Attempting to ride a wave of corporate and judicial disenchantment with aspects of the current patent system, a new project was unveiled Thursday designed to, as its name bluntly indicates, End Software Patents. (Press release is here. The group’s “first yearly report” on the state of software patents is here.)

The group is intended to become a clearinghouse for information and a hub for those strategizing legal challenges, according to its executive director, Ben Klemens. Though End Software Patents will not initiate litigation of its own, it will be on the lookout for appropriate test cases to support as they arise, he says.

Though the project is being sponsored and funded by leaders of the Free and Open Source Software movement, it hopes to attract support from the wider community of businesses, financial institutions and universities that have all been blindsided in recent years by lawsuits over software patents and their close-cousins, business-method patents.

The End Software Patents Web site, here, highlights a long list of diverse businesses that have been sued for allegedly infringing software patents, including the Green Bay Packers, OfficeMax, Caterpillar, Kraft Foods , ADT Security Services, AutoNation, Wal-Mart , Walgreen , Barnes & Noble, Circuit City Stores , Ford Motor , E I du Pont de Nemours and Co. , and so on. In most cases, the companies have been sued because of certain basic, routine functions performed on their Web sites — the way images are displayed, the way data is gathered or transmitted — which are said to infringe software patents.

The group also hopes to attract support from the many financial institutions, including JP Morgan , Merrill Lynch , and NCR Corp. , that have been asked to pay patent holding company DataTreasury for permission to send check images over the Internet. (For a Washington Post story about remarkable proposed federal legislation directed specifically at the DataTreasury patent, click here.)

The point, explains Klemens, is this: “If you’re running a business of any sort, you have to care about the software and business method patents.” That’s because nearly every business today operates a Web site and employs a staff of in-house IT programmers who enable them to conduct business in the digital age. In that sense, every business is now a software business.

Klemens is a mathematician (a guest scholar at the Brookings Institution since 2003) who uses algorithms to analyze data. In a recent article, for instance, he and his co-authors use data analysis to link certain genes to bipolar disorder. “I often run into patents on statistical methods and mathematical algorithms of the type that I implement,” Klemens says. “I don’t think I violate the ones I’ve seen, but I could be wrong, and I don’t know what else is out there. . . . That’s the thing that really woke me up: by doing pure math, I face legal liability. As far as I know, that’s a first in human history.” Klemens’s personal Web site is here.

In a 2005 book, Mathematics You Can’t Use, Klemens criticizes software patents from an economic and legal perspective, and does so in unusually crystalline, easy-to-understand terms. (For chapter one, see here, and for chapter six, see here.)

The book attracted the attention of the Free Software Foundation, whose president, Richard Stallman, has been railing against software patents since at least 1991, for related, but narrower, reasons: they posed a potentially mortal threat to his brainchild, free software — i.e., software, like Linux, that programmers are able freely to examine, modify, and redistribute without fear that their work will ever be taken out of circulation, declared off-limits, or placed behind a toll-booth by private proprietors. (For a feature story on the tension between patents and free and open software, “Microsoft Takes On the Free World,” see here. Generally speaking, though, software patents present dangerous traps for any programmer. Unlike copyrights, which are difficult to infringe inadvertently, a programmer can easily write software that inadvertently infringes someone else’s patent. That happens whenever the programmer independently comes up with an innovation that, unbeknownst to him, someone else has already staked a claim to. While copyrights are relatively easy to write around — since they protect only particular sequences of words or code — patents present broader, vaguer, and more durable obstacles, since they purport to proprietize implementations of ideas.)

In Klemens, the Free Software Foundation saw a potential ally who, thanks to the breadth of his critique and clarity of his writing, could attract a broader audience than just free and open source programmers. “We came to him,” says Peter Brown, the foundation’s executive director, “and said, we really want to fund your work. And he said yes.”

At the moment, the End Software Patents project is formally an offshoot of the Free Software Foundation. It also enjoys the “sponsorship” — though not monetary support — of the Software Freedom Law Center, which is led by Eben Moglen (an outside lawyer for the FSF and its former general counsel), and of the Public Patent Foundation, an organization led by the center’s legal director Dan Ravicher. The Software Freedom Law Center is itself funded largely by such Linux-supporting corporate patrons as IBM (IBM), Hewlett-Packard (HPQ), Red Hat (RHT), Novell (NOVL), Oracle (ORCL), and Sun Microsystems (JAVA).

