Why 16 WorldCom Underwriters Reject Citigroup-style Settlement

By Richard Sine, Special to the SCAS Alert

Craig Woker, a banking analyst at Morningstar Inc., was among the many who were surprised when Citigroup agreed to pay $2.65 billion to investors who bought stocks and bonds in WorldCom before its bankruptcy two years ago. It was the largest payment ever by a bank or brokerage firm to settle an underwriting fraud case, and the second-largest securities class-action suit ever. (It also forced Citigroup to post a 73 percent hit on second-quarter earnings on July 15.)

But Woker was not surprised when, 45 days later, the 16 other WorldCom underwriters rejected an offer to settle the case on the same terms as Citigroup. The banks would have paid a pro-rated share based on the dollar value of the securities they underwrote. The plaintiffs estimated that if the banks took the deal, investors in the class would have received another $2.8 billion; J.P. Morgan Chase, the second-largest underwriter, would have owed $1.2 billion. [Please click here for the list of the 16 underwriters.]

"The other underwriters played a much smaller role relative to Citigroup in terms of underwriting securities, and I don't blame them for not sticking to the same egregious formula that Citigroup agreed to play," Woker told SCAS Alert. "In the investment banking world, you usually have one lead bank you work with that underwrites the majority of whatever security you bring to market. Then there are a host of other banks that play more of a supporting role. Clearly in this instance Citibank was the lead for WorldCom on most of its offerings...it would have primary responsibility for doing due diligence on the bonds."

Woker's view jibes with that of Bank of America (BoA), which is one of the 16 defendants besides Citigroup. A BoA representative told the Wall Street Journal that "Citigroup played a considerably larger role in the issuance of securities than did Bank of America." Part of the Citigoup settlement related not to bond underwriting, but to the actions of its former star telecom analyst, Jack Grubman, in connection with WorldCom stock. Plaintiff's lawyers said they had amassed evidence that Grubman had manipulated the financial analyses he used in valuing WorldCom stock.

"Citigroup clearly had more exposure than anyone else because of Mr. Grubman," said John C. Coffee Jr., a prominent securities litigation scholar at Columbia University School of Law who has followed the case.

BoA did not respond to calls from SCAS Alert, and the other banks have declined to speak to the media. Indeed, it can be difficult to find candid views on the case, as a wide variety of law firms contacted by SCAS Alert had a stake in the mammoth filing. One insider estimated that 800 lawyers had been employed by the defense alone.

Before the settlement, the defendants may have pinned their hopes on an unusual decision by a federal court of appeals to review whether the class certification was valid. The appeals court said the trial judge might have erred in extending so-called "fraud-on-the-market" doctrine to opinions expressed by a research analyst.

Citigroup decided to settle after the Securities and Exchange Commission (SEC) filed an April friend-of-the-court brief that favored the plaintiffs by contending that the doctrine should indeed apply to analyst statements. The SEC cited economic studies finding that analyst reports do affect the market. The appeals court review was suspended after Citigroup settled.

One lawyer familiar with the defense's case speculated that the underwriters could be stalling for time or trying to wear down the plaintiffs. "Perhaps they believe the passage of time will help them. They think people will get tired of pursuing it, that it's old news."

But the plaintiff's lawyers remain confident that they are on the fast track to victory. On July 8, the appeals court denied a defense motion to postpone the scheduled January trial date. Trial dates are typically seen as driving settlements. And the plaintiff's lawyers may drive a hard bargain with one massive settlement under their belt and a war chest to fight with.

"[The plaintiffs] think it will be more expensive to settle from here on out," said one lawyer who is intimately familiar with the plaintiff's case. "They have a strong case and a trial date."

The lawyer said Citigroup demanded that the plaintiffs offer the settlement to the other banks as a condition of agreeing to the settlement. "Citibank felt for legal reasons that other banks had to be offered the prorated deal."

The lawyer said the case against the other underwriters is stronger than that against Citigroup. He pointed to internal memos showing that credit analysts at the top three underwriters after Citigroup--J.P. Morgan Chase, Bank of America and Deutsche Bank--downgraded their internal credit rating of WorldCom just weeks before underwriting a $12 billion debt offering in 2001. Investors weren't aware of the downgrades.

