By On the occasion of our 20th anniversary
By Gustavo Arellano
By R. Scott Moxley
By Alfonso Delgado
By Courtney Hamilton
By Joel Beers
By Peter Maguire
By Charles Lam
Congressman Christopher Cox will handily defeat an unknown challenger in Tuesday's primary election. The Newport Beach Republican will go on to trounce the competition in November's general election. Then, he'll quietly be sworn in for his eighth term. Not too shabby for a politician who helped pave the way for America's biggest fraud scandal in decades.
To understand how something like the Enron/Arthur Andersen debacle could happen, go back to 1993. That's when Cox, as part of conservative Republicans' so-called Contract With America, spearheaded efforts to torpedo protections for corporate investors and shield companies—like Enron—and their accountants—like Arthur Andersen—from investor lawsuits.
Claiming "a band of amoral plaintiff lawyers" was responsible for lawsuits that put investors and corporations alike into a "legal torture chamber," Cox pushed for securities-fraud reform in Congress. Nine hearings were held between 1993 and early 1995 before Cox unveiled his Private Securities Litigation Reform Act of 1995.
Consumer advocate Ralph Nader had a different name for the legislation: The Swindlers & Crooks Protection Act. The accounting and high-tech industries—Cox's biggest campaign contributors—pushed for the "reforms" because companies were being sued by investors when artificially inflated stock values crashed. Representative John Dingell (D-Michigan) characterized the bill as a raid on the small investor and predicted that Congress would regret it.
Lefties weren't the only critics. Former Nixon and Ford economic adviser Herbert Stein, then-Securities and Exchange Commission (SEC) chairman Arthur Leavitt, and top state regulators all opposed the bill, contending it would make it more difficult for defrauded investors to recover stock losses. "This would undermine confidence in Wall Street," Stein said, "and that would mean people would be more leery to invest."
To sell his reforms to colleagues in early '95, Cox claimed there had been an explosion in tort cases, citing 100 million filed annually. Nader accused Cox of being 98 million cases off; the figure the congressman was spouting represented all cases filed—including traffic tickets—not just torts. Even the conservative-leaning U.S. News & World Report agreed that statistics showed there had been no explosion of abusive litigation.
Reform proponents changed their tack, saying that whether there was a spike in cases wasn't the point; if the public perceived that runaway litigation was a problem, that perception might scare off potential investors and, ultimately, kill the market.
Independent legal analyses and securities lawyers agree the reform act significantly raised the bar at several points in the litigation process, making it much harder for plaintiffs to bring lawsuits. First, they would have to prove there was a "strong inference" that the defendant acted with the required state of mind for fraud. Securities lawyers refer to this requirement as "scienter"—a mental state embracing intent to deceive, manipulate or defraud.
The act also forbade plaintiffs from seeking documents and other information from companies that might prove their cases while a judge weighed motions to dismiss the cases; forbade forecasts of a company's health—like the ones that paint rosy futures so people will buy their stock—from being used against them; and allowed the court to appoint the lawyers who would represent plaintiffs, as opposed to the case going to the first lawyer to file.
The scienter issue is key because two federal appeals courts can't even agree on how plaintiffs can prove it. The 7th Circuit Court of Appeals in Chicago found that investors must conclusively prove company executives willfully ripped them off; the court even forgave executives who said they forgot to disclose bad financial news to investors. Meanwhile, the 2nd Circuit Court of Appeals in New York ruled that a plaintiff may plead scienter without direct knowledge of the defendant's state of mind if they prove there was a motive to commit fraud and either reckless or conscious behavior that resulted in fraud.
Lawyers and judges hoped the reform legislation would resolve the matter, so when the House bill got to the Senate, Senator Arlen Specter (R-Pennsylvania) amended it to include the 2nd Circuit Court's scienter finding. But Money magazine reported that "key Republicans and some nervous lobbyists fear that House conservatives, notably Chris Cox, would insist on preserving a few of the House's most extreme provisions in the [conference] committee's final compromise bill."
Sure enough, in conference, Cox deleted the Specter amendment, leaving open the opportunity for courts to rule under the stricter "state of mind" definition, something Dingell called the "Whoops, I forgot" provision.
President Bill Clinton vetoed the bill on Dec. 19, 1995, saying he supported the goal of the legislation, but, come on, "Whoops, I forgot"?
Cox was unrepentant.
"By vetoing this bill," he told Bloomberg News, "President Clinton has turned his back on everyone who owns a mutual fund, participates in a pension plan, or has a job at a public company."
He further alleged that Clinton caved to contributors such as flamboyant trial attorney William Lerach, whose San Diego firm gave $180,000 to Democrats in '95. Lerach, the most despised attorney in corporate America, is now being hailed as a hero for predicting Congress' fraud reforms would lead to an Enronesque scandal. Though under investigation for illegal solicitation of clients, Lerach was recently appointed lead counsel for Enron investors.