The cult of the CEO (as some business gurus now call it) promoted a celebration of testosterone and greed that has coarsened the culture and damaged economic life in severe ways. The adoration of corporate executives–those with a tough-guy disregard for their employees and social norms–seems to be receding now, along with stock prices and disappearing profits, but it does resemble a utopian cult, in which the followers obsessively worship a few strong guys said to possess superhuman qualities. The major media were taken in, but so were many sophisticates. The New Yorker published many admiring character studies of these new titans and even resurrected J.P. Morgan as a worthy icon for our time. Now that icons are falling all around, it seems daft that so many respectable, presumably rational citizens fell under the spell. The establishment’s first line of defense–“only a few bad apples”–has been completely crumpled by events. Leaders from finance are now solemnly promising “business ethics” reforms, anxious to restore “trust” in a system that runs on other people’s money.
William Lerach, the plaintiffs’ lawyer reviled and feared by corporate executives, brings a sharp-edged and refreshingly anti-establishment voice to the emerging debate over how to reform corporate governance. Based in San Diego, Lerach is a fiercely opportunistic advocate for victimized shareholders and has brought hundreds of lawsuits against corporations large and small, usually for fraud. This is clearly his moment in history. Lerach’s list of current defendants starts with Enron, WorldCom, Global Crossing, AT&T, Lucent and Qwest, along with many other firms where investors were duped and burned. His law firm, Milberg Weiss Bershad Hynes & Lerach, dominates the field and has an active docket of some 2,000 cases, roughly half of which involve stock-market abuses.
More significant, Milberg Weiss is opening up promising new territory for class-action litigation that could make Lerach and other trial lawyers into an important force for corporate reform–lawsuits that curb the grand larceny but also change operating routines and power structures within companies. The law firm has already won a string of minor victories in which corporations, in addition to paying cash settlements, were compelled to adopt various internal reforms–some of the same governance reforms that shareholder advocates have been pushing for years in proxy fights, usually without success.
In the present climate, Lerach and partners propose to up the ante. They are aggressively recruiting major pension funds and labor unions as plaintiffs with the promise that shareholder litigation can produce major reforms in corporate behavior–far beyond anything Congress is likely to enact or that the “self-regulating” measures proposed by financial leaders would accomplish. Their venture is untested, but has a potential to generate real leverage over the titans and a measure of power for victimized groups like investors, workers and communities.
As Lerach discusses the current scandals, one begins to grasp why he evokes fear and loathing in the executive class. He has a simple explanation for what generated the greedy excesses–the bloated CEO salaries and stock options, the insider loans and fraudulent bookkeeping to pump up stock prices. “Penis envy,” he said. “I don’t want to use the term, but that’s almost what it is. It’s like, ‘Gee, when the CEO of that company over there is making $20 million, I ought to make $24 million.’ Then the other guy says, ‘Well, if he makes $24 million, then I’ve got to make $30 million.'”
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Corporate moguls, Lerach explained, have a character flaw that is often fatal. “The CEO ultimately gets brought down by the very personality characteristics that made him successful in the first place,” he said. “How did these guys get to the point where they control a big public company? It’s not because they take no for an answer. Their whole life has been fighting and overcoming people who say no, you can’t do it, don’t do it, it’s illegal. These guys say, ‘To hell with you, we’re doing it, we’re getting it done, nobody can stop me.'” And, when they get to the top, nobody dares stop them.
What these animal spirits need is “adult supervision,” Lerach observed. He envisions a system of discipline imposed by independent overseers, inside and outside the corporation, with the power to say no and make it stick. But Lerach doesn’t expect much help in this from either reform legislation pending in Congress or from the Securities and Exchange Commission, which he has observed over the years steadily weakening the original intent of the securities laws enacted in the 1930s. “Since I view myself as a traditional liberal, I ought to be in favor of enhanced government regulation, but I no longer believe in that,” he said. “Because the regulated industries capture the regulators all the time. I don’t care what rules you write. With an army of highly paid lobbyists permanently in Washington, they’re too powerful, too permanent.”
Obviously, he said, the most effective reform is sending executives to prison, though Lerach doubts this will happen either. Prosecutors are either too timid or outgunned by the platoons of pricey defense lawyers. “There is no criminal accountability for white-collar crime at that level; there simply isn’t any,” Lerach said. “The head of J.P. Morgan Chase does not give a crap if he gets caught in Enron and he has to use the Morgan shareholders’ money to settle $2 billion in civil claims. He’s still going to have his four homes; he’s still going have his $300 million, his yacht, his life. You put him in jail for three years–not that I’m trying to pick on [CEO William] Harrison. But if he knew he had a real credible threat of going to jail for three years, he would behave differently.”
