute that creates whatever standards should be applied.  Businesses will adapt to it, and they should, and they have to.  That’s the way the solution needs to come about.

[Gap in recording]

Jonathan Cuneo:  Let me respond to a couple comments.  I think there’s almost nothing in common with the cases that we’re talking about here with the dry cleaning/pants case, except that they’re both in the news a lot.  The fact of the matter is that there are criminal indictments in here, criminal indictments in both cases, there were -– people lost a lot of money.  Even the Attorney General, General Gonzales, said his heart went out to the people who had spent their entire lives, invested their lifesavings at Enron and had it reduced to nothing.  And I actually think that -- and I don’t know if the suggestion was that losing your life savings is akin to losing a pair of pants, but I think a lot in America would disagree with that. 

Second, in terms of SEC enforcement, the SEC’s powers are different.  This is an area in which I would think that conservative thinkers would like, because there’s a privatized nature of this, and properly cabined, it’s a very powerful tool.  Congress has recognized that, the Supreme Court has recognized that, the SEC has recognized that.  And if you look at the frauds that are kind of household names in the past, since 2002 -- in Enron, the SEC recovered less than five hundred million dollars.  The private plaintiffs have recovered 7.2 billion dollars.  I don’t major in higher math, but that’s fourteen times as much. 

In WorldCom, I think the figures were 750 million dollars for the public authorities, 6.2 billion dollars for the private case.  In Cendant, I don’t think the public authorities recovered anything, and the private bar recovered 3.2 billion dollars. 

Now, finally, when I hear that the investment community is on both sides, yes, there are investors, but the professional people who represent the investment community in the United States, the Council of Institutional Investors, state pension funds from across the country – blue states, red states, northern states, southern states, populous states, little states, Guam – are on the side of the plaintiffs in this case.  And I have not read all the respondents’ amicus, but looking over the list, I couldn’t see a single investment group that’s on that side.  So I think – I’m sorry?  Ted.  Ted.  So, I think that the issue again is not trial lawyers v. business, but investors trying to promote marketplace accountability and honesty.  Thank you.

Michael S. Greve:  Rob.

Robert Gasaway:  Just two points.  First of all, the question isn’t life savings vs. pair of pants.  The question is, to extend the analogy, whether this lawsuit seeks to pick the pockets of innocent investors of Scientific-Atlanta and Motorola.  Obviously, people who are defrauded should get all the remedies from guilty parties they can.  The question in this lawsuit is whether they need remedies from innocent parties as well, and the whole point of this case is, to the extent there is any allegation that the shareholders, any group of shareholders of Motorola and Scientific-Atlanta, profited from this fraud, the allegation is they profited to the tune of 3.5 million dollars of cut-rate advertising on cable systems. 

There is no allegation whatsoever that they financially participated, that they had any financial participation whatsoever in the alleged fraud, so they’re in the same position, for instance, that a courier would be in a case where a law firm partnership is said to have gotten together and committed fraud for the benefit of the partnership, and the courier was an “active participant”, in the words that were used today, in the sense that the courier department carried the relevant documents, had no financial interest in them, but carried the relevant documents to the relevant person.  And even if, in that case, the courier who had no financial participation was told, “These documents are hot.  You better get them over there on time.” 

The question is, should that courier be held liable for the tune of the entire losses of the fraud?  And under the law of securities fraud, and we’re not talking about mail fraud, and we’re not talking about wire fraud, and we’re not talking about common law fraud, and we’re not talking about criminal fraud, and we’re not talking about any other kind of fraud that’s been punished for centuries, but we’re talking about securities fraud.  This new species of fraud that has arisen only in the last fifty or sixty years, which provides the opportunity for these enormous, enormous recoveries, where a seven billion- dollar recovery can be deemed “cutting your losses”, should they be potentially liable for that? 