To be sure, the goal of abolishing software patents remains a radical position in the sense that very few corporations endorse it. (A surprising exception is pharmaceutical manufacturer Eli Lilly & Co. See here. Evidently Lilly recognizes that poor quality software patents are among the problems spurring the tech industry to seek patent reforms, and it hopes to find of way of placating the tech industry without weakening protections for the drug patents that are the lifeblood of the pharmaceutical industry.)

Though many information technology companies, like IBM, Hewlett-Packard, and Cisco, are publicly championing patent reform, they only favor improving the quality of software patents, not abolishing them. After all, there are estimated to be more than 200,000 active, issued software patents in the United States, and most major tech companies have acquired, at considerable expense, substantial portfolios of them. Companies like Philips Electronics also argue that drawing the line between hardware and software is no longer easy, and that many patents relate to processes that were once accomplished using hardware but are now accomplished using software. Why should the modernization of the medium deprive Philips of recognition for its inventions, its lawyers have argued (albeit, in a slightly different context). See here.

Still, Klemens expects his group to find much common ground with the more moderate IT industry reformers, as well as with those whose main bugaboo is business-methods patents. “Pretty much every argument we make, top to bottom, applies to business methods as well,” Klemens says. In addition, the group’s supporters hope that the major tech players are coming to conclude that the vast number of software patents they have accumulated is part of the problem. “There are so many rights in so many hands,” says Moglen, of the Software Freedom Law Center, “everybody is at risk all the time.”

In any case, even if End Software Patents’ goals are extreme, they are not far-fetched. The U.S. Supreme Court has never ruled on the patentability of software, and at one time the predominant assumption among lawyers was that it could not be, because it amounted to nothing more than mathematical algorithms, which, in turn, were considered nonpatentable “laws of nature.”

That assumption was gradually turned upside down through a series of decisions rendered in the 1990s by the U.S. Court of Appeals for the Federal Circuit, a specialized court that had been set up to handle patent appeals, among other things, in 1984. Those decisions suggested that even if pure software itself was not patentable, software when loaded onto a general-purpose computer created, in effect, a new physical device that could then be patented. Some of the same rulings that opened the door to software patents effectively opened the door to “business method” patents, too.

In the past two years, however, it has become clear to all that the U.S. Supreme Court is extremely unhappy with the patent environment that the Federal Circuit has fostered in the two decades since its creation. In eBay v. MercExchange (May 2006), the Court unanimously junked one longstanding rule of that court, and last term, in KSR International v. Teleflex (April 2007), it unceremoniously dispatched another. (In eBay, the Supreme Court ruled that judges need not always enjoin defendants from infringing, even after a patent-holder has proven its case, and in KSR it made it much easier for judges and patent examiners to invalidate patents due to obviousness.)

For Klemens, however, the most encouraging ruling for his agenda was one that, technically, wasn’t. In LabCorp v. Metabolite Laboratories (June 2006), the Supreme Court had been asked to review the Federal Circuit’s precedents on patentability – the issue that ultimately also determines whether software patents and business-method patents are permissible. After hearing oral argument, the Court punted, deciding that, for technical reasons, it never should have heard the case in the first place. But three justices dissented, writing that they would have overturned the Federal Circuit and invalidated the patent in question, because it clearly amounted to an attempt to patent a nonpatentable “natural phenomenon,” though the phenomenon had been recast in the patent application as a patentable “process.” For that opinion, see here. Klemens contends that software patents amount to much the same thing.

Though only three justices signed the dissent, it does appear that it, in combination with the Supreme Court’s back-of-the-hand treatment of other key Federal Circuit precedents, has led the patent appeals court to engage in some soul-searching. Just two weeks ago, it announced, without having been spurred to do so by the parties, that it would rehear an important patentability case, In re Bilski. (See generally here.) It even asked the parties to brief whether a key ruling it rendered in 1998, State Street Bank & Trust v. Financial Signature Group – one of the pivotal ones greenlighting software and business-method patents — was correctly decided.

“There are test cases all over the place,” observes Klemens. Plainly, his timing is propitious.

Correction:  As a commenter points out, in an earlier version I misused the legal term of art “reads on.” Then I did it again in a comment. Regret both errors.

[UPDATE: I originally wrote this post on October 8, but am now updating it on October 9 after attending the oral arguments in the case. The updated portions are indicated below in italics.]

On Tuesday morning the U.S. Supreme Court heard oral arguments in what has been widely described as both the most important business case of the term and the most important securities case of the decade.

