The Attack of the Unhappy Investors : Shareholder lawsuits disrupt business and drain companies’ resources. For executives, reform can’t come too soon.

Norman and Roselyn Reiffman did pretty well with their investment in Amgen Inc. The Long Island couple bought 400 shares of the Thousand Oaks company’s stock in early 1993 at $45 per share, then sold the stock a little over a year later at a modest profit.

Amgen, however, didn’t fare so well with the Reiffmans. The giant biotechnology concern says it spent close to $1 million in legal fees fending off shareholder lawsuits launched by the Reiffmans and a handful of other investors when the price of Amgen’s stock took a temporary downturn two years ago.

The suits were withdrawn 13 months later when attorneys for the Reiffmans and other shareholders admitted they had no case. But by then, Amgen had been forced to hand over thousands of internal documents, waste hundreds of hours of executives’ time and pay a small army of legal experts at rates of up to $350 an hour.

“This is a perfect illustration of the kind of thing that drives executives crazy,” said William Freeman, a Palo Alto attorney who represented Amgen executives in the case. “They can’t even do the right thing without getting sued,” he said.

Reviled as legal holdups by some and championed as effective protection against fraud by others, shareholder lawsuits are a fact of life for many public companies today. They disrupt business, distract executives, and end in costly settlements 85% of the time, according to Securities Class Action Alert, a monthly newsletter published in New Jersey.

With total shareholder suit settlements exceeding $1.4 billion annually in recent years, noisy calls for reform earned the issue a spot on the GOP’s “contract with America.” Last month, the House of Representatives passed a bill designed to curb shareholder suits by requiring plaintiffs to make more specific allegations in initial complaints, allowing executives to speak more freely about their company’s prospects, and forcing losers to pay winners’ legal costs in certain situations. A somewhat softer version of the bill is winding its way through the Senate.

Some legal experts say the House bill goes too far in spooking potential plaintiffs. “It may deter good lawsuits because plaintiffs can’t afford to take the risks,” said George Brown, a professor of securities law at UCLA.

But executives at local companies that have faced shareholder suits in recent years say reform can’t come too soon. “There are circumstances in which companies deserve to have class-action suits,” said Michael Manahan, chief financial officer of Janex International Inc., a Woodland Hills toy company that has faced two such suits since 1992. “But it’s become an automatic thing. Lawyers file suits without even knowing why the stock dropped.”

Of 19 San Fernando Valley companies surveyed for this article, eight reported facing shareholder suits in recent years, including health-care giants WellPoint and Health Systems International, the Hamburger Hamlet restaurant chain, a telecommunications company called Incomnet, and Glendale Federal Bank.

Most shareholder suits are filed as class-action claims by investors who say they have been deceived by executives’ unjustifiably optimistic projections about their company, or failure to disclose bad news in a timely fashion.

The Reiffmans, for example, said they bought Amgen stock after company executives forecast robust growth, and that they were infuriated a few weeks later when Amgen reported that quarterly sales would fall short of analysts’ expectations. “I just felt their hand should be slapped for doing what they did,” said Norman Reiffman, 62, a structural engineer.

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But Amgen’s attorney, Freeman, points out that “optimism is not illegal,” and that company executives were themselves surprised by a drop-off in sales of one of Amgen’s top-selling drugs.

To win a shareholder suit, plaintiffs must prove that a company intentionally or recklessly misled investors. To accomplish this, plaintiffs usually demand to see a company’s internal memos, financial projections and any documents that might yield a “smoking gun”--information that contradicts a company’s public statements.

The daunting prospect of gathering and reviewing thousands of documents is often enough to get skittish companies to settle, but there are additional incentives. Attorneys say that trying to defend a shareholder case before a jury is costly and terribly risky. The cases are complex, juries tend to sympathize with investors, and even if a stock dropped just $5 a share, that could turn into a $25-million award if the class-action suit covers 5 million outstanding shares.

“That is a gamble you might take at the $5 blackjack table, but you can’t take with the future of your company,” Freeman said. “That’s why very few (shareholder suits) ever go to trial.” It also helps explain why the average settlement in a shareholder suit was $7.7 million last year, according to Securities Class Action Alert.

The headaches associated with shareholder suits, however, aren’t confined to the corporate legal department. Consider Janex, which sells licensed products such as gumball machines and clocks tied to Disney’s Lion King and Little Mermaid characters.

Formerly known as With Design in Mind, Janex has survived deep troubles in recent years, including the ouster of its top two executives in an embezzlement scandal, the crash of its stock from $8 a share to as low as 97 cents, and products made so poorly that one-third were being returned as defective.