(The memos can be found on the WorldCom litigation site, www.worldcomlitigation.com, as attachments T, U and V to a filing located at http://www.worldcomlitigation.com/courtdox/2004-03-08DeclarationJPCNOTREDAC.pdf. They are discussed in another filing, http://www.worldcomlitigation.com/courtdox/2004-03-08LPMemoinOpp3.15REDAC.pdf)

The other underwriters may regret letting the case go to trial, the plaintiff-affiliated lawyer said. "[District Judge Denise] Cote will make law in WorldCom," he said. "The risk underwriters face is that she will make law that makes it a more dangerous environment for underwriters."

The Elusive Law of Insider Trading By Bruce Carton, Executive Director

The Martha Stewart case has propelled insider trading back into the news, demonstrating once again the need to sharpen the current laws prohibiting such trading.

Few would disagree with the proposition that trading on nonpublic information is unethical and harmful to shareholders who do not benefit from the same inside information, and that it undermines public faith in the markets. Although we may feel that we will know insider trading when we see it, case after case shows that this simply is not so. Indeed, after reviewing the exact same set of facts, federal prosecutors elected not to charge Ms. Stewart with the crime of insider trading while the Securities and Exchange Commission (SEC) came to the opposite conclusion and filed a civil lawsuit against her alleging insider trading.

The root of the problem with the "insider trading laws" is that there really aren't any. The offense of insider trading stems from Section 10(b) of the Securities Exchange Act of 1934, a vague statute that prohibits the employment of "any manipulative or deceptive device" in connection with the purchase or sale of securities. Although insider trading is sometimes loosely defined as any trading based on "material, nonpublic information," the legal definition flowing from case law is much more complicated and relies heavily on concepts such as fiduciary duty and the "familial duty of trust and confidence."

For instance, in the 1980s, football coach Barry Switzer attracted the attention of the SEC when, after overhearing a corporate executive discuss the imminent "liquidation" of a public company merger, he profitably traded on that information in advance of the liquidation. The SEC brought an enforcement action against Switzer alleging insider trading.

Although Switzer's conduct would seem to meet any commonsense definition of insider trading, he nonetheless defeated the SEC's case against him. The court ruled that the necessary "duty" had not been breached--because the corporate executive was unaware that Switzer had overheard his discussion of the liquidation, the executive had not breached his fiduciary duty to the company. Accordingly, because Switzer's potential liability as a "tippee" under Section 10(b) would have been derivative of his "tipper's" liability, the court's finding that the executive did not breach his fiduciary duty meant that Switzer's trading based on nonpublic information was actually legal.

A case brought by the SEC last month, SEC v. Galluci, also is illustrative of the vagaries of the insider trading laws. In that case, the SEC alleged as follows: A secretary for a prominent corporate lawyer told her husband about confidential, pending mergers and acquisitions on which her boss was working. Husband shared information about imminent mergers with Friend A, and Friend A then shared this information with his own Friend B. Friend A initially did not tell Friend B the source of his information. Later, Friend A told Friend B only that "he had a good friend who worked for an attorney that did mergers and acquisitions."

Can Friend B, presented with this information from Friend A, trade based on this information? The safe answer in terms of both potential liability and ethics, of course, is to refrain from trading. As a purely legal matter, however, is it even possible for Friend B to determine whether trading is against the law in this situation? To answer this question, Friend B would first need to be aware that under applicable case law, his trading would be illegal if (a) the "tipper" breached his duty of confidentiality, and (b) Friend B was aware of that breach.

Even assuming this level of knowledge, however, the answer is still out of the grasp of mere mortals: who is the "tipper" at issue in this situation (Secretary? Husband? Friend A?) and what duty is in question (Secretary's duty to law firm? Husband's duty to Secretary, his wife? Friend A to someone else?)? Does it matter that neither Secretary nor Husband ever traded at all? Does the answer vary given that Friend B initially did not know the source of the information about imminent mergers (when he made some of his trades) but later did possess sketchy information about Friend A's "good friend who worked for an attorney..." (when he made several other trades)?