If, as Lerach sees it, the regulators, the politicians and the prosecutors are not up to the task, that leaves trial lawyers to clean up the mess. An obviously self-interested conclusion, but Lerach said this on behalf of the much-disparaged trial lawyers: “We may not be perfect, but we are not corruptible. J.P. Morgan and the accounting industry and the high-tech companies can’t buy us off. They can’t stifle us the way they stifle the regulators. If there was a fair, level playing field for civil litigation, where victims could hold the perpetrators to account, it’s not as powerful as jail time but it would have a prophylactic impact.”
Yes, class-action lawyers do reap huge personal fortunes for their efforts, typically taking a quarter or a third of the cash that plaintiffs win. Yet, looking back over the past twenty years, trial lawyers seem to be the only successful reformers in American political life, consistently able to win significant public-interest victories over powerful business interests (tobacco is the best example). As a type, trial lawyers are attack dogs, not political theorists, but their leverage is real because it is based on large sums of money. Conceivably, their influence could help revive serious arguments about the nature of the corporation and of financial markets, making public space for fundamental critiques of the system that for many decades have been confined to academic conferences or kitchen-table conversations about who runs America.
The deeper debate is urgently needed. If the current swirl of reform actions succeeds only in restoring the status quo ante–a stock market that investors once again “trust”–then Americans at large will remain the losers. The problems of corporate governance are about much more than rapacious egotism. The glorification of CEOs and their outrageous self-dealings grew directly out of Wall Street’s narrow-minded concept of the corporation’s purpose, the doctrine known as “shareholder value.” Starting in the 1980s, corporate raiders (often supported by the major pension funds) attacked and took down numerous managements on grounds that the CEOs were too timid about downsizing their companies–that is, squeezing and shedding workers or discarding viable units of production or slashing long-term research budgets in order to maximize short-term gains for shareholders and insiders.
In effect, CEOs were told to abandon the company’s obligations to other interested groups and objectives, including the long-term viability of the company itself. Top executives were sacked if they hesitated, but richly rewarded when they embraced this new order of shareholders über alles. The theory is used to justify the inflation of executive pay and stock options–incentives pegged to stock prices and meant to align CEOs more tightly with the shareholders’ objective (making more money every quarter). The CEO’s supposed solicitude for stockholders is now exposed as a cruel hoax. For investors who were enthralled by the cult of the CEO, the contagion of financial scandals is Wall Street’s version of Jonestown.
The fundamental perversion is a doctrine that encourages managers to squeeze the other constituent contributors to a corporation’s success–taking away real value from employees, suppliers, supporting communities and even customers–in order to reward the absentee owners. That twisted logic explains the internal destruction familiar to those who work for many (though not all) major corporations, from the researchers to middle managers to assembly-line workers. If this false doctrine survives reform, then CEOs may no longer be ripping off the shareholders so boldly, but society’s larger long-term interests will continue to be sacrificed on the altar of “shareholder value.”
It is probably too much to expect Lerach to challenge the theory head-on, since he and many of his clients, the pension funds, rely on “shareholder value” as an argument for their damage claims. However, his list of corporate governance reforms–especially the objectives in labor-backed cases–could definitely alter the balance of power, causing boards of directors to take a broader view of the company’s purpose and to rethink their accountability to employees and society’s values. In any case, Lerach’s corrosive view of management is threatening to the Wall Street order, and so is his utter fearlessness (witness the Enron lawsuit in which he has targeted nine of the most powerful investment banks as insider culprits). Indeed, Lerach’s edgy intellect is so aggressive it makes some allies nervous too. “He is very, very smart and aggressive,” one labor official said. “But sometimes you think of a monkey with a razor blade.” When I asked Lerach how he became such a zealous champion of defrauded investors, he spoke without a moment’s hesitation about painful memories of his father.
“My father lost all his money in the ’29 crash,” Lerach explained, “and it scarred him for the rest of his life. He became 21 years old in April of 1929, inherited his own money, went to work as a stockbroker and lost it all [when the market crashed in the fall], lost his mother’s money and lost his aunt’s money. He ended up, like, selling goddamn shoes. Never got over it. He was just one of those men who were destroyed by the Depression. But, you know, he still loved the stock market. He always talked about it at dinner.”
After law school at the University of Pittsburgh, Lerach joined a “white shoe” establishment law firm in that city and was further educated about the system from the inside. He worked on various corporate-finance deals and saw the power of the CEO’s word. He participated in the defense of corporate clients against several class-action lawsuits, complaints that seemed absolutely meritorious to him. “We got them thrown out of court and investors didn’t get shit,” Lerach recalled. “I saw in those days that, if the plaintiffs’ lawyers had two things–money and brains–they could do it. But money was the most important thing because the companies have the money.” Milberg Weiss, which he joined in the late 1970s, has plenty of both.
