'Fair Funds' Give Investors Recourse

By Jonathan Peterson

Sept. 27, 2004 12 AM PT

Times Staff Writer

WASHINGTON —

A federal initiative to repay investors who lost money because of corporate wrongdoing and other misdeeds has amassed $2.6 billion in just two years and has played a role in almost 100 cases settled by federal regulators.

Little of the cash has been returned to shareholders so far, but officials with the Securities and Exchange Commission maintain that the little-noticed effort is on track and ultimately will pay off big for investors who get hurt when fraud torpedoes a company’s stock.

“Knowing at the end of the line that victims are going to receive tangible compensation -- it’s meaningful to us, and it’s certainly meaningful for people who are finally getting something back that they’ve lost,” said Amy J. Greer, an SEC senior trial counsel who recently administered a $2-million payback for investors of Nevis Capital Management. Nevis was charged with steering shares in initial public offerings to favored accounts instead of all clients, as it had claimed.

The pots of victim compensation money, known as Fair Funds, were created through an obscure provision in the 2002 Sarbanes-Oxley corporate reform legislation. The idea was to reimburse investors who lose money -- when company executives are caught in illegal behavior, for example, or in the case of mutual funds, when trading abuses benefit favored investors at the expense of most others.

Since Sarbanes-Oxley became law, accounts have been set up in 96 cases, including one account set up for investors in WorldCom Inc. (now known as MCI Inc.) and smaller cases settled for tens of thousands of dollars, SEC officials say. For WorldCom investors, who lost an estimated $2 billion in shareholder value, the account is now valued at $684 million.

Increasingly, Fair Funds have become a routine part of the SEC enforcement effort, particularly in those cases in which loss is measurable and losers can be identified.

“Any case where we’re getting money, where you can arguably say there are victims ... there’s probably going to be a Fair Fund,” said Linda Chatman Thomsen, the SEC’s deputy director of enforcement.

Fair Funds have been used to help settle many charges of abusive trading by mutual funds. Accounts established to date include $250 million for investors in Alliance Capital Management funds and $226 million for investors in funds under the Massachusetts Financial Services Co. umbrella

Just last week officials announced that software firm Computer Associates International Inc. would hand over $225 million to pay back investors for losses it caused through criminal fraud.

Compensating investors for losses is not a new business for the SEC. Regulators have long been allowed to return a defendant’s ill-gotten gains to shareholders. But in reality, such gains often went uncollected. Financial penalties, meanwhile, were shipped off to the U.S. Treasury.

Under the new approach, the SEC is allowed to use those penalties to pay back investors for losses -- dramatically increasing the pool available for restitution and easing the concern that heavy fines are a second blow to shareholders of a troubled company. Collections have been efficient, officials say, noting that many of the recent defendants are deep-pocketed corporations and investment firms.

On top of all that, some supporters of the Fair Funds strategy, including influential Republicans, liked the fact that the funds gave investors a means beyond class-action lawsuits to reclaim their losses.

“When corporate executives make out like bandits, the money ought to go back to the investors, not to trial lawyers,” Rep. Michael G. Oxley (R-Ohio) said when the funds were proposed. “This money is for investors’ retirement accounts, not oceanfront estates for ambulance-chasing trial lawyers.”

At the same time, only a few million dollars have gone back to shareholders, even as the funds proliferate and fill up with cash.

“The pot is bigger for investors,” said Dixie L. Johnson, a Washington attorney who chairs an American Bar Assn. panel on securities regulation. “The question is: Are investors getting it?”

Some are downright skeptical: “The problem with putting responsibility [for restitution] in the hands of any federal agency is that the agency will never have the resources -- or the wherewithal -- to do that adequately,” maintains Pamela Gilbert, a lobbyist who represents the National Assn. of Shareholder and Consumer Attorneys.

Regulators say they are up to the task, although in some cases the wait could take years, Thomsen conceded. “It’s very complicated, and everybody wants to do it in a way that maximizes recovery,” she said.

In a typical case, fund administrators must determine who qualifies for reimbursement and how to compute their loss, while keeping track of such details as names, addresses and tax identification numbers for what may be long lists of claimants.

Fund planners also may delve into knotty problems, such as the relative standing of small investors versus institutions. Another issue: whether shares of stock that had been held patiently by small investors should be considered differently from shares that had been churned rapidly by professionals.

The answers may vary. Fair Funds have been arranged for an array of cases, including giant corporate frauds, instances of insider trading and last year’s settlement with Wall Street firms over biased research. Currently, $399 million from 10 companies has been set aside to pay back investors in the research analyst case, a figure that will grow by some $30 million after recent settlements with Deutsche Bank and Thomas Weisel Partners.

“It’s a great intellectual challenge,” said Francis McGovern, administrator for the funds in the research analyst case, who has consulted on reparations in the Gulf War, the A.H. Robins/Dalkon Shield bankruptcy and controversies involving asbestos, silicon gel breast implants and toxic exposure to DDT.

In financial fraud cases, McGovern added, “even when you say, ‘making somebody whole,’ there are going to be complicated decisions about what ‘whole’ means.”

McGovern faces an Oct. 6 deadline to give his distribution plan to U.S. District Judge William H. Pauley III. Once the plan is approved by the judge, McGovern will have nine months to send out the checks. The number of qualified claimants has yet to be determined.

The amount available for that goal also varies from case to case, and Fair Funds indeed have limits.

Stuart Markus, a resident of Long Island in New York, lost most of a $2,500 investment when North Face Inc., a maker of outdoor clothing and equipment, disclosed in the late 1990s that it had inflated its sales figures. (North Face is now a unit of VF Corp.)

The musician eventually got a check for $143.58 as his share of a class-action settlement.

“Cases like this shouldn’t just be about chances for lawyers to get rich,” Markus said. “They should be about a way of getting justice and restitution for people who lost money.”

He doesn’t rate the SEC very highly in accomplishing that aim. When regulators created a $70,000 Fair Fund from fines and improper gains returned by a former executive of North Face, no check came in the mail for Markus. His 100 shares proved too small a stake to qualify under the distribution plan

Fair Funds, Markus said, should be renamed “Fair to Poor.”

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‘Fair Funds’ for investors

Here is a partial list of pools set up or being established to benefit investors victimized in the following cases:

WorldCom: $684 million

Wall Street research (multiple brokerages): $399 million

J.P. Morgan Chase, Citigroup (for aiding Enron Corp.): $236 million

Alliance Capital: $250 million

Massachusetts Financial Services: $226 million

Computer Associates: $225 million

Strong Capital: $141 million

Janus: $100 million