Though everyone advises against making predictions based on justices’ questions at oral arguments, everyone does so anyway. For what it’s worth, it seemed to me the Court was tending in the pro-business direction by about a 5-3 margin. (Justice Stephen Breyer did not participate.)

Chief Justice John Roberts stressed that in recent years Congress has been active in defining precisely which sorts of securities fraud actions private parties – as opposed to the Securities and Exchange Commission – should be allowed to bring, and that he felt the plaintiffs were asking the Court to “expand” upon those remedies. “We did that sort of thing in 1971,” the Chief Justice said, “But we haven’t now for some time.”

The case, known as Stoneridge Investment Partners v. Scientific-Atlanta, will determine how easy or difficult it will be for plaintiffs lawyers bringing class actions for alleged securities fraud to sue third-parties in addition to the corporation that issued the stock in question. The third parties most frequently targeted are accounting firms, law firms, investment banks, and vendors who did business with the issuer.

Today, if third parties formally sign documents that are included in an issuer’s SEC filings — the way auditors do when companies file their annual reports — there is no question that they can be held liable as “primary violators” if they make false statements. But if their role is anything less direct than that, they can currently be sued, if at all, only under a controversial theory known as “scheme liability”: I.e., they are accused of having committed acts with the “purpose and effect” of furthering the issuer’s allegedly fraudulent scheme. In the Stoneridge case, the Court will either accept or reject “scheme liability” as a legitimate basis for suing third parties in private class-action suits. (The Court is not expected to rule until several weeks after the oral argument, at a minimum.)

In today’s arguments, Chief Justice Roberts and Justices Anthony Kennedy, Samuel Alito, and Antonin Scalia all asked tough questions of Stanley Grossman of Pomerantz Haudek Block Grossman & Gross, who was representing plaintiff Stoneridge, while generally letting Stephen Shapiro of Mayer Brown Rowe & Maw, who argued for the defendants, off more easily. If Justice Clarence Thomas (who, as is his custom, asked no questions) votes with the other conservatives, that would make a majority. (Deputy Solicitor General Thomas Hungar also argued for the United States, supporting the defendant.) On the steps of the courthouse afterwards, former SEC commissioner Joseph Grundfest, the co-director of Stanford University’s Rock Center on Corporate Governance, said – after stressing the usual provisos about the futility and inadvisability of making such predictions – that his count was at least 5-3, and possibly 8-0. (Grundfest had joined a friend-of-the-court brief opposing the concept of scheme liability.)At a stand-up interview being televised elsewhere on the plaza, Nina Totenberg told Stoneridge’s counsel Grossman that, after watching the argument, she couldn’t see how he could get five votes. Grossman replied, “I wasn’t counting.”

The recurring theme of the conservative justices’ questions was that they could not see a practical difference between “scheme liability” and the older, more familiar theory known as “aiding and abetting” liability, which the U.S. Supreme Court barred private plaintiffs from invoking in securities fraud cases in the 1994 case known as Central Bank v. First Interstate Bank. Even Justice David Souter asked plaintiffs counsel Grossman at one point, “are you making a distinction that in the real world is not a distinction?”

On the other hand, questions from Justices Ruth Bader Ginsburg, John Paul Stevens, and, at times, Souter, too, suggested that they might still see room for a meaningful distinction to be drawn between the two concepts.

Six of the nine justices on the Central Bank court are still sitting. Three were in the majority that disallowed the aiding and abetting theory in that case – Justices Kennedy, Scalia, and Thomas – while three were among the dissenters: Justices Ginsburg, Souter, and Stevens. Justice Kennedy, who is often now seen as the Court’s swing vote – because he is the most moderate member of the five-justice conservative faction – wrote the pro-business majority opinion in Central Bank.

More than 30 interested outside groups have submitted “friend-of-the-court” briefs. Briefs in support of the scheme liability concept have been submitted by several of the nation’s largest pension funds, attorneys general for more than 30 states, major labor unions, AARP, the Consumers Federation of America, and the trial lawyers trade group, now known as the American Association for Justice. Briefs opposing the concept have been filed by the U.S. Chamber of Commerce, the major securities exchanges, the securities industry, accounting industry, banking industry, insurance industry, law firms, and law firm insurers. The Solicitor General of the United States has weighed in on the side of the business community – i.e., opposing the scheme liability concept – though it did so over the objections of the Securities and Exchange Commission, which voted, 3-2, to support the concept. (All key briefs are available here.)

