TESTIMONY OF ANDREW FRIEDMAN, ESQ.
BEFORE THE COMMITTEE ON THE JUDICIARY
OF THE UNITED STATES HOUSE OF REPRESENTATIVES
FEBRUARY 6, 2002
Good morning Mr. Chairman and Members of the Committee.
I am Andy Friedman. I am a lawyer from Phoenix, Arizona and am a founding member of Bonnett, Fairbourn, Friedman & Balint. Our law firm represents businesses and professionals in litigation matters. I have extensive experience prosecuting and defending commercial cases in both federal and state courts. For the past twenty-three years, my practice has been in the commercial arena. Most recently, I have focused on helping victims of fraud attempt, through class actions in federal and state courts, to recover money stolen from them.
I was one of the lawyers who represented the defrauded bondholders in the Charles Keating/Lincoln Savings & Loan/American Continental Corporation case. As you doubtless will recall, Keating’s victims included 23,000 Californians and Arizonians – mostly seniors – who were deceived into believing they were making insured deposits at Lincoln S&L’s Southern California branches but were fraudulently sold uninsured bonds in another Keating entity. The bonds were worthless and many lost their lives’ savings. That case went to trial in 1992 in Tucson. All told, we obtained a total recovery of over $250 million, and have recovered more than seventy cents on the dollar of the victims’ losses after payment of attorneys’ fees. I also have served as class counsel in state and federal court class actions to recover losses on behalf of victims of deceptive sales practices perpetrated by life insurance companies during the 1980s. In total, these cases, which we brought in both federal and state courts, have recovered over $15 billion for life insurance purchasers.
I appreciate the chance to offer my comments on the class action legislation pending before you. H.R. 2341 would “federalize” most class actions. If enacted, this legislation will impose onerous requirements that inevitably will create delays, increase litigation costs, erect barriers to recovery by victims, and reduce or eliminate recoveries for those who have been victimized by fraudulent and deceptive corporate practices.
To illustrate the difficulties of H.R. 2341, I would like to explain how it would apply to a current case that occupies much of my time. This case was the subject of a front-page article in the Arizona Republic just last week, a copy of which has been submitted to the Committee. The article notes the parallels between the Arizona case and the Enron case, which I will address shortly.
My case involves a fraudulent scheme perpetrated by an Arizona religious organization that called itself the Baptist Foundation of Arizona (“BFA”). The Arizona Attorney General has called the BFA scandal “one of the largest affinity fraud cases in U.S. history.” Our lawsuit charges that the defendants, with their auditors’ knowledge and assistance, maintained a “Ponzi” scheme to bilk faithful church-going people of their retirement income and life savings. BFA issued worthless notes and pedaled them in many Arizona communities. All told, approximately 13,000 investors in BFA lost approximately $590 million in this scheme.
Many, if not most, of the BFA victims are elderly and retired. Twenty-five percent of the BFA investors are 70 years of age or older. Two thousand of these investors are 80 years of age or older! One of our class representatives, Mrs. Ann Cacace is 67 years old. She lives in Sun City, Arizona with her husband Joe, who is 83 years old. Mr. Cacace has significant health problems that prevent him from working. The Cacaces are both here with me today. After the Cacaces invested and lost their lives’ savings with BFA, Mrs. Cacace was forced to go back to work to support her family. Tragically, the Cacaces are typical of the other thousands of investors who mortgaged their homes or invested their life savings both because they were assured the investments were “safe” and because they wanted to support their charitable causes. Various offering circulars touted these investments as a good way of “protecting capital,” while supporting “stewardship ministries” and other religious causes. They were promoted as appropriate “to achieve your retirement dreams” and “prudent, profitable, and protected.”
The BFA tragedy is a mirror image of the Enron scandal. Like Enron, the Baptist Foundation hid millions and millions of dollars in losses in “off the books” transactions with sham companies that were controlled by BFA and corporate insiders. Like Enron, BFA operated through a complex maze of corporate subsidiaries and falsely portrayed itself as financially sound when, in reality, BFA was a financial house of cards. And, like Enron, BFA collapsed even though the company had received an unbroken string of supposedly “clean” audits by its outside accountant.
But the similarities to the Enron meltdown do not end there. The outside auditor who gave BFA a clean bill of health virtually up to the time the company collapsed was none other than Arthur Andersen. Andersen’s conduct with respect to BFA is eerily reminiscent of its actions in the Enron scandal. The facts that have emerged show that, just as in Enron, Andersen ignored a parade of whistleblowers, including a BFA accountant, who described to Andersen auditors the ongoing financial fraud involving hundreds of millions of dollars in losses hidden in overvalued assets and off-book companies. Just like Enron, reports of BFA’s improprieties were circulated to Arthur Andersen’s management and lawyers at its Chicago offices. Just like Enron, the evidence suggests that high-level Andersen personnel destroyed documents and sanitized work papers. And just like in Enron, the Andersen audit partner in charge of the BFA engagement has invoked the Fifth Amendment to avoid answering questions about Andersen’s conduct. It is no small irony that the Arthur Andersen audit partner in charge of the Baptist Foundation account was the same Andersen audit partner who worked on Charles Keating’s books!