And the other question here has to do with whether or not we can accept the active participation line is a clear- and bright-line rule, as it was said today.  Active participation – think about that.  What acts did you do to further the scheme? Were you the courier that carried the documents?  Were you the rental car company that rented the car?  Even if you knew – even if you knew that they were overpaying for your courier services or rental car services, and there was something fishy about it, should you be liable to the entire tune of the loss?  That is not a bright-line rule.  The bright-line rule that’s available here, that’s absolutely clear is, “Did you stand to profit from the success or failure of the alleged fraud?”  And under that standard, it’s absolutely clear that the Motorola and Scientific-Atlanta investors are absolutely innocent.  They had nothing to gain for the success or failure of the alleged fraud by the management of Charter Communications against their investors.  Thank you.

Michael S. Greve:  Thank you, Rob.  I’ll – before opening up to the audience I want to give it one more round here, and perhaps by illustrating my own obtuseness.  I do, however, have two questions, and they’re directed to anybody who cares to respond to them.

As I understand the economic theory – sorry, take that back.  A lot of law econ scholars, a lot of economists are very skeptical of these forms of securities litigation and here is why, as I understand their argument.  The risk of fraud has to be diversifiable for investors.  In any aftermarket fraud, there has to be one winning participant as well as a losing participant, and if you can fully diversify that risk, it’s hard to see what you can stand to gain over the long haul by constantly making your winning self compensate your losing self while paying the lawyers thirty cents on the dollar on each of those transactions. 

If that is true, or if that is roughly plausible, then it is very hard to account for a fact that Jon has rightly pointed out twice, namely, the fact that a lot of pension funds, retirement funds, investment funds, or the Council of Institutional Investors are, in this case, on the plaintiff’s side.  There are really only two explanations that come to my mind.  One is the economic theory is wrong, and two is that these funds that are here on the plaintiff’s side have their own agency problems and may not represent the authentic interest of investors at large.  Which one of these is it?  That’s my first question.  Or is there some third possibility that explains this puzzle? 

My second question is this, and it concerns the issue Lou brought up, which is the possibility that the court may go off on reliance, in part because that’s what the SG now says, and that may be of interest to the Court even if it’s not within the scope of the question presented, or whatever. 

Here’s my question about reliance.  Isn’t the problem here presumed reliance?  That is to say, the notion that we start with the idea that markets are efficient, and therefore we presume that there was reliance on the part of the purchasers when they conducted these transactions, and if there wasn’t, well, it’s incumbent upon the defendant to disprove it.  If that weren’t the rule, if there were no presumed reliance, if you have to prove it up and plead it adequately at a very early stage of the proceeding, it’s hard to see the rule.  The difference between the reliance theory, it seems to me, on the one hand, and the Eighth Circuit’s theory, in this case, because if there isn’t some utterance, some misleading statement or some omission on the part of somebody who owes a duty, then it’s hard to see how there could ever be individual reliance over that matter of lost causation down the road.  And if that is true, might it not be time to sort of tee up the case that established this presumed reliance, namely Basic vs. Levinson?  There’s only one justice around from that period.  Tee it up, see what they have to say.  And isn’t that – I understand Rob’s desire here to have a hard and fast line, and say no -- put the reliance stuff aside, but if they don’t go there, isn’t that the proper course of action?

Theodore H. Frank:  I can start on the first question.  I think there is an agency problem, and I think that’s very vividly illustrated by the case of the New York state retirement system, which used to be run by Alan Hevesi, if I’ve pronounced that right, which I may not have.  And in the Enron litigation, or maybe it was the WorldCom litigation, where they were a lead plaintiff, the recovery that they got from all the settlements was less than they took as diversified investors in many of the defendant banks.  They lost money on that deal.  Now, Alan Hevesi himself got a lot of donations from trial lawyers, and maybe he came out ahead, but I think there really was a principal-agent problem.  And the studies that have been done on this have shown that diversified investors, as a group, lose money on these securities lawsuits, that they’re worse off because of them than without them, assuming that the SEC is enforcing as they should be, and the argument’s out there is that the SEC is over-enforcing, that you see people going to jail for what are essentially criminalized business decisions.

And I think the exception to that is the special case of insider training, where you don’t have the sort of right pocket/left pocket problem, where you do have somebody extracting wealth from the diversified investors as a whole, and I certainly don’t have a problem with litigation in that circumstance.

