Donald J. Devine

February 21, 2005
President Gets Legal Reform

At the urging of President George W. Bush, Congress has just passed a major reform of class action legal suits. While the president has been widely recognized for proclaiming freedom as the most important political value, what has been less noticed is that he has also said that freedom must be "sustained by the rule of law" if it is to grow and survive.

At one of his earlier White House "discussions" this month, the president noted that "a capitalist society depends on the capacity for people willing to take risk and to say there's a better future, and I want to take a risk toward that future. And I'm deeply concerned that too many lawsuits make it too difficult for people to do that." The World Bank has been trying for years to understand what brings prosperity to nations. After analyzing forty years of data from just about every existing nation, its main study found that having a sound rule of law was the number one prerequisite for prosperity, much more than trade, education, democracy, or higher government spending (which had a negative effect).

Yet, just this year, the authoritative Heritage Foundation/Wall Street Journal "Index of Economic Freedom" study, which includes many measures of rule of law, found that the United States for the first time dropped out of the top ten countries on these measures. That is why the president has made legal reform, and especially tort reform, one of his top priorities. Dealing with class actions was the first step.

In 2003 the tort system cost $246 billion, or $845 in higher costs for goods, services and medical care per year for each American. Less than half of the funds went to the injured plaintiffs and an incredible 54 percent went to administration, with 33 percent going directly to the lawyers. Rather than the seriousness of the injury, the make-up of the jury and the availability of deep pockets determine how much plaintiffs get. If settlements are haphazard rather than based on known standards or hit the richest party nearby even if not at fault, companies or medical doctors do not know how to change their procedures to avoid additional injuries and suits in the future.

The problems with the law go well beyond torts to fraud generally. The collapse of the Houston energy trader Enron in 2001 provided a convenient opportunity for government prosecutors. Enron was fast and loose with contracts and undoubtedly engaged in fraud. Prosecutors won plea agreements from its chief financial officer, who apparently was the guilty mastermind behind the scheme by threatening a longer sentence for his wife. The chairman of Enron, Kenneth L. Lay, was better known, more smooth and richer so made a better target even though John C. Coffee, Jr., a Columbia University law professor, says Lay was "a distant, hands-off manager who had resigned and come back" and was unlikely to have known the details of the fraud. The Wall Street Journal estimates that he and his directors lost an incredible $250 million on their sales of stock.

The problem is that, according to another law professor, Robert Weisberg of Stanford University: "It's hard to remember a major fraud case that went to a jury trial and led to an acquittal." Just recently, WorldCom's Bernard Ebbers was indicted too, as ten of his directors reached tentative settlement by paying over $18 million each from their own pockets--without being able to use directors' insurance--representing one-fifth of their collective net worth. A few days later, ten former Enron directors agreed to pay $13 million each of their own money to settle a shareholder suit, in spite of a federal judge ruling that there were no grounds to seek redress from the directors on fraud or insider-trading charges. But they were easy targets, including the wife of a former U.S. Senator.

As President Bush noted, this type of law discourages risk-taking. Since even insurance cannot protect, it is financially dangerous to become a mere director and one faces prison for making poor decisions as a CEO. This lack of fair rules is what has kept most of the World Bank countries from achieving economic success. Fraud should be rooted out but it should not be criminal to make a poor business judgment and those who are most guilty should pay, not those who garner the most media attention. Extorting pleas by threatening wives (which happened with Ebbers too) is probably not the most edifying approach for those who are supposed to be representing the dignity of the law.

Yet, as important as it is to prosperity, a rule of law is even more important as the foundation of our government based on popular consent and our very freedom, as Mr. Bush was kind enough to reminded us.