Stoneridge specifically focuses on a fraud committed in 2000 by officials of cable operator Charter Communications (CHTR). (Several Charter officials ultimately pled guilty to criminal charges in connection with these acts.) To inflate its revenue, Charter asked two of its set-top box vendors, Scientific-Atlanta (a unit of Cisco (CSCO)) and Motorola (MOT), to bill it $17 million more than previously agreed upon, and then to use that extra money to buy advertising from Charter, which Charter then improperly booked as revenue. The vendors allegedly assisted in the scheme by backdating contracts and providing phony invoices and correspondence to help Charter deceive its accountants into approving the bogus revenue recognition. Neither vendor misrepresented its own finances to its own shareholders, and Charter’s shareholders never directly saw any of the misleading documents prepared by the vendors.

In April 2006 the U.S. Court of Appeals for the Eighth Circuit (in St. Louis) rejected the scheme liability concept and dismissed Stoneridge’s case against the vendors. Two months later, the U.S. Court of Appeals for the Ninth Circuit (in San Francisco) came out the other way in a case known as Simpson v. AOL Time Warner, approving the scheme liability concept. (Time Warner (TWX) is the parent of Fortune’s publisher.)

The most famous scheme liability case is one that is not directly before the Court, but whose presence will obviously loom large at the argument. After the Enron catastrophe, class-action impresario Bill Lerach filed a scheme liability case on behalf of holders of Enron securities against more than ten banks who had allegedly engaged in dubious transactions with Enron whose only apparent purpose was to help Enron draw up misleading financial statements. Lerach has already recovered $7.3 billion in settlements in the case from such banks as Citibank (C), J.P. Morgan Chase (JPM), and CIBC (CM). But in March 2007, the U.S. Court of Appeals for the Fifth Circuit (in Houston) ruled the same way the Eighth Circuit had, rejecting “scheme liability” and tossing out the case against the banks who had not yet settled, which included Merrill Lynch (MER), Credit Suisse (CS), and Barclays (BCS). (Lerach himself is scheduled to plead guilty on October 29 to conspiring to obstruct justice by bribing plaintiffs and deceiving judges in more than 150 shareholder class actions over more than two decades.)

The Stoneridge case is in one respect a very difficult case to decide but, in another, perhaps, quite easy. The difficult part is that, however the court rules, it will make a decision that works some real injustice to someone. If it rejects scheme liability, investors who have been hurt by mammoth frauds that have led to corporate bankruptcies will be unable to seek reimbursement from deep-pocketed third-parties who really do bear some responsibility for what happened to them. On the other hand, if the Court endorses the scheme liability theory, innocent third-parties will routinely and inevitably be joined as defendants in scores of frivolous cases and — having no way to get those cases dismissed at an early, inexpensive stage (i.e., on a “motion to dismiss”) — will be induced to pay extortionate settlement payments.

The potentially easy part of the case is that it may have already been effectively decided 13 years ago. “Scheme liability” sounds an awful lot like “aiding and abetting liability” — i.e., the notion that plaintiff shareholders should be able to sue third-parties who aided and abetted the issuer’s fraud. The U.S. Supreme Court rejected that theory, however, in its 1994 ruling in Central Bank v. First Interstate Bank. Though that 5-4 ruling was controversial at the time, Congress subsequently made its peace with that ruling — twice! In 1995, it restored by statute the right of federal prosecutors and the Securities and Exchange Commission to prosecute and sue aiders and abettors, but it specifically chose not to restore that right to private plaintiffs. Simply put, Congress decided that private securities actions were so subject to abuse that the costs to society of allowing private parties to sue alleged aiders and abettors were just not worth the benefits.

Congress then made exactly the same cost-benefit determination in 2002, when it passed the Sarbanes-Oxley legislation. Again it was asked to restore the right of private plaintiffs to sue aiders and abettors of securities fraud, and again it said no. Instead, it expanded the SEC’s power to impose fines and disgorgements on aiders and abettors – i.e., forcing them to cough up their profits – and then empowered the SEC to distribute those sums to defrauded investors in partial reimbursement for their losses. (These sums are not, however, as much as private plaintiffs could recover; so far the SEC in the Enron case has recovered about $400 million for shareholders, compared to the $7.3 billion collected by Lerach.)

Obviously, the plaintiffs in Stoneridge (and Enron) claim that scheme liability is distinguishable from aiding and abetting liability; they claim that with scheme liability the third-party has to be shown to have played a slightly more active role in the fraud than had been required to establish aiding and abetting liability, although the precise definition of that magic extra oomph has varied depending on the court and the facts of the case. The defendants and their amici argue, on the other hand, that scheme liability is just a semantic ploy; it’s old wine in new bottles. For what it’s worth, to me scheme liability and aiding and abetting liability sound like one and the same thing.

