After the Ball Is Over: Investor Remedies in the Wake of the Dot-com Crash and Recent Corporate Scandals

• Publication year: 2021
• Citation: Vol. 83

83 Nebraska L. Rev. 732. After the Ball Is Over: Investor Remedies in the Wake of the Dot-Com Crash and Recent Corporate Scandals

732

Daniel J. Morrissey*

After the Ball Is Over: Investor Remedies in the Wake of the Dot-Com Crash and Recent Corporate Scandals

TABLE OF CONTENTS

I. The Bursting Bubble .............................................. 732
II. A String of Corporate Scandals .................................. 734
III. Regulating the Conflicted Securities Industry .................. 737
IV.The Supreme Court Turns Away from Investor Protection ............ 739
V.Some Promise of Investor Relief in the Enron Litigation ........... 741
VI. Mixed Results in Market Fraud Litigation ........................ 745
VII. Customer Claims Against Brokers ................................ 748
VIII. Arbitration as a More Promising Forum ......................... 751
IX. Claims That May Not Prevail in Arbitration ...................... 760
X. Conclusion ....................................................... 761

I. THE BURSTING BUBBLE

The technology and telecommunications boom made fools of all of us. From the corporate executives who promised results that in hindsight seem absurd to the ordinary day traders . . . all were overcome with a complex mixture of credulity, jealousy, vanity, and greed. In between were the enablers--the regulators, bankers, analysts, consultants, accountants, lawyers, credit agencies

733

and journalists who could have done something to stop the madness, but did nothing until way too late.(fn1)

As the millennium approached, about half the households in the United States owned stock(fn2) and many of them had substantial savings and retirement funds invested either directly or indirectly in the equity markets.(fn3) Some of those investors had experienced phenomenal gains during the run-up of share prices during the late 1990s, while others were only just getting into the market, enticed by the rapid stock appreciation that looked like it would never end.(fn4)

But beginning in April 2000, a swift downturn left investors reeling. The Dow would eventually lose almost one-third of its value, and the high-flying NASDAQ index would crash unbelievably worse, tumbling from over 5,000 to just about 1,100. It left shareholders in the tech companies traded there with, on average, only about twenty percent of the value they had had several years earlier.(fn5)

At first, the bursting bubble just seemed like another chapter of the manic-depressive cycle of stock trading,(fn6) a long-overdue correc

734

tion for all the "irrational exuberance"(fn7) that had led purchasers to bid the price of stocks in unproven companies to exorbitant heights. But then commentators began to focus more intensely on what had driven the speculative surge of the late 1990s and the groups that had engineered and profited from it. Under that analysis, it seemed that ordinary investors had been the victims of a pervasive "pump and down" sting that took $6 trillion of the wealth they had placed in the capital markets and transferred it to corporate and securities-industry insiders.(fn8)

That devastating indictment, however, provoked a contrary explanation premised on W.C. Fields' famous insight that "you can't cheat an honest man."(fn9) According to that theory, greedy investors had no one to blame but themselves by expecting astronomical returns and had gotten their just deserts for failing to exercise the ordinary prudence required when entrusting money to high-risk ventures.(fn10)

II. A STRING OF CORPORATE SCANDALS

Then in the fall of 2001 came revelations of an unprecedented string of corporate and accounting malfeasance that had fraudulently fueled the market boom. It began with the disclosure that Enron had

735

manipulated its profits by improperly hiding debt in off-book partnerships at the same time that it was manipulating the California and Texas energy markets.(fn11)

By the end of 2002, over two dozen large public companies admitted to inflating their revenues by improper accounting practices,(fn12) while many of their top executives, like Dennis Koslowski of Tyco,(fn13) lived opulent lifestyles at their shareholders' expense. Such chicanery was facilitated by the firms' outside accountants, such as Arthur Andersen, which shredded documents when the Securities Exchange Commission ("SEC") began investigating the firm's auditing of Enron.(fn14)

As these shenanigans were exposed, it became increasingly more apparent that they were condoned by captive boards of directors(fn15) and were abetted by the deregulation of two sectors that had led the spiking market--telecommunications and finance.(fn16) The recent resignation of New York Stock Exchange ("NYSE") chairman Richard Grasso reinforced outrage about such lax oversight when it came to light that the Big Board's directors had only a vague understanding of how the