Those troubles led to two shareholder suits, including one that was dismissed in 1992 and another case the tiny firm has agreed to settle for about $75,000. That settlement is still being reviewed by the company’s attorneys “at $300 an hour,” noted Manahan, who helped uncover the former executives’ embezzlement scheme. Meanwhile, the stigma of the unresolved suit has haunted the company’s recovery.

Merger talks with several companies were aborted after the potential partners learned of the lingering suit, Manahan said. Banks refused to do business with the company, which has given up hopes of expanding its $150,000 credit line. And Janex makes do with just three board members, because the company would have to spend at least $60,000 a year on directors insurance to attract others.

Every quarter, an update on the existing shareholder suit must be included in financial reports to the Securities and Exchange Commission. And every year, the company’s auditors have to get a separate legal opinion on the suit. “That’s another $1,200,” Manahan said.

Then there are the daily disruptions. “Not a day goes by that I don’t get a call from a broker or analyst asking what’s happening with the suit,” Manahan said. “If you start to add up all that time, we’re talking hundreds of hours.”

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Even companies that have never faced shareholder suits are not insulated from their costs. Most companies buy insurance to cover legal expenses incurred by directors and officers. To get $1 million in coverage, a modest amount, companies have to pay premiums ranging between $10,000 and $100,000 per year, said Blake Rea, an insurance broker at Alexander & Alexander in Pasadena.

High-tech companies face the highest insurance premiums because their volatile stocks make them popular targets for shareholder suits. One Valley-based computer company started carrying directors insurance after settling a 1991 shareholder suit for $2.3 million. An executive at the company said annual premiums are $250,000 for $5 million of coverage. He asked that his company not be named, saying that having insurance sometimes invites investor suits.

This type of litigation isn’t new--shareholder suits stem from securities legislation passed in the 1930s--and isn’t very common. Last year, just 290 such suits were filed in federal courts, according to the Securities Class Action newsletter. But the lure of quick and large settlements has spawned law firms that specialize in such claims. These firms usually work on contingency, collecting one-third of each settlement they win for shareholders.

The reputed king of shareholder suits is William Lerach, an attorney who works in the San Diego office of the Milberg Weiss law firm. Lerach’s name was at the top of recent suits filed against Amgen, Incomnet and WellPoint, and his office is involved in hundreds of pending shareholder cases nationwide. Lerach is also a leader in trial lawyers’ effort to block congressional tort reform.

One glaring inequity in securities litigation, critics say, is that it is far easier to start a shareholder lawsuit than to stop one. Glendale Federal Bank, for example, has been fighting the same shareholder lawsuit for five years, even though the case has never advanced beyond the initial pleading stage before a judge, said Martin Washton, a Los Angeles attorney representing the large savings and loan.

Like many other lending institutions, Glendale Federal’s loan portfolio was battered by the recession of the early ‘90s, and the company posted a quarterly loss of $141 million in 1991. Within 48 hours, Washton said, the company was hit with six suits filed by investors who contended they were misled by statements in the company’s annual reports that referred to “superior” asset quality and “stringent” credit procedures.

The case was dismissed by a federal judge, appealed by shareholders, dismissed by a three-judge panel, then appealed again. Most recently, an 11-judge panel chastised the plaintiffs in a 27-page ruling. The judges wrote that the shareholders “seem to have done little more than copy verbatim language from Glendale Federal’s public filings, and then proclaim . . . the statements were false.”

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Nevertheless, the panel concluded that “despite its many deficiencies,” the suit could not be dismissed for the reasons cited by the three-judge panel. The case was returned to that lower panel, which was directed to find other grounds for dismissal or allow the case to proceed.

Washton, Glendale Federal’s outside attorney, makes a comfortable living defending companies named in shareholder suits. But he says cases like this make it obvious that reform is needed. “When companies have to pay hundreds of thousands of dollars to defend cases that have no basis in fact and very little merit,” Washton said, “it is not in the best interests of society.”

Unlike small companies, large corporations like Glendale Federal and Amgen can afford to fight these costly legal battles. In fact, Thomas Workman, general counsel at Amgen, said the company made a point of not settling with the Reiffmans and others in order to send a message. “If they want to sue us again, they’re going to have to go all the way,” Workman said.

Meanwhile, Amgen has been hit with another batch of suits. These stem from the company’s recent acquisition of Synergen, a struggling Colorado-based biotechnology company. Plaintiffs in four of these cases are former Synergen shareholders who allege the company was worth more than the $9.25 per share acquisition price Amgen paid.

The cases, Workman said, “are winding their weary way along.”