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.
There was bipartisan debate over Cox's conference report. Some believed he removed the Specter language to leave the door open for the U.S. Supreme Court to decide that recklessness is not sufficient in such cases. But Democratic Senators Chris Dodd (D-Connecticut) and Bill Bradley (D-New Jersey)—who received heavy backing from Wall Street—were among those who defended Cox's report, and before the year ended, Congress overrode Clinton's veto with a 319-100 vote.
Since that law made it harder for securities-fraud cases to be argued in federal court, those cases started migrating to the state courts, particularly in California. Silicon Valley noticed this trend and contacted their friends in Congress, Republicans and Democrats, who pushed the Securities Litigation Uniform Standards Act of 1998, which forced state courts to abide by Cox's '95 reforms.
This resurrected the debate over the recklessness issue, and when the bill got to the Senate, Specter once again inserted his amendment, something Clinton insisted on before signing the law.
That was not the end. When the law was printed by the government printing office, the final page—the one containing the Specter language—had mysteriously disappeared. It was put back in after Dingell caught the error.
More recently, in 2000, Cox and Representative Cal Dooley (D-Fresno) introduced a bill that would have delayed the implementation of accounting standards established by the Financial Accounting Standards Board (FASB) so investors could know the true cost of company mergers. Cox's bill brought a strong rebuke from FASB chairman Edmund L. Jenkins: "To delay the completion of the project on business combinations is clearly a political intrusion into the FASB's mission." That intrusion worked. The threat of Cox's bill spurred the FASB to relax its new standards.
If you still believe that Cox is a pro-business Republican, consider that the FASB is an industry—not government—board. One accounting expert accused him of acting on behalf of high-technology interests.
Cox told the Weekly he opposed the proposed FASB standards because they would have distorted the actual costs to a merged company. The purpose of his legislation, he said, was to incorporate accounting principles developed by the SEC and academics.
Once mentioned as a possible Bush nominee to chair the SEC (the job ultimately went to Harvey Pitt), Cox knows the investment game intimately. Before he was elected to Congress in 1988, he was a corporate lawyer for the failed Irvine securities firm First Pension Corp. First Pension's flashy founder, William E. Cooper, lavished the Cox campaign and Orange County Republican Party with hefty contributions.
First Pension collapsed in 1994 after stealing $136 million from 8,500 investors, many of whom were senior citizens who lost their life savings. As previously reported in the Weekly (R. Scott Moxley's "Chris Cross," Aug. 9, 1996), an investor suit accused Cox of knowing of the securities fraud and helping to conceal it. A judge later dismissed Cox from the case, saying there wasn't enough evidence to link him to the scheme.
These days, like many of his colleagues on Capitol Hill, Cox has reinvented himself. He has resurrected his longtime criticism of agencies that rate companies, saying they proved "essentially worthless" in the bankruptcies of both Enron and Orange County, and when Andersen's CEO recently appeared before the House's Capital Markets subcommittee, Cox grilled him over the giant accounting firm's alleged violations of the 1995 reform act.
But as Cox's Democratic House colleagues and the New York Times observed, corporate monkey business is not only something Cox tolerates, but also something he outright encourages. They point out that Cox's securities "reforms" from the '90s paved the way for the Enron/Arthur Andersen debacle. "It was the ultimate in special-interest legislation," Duke University law professor James Cox (no relation, obviously) recently told the San Francisco Chronicle.
"The '95 act protects a company's shareholders, employees and retirees who in the past have been victimized by strike suits," Cox told the Weekly. "It grants many new rights to plaintiffs that make good cases more rewarding and requires of complaints only that they not be of the 'word processor' variety—an abuse that hearings showed was all too common."
Ironically, Cox, who championed the measures to reduce frivolous lawsuits, now brags that his law has had the opposite effect.
"Since its enactment," he said, "the number of securities class-action suits has gone up, and the average settlement has doubled."
Cox also contradicted the independent legal analyses of his reforms, claiming that the law not only allows forecasts of a company's health to be used against companies, but it also "requires a company and its officers to constantly update and correct any forward-looking statement once made," something that further protects investors. He also disagreed with legal experts' assertions that the law stops evidence gathering while a motion to dismiss is being considered.
Indeed, Cox cast his reforms as a godsend for Enron's screwed employees and investors. One section of the law, he said, "is devoted to imposing elaborate new requirements on accountants that strongly anticipate the Enron situation. The failure of Andersen and Enron to observe it will provide another weapon in the plaintiffs' arsenal in the lawsuits and government enforcement actions now under way."
While debate rages over whether Cox's reforms created the atmosphere that produced the Enron/Andersen scandal, it seems unlikely those companies' executives will elude prosecution faced with such intense media and public scrutiny. But in congressional testimony, we've already witnessed Enron's CEO and vice president of human resources employ the "Whoops, I forgot" defense. And what about all those other Enrons out there the American public doesn't know about that may be using the Cox reforms to escape prosecution every day?
In a recent National Review Online interview, Cox said his reforms' new responsibilities on auditors to report wrongdoing might help Enron shareholders and employees because "Andersen remains a deep pocket, where Enron probably isn't."
Cox certainly knows how deep Andersen's pockets are. Federal Elections Commission data show that between 1989 and 2001, Andersen's employees and political-action committee gave Cox $21,750—three times more than their combined contributions to the rest of Orange County's congressional delegation. Between 1995 and 2000, Cox received $125,109 from the accounting industry, according to the Center for Responsive Politics.
Too bad for them that money may soon go to waste; that "band of amoral plaintiff lawyers" are now saying securities laws should be rolled back to their pre-1995 state. A lot of Americans are listening.