Michael S. Greve:  Anybody?

Louis M. Bograd:  I think, Ted, your answer points directly to the problem with the theory.  I think it may well be correct if the level of fraud in the investing world would be the same, whether or not we had securities litigation; that institutional investors would be better off without securities litigation.  If the level of the fraud would be exactly the same, then Michael’s point might well be right, that the transactional cost of litigating these cases is an unnecessary transactional cost to move money from their left pocket to their right pocket.  But I don’t see any reason to believe that the level of fraud would be the same if we took away an important enforcement tool against fraudulent conduct, and economic theory certainly suggests – I mean, there’s the classic problem of the separation of ownership and control in American corporations -- but economic theory would suggest that creating incentives on owners to monitor the behavior of their managers will promote more, better management, and I think that’s what we’re talking about here.

Harvey Pitt:  And I think the reason that the civil securities recovery laws do not reduce the level of fraud is because the fraudulent companies are not treated any different than the innocent companies.  We see the bragging here that there was 7.2 billion dollars of civil recovery in Enron and the problem is that well over ninety percent of that came from innocent parties that lost money in the Enron transaction.  And when the innocent parties are not treated any differently than the guilty parties, that they’re just – because they’re the bystanders they are hit with the problem of fraud, with being sued, and because of the tremendous numbers involved, as Rob pointed out, these cases just don’t go to trial.  Nobody risks them.  You pay the protection money, and you settle out, and that was how the entire securities class action business -- that’s the entire business model of it.

Jonathan Cuneo:  The problem with economic theory, and I’m a big believer in economic theory, but the problem here is that theories don’t really capture real life.  Part of my problem, and this was alluded to in the amicus brief I signed on to, but I tried to get it as watered as I possibly could, is, there is a theory that if you have a diversified portfolio, you don’t need any recovery because over time you’ll both benefit and be harmed by fraudulent conduct, and it will balance out.  The difficulty I have with that theory is that Congress made a decision.  It said, “If you are defrauded into buying or selling a security, you should have a recovery.”  And so, I’m perfectly content to see the recovery.  My problem is, who pays it, what the standards are, and how much that recovery ought to be.  Those, I think, are incredibly difficult questions.  They don’t get answered by theories, and they don’t get answered, unfortunately, by platitudes.  They get answered by sitting down and trying to construct a meaningful framework that tells people what their obligations are. 

I have no difficulty imposing responsibility on corporate officers and directors or investment banks, and law firms, and accounting firms, to be professional, duly diligent, and not to be egregiously careless, et cetera, provided the standards are as clear as we can make them, and provided everybody knows what those standards are before they go into a transaction, and provided we have done something to measure the amount of damages that might be recoverable from certain parties against the damage A) that was inflicted in general, and B) the damage that was inflicted by the conduct of the people we’re now trying to hold responsible. 

There’s nothing like that in this case.  There’s no attempt to try and measure the extent of liability, the extent of misconduct, the appropriate sense of how responsible these individuals were.  There’s just a concern about trying to hold people liable, and the difficulty I have when we talk about investor classes, and I hear my colleagues make comments about, “Well, you know, we’re just incentivizing people to be more careful.”  I don’t know how I can be more careful about Lou’s fraudulent misconduct, assuming he were to engage in it, which I know he wouldn’t.  How do I protect myself?  How do I know all the things he’s doing?  This isn’t a game, unfortunately, and the problem I have when I hear us talking about two different classes of shareholders, is that the only real difference between the innocent classes of shareholders that we’re trying to judge competing rights about is that the one set is represented by council, and the other set, unfortunately, has to get defense council to try and protect against the liability.  To me, that’s not a good way for us to be making decisions.

Michael S. Greve:  Quick follow-up question.  This has come up repeatedly.  Is it the case that regardless of how this particular litigation comes out, Congress will most likely address these issues so that we’re only talking about the default rule that obtains when it gets to Congress?  That is to say, whether, if the business guys lose, they will have to go to Congress and ask for a remedy, or if the plaintiffs lose, they will have to go to Congress.  Or is it that, it could be that Congress, no matter how this comes out, just sits on its duff?  Just in terms of the atmospherics, and the interaction between the Supreme Court and the Congress, I’d be very interested in your views or predictions on that issue.

