The accounting and financial scandals of the summer meant that Joseph A. Grundfest ’78, W A. Franke Professor of Law and Business, was constantly fielding calls from reporters, trying to make sense of the carnage. Grundfest, a former Securities and Exchange commissioner, was the perfect source, having established both the Law School’s Directors’ College (see previous page) and the Law School’s Securities Class Action Clearinghouse (http://securities.stanford. edu!), which tracks securities fraud lawsuits and settlements. He has been widely quoted in the Wall Street Journal, the New York Times, and other media outlets. At the end of August, he shared some insights with Stanford Lawyer.

Q: WHAT DO THE NUMBERS FROM THE CLEARINGHOUSE TELL YOU ABOUT TRENDS IN SHAREHOLDER SUITS?

A: Well, they suggest that class-action securities litigation has been a good business for a long time and is going to continue to be a good business.

Q: BUT WASN’T THE LITIGATION REFORM ACT OF 1995 SUPPOSED TO MAKE IT HARDER TO SUE?

A: When you talk to people about that, you generally find that their answers are highly consistent with their own financial interests. Isn’t that a surprise? Plaintiffs’ lawyers will swear that the act has contributed to fraud. Defense lawyers will swear that the act had nothing to do with it. 

We’re finding that, first, the price of settling a lawsuit that isn’t dismissed early has increased very dramatically since the act became effective. Second, the number of lawsuits that are dismissed early on has also increased. This pattern is consistent with the courts’ dismissal of weaker lawsuits and the courts’ operating as a filter: they allow the stronger lawsuits to move forward while making it even more expensive for plaintiffs to settle the stronger lawsuits. Ifso, it appears that the Reform Act might be working as some intended.

Q: WHAT DOES YOUR RESEARCH REVEAL ABOUT SHAREHOLDER LAWSUITS SINCE THE REFORM ACT PASSED?

A: If you look at all settlements for $100 million or more since the Reform Act passed-and we’ve identifIed 12 such mega-settlements-me plaintiffs’ classification lawyers rarely discovered the fraud. The fraud is typically either discovered by the press or disclosed by the company itself, through whistle-blower activity or other means. 

The other point that we’re finding is that when the plaintiffs’ class-action lawyers collect a settlement, very little if any of it comes from the individuals who actually committed the fraud. Typically it comes out of me shareholders’ pockets. So what you have is a situation in which you can really ask fundamental questions about the benefits of class-action securities fraud litigation. It appears to have little if anything to do with the mechanisms by which the fraud is actually discovered, and it has very little to do with punishing the individuals who are acmaJly responsible for tile fraud.

At the end of the day, it’s not at all clear that society benefits optimally from plaintiffs’ class-action litigation. Would we be a lot better off if we took the money that society spends to run tile private class-action shareholders’ business and use mat to fund more aggressive enforcement by the SEC? I think a strong case can be made.

Q: WHY DID YOU START DIRECTORS’ COLLEGE AT STANFORD?

A: Stanford Law School is to our knowledge the only major law school and perhaps the only law school in the country that has an organized executive education program designed to address the needs of executives, not lawyers. We actually believe that we have something constructive to say to people who are directors. We believe that if directors of corporations become better educated about the legal environment in which they have to do their jobs, they can avoid problems. And a problem avoided is infinitely better than a problem solved. 

Q: HOW HAS DIRECTORS’ COLLEGE CHANGED SINCE ITS INCEPTION?

A: Eight years ago we actually had to spend a lot of time and energy persuading people about the “value added.” Today everybody says it’s an obvious idea. Suddenly, post-Enron, everybody is running around and discovering director education. We want these programs to multiply. In August we cosponsored with Wharton and the University of Chicago Business School at a conference for new directors. Our Directors’ College will continue to offer a broader set of educational opportunities, to provide greater opportunity to interact with practitioners and directors, and to target experienced directors with more advanced seminars. It is a mission that Stanford Law School has embraced and will continue to push forward.

Q: WHAT OVERARCHING THEMES EMERGED FROM THIS YEAR’S DIRECTORS’ COLLEGE?

A: The main theme was a sense of real uncertainty. People were uncertain as to how the regulatory environment was going to change. People were concerned with how bad the problem in corporate America really was. Honest people were uncertain as to the steps that they should take to comply with the new heightened scrutiny that attaches to all publicly traded firms. It’s as though the presumption in corporate America has changed. A year ago, the presumption was that if you presented a financial statement, it was the burden of someone to claim that it was wrong; now it’s the burden of management to demonstrate that the financial statement is right. That’s quite a shift.

Q: IN YOUR VIEW, WHAT CONCRETE THINGS NEED TO HAVE HAPPENED BY THE END OF 2002 FOR INVESTORS TO HAVE CONFIDENCE THAT REAL REFORM IS OCCURRING?

A: We need to have a set of government enforcement agencies that aggressively go out there and attempt to root out fraud. The public needs to have confidence that we have real cops on the beat, and that they really are in the thick of problems. We have to create an environment in which executives and financial officers expect that if they fool around with the books, there’s a high probability they will get caught and that they will have to pay a penalty.

Q: WHAT PENALTIES WOULD BE MEANINGFUL?

A: It has to be an individualized penalty. It has to hit the individual’s pocketbook, and people have to serve some jail time. What you can’t do is have mutualization of the penalty. You can’t have all of the downside covered by an indemnification policy or insurance. At the end of the day, the person who creates the problem has to feel the pain for the problem he or she created.

Q: SEC CHAIRMAN HARVEY PITT HAS REQUIRED THE TOP CORPORATE EXECUTIVES AT 947 OF THE NATION’S LARGEST COMPANIES TO CERTIFY THEIR FIRMS’ FINANCES ARE ACCURATE. IS THIS MORE THAN A PUBLIC RELATIONS STUNT?

A: This is much more than PR, because what it’s done is give executives the great opportunity to do what in the military is called a stand-down. If the military experiences a series of crashes with carrier aircraft, they cease carrier operations for a period of time, review training and safety, and make sure that everybody understands what needs to happen. We’ve had a series of crashes in corporate America. The SEC requiring these certifications is about as close to a stand-down as you can imagine. It’s as though Harvey Pitt waved a red flag and said to everybody, “Go back and look at your books.”

Q: SPECULATION CONTINUES TO CIRCULATE THAT JOE GRUNDFEST IS PRESIDENT GEORGE W. BUSH’S FIRST CHOICE AS A REPLACEMENT TO CHAIR THE SEC. IS THERE ANY TRUTH TO THE RUMORS?

A: You might as well speculate that the Queen of England is going to abdicate in my favor.