During the past few years, in addition to harvesting lots of money, Milberg Weiss and some other plaintiffs’ firms have been rewriting the rules of corporate governance, company by company, issue by issue. Cendant, a once high-flying conglomerate recently sued by the California and New York public-employee pension funds, agreed to make a majority of its directors independent, as defined by the Council of Institutional Investors. The board’s audit, compensation and nominating committees will be composed entirely of independent directors. The repricing of stock options, a practice that keeps them whole while the other shareholders are losing, is prohibited unless approved by the shareholders. Dollar General, settling a fraud claim for $162 million in cash, agreed to reorganize its board too, with directors standing for re-election annually and two-thirds of them demonstrating actual independence. The board can hire its own outside advisers. Top executives must maintain a large equity stake in the company so they can’t avoid personal losses if things go badly.
Wisconsin Energy, heavily fined for environmental violations and lying in court, agreed to create special internal officers to audit environmental behavior and various liabilities. They report directly to the board. Samsonite paid $24 million and settled for new controls to prevent insider trading and excessive executive pay. Its board, two-thirds independent, will meet at least once a year in executive session, without management. Occidental Petroleum, accused of breaching its fiduciary duty to protect shareholders, accepted similar reforms and a “lead independent director” who will oversee the other independent directors. Corrections Corporation of America agreed to prohibit repricing of stock options and various insider payments. WellPoint abolished its “golden parachute” payments to top managers. Calfed eliminated the “special benefits” company insiders were awarded in a proposed merger.
These and other victories demonstrate how a lawsuit’s leverage can alter important points in a corporation’s rules and standards, but they do not yet add up to a major breakthrough (partly because some of the companies were small or bankrupt). “We are just now at the outset of this corporate governance revolution,” Lerach predicted in a speech last year before the Council of Institutional Investors, whose members include scores of major public pension funds like California’s CalPERS, most labor pension funds jointly run by union-management trustees, and a few major companies. The council’s newsletter, reflecting the wariness felt by many fund administrators, once described Lerach’s approach as “corporate governance at gunpoint.” He didn’t disagree. “Just remember,” he said, “oftentimes more is obtained with a kind word and a gun than a kind word alone.”
Some skepticism continues, but Lerach has won an important endorsement from Robert Monks, the “dean of shareholder activists,” as Fortune called him. “I like Lerach,” Monks told me, “but I am frankly not hugely impressed with the governance accomplishments. However, this is the best game in town, so I am helping him get new clients and trying to work with him to effect more dramatic governance changes.”
For the past two decades, Monks has been a leading theorist and activist in focusing shareholder proxy fights on the governing rules of major corporations. He urges the pension funds to drop their passive style of investing and become aggressively involved in the affairs of the companies they own. Shareholder proxy fights are also gaining energy from this season of scandals. Twenty percent of ExxonMobil’s stockholders voted recently for a resolution demanding that the oil giant drop its hostility to global-warming reforms. That was more than double last year’s vote, but it still lost. Shareholder resolutions may influence company attitudes, but except for rare instances, they do not force much actual change even when they win, because the companies are free to ignore the stockholder recommendations and regularly do.
“At least with litigation, if you win, you win,” observed Sarah Teslik, executive director of the Council of Institutional Investors. Teslik shares the ambivalence toward Lerach and questions whether Milberg Weiss would really push that hard for governance reforms if it meant accepting a smaller cash settlement. The law firm has been accused of generating lawsuits for quick settlements that do not deliver much for plaintiffs, and it was explicitly targeted by the Private Securities Litigation Reform Act, passed by Congress in 1995 on behalf of Wall Street bankers, accounting firms and corporate execs. The law requires lead plaintiffs of status for shareholder litigation, but it seems to have backfired on the moguls. Lerach simply recruited more prestigious clients like the Regents of the University of California as lead plaintiff for the Enron case and is more adventurous than ever. “No question, Milberg Weiss and others are showing the way, even if imperfectly,” Teslik said. “No question, the corporate lawyers fear Bill Lerach more than they do the SEC.”