Theodore H. Frank:  Well, I think it’s always risky to predict what Congress might or might not do, and certainly I have no more expertise to speak about that than anyone else, but I think that Chairman Pitt made the salient point, and that is that Congress has decided that there is a private right of action, and the courts initially decided that, the Congress reaffirmed it, that is the position of the SEC, that is the position of the administration. 

Now, what you’re asking is a much broader question.  Should there be a private right of action?  Well, that is something that not even the most radical reformers put forward in the very extensive 1995 debate, and if that is a view, a view I might say I disagree with, that needs airing, the proper place is the United States Congress, and that is something, I might say, that Chairman Frank, not our Chairman Frank, the Financial Services Committee Chairman, has expressed a willingness to hold hearings on these issues, so, but what happens there is always uncertain.

Louis M. Bograd:  I don’t think anyone on the panel disagrees that the Supreme Court doesn’t have any power to fix the securities laws such that all these inefficient civil securities suits completely go away.  But I think that they’re being mentioned just simply as a dynamic that –- as social benefits go -- these are not on the positive side of the ledger on the large part.

  Harvey Pitt:  I’ll just give one slightly different take, and I join everyone in saying I have no idea what Congress will do, and I’m constantly amazed by what, in fact, it does do.  So -- but putting that to one side, I think if the business community loses, they will not go to Congress for relief.  Nobody can predict the outcome of elections, but I would say, at this moment in time, this is not going to be a great time for the business community to go to Congress and ask for relief from a Supreme Court decision, should it occur, that holds liability.  I just don’t think that’ll happen. 

I do believe that if the plaintiffs lose, and I guess my own position, which I’ve now said ad nauseum, is that whoever wins or loses, in a sense, the problem with this issue is, it’s far more complicated than a particular piece of litigation can ever address.  This is the wrong forum.  And so, my view is, and I’m willing to run the risk, as we all do, that I will not like what comes out of Congress. I didn’t like the way Sarbanes-Oxley came out.  I thought it had a good intent, I just didn’t think it was well-drafted, and so on, but the fact of the matter is, I’m much more willing to live with that, and that approach, than to try and craft these on a case-by-case basis, where individual facts and individual circumstances will be overplayed into dictating the outcome. 

So my view is: I think if the plaintiffs lose, they will seek relief.  And I believe that whether they win or lose, Congress should really do a serious job of trying to understand both sides of the issues.  As you’ve heard here today, there really are some very strong arguments on both sides of the issue, and policy judgments have to be made.  But in my view, those aren’t judicial judgments.

Michael S. Greve:  We’ll take questions from the audience.  Please, would you kindly wait for the microphone, and then when you speak and ask a question, identify yourself by name and affiliation.  We’d be grateful.

Ryka Fluis [sounds like]: Hello, my name is Rika Fluis from Intellectsifa or Ryka Fluis Enterprises, SB.  I came a little late, so I want to ask a question for those of us who are not experts in economics in law, just for clarity purposes.  And I know it may be a little off, but just, here it is:  where the beneficiary of the transaction is made aware that there may be fraudulent activity afoot, whether it be directly related to the transaction, or just in the general conduct of the business operation overall, and where, if the fraud is proven, it could negatively impact that person’s benefit, should that person be held liable if he or she withholds information, even if he or she personally believes that the complaint of fraud is utterly frivolous?  Is there a difference in a civil action versus a Security and Exchange Commission action, and with regard to the SEC actions, is there a difference in corporate shares versus investment trusts?  That’s the question.  Thank you.

Michael S. Greve:  Any volunteers?

Male Voice:  Are you reading from a particular brief?  You seem to be –

Ryka Fluis:  [Too far from microphone.] 