In an earlier post on these issues, see here, I came down on the liberal side of this dispute, because of the unfairness of depriving shareholders of the right to sue parties who aided and abetted in the frauds that injured them. (There are very few other areas of the law where aiders and abettors are not liable to the same degree as principals.) But after reading many of the briefs from both sides in Stoneridge, I’ve changed my mind. These issues were decided in 1994, and Congress has twice consciously chosen not to overrule the part of that Court decision that barred private suits against aiders and abettors, which is what Scientific-Atlanta and Motorola really were (if anything) here. Congress decided — reasonably — that shareholder litigation is so fraught with abuse, and is such a grotesquely inefficient and ineffective way of reimbursing fraud victims, that it was wiser to leave the deterrence and punishment of aiders and abettors to the SEC and federal prosecutors.

(This item is by Roger Parloff and Fortune Editor at Large Peter Elkind.)

Defendant David J. Bershad, 67, a named partner at the indicted class-action law firm now known as Milberg Weiss & Bershad, is expected to plead guilty to conspiracy to obstruct justice at 2 p.m. PT today in Los Angeles federal court. (At 2 pm ET, the U.S. Attorney’s office in Los Angeles confirmed this in a press release, and also released certain accompanying documents, including the information, the plea agreement , and the statement of facts. See more updates at end of post.)

By pleading guilty to non-fraud counts, Bershad appears to limit his sentencing exposure under the guidelines a range of 27 to 33 months. Because he is cooperating with the government, he will be eligible for a significant “downward departure” from that range.

Bershad’s plea relates to the core allegations of the indictment: misleading judges into believing that plaintiffs were not receiving any special, secret compensation from Milberg Weiss, when in fact they were. A “factual statement” accompanying the plea is also expected to unveil new details of the government’s allegations against the still unindicted “Partner A” and “Partner B,” who are widely assumed to be, respectively, name partner Melvyn Weiss and former name partner William Lerach. Lerach and the San Diego-based west coast office of Milberg Weiss split away from Milberg Weiss in 2004 to found Lerach Coughlin Stoia Geller Rudman & Robbins.

Lerach said last month that was considering retiring. (See posts here and here.) The Los Angeles Daily Journal reported on June 28 that Lerach and Weiss had each turned down a plea agreement that would have required each to serve three to four years in prison. (See earlier post here.)

Since the split, Lerach Coughlin has probably been the nation’s premier class-action firm, and it has thus far recovered more than $7 billion from various banks on behalf of Enron bondholders. Lerach has also been leading the fight, both in the press and in the courts, to have the U.S. Supreme Court recognize the concept of “scheme liability,” which was crucial to his recoveries in the Enron case. The concept is coming before the High Court next term in the case of Stoneridge v. Scientific-Atlantica, and Lerach has asked the Court to also review what remains of his Enron case, too, after a federal appeals court rejected scheme liability theory and dismissed the case against nonsettling banks Merrill Lynch (MER), Credit Suisse (CS), and Barclays (BCS).

Another character in the investigation, Steven Cooperman, is also scheduled to plead guilty of conspiracy to obstruct justice tomorrow morning at 9 a.m. Some details of his agreement have been known since January, however, when he filed a written plea agreement with the court. A former eye surgeon and frequent class-action plaintiff for Milberg Weiss, Cooperman kicked off the Milberg Weiss investigation in 1999, when he began talking to prosecutors in a bid for leniency after being himself convicted of an unrelated insurance fraud. For Peter Elkind’s November 2006 Fortune feature story about the whole Milberg Weiss investigation, click here.

UPDATE: According to the plea agreement, Bershad has agreed to forfeit $7.75 million, in addition to paying a fine of up to $250,000. The government has agreed to recommend a downward departure from the sentencing guideline range, which appears to me to be 27-33 months.

Bershad’s statement of facts refer to, but do not name, three more illegally paid plaintiffs in Florida, in addition to the ones already alleged in the indictment: Seymour Lazar, Howard Vogel, and Cooperman. Bershad says that he, Partners A, B, and E all personally delivered some illegal payments in cash. (A and B have previously been reported to be Weiss and Lerach, respectively, while E has previously been reported to be Robert Sugarman, who left Milberg Weiss in 1999 and was later granted immunity by prosecutors.) Bershad describes incidents that implicate co-defendant Steven Schulman, partners A and B, and two other Milberg Weiss partners described as F and G. He says that he, A, B, F and G contributed personal money to a fund that was used to make secret payments to plaintiffs, and that the partners were then effectively reimbursed by the firm through bonuses. The firm’s partnership agreement, first formalized in 1986, had provisions designed to facilitate this process, Bershad says. He also describes in some detail the $1.1 million payment to plaintiff Vogel in December 2003, which occurred while the firm was under investigation. Bershad says Milberg Weiss provided false information to accountants, tax preparers and the Interal Revenue Service in order to hide and disguise the illegal payments.