Notably, as in the Martha Stewart case, the entities responsible for enforcing the securities laws appear to have again come to opposite conclusions: the SEC concluded that Friend B engaged in insider trading (and sued Husband, Friend A and Friend B) while federal prosecutors reportedly brought criminal insider trading charges only against Husband and Friend A.

It can be argued that the continued vagueness of the insider trading laws serves the useful purpose of deterring all trading based on nonpublic information, whether it is technically "legal" or not. While vague laws may have that desired effect, a fairer and more direct use of the law to achieve society's goals in this area would be for Congress to identify what is legal insider trading and what is not, and to articulate the distinction in a coherent statute.

TENTATIVE SETTLEMENTS

Enron Corp.

Bank of America has agreed to pay $69 million to settle an Enron Corp. securities class-action lawsuit filed in October 2001 in U.S. District Court for the Southern District of Texas. Investors of Enron Corp. between Sept. 9, 1997, and Nov. 2, 2001, are expected to be eligible to take part in the settlement.

Bank of America is one of many defendants in this case involving Enron securities. Bank of America reached its agreement with the University of California Board of Regents on July 2, 2004. Bank of America is the second settlement thus far in this litigation, the first coming with Arthur Andersen in July 2002.

In the class-action suit, Bank of America was not alleged to have committed fraud on Enron shareholders. Rather, the financial institution was sued in its role as an underwriter for certain Enron and Enron-related debt offerings only. Under the 1933 Securities Act, Bank of America's potential liability was limited to the loss of value of the securities it sold in the offerings it underwrote.

"Bank of America's payment represents more than 50 percent of its potential damage exposure for the debt offerings sued for in this case," said William S. Lerach of Lerach Coughlin Stoia and Robbins LLP, lead counsel for the University of California in the litigation. "We anticipate this settlement will be the precursor of much larger ones in the future, especially with the banks that face liability for participating in the scheme to defraud Enron's common stockholders."

Montana Power Co.

Montana Power Co. has agreed to pay $67 million to settle a class-action lawsuit filed in June 2002 in U.S. District Court of Montana. Investors who purchased Montana Power securities between Jan. 30, 2001, and Nov. 14, 2001, are expected to be eligible to take part in the settlement.

The complaint alleged that the defendants issued positive statements regarding the company's successful restructuring from an energy company into a stand-alone telecommunications company. These statements failed to disclose that the company was having problems with the assets that it acquired from Qwest Communications International in lieu of the power generation assets it had sold, and that it was having problems in its relationship with Qwest. As a result the company experienced declining revenues in its telecommunications business and declining demand for its broadband products and services.

Montana Power supplied electricity for the state of Montana until it decided to sell its assets and transform itself into Touch America, which went bankrupt when the fiber-optic industry collapsed.

Ashworth Inc.

Ashworth has agreed to pay $15,300,000 to settle a class-action lawsuit filed in January 1999 in U.S. District Court for the Southern District of California. Investors who purchased Ashworth common stock between Sept. 4, 1997, and July 15, 1998, are expected to be eligible to take part in the settlement.

The complaint alleged that during the class period, defendants failed to disclose that Ashworth's new, redeveloped infrastructure, including its increasing use of offshore factories, suffered from inadequate quality-control testing and insufficient supervision; that Ashworth had accumulated large excess inventories of its Basics product line; and that Ashworth's attempts to accelerate the relocation of its manufacturing operations offshore were resulting in significant operational inefficiencies and increased expenses.

According to the company, Ashworth is one of the world's top manufacturers of conveyor belting and specialty conveyor systems.

Cryo-Cell International Inc.

Cryo-Cell International has agreed to pay $7 million to settle a class-action lawsuit filed in May 2003 in U.S. District Court of Florida. Investors who purchased the common stock of Cryo-Cell between March 16, 1999, and May 20, 2003, are expected to be eligible to take part in the settlement.