Male Voice:  That’s a question with a lot of moving parts, and I hesitate to answer without seeing the transcript of precisely what you said.  Maybe Harvey has a -

Harvey Pitt:  Again, I get concerned if somebody is truly aware of a fraudulent activity and stands to benefit from that fraud and allows the fraud to go on.  That kind of conduct troubles me.  As a regulator, for example, we were very, very strong in taking action against investment banking firms and lawyers, and accountants, and so on, who were in positions where they could have prevented a fraud from occurring, they knew about it, and they benefited from it.  But the key here is, obviously, or, I should say, the devil is in the details.  We don’t know when somebody is engaging in a fraud necessarily.  If you look at it after the fact, sometimes you see it, sometimes it should have been clear, and in hindsight, I have to say, it’s always clear, so one concern I have is, “Do we really know?”

Second, could we have taken steps to prevent the fraud?  One of the concerns that I have in this particular case, and again, as I said at the outset, it’s not my purpose to argue this specific case, or how it should come out, but one thing that does concern me is whether the people involved really A) knew there was a fraud, B) benefited from the fraud, and C) were in a position where their conduct could have prevented the fraud.  I believe if you don’t satisfy rigorous standards like that, and I’m not now talking about a legal answer, I’m talking about a policy answer, it becomes very hard.  But all of us have to sit by and say, if we observe a drive-by shooting, or, as happened in Queens, in my beloved city of origin, New York, somebody witnesses a murder and doesn’t do anything to the person who commits the murder, yes, I have very strong feelings that people should act nobly and should prevent frauds. 

I also would tell you that, even though I’m a lapsed lawyer now, in my role of counseling companies, I would be very worried about having companies actively assert that they know a fraud is going on at another company, and actively take steps, without doing a reasonable amount of diligence.  But the concept is one that I can fully support.  If you know a fraud is going on, if you can benefit from it, and if you could prevent it with your own conduct, I have less of a problem in that circumstance in trying to hold people to a higher duty and a higher standard.

Michael S. Greve:  Yes.

Bonnie Wachtel:  Bonnie Wachtel.  I come to the issue as a professional investor and a participant in the securities industry, and so, in general, I don’t like plaintiffs’ lawyers or have a lot of confidence in the litigation system, but on the other hand, I’d like to actually take the opposite position for a moment to ask a question about this issue, which relates back to 2002.  I don’t know about the facts of this case.  I’m going to get away from that and talk more about the Enron situation, because what it seemed that we had in 2002, WorldCom, Enron, and a series of public company situations is that there was a massive relaxation of standards among the secondary players, meaning the accounting firms, and the financial institutions on Wall Street.  And my impression of that situation, which may be wrong, please correct me, but my impression of the situation is, first, you have some people that are interested in actively committing fraud in the companies, and then they go out to directly market, to find other professionals, other corporations that will assist them, and what those other institutions are doing is essentially saying, “All, right, yes, we can see.  This is to make things look good for your financial statements, and we know exactly what we’re being paid to do and what our reputation is going to do for you,” and nobody wants investors to lose billions of dollars, and maybe it won’t come to that, but essentially they’re all participating in, you know, a sort of willful blindness. 

Now, it does seem to me that it’s too much to ask just the government, the SEC, and government regulators to come in, to slap around the banks and the accounting firms directly, in part because as you know, government can be -- regulators can be -- captured.  So in that case, it wouldn’t surprise me a bit if the guys at Citigroup and all these other places really said, “Yes, we didn’t want to face the jury, but the fact is  did we owe some money to kick into that situation?  Yes, we did.”  In the bizarre mix of justice and injustice that creates these big situations where people are being paid a lot of money. 

So, would you, maybe Mr. Pitt, you can answer that.  I mean, don’t you think in that system-wide situation, that this big slap in the face of all those investor lawsuits and the settlements and the rest really was helpful to a system-wide change in standards, which we had?  I mean, with or without Sarbanes-Oxley there would have been a rise in standards in the accounting industry and in the financial markets, and to some extent in how people were operating, at least temporarily.  So should you have a rule that encompasses that, you know, to take account of a situation like that, and was it helpful there?

