Bill Hits Fraud Victims On The Chin

Of all the bills making their way through this Congress, the most devastating to its area of the law may be one that has had relatively little attention: legislation to weaken the protection of the public against securities fraud.

The House passed a bill in March. Now the Senate Banking Committee is working on its version. To judge how devastating the legislation would be, consider what it would have done to some of the most notorious recent fraud cases.

In the 1980s, Prudential Securities brokers lured customers to invest in risky securities with deliberately false statements about how much they would make. The defrauded investors and the Securities and Exchange Commission sued Prudential Securities, and in the SEC case alone the firm agreed to repay more than $700 million to the victims.

The victims would probably have been unable to sue if one section of the current House bill had been law.

Known as the “safe harbor” provision, it immunizes from suits by the defrauded all “forward-looking statements” about securities. Companies and their agents could make false “projections” and “estimates” of future performance, even if they were deliberate lies, without fear of lawsuits by those defrauded.

The chairman of the SEC, Arthur Levitt Jr., is concerned about the “safe harbor” provision. He has just written to the Senate committee urging it not thus to protect “purposefully fraudulent” financial predictions.

That is not the only part of the pending legislation that would make it difficult - perhaps impossible - for victims of fraud to sue.

Another is a provision of the House bill requiring anyone who brings a securities fraud suit to show at once, when he or she sues, the state of mind of the defendant indicating fraudulent intent. That kind of information is usually found only during the discovery phase of a case.

For example, two months ago shareholders in Koger Properties Inc. won an $81.3 million judgment in a fraud suit against its accounting firm, Deloitte & Touche. During pre-trial discovery, the plaintiffs’ lawyers found that the partner in charge of the audit owned stock in Koger, a violation of accounting standards. They could not have known that when they sued.

Still another provision of the House bill, and the Senate’s as it stands, would limit what is called “joint and several liability.” That allows the victims of fraud to recover from others involved if the principal fraud perpetrator is not able to pay.

Last month, for example, Steven Hoffenberg of Towers Financial Corp. pleaded guilty to securities fraud and criminal conspiracy in a Ponzi scheme that cost investors $460 million.

He said his accountants and lawyers helped carry out the fraud by issuing false financial statements and making misleading statements to the SEC. Towers is bankrupt, so the victims are suing the lawyers and accountants.

Some of the worst scams in recent history would have left the defrauded investors with little or no recourse if the “joint and several liability” limit had been in effect. The victims of Charles Keating, the great savings and loan swindler, would have been out of luck when he went to prison and said he was broke.

The legislation sounds highly specialized, and it is. But it would have widespread effects on real people. In addition to individual investors who have been defrauded, many local governments have lost large sums in recent years and are suing brokerage firms and others. The big example is Orange County, Calif., which lost more than $1 billion, but there are dozens more.

It is a peculiar time to weaken legal protections: a time of spectacular financial frauds. The latest involves the Foundation for New Era Philanthropy, whose scam attracted many charities and such investors as Laurance S. Rockefeller and William E. Simon. New Era collapsed last week, and the SEC charged its founder with “massive” securities fraud.

But this Congress evidently does not care a lot about the victims of fraud. It is listening to the lobbyists for accounting firms and insurance companies, whose political action committees have made large campaign contributions, and others who want to operate without fear of being sued for securities fraud.