Some leading public pension funds are getting over timidity and making more aggressive demands themselves. CalPERS joined the New York and North Carolina employee pension funds recently to warn dozens of Wall Street investment firms that unless they eliminated their internal conflicts of interest, along the lines that New York Attorney General Eliot Spitzer imposed on Merrill Lynch, the three funds won’t let them manage any of their pension money. Altogether, that represents more than $400 billion–a huge loss of business for bankers who don’t comply. Feeling the general disgust, the New York Stock Exchange has proposed its own substantial list of corporate governance reforms to cover the exchange’s listed companies, and its rules embrace many longstanding reform goals of shareholder activists. “I’m as surprised as anyone,” Teslik said. “I’ve always referred to them as dinosaurs.” These rules, however, apply only to “self-regulation,” and the NYSE has a dismal record in getting tough with the people who pay its bills. Nevertheless, Teslik noted, the exchange’s new rules will provide good ammunition for enforcement by Bill Lerach’s lawsuits.
Lerach is building his own wish list for reforming companies: Require the rotation of auditors every three years. Install a corporate ethics officer with real authority and independent reporting responsibility to the board. Also a regulatory compliance officer with similar power. Rigorous controls to prevent “option flipping,” insider trading and other forms of self-dealing. A holding period on stock options that prevents CEOs from cashing out in a falling market when other shareholders are losing. “These are our companies,” Lerach said. “We own them. There are reasons beyond money to litigate.”
Lerach is also examining the widespread mismanagement of 401(k) pension funds. “I think we may be sitting on a real powder keg here,” he said. “In many instances, while 401(k) money was being shoved into the company’s stock, the executives were bailing out of the company’s stock. That doesn’t look too pretty in hindsight. The executives have $50 million or $70 million in their pocket and Joe Sixpack, who spent forty years working for the company and thought he had $150,000 to retire, has got $9,000. That’s not nice.” The pension-fund trustees could be sued for violating their fiduciary obligations to the employee investors by pushing them into a stock they knew was in trouble and failing to disclose the true condition of the company. There are dozens and dozens of these cases, Lerach said, that would test the limits of the federal government’s own pension-fund supervision and insurance liabilities.
In terms of broader social objectives, some of the most intriguing possibilities in Lerach’s arsenal are the union-backed lawsuits against companies, brought by workers who are also shareholders, either directly or as beneficiary owners of pension-fund capital. Union-sponsored pension funds hold about $400 billion (modest compared with the company-sponsored funds), and Lerach argues that as lead plaintiffs in securities cases, they can win settlements that force businesses to accept union-friendly conditions, the right to organize, improved workplace safety, limits on moving production offshore and other concrete goals. “The labor union pension funds adhere to a view that I happen to agree with,” he said. “Public companies that allow their workers to organize, treat them fairly and compensate appropriately–you know what? Those companies do better long-term. They don’t get sued for violating wage and hour laws or civil rights or environmental laws. Good corporate citizenship pays off in performance. Labor pension funds have every right to advance their values as investors who happen to be workers. This could be a way for labor to makes its capital work for it.”
A lawsuit backed by the Service Employees International Union against Fruit of the Loom accuses CEO William Farley and other executives of destroying the corporation’s value with more than $700 million in losses and 16,000 US jobs shipped offshore, then bankruptcy. The Teamsters are supporting a suit against Overnite Transportation and its owner, Union Pacific, for violating labor and environmental laws. The Teamsters, Plumbers and Carpenters unions are suing Cisco Systems executives for defrauding shareholders by overstating earnings, while selling more than $600 million of their own stock.
The distinctive feature in most of these actions is that the workers, as shareholders, are suing the executives on behalf of the corporation itself, seeking to recover wasted company assets and perhaps win governance reforms in the settlements. Al Meyerhoff, a Milberg Weiss partner who is a former lawyer with the Natural Resources Defense Council, said that so-called derivative lawsuits “give a whole new line of attack to labor unions, environmentalists and others to go after corporate malfeasance. And it hits them where they live because the executives can be held personally responsible for the damage to the company.” Milberg Weiss is applying similarly aggressive tactics against US multinationals operating overseas. It has won substantial cash settlements for workers exploited in the notorious Saipan sweatshops by brand-name clothing makers. “There wouldn’t have been any settlement on Saipan if it weren’t for Milberg Weiss,” one labor-fund official said. “They really carry a big stick. The companies treat them viciously because they know this is real.”
Of course, the overbearing power of American corporations is not going to be dismantled one lawsuit at a time. The larger structural elements of the corporation–the reach and purpose and unique legal privileges of these large private organizations–are artifacts embedded in law and politics. They are unlikely to be altered significantly as long as the alliances of corporations dominate public life so thoroughly, like latter-day political machines. But what trial lawyers bring to the abstraction of corporate governance is a sharp new blade that is cutting into some substantive territory. Together with shareholder activists, labor’s working capital, environmentalists and others, the litigators can help make long-neglected questions of corporate power visible again, a necessary predicate for new politics.