Harvey Pitt:  I see our time has expired.  Oh, sorry.  I -- the sentiment is one I share.  We were very aggressive in taking action with WorldCom, and Enron, and at WorldCom, we were in court within forty-eight hours of learning of the issue.  And as I said earlier, I don’t have anything against plaintiffs’ lawyers.  I’m not sure I’d want my daughter to marry one, but that’s a separate issue.  But, in all seriousness, I don’t have any problem with plaintiffs’ lawyers, and I don’t have any problem with creating remedies for people who are defrauded.  I believe our capital markets function best and most efficiently when people know you cannot commit fraud in those markets and there’s a price to pay. 

There is a premium, I believe, where our capital markets have an advantage.  That advantage is starting to erode because some of our rules get applied rather haphazardly.  What I really prefer is that we know what the standards are.  I practiced law for forty years and most of the people I knew, and that I counseled, and that I dealt with, were interested in doing the right thing.  What they really wanted to know was, “What is the right thing?”  So I think there’s a premium on having rules that have clarity. 

I don’t believe that the SEC can do it all, but when I was chairman, we instituted a program which I think has now somewhat fallen into disrepair called real-time enforcement.  My notion was that the most effective thing the government can do is discover fraud and either move while it’s still ongoing or move while there are still some profits left because unfortunately, what happens is -- and I railed against this when I was at the SEC -- you see a lot of people who not only are hell-bent on committing fraud, but then they’re hell-bent on spending the rewards of their fraud, so that when they do get caught -- and they usually do – when they do get caught, there won’t be anything left for anybody else to get.  That’s a terrible system, and that’s why we did institute a concept of real-time enforcement.  It’s also why we lobbied and we drafted Section 308 of Sarbanes-Oxley, which is the Fair Funds Provisions, which says that when people are fined, those dollars should be able to go into a kitty to allow redress for investors. 

I think there are better ideas on how to do this, how to upgrade the standards, and the like.  What I don’t think we can continue to do is do this in an ad hoc fashion.  I think we really need to think it through.  And frankly, if I were a plaintiff’s lawyer, and occasionally, I have been on the plaintiff’s side of issues, but if I were a plaintiff’s lawyer, my biggest concern is the class of people I’m representing, and getting recovery for them, and I don’t think about the broader concerns, not because I’m indifferent to them, but because that’s not my job.  So I’m really interested in finding somebody whose job it is, so that when litigation is brought, we know what the standards are, people can adhere to them, and if they fail to meet those standards, then they ought to have the book thrown at them. 

But I think it has to be a rational system.  I believe the system we have, which has grown up completely from the judiciary, and it includes the implication of a private right of action under 10b-5, something that could never happen today.  The decision back in the 40s, in Kardon v. National Gypsum, which set this whole thing in process -- a district court in the eastern district of Pennsylvania held that there was an implied right of action under 10b-5, and it grew like topsy.  My concern is: if you look at the express remedies in the federal securities laws, they are intricately crafted.  I think the reason people don’t like to use them is because they’re too restrictive.  I think in the modern day, maybe Congress erred in its original formulation on the wrong side. 

So people were looking for another vehicle.  And what happens when the courts do this is that there are no rules.  The Supreme Court, in most of its decisions, starting from 1975 on, has been -- not completely, but almost completely -- applying brakes to this animal that got created by the judiciary with no standards.  And this is not the way civilized society ought to hold people liable.  Yes, there should be liability, but let’s do it in a rational fashion, let’s not do it on a case-by-case basis, because bad cases, as we all know, absolutely – hard cases, I should say, absolutely do make bad law.  And that’s unfortunately what we’re stuck with.

Michael S. Greve:  Would the guests care to comment or say something in --

Panel Member:  Well, I’d just like to say that first, that I agree with Chairman Pitt, but also that Ms. Wachtel may not like plaintiffs’ lawyers, but she certainly sounded just like one, and I couldn’t agree more with her remarks.  I’d say massive relaxation of standards may be a euphemism for what was going on in the early 90s, but it certainly – it was at least that, and we do need private securities litigation as a check on that sort of behavior.  Now, whether the system could be tweaked, and whether Congress should revisit the issue is something I’d certainly be open to discussing, but the idea that having private litigation is somehow a problem, it seems to me, is misguided.