736

lush compensation package they had unwittingly handed Grasso might compromise the man charged with policing their industry's trading practices.(fn17)

But the most shocking disclosures of deceitful conduct by the securities industry came in the spring of 2002 in a long-awaited global settlement spearheaded by New York Attorney General Eliot Spitzer.(fn18) Ten of Wall Street's largest investment banking firms agreed to pay $1.4 billion in penalties to settle charges of fraudulent practices in which they had engaged during the go-go market of the late 1990s.(fn19) Spitzer's investigation found myriad instances where

737

market analysts had distorted their research reports or stock ratings to win investment-banking business for their firms or in other ways curry favor with their corporate clients.(fn20) For their deceit, the analysts were awarded huge bonuses.(fn21)

The most prominent examples of this unscrupulous activity were the activities of two analysts who had become financial celebrities during the market bubble--Henry Blodget and Jack Grubman.(fn22) Blodget, Merrill Lynch's leading tracker of Internet stocks, was publicly touting shares in companies that he was privately deriding in his personal e-mails as "junk."(fn23) And proving that there are all sorts of ways to be bribed, one of Grubman's many inflated stock valuations was a rating he gave to a company in exchange for admission of his children to an elite private school.(fn24)

III. REGULATING THE CONFLICTED SECURITIES INDUSTRY

In the largest sense, these pervasive fraudulent practices can be seen as the invidious results of the inherently conflicted position occupied by investment bankers and brokers. Stock traders and jobbers make money--very good money--by selling the shares of companies to the public, thus purporting to serve two masters with very different interests. Their corporate clients want to sell their shares for the highest price, while the public customers who buy them want fairlyvalued, quality investments.(fn25)

Securities, unlike other items of investment property such as real estate, have no intrinsic value in themselves. Rather, they represent the right to something of value.(fn26) Stock purchasers, therefore, must

738

have particular confidence in their brokers, and those salesmen, in turn, seek to foster such a relationship of reliance. For instance, in its promotional material Merrill Lynch speaks of its "tradition of trust" where the interests of clients come first.(fn27) Yet brokers are typically compensated by commission.(fn28) As the skeptical insight goes, when a broker recommends a stock, the purchaser does not know whether the broker thinks it is in the purchaser's best interest to buy it, or whether the broker just needs the sale to make a car payment.

Because of this obvious conflict of interest and because securities are such intricate merchandise (i.e., a pure bundle of rights, not a discrete piece of solid property),(fn29) the law has heavily regulated the sale of securities. The basic legal mandate is that anyone participating in the marketing of securities must reveal all relevant facts about them.(fn30)

This regime of full disclosure is encapsulated in the SEC's renowned Rule 10b-5,(fn31) promulgated under the authority of the Securities Exchange Act of 1934.(fn32) Rule 10b-5 is a criminal provision prohibiting all deceitful practices and schemes to defraud in connection with the purchase and sale of securities.(fn33) For almost sixty years, courts have also implied a private right of action from that rule, allowing defrauded investors to use it to recover damages.(fn34) In addition, the practices of brokers and all who underwrite the sale of securities are highly regulated by the SEC and by the self-regulatory agencies of which they are members, most prominently the New York

739

Stock Exchange and the National Association of Securities Dealers ("NASD").(fn35)

As Holmes famously observed, all our notions of civil and criminal liability are probably rooted in a primal desire to take revenge on those who have injured us.(fn36) In that vein, the reasons to allow investors to recover from those who have cheated them are obvious. In addition, one does not have to cite the Ten Commandments(fn37) or the categorical imperative(fn38) to prove that fraud is bad. Furthermore, it seems that law-and-economics types belabor the obvious when they assert that situations involving asymmetrical understandings of information distort markets.(fn39)

IV.THE SUPREME COURT TURNS AWAY FROM INVESTOR PROTECTION

In roughly the two decades between the mid-1970s and the mid1990s, however, the federal securities laws became progressively less friendly to the claims of investors.(fn40) This occurred through both new legislation and judicial interpretation of existing statutes.

First, in a string of opinions in the 1970s, the Supreme Court imposed...