Shareholder litigation and the board.

• Author: Jones, Ralph E., III
• Position: Includes related article - Chairman's Agenda: Managing Health Care Costs

Any company involved in a controversial transaction, business reversal, or just a plain bad quarter is susceptible to a shareholders' suit.

Corporate officers and directors operate in a more complex business and legal environment today than at any time in history. Economic recession and financial restructuring in Corporate America, combined with the advent of the "professional plaintiff," has produced a virtual explosion of shareholder litigation against corporate board members as they try to fulfill their responsibility to disclose meaningful information to the investing public about their company's performance and prospects.

It's like walking a tightrope, balancing the need to communicate fully and effectively about a company's performance, products, and prospects, with the care and caution required by the law. This balancing act is complicated by the disparate goals of corporate communications.

As Harvey Pitt, a noted defense counsel, recently wrote to this clients: "A certain amount of tension exists between the two forms of corporate pronouncements. Formal filings with the Securities and Exchange Commission and/or investors tend to take on somber tones usually associated with the legal profession, while corporate product announcements, press releases, and advertisements, often take a more free-flowing (and perhaps upbeat) form of expression, sometimes unencumbered by any concern for the potential legal liability...."

One slip on the tightrope or overly optimisitc forecast that doesn't materialize and the chances are high that management will face a lawsuit. (See accompanying sidebar for suggestions on minimizing disclosure exposure.)

Shareholder lawsuits continue to grow with no slowdown in sight. There are currently between 500 and 700 shareholder suits pending in the federal court system, according to the editor of Securities Class Action Alert. This uniquely American phenomenon is a growth industry for plaintiff's lawyers, as the number of these suits has nearly tripled in the past three years. A recent study concluded that "virtually every company in every industry faces a significant probability of being used, most likely by one of seven law firms."

The simple reason for the escalation in shareholder litigation is that the monetary incentives to plaintiffs' law firms in bringing these cases are extraordinary high. The law firm representing shareholders in a class action will probably receive one-third of the settlement. These contingency fees compound rapidly in view of the frequency of settlements. Recently, the Economics Consulting Group in Berkeley, Calif., reviewed 330 cases and found that only three went to trial. Most shareholder suits are settled out of court, as is nearly two-thirds of all civil litigation in this country. Alan Shugart, who has faced several suits as the CEO of Seagate Technologies, a Silicon Valley disk drive manufacturer, calls the suit-and-settlement gambit "legalized extortion." Shugart, as quoted in Forbes, said, "They know how expensive it is for us to take our case to court. We're supposed to give them a few million dollars to make it go away."

The largest and most active of these firms is probably Milberg, Weiss, Bershad...