Chris Rugaber:  Hi, Chris Rugaber, Associated Press.  I wanted to ask about -- if the court does side with the respondents in this case and upholds the Eighth Circuit’s Decision, are we looking at sort of just a status quo – clearly it depends on the details, but, I mean, would this be a status quo decision, or is there a possibility of the court in any way, perhaps, narrowing the liability that companies face, or taking things in a different direction?  Thank you.

Robert Gasaway:  Well, I think you asked the correct question, or put the correct qualifier on it, and that is, you know, how do they write the decision?  In terms of the narrowest possible decision that they could make, and the participation of the Chief Justice bodes well for this, because he is a fan of narrow decisions.  The narrowest possible decision they could make is simply that these people were buying and selling set-top boxes.  They’re not like any of the people that we think of in the Enron situation.  Not like the management, Mr. Lay, or Mister Fastow, not like the accountants, Arthur Anderson, not even like the banks.  They had no financial participation in the capital structure, no incentive, no benefit, as Chairman Pitt would say, in the success or failure of the fraud, no professional duties, no fiduciary duties.  These are purveyors of set-top boxes.  And I think that is what the Eighth Circuit was driving at in its decision when it created this standard of an arm’s length transaction. 

Remember, I just quoted for you multiple times in the plaintiffs’ brief, where they took exception to the description of the transaction as arm’s length.  Now, what’s so interesting about that is not only that they don’t really deny that, or don’t really grapple with the fact that it is arm’s length, it’s really a fight that they don’t have to pick.  The description of transactions at arm’s length in the securities laws has never been a determinant of the outcome of cases.  It’s never been dispositive.  It’s the Eighth Circuit’s shorthand for its intuitive recognition that there should be no liability here, and to impose that liability would open the Pandora’s box. 

So the narrowest possible legal decision would just be to read the Eighth Circuit decision in the spirit which it was rendered, translate the arm’s length language into the end connection with technical language of the securities law, rule on that very narrow ground, and basically leave the world entirely unchanged from what it is today.  Doesn’t affect at all accountant liability, doesn’t affect at all capital provider liability, lawyer liability, underwriter liability, management liability, any of these hard questions that people are asking, it just cuts out a group of people, as Chairman Pitt says, do not have an interest in the fraud, or benefit from the fraud, or a financial participation in the fraud.

Panel Member:  Actually, I’m not sure I completely agree with that characterization.  And I do agree with Rob’s first point, which is the devil will be in the details, and who knows how the Court is going to come out, and there are lots of different -- among the amici in this case, they’ve been given many different pieces of Section 10b they can hang their hat on, which results in trying to anticipate what the effective outcome will be is impossible without knowing where they’re going to hang their hat. 

I would say that the Eighth Circuit decision is untenable.  The notion that deceptive conduct is somehow shielded from securities liability, whereas deceptive statement, false statements or omissions by someone with an obligation to speak are actionable, that deceptive conduct is not actionable, clearly is a distinction that is not grounded in the law, is not grounded in the statute, and is one that I can’t believe the Court will not reverse, and that’s the question that’s squarely presented in the cert grant, and the question, as I noted, that everyone, including the Bush administration, recognizes the Eighth Circuit got wrong. 

Now, whether having done that – that would be the narrowest ground, would be to reverse on that ground and leave all these other questions for remand on another day, but what the implication of the decision will be, I think, turns on, I think, all those other questions as well.

Alfred Pollard:  My name’s Alfred Pollard.  Rushing ahead, if the plaintiffs are unsuccessful, what is the availability to them of state actions, not necessarily securities law now, but I mean is this the name of the case?  The ’95 Act seems to carve out a lot, but is there still action, tort liability, very active in many states, and common law fraud?  So, I mean, is that the end of the case if the Supreme Court says no?

Michael S. Greve:  Terrific question.

Panel Member:  Well, in terms of class cases, there’s a subsequent act called SLUSA.  If I can remember what it stands for, but essentially, in a class action, and even when you have multiple plantiffs, and I’ve forgotten –

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