Here’s a statement from the defendant Milberg Weiss firm, issued at 3:09 pm:

“We understand that David Bershad will plead guilty today to conspiracy
to obstruct justice. Mr. Bershad had been on a leave of absence since
May 2006 and his relationship with Milberg Weiss LLP has been
terminated. His plea was not unexpected as we indicated in a statement
we released May 30, 2007 (and which is available on
www.milbergweissjustice.com). We remain confident that his actions will
have no effect on the firm’s commitment to its clients and its ongoing
work to protect public shareholders and consumers. “

This morning the U.S. Supreme Court threw out, by a 7-1 vote, an antitrust class action suit filed by investors against 10 leading investment banks, alleging collusive and manipulative IPO underwriting practices during the height of the dot-com boom. The justices did not condone the alleged practices, but merely ruled that the plaintiffs could not invoke the antitrust laws in this instance because those laws were precluded by the more nuanced and particularized regulatory scheme set up by the securities laws.

Justice Stephen Breyer, writing for a majority that crossed ideological lines, said that the sorts of fine distinctions that the case presented — like which forms of coordinated actions taken by members of underwriting syndicates are beneficial to securities markets and which may be harmful — are better drawn by securities experts at the Securities and Exchange Commission (SEC) than by lay juries all over the country.

He also noted that any other ruling might encourage plaintiffs to “dress what is essentially a securities complaint in antitrust clothing” in order to do an end-run around the special hurdles that Congress enacted in 1995 “to weed out unmeritorious securities law suits.”

The investment banks had been accused of acting together to take advantage of the extraordinary demand for IPO securities during the late 1990s by forcing buyers to commit to bidding up the price of a stock in the aftermarket (a practice called “laddering”), or to paying unreasonably high commissions to the brokers on other transactions (a practice that resembles commercial bribery), or to buying less valuable stocks as well (“tying”).

The case had caused a split within the government, with the SEC favoring preemption and the Department of Justice Antitrust Division opposing, but the Court did not appear to find the case very difficult.

The case is called Credit Suisse Securities v. Billing, and the defendants included units of Credit Suisse (CS); Bear Stearns (BSC); Citigroup (C); Deutsche Bank (DB); Goldman, Sachs (GS); Lehman Brothers (LEH); Merrill Lynch (MER); Morgan Stanley (MS); and Bank of America (BAC).

The sole dissenter was Justice Clarence Thomas, who wrote that a broad “savings” clause in the securities statutes — saying that the securities laws were not intended to eliminate other legal remedies investors might resort to — meant that the antitrust laws and securities laws should both apply notwithstanding potential conflicts and confusion. Justice Anthony Kennedy did not participate.

Meanwhile, the Court has still not yet ruled on what is expected to be the main event of the term, as far as securities class actions go: Tellabs v. Makor Issues & Rights. That case involves interpretation of one of the critical hurdles enacted by Congress in 1995 to, as the Court said today, “weed out” frivolous cases — the requirement that the plaintiffs plead facts creating a “strong inference” that company officials acted with fraudulent intent.

[This posting is written jointly by Fortune editor at large Peter Elkind and senior editor Roger Parloff]

The nation’s preeminent class action lawyer, Bill Lerach, 61, informed at least one major client this week that he would be retiring imminently from his firm, Fortune has learned.

The reason why Lerach, who heads San Diego-based Lerach Coughlin Stoia Geller Rudman & Robbins, would retire is not known. Lerach has been under scrutiny in connection with a federal investigation that has already led to the indictment of the firm Lerach formerly co-led, Milberg Weiss Bershad & Schulman, and to two name partners there, David Bershad, 67, and Steven Schulman, 55. That indictment, obtained by the U.S. attorney’s office in Los Angeles, alleges that Milberg Weiss paid $11.4 million in illegal kickbacks to three plaintiffs in about 180 cases over 25 years. All defendants have pleaded not guilty. (For Peter Elkind’s Fortune feature story on that investigation, see here.)