The complaint alleged that during the class period, Cryo-Cell overstated its earnings, net income and earnings per share; recognized revenue in violation of generally accepted accounting principles (GAAP) and the company's own internal accounting principles with respect to related-party transactions, revenue sharing agreements and revenue recognition for the sale of area licenses; lacked adequate internal controls; and overstated financial results as a result.

According to the company, Cryo-Cell is the oldest and largest family cord blood stem cell bank in the United States. The company provides expectant parents with private collection, processing and cryopreservation of their newborn's stem cells.

HPL Technologies Inc.

HPL Technologies has agreed to pay $4,893,000 to settle a class-action lawsuit filed in July 2002 in U.S. District Court for the Northern District of California. Investors who purchased HPL Technologies securities between July 31, 2001, and July 19, 2002, are expected to be eligible to take part in the settlement.

The complaint alleged that the defendants took advantage of price inflation, selling 85,500 shares of their individual holdings. Then, on July 19, 2002, before the markets opened, HPL shocked the market with news that it was investigating accounting irregularities with respect to revenue recognition on shipments to distributors, that its CEO had been fired, and that its CFO had been reassigned. On this news, HPL's stock plunged 72 percent before trading was halted.

According to the company, HPL Technologies is a leading provider of yield optimization solutions for the semiconductor and flat panel display industries. HPL offers a comprehensive portfolio of products and services including: silicon-proven intellectual property, highly flexible data analysis platforms, factory floor systems and professional services.

Tidel Technologies Inc.

Tidel Technologies has agreed to pay $4,420,000 to settle a class-action lawsuit filed in October 2001 in U.S. District Court for the Southern District of Texas. Investors who purchased Tidel common stock of between April 6, 2000, and Feb. 8, 2001, are expected to be eligible to take part in the settlement.

The complaint alleged that, during the class period, Tidel falsely touted its sales of automated teller machines, or ATMs, as occurring at a "record" pace. These claims allowed the company to begin trading on the NASDAQ national trading system. When Tidel finally disclosed that its largest customer's orders would be at "substantially reduced levels for the quarter ending March 31, 200l," Tidel's stock price declined precipitously. The lawsuit alleged that Tidel did not disclose that its largest customer was in the process of switching to a competitor and reducing orders.

According to the company, Tidel began in 1977 as part of the Southland Corp. (now known as 7-Eleven Inc.) by inventing a popular retail store robbery deterrent product, the Timed Access Cash Controller (TACC). Today there are over 150,000 TACCs in retail locations throughout the world. In 1992, Tidel made history once again by introducing dial-up ATM technology to the commercial marketplace. It has expanded its product line to include scalable ATMs and multimedia point-of-sale kiosks capable of dispensing everything from cash to stamps to event tickets.

DISMISSALS

Aegon, N.V.

A class-action lawsuit filed in January 2003 in U.S. District Court for the Southern District of New York has been dismissed. The lawsuit was filed on behalf of purchasers of the securities of Aegon N.V. from Aug. 9, 2001 to July 22, 2002.

Aegon, through its member companies, is an international insurer. The complaint alleged that as stock markets suffered substantial declines, increasing numbers of investors gravitated from variable products to fixed products. Aegon distinguished itself from its competitors with the claim that its broad product mix better enabled it to take advantage of this market shift, while it simultaneously assured investors that it had sufficient reserves to fund the sharply increasing guaranteed payout obligations required by its fixed products.

The complaint alleged that Aegon also assured investors that it was less vulnerable to the vicissitudes of the equity and credit markets than competitors because the company matched "high quality investment assets . . . in an optimal way to the corresponding insurance liability, taking into account currency, yield and maturity characteristics." The company claimed that, for the foregoing reasons, "consistency and reliability in earnings forecasting is a particular source of pride" and that, while not immune to equity and real estate market shifts, the company was not subject to sharp downward variations in annual net income. Accordingly, the company reduced its earnings guidance for 2002 but at all relevant times maintained its forecast that 2002 net income would at least equal 2001 net income.

The Dutch life insurance giant is using its expertise in acquisition (U.S. rival Transamerica was its largest catch) and consolidation to build a transnational collection of financial services businesses. Its subsidiaries operate primarily in the U.S., the Netherlands, and the U.K., offering personal and commercial life and accident insurance, as well as retirement and savings advice and management services.

