Specter Law Would Let Investors Sue Fraud Accomplices

By Joshua Gallu

(Bloomberg) -- U.S. Senator Arlen Specter introduced legislation to let investors sue law firms, accountants and investment banks that helped perpetrate fraud, seeking to overcome recent Supreme Court limits on such cases.

The measure would make individuals or firms that provide “substantial assistance” in a fraud subject to investor lawsuits, Specter, a Pennsylvania Democrat, said on the Senate floor last week. The Supreme Court has decided two cases since 1994 that restrict investors from recouping losses from fraud accomplices. The House isn’t considering similar legislation.

“It would be an appropriate change,” said Donald Langevoort, a securities law professor at Georgetown University. “Secondary actors who play a big enough role in perpetrating a fraud should bear responsibility just like anyone else and shouldn’t be able to hide.”

Shareholders are barred from suing parties that have only an indirect role in a fraud after Supreme Court decisions that limited liability to those directly and publicly involved in the scheme. The Specter measure would upend rulings in Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc. of 2008 and Central Bank of Denver v. First Interstate Bank of Denver.

Prior to the rulings, investor lawsuits against fraud accomplices were common, Langevoort said. The 1994 Central Bank decision was a “major gift” to individuals and corporations that aided in a fraud, he said.

“There’s not going to be any real functional limit to who they could go after,” said Matthew Webb, senior vice president for legal reform policy at the U.S. Chamber of Commerce Institute for Legal Reform. The bill may spur lawsuits, he said.

SEC Plans

The Securities and Exchange Commission plans to weigh in this week on an investor lawsuit against Joseph Collins, Refco Inc.’s former outside lawyer, and his law firm, Mayer Brown LLP, said Salvatore Graziano, a lawyer at Bernstein Litowitz Berger & Grossmann LLP in New York representing the plaintiffs.

U.S. District Judge Gerard Lynch in March dismissed an investor suit against Collins, saying neither could be sued for aiding a fraud, even though he was convicted in criminal court. The issue should be reviewed by lawmakers, Lynch said in his opinion dismissing the suit.

For almost a decade, Refco concealed trading losses by secretly transferring them to a holding company owned by Chief Executive Officer Phillip Bennett. Prosecutors said Collins knew of the scheme and drafted legal documents that let Bennett deceive investors, including Boston-based Thomas H. Lee Partners, which paid $507 million for a 57 percent stake in Refco in 2004.

‘Not Appropriate’

“While the impulse to protect professionals and other marginal actors who may too easily be drawn into securities litigation may be sound, a bright line between principals and accomplices may not be appropriate,” Lynch said.

He dismissed a separate lawsuit in April seeking $2 billion from Bank of America Corp., Deutsche Bank AG, Credit Suisse Group AG and other defendants for Refco creditors. He also dropped similar cases against accounting firm KPMG LLP, Ernst & Young LLP, Grant Thornton LLP and PricewaterhouseCoopers LLP.

Immunity under the two Supreme Court decisions has removed incentives for firms “to avoid complicity in and even help prevent securities fraud,” Specter said. While the SEC can sue for aiding and abetting, it can’t recoup losses, he said.

A public company’s auditors, bankers, business affiliates, and lawyers “all too often actively participate in and enable the issuer’s fraud,” Specter said, citing cases of Enron Corp., Tyco International Ltd., WorldCom Inc. and Refco.

“There’s a lot of investor anger, especially against major players on Wall Street, and aiding and abetting liability taps right into that,” Langevoort said.

To contact the reporter on this story: Joshua Gallu in Washington at jgallu@bloomberg.net.

Last Updated: August 4, 2009 12:07 EDT

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