Lerach did not respond to a detailed voice message left with his receptionist this morning, a voicemail left at a home phone number, or to email messages sent to two different email addresses. Firm spokesperson Dan Newman also did not return a phone message, and phone calls or email inquiries to more than 50 partners in the firm’s San Diego office also went unreturned. Phone messages left with Lerach’s attorney, John Keker, were also not returned.

Lerach is best known at the moment for his role as lead counsel for the class of Enron debt and equity securities holders, a case in which he has already recovered about $7.3 billion for class members from such defendants as Lehman Brothers (LEH), Bank of America (BAC), Citigroup (C), JP Morgan Chase (JPM), CIBC (CM), and Enron’s outside directors. Three nonsettling defendants still in the case, Merrill Lynch (MER), Barclays (BCS), and Credit Suisse First Boston (CS), won dismissals of the case against them from a federal appellate court in March, but Lerach’s firm is seeking review by the U.S. Supreme Court. (See earlier post here.)

In recent years Lerach has also been involved in shareholder actions against Dynegy, Qwest (Q), WorldCom, and AOL/Time Warner (TWX). Time Warner, as the last company is now called, is the parent of Fortune’s publisher, Time Inc.

In the criminal inquiry, Milberg Weiss’s founding partner, Mel Weiss, 71—regarded as the dean of the class-action securities bar—remains a target as well. Though neither man was charged, both Weiss and Lerach are reportedly referred to in the indictment, under the pseudonyms “Partner A” and “Partner B,” respectively. Weiss attorney Ben Brafman did not return a phone call.

STATEMENT FROM LERACH COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP (RECEIVED 6/1/07 AT 4:10 PM.):

“As has been speculated on internet blogs and in newspaper articles, after 35 years of successfully practicing law, Bill Lerach is considering retirement. The investigation into allegedly improper activity at Milberg Weiss has continued for almost 7 years, and Mr. Lerach is cognizant of the fact that although our firm has never been a target of this or any other investigation, the investigation should not become a distraction to our firm and its ongoing work.

“As the Honorable J. Lawrence Irving, former U.S. District Judge and Senior Counsel to Lerach Coughlin notes: ‘As a result of our high-profile successes, this firm and its partners have been a regular subject of rumors and speculation. It is important to note that our firm has never been under investigation. The outstanding lawyers in our firm will not be distracted from providing our clients with top-notch legal services.’

” ‘If Bill Lerach retires, our firm will continue pursuing the largest ongoing corporate fraud cases in the country,’ said Patrick Coughlin, co-founder of the firm. ‘No single firm has the depth or breadth of talent that our firm has, nor does any other firm have as many tough, high-profile cases on behalf of the largest public and private pension funds.’ “

Warning: We are about to peek inside the class-action sausage factory; it’s not a sight for the squeamish.

Last October, three clients of the nation’s preeminent class action lawyer, Bill Lerach, got some good news and some bad news. The good news was that Lerach had won a $10 million settlement in the class-action case he’d filed for them back in 2001. The bad news was that he had won it two years earlier, had never told them about it, and that all the money from it had already been doled out, according to a motion the three clients filed in federal court May 4.

Lerach and partner Darren Robbins did not respond to emails sent Thursday seeking comment, nor did Lerach respond to a phone message left Friday. (Lerach is a big deal; he is currently the lead counsel for Enron securities holders who are suing Enron’s banks. He has won $7.3 billion in settlements so far in that case, and is now seeking U.S. Supreme Court review of a court’s dismissal of the remaining defendants: Merrill Lynch (MER), Credit Suisse First Boston (CS), and Barclays (BCS). Lerach is also currently under criminal investigation in connection with matters that have already led to the indictment of his former law firm, Milberg Weiss, and two name partners there. For details on that, see this award-winning feature story by my colleague Peter Elkind.)

The new claims about Lerach arise in a securities class action called Yusty v. Tut Systems, which Lerach filed in July 2001 on behalf of named plaintiffs Carlos Horacio Yusty, Andres Jaramillo, and Rodrigo Jaramillo. The case was brought in federal district court in Oakland, California. (The defendant tech company, Tut Systems, was acquired by Motorola (MOT) in March 2007).

In May 2004, the case was settled for $10 million, with 25% of that — $2.5 million — going for attorneys fees.