The BFA Ponzi scheme collapsed in August 1999. While Enron is the largest for-profit bankruptcy in our nation’s history, BFA is the largest not-for-profit bankruptcy in this nation’s history. After the Ponzi scheme collapsed, we brought a class action lawsuit for investors in Arizona state court against a number of the perpetrators and Arthur Andersen. We filed our suit under state securities statutes and consumer fraud laws. Fortunately for the investors, because BFA securities were not registered or traded on a national stock exchange, we were not required to file our case in federal court under the onerous provisions of the Private Securities Litigation Reform Act. The PSLRA would have imposed tremendous hurdles to recovery, including heightened pleading requirements and a crippling discovery stay; it would have abrogated the investors’ ability to hold Andersen jointly and severally liable for their enormous losses; and (since an amendment to the PSLRA to restore aiding and abetting liability was defeated) it would have prevented investors from holding Arthur Andersen accountable as an aider and abetter of the BFA insiders.
So, we filed a state court class action under the state securities laws. That action is one of several BFA-related cases that are currently pending in Arizona state court. Those actions include cases brought by the BFA liquidation trustee, the Arizona Attorney General’s office, the Arizona Board of Accountancy, and criminal proceedings. All of the civil cases have proceeded in a coordinated fashion, with common discovery and depositions. Because the Arizona civil rules provide for expedited trial settings in hardship cases, the first of these cases is scheduled to go to trial in early March, 2002, only 18 months after it was filed.
H.R. 2341, the so-called Class Action Fairness Act of 2001, would not be “fair” in any sense of that word. If it were law in our case, it would raise substantial hurdles for us to recover from the defendants. It would force cases into federal court that belong in state court; it would provide no exemption for companies that do substantial business in the state but are not headquartered or incorporated there; and it would cause unconscionable delays for the victims of wrongdoing.
Our case belongs in state court. Four of six of the “lead plaintiffs” live in Arizona. The Baptist Foundation of Arizona was an Arizona corporation with its headquarters in Arizona. Most, but not all or substantially all, of the 13,000 individuals and entities who invested close to $600 million with the BFA were Arizona residents. The for-profit subsidiaries of the Baptist Foundation were Arizona corporations. The individual defendants were all Arizonians.
And, Arthur Andersen has a substantial office in Phoenix, Arizona, although it is headquartered in Chicago, Illinois. It receives audit fees, consulting fees, and otherwise does business within the state of Arizona and is certainly eligible to sue and be sued in the state of Arizona.
In short, the State of Arizona has an overriding interest in this case. That local interest is reflected not only in the overwhelming contacts between the BFA fraud and Arizona, but also in the pending criminal and civil enforcement proceedings brought by Arizona officials.
I file many cases in Federal court when that is the proper forum. I am currently prosecuting a number of Federal class action cases under the Civil Rights Act on behalf of African-Americans who were charged more for life insurance based on the color of their skin. Those cases belong in Federal court. But in the BFA case, we are seeking to enforce Arizona laws against Arizona defendants for the benefit of a predominately Arizona class against defendants who either live in Arizona or that do a substantial amount of business in Arizona. How in the world is a Federal court more qualified to hear those claims than an Arizona court?
Why would Congress pass legislation to benefit corporate defendants such as Arthur Andersen at the expense of innocent and elderly victims like the BFA investors? I think it is extraordinary in light of Enron that Congress would even consider this move.
The Arizona judicial system is perfectly capable of fairly judging the rights of a business such as Arthur Andersen. The argument that class actions are complex and therefore must go into Federal court is to me extremely questionable. State courts routinely hear and resolve complex commercial disputes between corporations. State courts routinely handle cases involving product defects, construction defects and other complex cases. We charge state courts with complex determinations on matters of life or death – capital murder cases frequently involve complicated evidence about the sanity of those charged with crimes and, ultimately, whether the death penalty is warranted. State courts are perfectly capable of affording fair treatment to consumers and victims and those who are alleged to have perpetrated fraudulent schemes.
How Would H.R. 2341 Hurt the Victims in the BFA Case?
H.R. 2341 permits any defendant or any absent class member to “remove” the case to federal court. If the law were to apply in the BFA case, it could have devastating consequences to the BFA investors.
First, H.R. 2341 is a prescription for delay. Once a defendant opts to pull the removal trigger and the case is automatically removed to Federal court, cases will be bogged down with collateral litigation to determine whether the case was properly removed and should stay in Federal court or should be remanded back to state court. Then, any consideration of the merits will be stalled in the face of motions to dismiss and the class certification motion practice. Moreover, in addition to the stay of the proceedings during the motion to dismiss, the bill would permit an immediate appeal of the class certification decision and another stay of the proceedings during that appeal. All the while, plaintiffs will be precluded from obtaining discovery to prove their case.