The financial meltdown has already started a re-education process among victimized citizens, but, for the most part, progressives were caught flat-footed, not having developed a coherent vision of what the larger reforms should look like, much less a strategy for accomplishing them. The trial lawyers do not yet have a grand theory either, but maybe reformers can help them develop one. Here are some of the propositions that need discussion:
1. Other people’s money.
The stock-market system, as it currently functions, lacks legitimacy for many reasons, but a central one is this: Americans typically hand over their savings to financial firms that, by their nature, are driven by self-interested profit objectives and serve other, larger clients (mainly corporations) in ways that directly conflict with the interests and values of the investors. The scandals have illustrated these conflicts of interest on a grand scale, but the fundamental problem can be resolved only with new financial institutions, not internal rule changes. Ordinary investors need freestanding investment firms that are trustworthy because they are beholden to only one group–the people whose money is at stake. A few exist; more are developing. Working Americans are, likewise, entitled to their own representatives, preferably elected, to oversee their pension savings–trustees who can influence the investment policies and resist the antisocial enthusiasms that sweep through corporate boardrooms and Wall Street. Why give your capital to the known egomaniacs?
2. Governance for whom?
If the “shareholder value” doctrine is repudiated, it must be replaced with a broader understanding of the corporation’s purpose, its obligations to the other constituencies like employees, communities and society at large–and their right to be heard on major policy decisions. Contentious questions will have to be settled on how to design such a realignment, but many of the best-run corporations in America have never forgotten the value of inclusiveness. They already operate, quite successfully, with an explicit culture of encouraging bottom-up participation in workplace decisions, even business policy. For the recalcitrant, reformers might propose a variety of modest steps. Every couple of years, employees (or other constituents) could participate in a vote of confidence on the CEO’s performance, only advisory and with secret ballots, but a chance to vent and surface deeper problems. Or communities could have a formal right to petition the board about larger priorities. As Lerach’s reforms suggested, companies could be required to maintain independent audits of their risk management and environmental behavior, regularly shared with the public. Is the company ignoring the law? What are the potential liabilities if it gets caught?
3. Maximizing long-term value.
Corporate behavior has been deformed, especially during the past two decades, by the pressures to generate short-term gains, and pension funds often participated in the pressuring. The question needs to be asked: Do pension funds and other institutional investors violate their fiduciary responsibility to investors and the beneficiary owners of retirement savings–workers and their families–when they ignore the long-term consequences of how the money is invested? Fiduciary duty is defined by law quite narrowly–maximizing value for the beneficiaries–but many corporations maximize returns by doing damage to society and trashing the very things people need and value in their lives (safe workplaces, stable communities, a healthy environment). The original purpose of the corporation is maximizing wealth for long-term benefit, not for the next quarter, and that principle needs to be restored.
Business professors James Hawley and Andrew Williams elaborated a compelling new theory, in The Rise of Fiduciary Capitalism, that describes pension funds as “universal owners,” since they invest in all the major corporations across the stock market and effectively own the entire economy. Therefore, their portfolios are directly injured by antisocial corporate behavior, and they will pay the cost, one way or another, of pollution or abusive operating methods even if it yields profit to a particular company. This perspective invites the possibility of a challenging lawsuit by inventive trial lawyers and renewed activism to persuade pension-fund managers to rethink the meaning of their obligations.
4. New ownership.
Who really owns the corporation? The historic fiction that it is the shareholders has been badly tattered by recent events and open again to critical scrutiny. They own the certificates called “stock shares,” but that’s about it. In practical reality, executive insiders exercise the controlling powers of ownership, usually accompanied by a few financiers and large-bloc shareowners, and they decide what happens to the returns. So long as shareholders remain distant from the actual company and ready to dump their shares on short notice, it is illogical to imagine they will ever exercise wise and patient supervision. In fact, the destructiveness and inequalities generated by corporations are unlikely to be reduced until the steep pyramid of power is flattened, with the ownership distributed broadly among employees and other interested constituencies, including trustworthy community institutions.
Workers at every level have a unique, intimate knowledge of the firm that shareholders and even executives can never acquire. The employees also accept various risks on behalf of the company’s future that, unlike the CEO contracts, are seldom compensated. Employee stock ownership (or cooperatives and partnerships) can lead to the creation of more democratic systems of management and more equitable distribution of the rewards. It is not that workers will always get things right, but that the power to determine a company’s direction and purpose is shared more widely among many minds and voices. The operating values of employees ought to be more firmly anchored in the surrounding social context and, for that matter, in common sense. It is hard to imagine that worker-owners could do any worse than those recently fallen titans.
