Shareholder Suits

Last week, Tyco's Dennis Kozlowski was found guilty of looting the shareholder's assets for his own personal gain.  Good.  Too many CEO's treat public companies as their own, rather than other peoples' companies for which they have fiduciary responsibility.  And, unlike the Dick Grasso mess I commented on earlier, this was a much clearer case of looting as opposed to just negotiating themselves a good deal.  (updateStephen Bainbridge has a different take here)

According to the Wall Street Journal, which requires a subscription:

The guilty verdicts are in for L. Dennis Kozlowski and Mark H. Swartz. For Tyco International Ltd., the company they looted, there may be more court dates to come.

Tyco was hit with dozens of shareholder lawsuits in
2002 and 2003 as the company disclosed waves of accounting problems
that sank its stock. It has restated results several times, going as
far back as 1998. A July 2003 restatement cut about a billion dollars
from pretax profit over several years.

The convictions
lend credence to the plaintiffs' allegations that Tyco was grossly
mismanaged. The suing shareholders already have a strong leg to stand
on: Tyco's string of past restatements amount to an admission that its
accounting was deeply faulty. Shareholders claim they were deceived by
accounting practices that presented rosy pictures of the performance of
the company and its acquisitions, then suffered losses following the
revelation of allegations against Mr. Kozlowski and the restatements.

I have never been able to justify most lawsuits by shareholders against companies in which they own shares.  Any successful verdict would effectively come out of the pockets of the company's owners who are.. the shareholders.  So in effect, shareholders are suing themselves, and, win or lose, they as a group end up with less than if the suit had never been started, since a good chunk of the payout goes to the lawyers.  The only way these suits make financial sense (except to the lawyers, like Bill Lerach) is if only a small subset of the shareholders participate, and then these are just vehicles for transferring money from half the shareholders to the other half, or in other words from one wronged party that does not engage in litigation to another wronged party who are aggressively litigious.  Is there really justice here?

OK, you could argue that many of these shareholders are not suing themselves, because they are past shareholders that dumped their stock at a loss.  But given these facts, these suits are even less fair.  If these suits are often made by past shareholders who held stock at the time certain wrongs were committed, they are paid by current and future shareholders, who may well have not even owned the company at the time of the abuses, and may in fact be participating in cleaning the company up.  So their argument is that because the company was run unethically when I owned it, I am going to sue the people who bought it from me and cleaned it up for my damages?  Though it never happens, the more fair approach would be for current shareholders to sue past shareholders for the mess they left.

The vast majority of these suits are dreamed up by attorneys for the benefit of attorneys.  They help shareholders not at all.

Postscript: There are a couple of circumstances where these suits are entirely justified.  The two that come to mind are:

  • Suing a particular group of shareholders who somehow got disproportionate rights in the company or disproportionately benefited financially at the expense of other common shareholders.  A good example would be suing the Rigas family at Adelphia Communications for hosing the minority shareholders.  Note, however, I am talking not about suing the company, but suing certain owners who abused minority shareholders to their benefit.
  • Suing to modify certain governance rules that are seen to be unethical or illegal.  I would hope this would be a last resort after trying a number of proxy fights and other remedies, but this can in certain circumstances be the last protection of minority shareholders abused by the majority.
  • http://honestpartisan.blogspot.com honestpartisan

    I agree with your post to some extent, but I'm left wondering what remedy you would contemplate for, say, a shareholder who was induced to buy stock based upon a fraud perpetuated on them by a corporation. If suing the corporation doesn't make sense, as you argue, what civil remedy is there? Sanctions by the SEC? I was under the impression that shareholder derivative suits exist in part because the SEC just doesn't have the resources to police all of the fraud that goes on out there.

  • http://americaninlebanon.blogspot.com/ Matthew

    Suing for damages from the company is a bit tweaky, but going after the CEOs for criminal charges, and grabbing their ill-gotten personal assets seems like a great idea. When there is actual fraud and culpability of course.