Cerner Corp.

A class-action lawsuit that was filed in April 2003 in U.S. District Court for the Western District of Missouri has been dismissed. The lawsuit was filed on behalf of investors who purchased the common stock of Cerner Corp. from July 17, 2002, to April 2, 2003.

The complaint alleged that during the class period, Cerner failed to disclose that it was losing sales to competitors; that some of its clients were delaying, deferring or canceling purchases; and that the company was losing sales due to the reorganization of its sales force. As a result, the complaint alleges that Cerner's earnings projects were misleading. Meanwhile, a company insider allegedly took advantage of the artificial inflation of Cerner stock to sell more than 113,000 shares of Cerner common stock at a price of $4.1 million.

Cerner provides health care software systems designed to aid in effective, real-time decision making across the enterprise.

Gold Banc Corp.

A class-action lawsuit filed in March 2004 in District Court of Johnson County, Kansas has been dismissed. The lawsuit was filed on behalf of Gold Banc stockholders.

The complaint alleges that the sale of Gold Banc Corp. to Silver Acquisition Corp. was a mechanism that permitted several of the directors who had substantial holdings in restricted shares of the company's stock to "cash out" of those shares before they otherwise would have been permitted to sell them. Motivated by a desire to redeem their shares, the directors accepted a sale price that did not provide an adequate premium to the company's public shareholders, the complaint alleged. The proposed transaction offered a mere 16-percent premium to the company's public stockholders but a 54-percent premium to the directors, the complaint alleged.

According to the company, Gold Bank provides commercial banking, wealth management and personal banking products and services to a variety of customers both nationwide and abroad.

J. Jill Group Inc.

A class-action lawsuit filed in May 2003 in U.S. District Court of Massachusetts has been dismissed. The lawsuit was filed on behalf of purchasers of the common stock of J. Jill from Feb. 12, 2002, to Dec. 4, 2002.

The complaint alleges that the company failed to disclose that its same-store sales growth was declining as demand weakened; that it was amassing a material amount of product that would have to be discounted in promotional campaigns; and that it was not collecting taxes in certain states where it made Internet sales and also had a retail store, exposing itself to the risk of regulatory scrutiny. As a result, the company's earnings projections were false and misleading.

Nash Finch Co.

A class-action lawsuit that was filed in December 2002 in U.S. District Court of Minnesota has been dismissed. The lawsuit was filed on behalf of shareholders who acquired Nash Finch common stock from Feb. 23, 2000, to Feb. 4, 2003.

The complaint alleged that during the class period, Nash Finch issued financial results that included income from vendor promotions to which the firm was not entitled, so as to maintain favorable credit ratings on its $400 million in debt. The false statement allegedly caused the company's stock to trade at inflated prices, permitting Nash Finch to maintain its credit ratings.

According to the company, Nash Finch is one of the leading food retail and distribution companies in the United States, with nearly $4 billion in fiscal 2003 annual revenues.

• SafeSkin Corp.
• American Image Motor Co.
• Nike, Inc.
• Sagent Technology, Inc.
• Pharmaprint, Inc.

Enron former chairman and chief executive Kenneth Lay pleaded not guilty July 8 to criminal charges that he took part in a conspiracy to defraud investors. Lay was the latest, and highest-ranking, Enron exec to be charged by federal prosecutors. Lay told reporters he was unaware of the fraud. Meanwhile, a federal judge approved Enron's plan to reorganize its debt, but the plan hit a roadblock July 21 when the Oregon Public Utility Commission issued an initial recommendation to reject the sale of key Enron subsidiary Portland General Electric.

Adelphia Communications Corp. founder John Rigas and his son Timothy were found guilty July 8 of conspiring to loot the cable-television company. Convicted of securities and bank fraud and acquitted of wire fraud, they face decades in prison. The company funded $50 million in cash advances, $1.6 billion in securities and $252 million in margin loans for the Rigas' personal use, according to prosecutors. The prosecutors also said that the Rigases lied to investors about finances at Adelphia from 1999 to its bankruptcy in 2002. The next day the jury deadlocked on fraud charges against Vice President Michael Rigas. Jurors told Bloomberg News that they favored acquitting him by a 9-3 margin. Juror Gladys Oliveras said the panel needed "more jurors who were more experienced in finances."