More importantly, the Federal courts are clogged and backlogged with criminal cases. Federal judges have long complained that they are overwhelmed and understaffed. For this very reason, Congress has consistently increased the minimum amount in controversy requirements for Federal diversity jurisdiction. As a result of these practical realities, cases filed in Federal court on average take far longer to reach trial than cases filed in the Arizona state court system. H.R. 2341 runs directly counter to ongoing efforts to decrease the workload of the Federal courts.
The inevitable delays resulting from removal of the BFA action to Federal court would have devastating consequences for the investors. As noted, thousands of the BFA investors are elderly and many of them are infirm. Thousands of the BFA investors have lost their lives’ savings and their retirement incomes. Time is not on their side; for the BFA investors, justice delayed will be justice denied. Based on these circumstances, one of the BFA cases was assigned priority status and the trial was accelerated under the Arizona rules. The Federal rules contain no counterpart.
Second, if H.R. 2341 applied to the BFA case, it would erect additional obstacles to certification of a class of BFA investors. In addition to federalizing class actions, H.R. 2341 adopts some of the most onerous provisions of the Private Securities Litigation Reform Act. For example, like the PSLRA, it requires that the plaintiff plead the defendants’ state of mind with particularity. It states:
In any class action in which a claim is asserted on which the plaintiff may prevail only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or failure to act alleged to give rise to liability, state with particularity facts which, if proven, will demonstrate that the defendant acted with the required state of mind.
In many cases, pleading with particularity that a defendant acted with a certain state of mind at the beginning of a case, before discovery is taken, is extremely difficult, if not impossible.
At the same time, the statute imposes a “stay of discovery” during the pendency of any motion to dismiss. This is a Catch-22. In order to defeat a motion to dismiss and obtain discovery, the plaintiff must plead specific facts with no opportunity to discover them. Class actions are the primary vehicle for recovery by victims of fraud and deception. By its very nature, this sort of wrongdoing is self-concealing and the true facts are simply not available to the defrauded victims. This pleading requirement sets a standard that is often impossible for victims of fraudulent conduct to satisfy, as experience with the PSLRA has proved. Professor John Coffee, the Adolf Berle Professor of Law at Columbia School, has cited these pleading requirements as among the chief causes of creating an atmosphere of laxity that led to the Enron scandal. Indeed, Arthur Andersen was busy destroying documents while the discovery stay was in place in the Enron case.
In fact, the same sort of draconian pleading standard that H.R. 2341 seeks to impose in all class actions directly impacted some BFA investors. A group of approximately 100 investors filed a separate individual action in Federal court under the PSLRA. They alleged facts that were similar to those alleged in our state court class action. The Federal case was dismissed because it failed to meet the onerous PSLRA pleading standard. Similar motions to dismiss the action in State court were rejected. The contrast is clear: In our case, our class has a shot of recovering $590 million based on a Ponzi scheme. If this case were brought in Federal court, the chances of recovery would be far less. If H.R. 2341 were the law, Arizona investors seeking redress for an Arizona scheme against Arizona defendants under Arizona law would be hauled into Federal court to face potentially insurmountable hurdles.
Third, if H.R. 2341 applied to the BFA case, the elderly BFA investors would lose a host of procedural and substantive protections that they now have in the Arizona state court. In Arizona state court, defendants (and plaintiffs) must make extensive disclosures about the facts and documents bearing on the case and the existence of insurance coverage to protect victims; the same detailed disclosures are not required in Federal court. The Arizona court system provides procedures for the parties to appeal important decisions on Arizona law directly to the Arizona appellate courts. The Arizona state court has rules allowing for the coordination and consolidation of related cases, such as the BFA investor class action and the pending civil enforcement proceedings brought by the Arizona Attorney General; there is no formal system to coordinate or consolidate cases in Federal court with cases pending in the state courts. In the Arizona state court, the BFA victims will obtain a successful verdict if 75% of the jurors conclude that Arthur Andersen is guilty; in Federal court the verdict must be unanimous. And, as I stated earlier, the Arizona rules provide for an accelerated and early trial in hardship cases brought by elderly investors; the Federal system has no directly comparable rule.
All of these protections would be lost if H.R. 2341 were the law. So, who would H.R. 2341 protect? Cigarette companies, Enron types, huge powerful wrongdoers. Who would it hurt? Investors, consumers, your constituents. Congress tinkered with the class action device with respect to securities in 1995 when it enacted the PSLRA over President Clinton’s veto. As Professor Coffee has testified, that law contributed directly to the Enron debacle. Why would Congress now essentially extend the disastrous PSLRA to the rest of class litigation?
Congress should reject H.R. 2341.