About 29 months later, in October 2006, named plaintiff Andres Jaramillo emailed his local lawyer, Bruce Murphy of Vero Beach, Florida, to ask about the status of his case. Murphy, who was the lawyer who had originally referred the case to Lerach’s firm, then forwarded Jaramillo’s email to Dave Walton, an attorney he dealt with there. Walton informed Murphy that the case had ended two years earlier, according to the May 4 filing, which Murphy submitted on behalf of Yusty and the two Jaramillos. (Walton did not respond to an email sent Thursday seeking comment.) Apparently all the settlement money had been distributed by then. (The three named plaintiffs’ stock losses together had come to $24,855, according to Murphy’s filings.)

Obviously, lawyers have an ethical duty to inform clients about a proposed settlement, so that the clients have an opportunity to object to it or, if they’re okay with it, file a claim form and get their share of the money. In an affidavit, Yusty and the Jaramillos claim they never got any notice of any kind. (According to court documents filed in 2004, the plaintiffs lawyers promised to send “individual notice” of the settlement to all class members “who could be identified through reasonable effort.” An outside claims administrator then certified that more than 5,500 class members were sent such notice, and that an announcement of the proposed settlement had also been published in one issue of Investor’s Business Daily.)

There’s a bit more. Murphy also says the Lerach firm stiffed him on a “referral fee” he was owed in the case — 10% of the attorneys fees, or, in this instance, $250,000 plus interest. In 1998, Murphy writes, he made an agreement with Lerach’s then firm, Milberg Weiss Bershad Hynes & Lerach, that he’d refer them shareholder cases in exchange for 10% of the fee. (The west coast office of Milberg Weiss — including all the lawyers handling the Yusty case — split away from that firm in May 2004, forming the firm now known as Lerach Coughlin Stoia Geller Rudman & Robbins.)

Murphy writes that Lerach’s firm paid him referral fees in least 16 cases over the years. (Referral fees are ethical if they are disclosed and the referring lawyer does some actual work on the case.) Murphy’s name appears as co-counsel with Lerach’s on the original complaint in the case, but Murphy alleges in his motion that Lerach’s firm “cut [him] off the service list” at some point, meaning that Murphy stopped receiving copies of the papers filed in the case.

You might think that with a dispute this unseemly, lawyers would try to settle it quietly and far from public view. Well, in an amusingly blunt footnote on the last page of his motion, Murphy offers a theory about why the Lerach firm hasn’t been willing to do so, though the theory may be being offered tongue-in-cheek. In the footnote, Murphy reminds the court that Lerach is currently under criminal investigation and that his former firm is under indictment for allegedly “paying illegal kickbacks to clients in class actions.” In that context, Murphy writes, “Lerach Coughlin needs the cover of an order to pay damages and sanctions” to Yusty and the Jaramillos.

To read the 18-page memorandum accompanying Murphy’s motion, click here.

UPDATE (ADDED 6/3/07)

On Thursday, May 31, Lerach Coughlin filed response papers to Murphy’s motion, which do cast the dispute in a very different light, though they still do not inspire confidence in class action notification procedures. Though Lerach Coughlin was listed as counsel for Yusty and the two Jaramillos in court records, the firm states that it “has never had direct contact with these three individuals and does not have addresses or telephone numbers for them.” It contends that only Murphy, who was originally listed as co-counsel for those three plaintiffs, had their contact information, and it suggests that Murphy did not want to share that information with the Lerach firm. The Lerach firm effectively contends, therefore, that Murphy should have monitored the case more closely — perhaps by looking in the electronic docket sheets online — even if he had been somehow cut off the service list in 2001, as he contends.

More significantly, the firm says that Murphy was told in April 2007, by the claims administrator for the Tut settlement account, that, even though the settlement funds had been fully “distributed,” there was still enough money in the account, due to interest earned, to pay Yusty’s and the Jaramillos’ claims, if Murphy simply filed the necessary paperwork on their behalf with the claims administrator. Inexplicably, the Lerach firm contends, Murphy has still failed to do so. (Murphy has yet not returned email and phone messages I left for him Friday, June 1, seeking comment.)

Accordingly, the Lerach firm contends, the dispute is not really about the plaintiffs’ recovery, but simply about the 10% referral fee Murphy claims to be owed. Lerach Coughlin claims there was never any such agreement. It acknowledges that Murphy referred the Yusty case to the Lerach firm, but says he played no role in litigating it beyond reviewing a copy of the complaint before it was filed. The firm has offered him $15,000 to settle his demand, the Lerach lawyers say, but Murphy refused. It notes that Murphy made a similar demand in a different case in 2004, and did ultimately settle that claim for $15,000.

FOR FOLLOW-UP POST, CLICK HERE.