Tyco International lawyer Mark A. Belnick was acquitted on charges of first-degree grand larceny, securities fraud and falsifying business records July 15. He faced up to 25 years in prison. The Associated Press reported that the prosecution suffered "from the absence of a smoking gun." Compensation expert Graef Crystal, writing for Bloomberg after the acquittal, blasted the SEC's overly lax rules governing executive compensation disclosure in proxy statements: "If [more] sunlight had hit Belnick's pay, he just might not have received anywhere near what he got."

Martha Stewart and her former Merrill Lynch & Co. broker each received five months in prison and two years of probation July 16 for lying about a suspicious stock trade. Stewart, allowed to remain free on appeal, was defiant when speaking to reporters outside the courthouse. Stock in her company, Martha Stewart Living Omnimedia Inc., soared 40 percent on news of the lighter-than-expected sentence. Kmart, which has exclusive rights to the Martha Stewart Everyday brand, reiterated its loyalty to Stewart on the day of the sentence.

Former New York Stock Exchange chairman and chief Richard A. Grasso sued the Big Board July 21 for at least $50 million, claiming it owed him additional compensation and that current chairman John Reed violated a clause in Grasso's employment agreement by speaking out against him after he resigned. Grasso also formally denied the claims of New York Attorney General Eliot Spitzer that he had misled NYSE board members and defended his pay. Spitzer filed his suit May 24, seeking the return of at least $100 million from Grasso.

Meanwhile, former NYSE board member Kenneth G. Langone asked a federal judge to toss the portion of Spitzer's lawsuit that involves him. Spitzer claims Langone hid $18 million of Grasso's compensation from the rest of the board. Langone's lawyers told the Associated Press that he received no financial benefit and therefore should not be asked for restitution.

Former Credit Suisse First Boston banker Frank Quattrone was denied a new trial July 12 by a judge he accused of giving biased jury instructions. Quattrone claimed U.S. District Judge Richard Owen instructed the jury in a way that made them more likely to convict him. Quattrone, 48, was found guilty of obstructing an investigation into how his bank allocated shares of initial public stock offerings. Quattrone could get more than a year in federal prison. His sentencing is set for Sept. 8. Quattrone's lawyers say they will appeal his conviction.

Supreme Court to Mull Fraud-on-the-Market Theory
By Richard Sine, Special to the SCAS Alert

Do securities fraud plaintiffs need to prove that the fraud caused their losses, or merely that misleading statements inflated the stock price?

When it agreed to consider this issue last month, the U.S. Supreme Court took on an issue that affects the vast majority of securities class-action cases and may make the difference in hundreds of millions of dollars in awards, fees and costs, observers say.

The case is a test of the so-called "fraud-on-the-market" theory, a central tenet of securities law. At issue is whether for a case to go forward, plaintiffs must trace their losses and damage requests to a stock price drop following a "corrective disclosure" of concealed information, or whether they must merely prove that a stock price was artificially high due to the company's deceit.

The suit against Dura Pharmaceuticals is on behalf of investors who bought the stock between April 1997 and February 1998, when Dura's stock plunged 47 percent after slower-than-expected sales. Nine months later the price fell another 21 percent, after Dura announced the Food and Drug Administration would not approve its much-hyped experimental asthma-medicine dispenser, Albuterol Spiros. The FDA chided Dura for glossing over regulators' concerns about the device in its news releases.

A lower court blocked the claim, ruling that the disclosure about the medicine dispenser was not related to the earlier price drop. But the Ninth Circuit Court of Appeals reversed that ruling, finding that "loss causation does not require pleading a stock price drop following a corrective disclosure or otherwise. It merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." If the shareholder would not have purchased the stock if the truth was known, "the injury occurs at the time of the transaction," the court found.

The issue has divided the federal courts, as the Securities Industry Association (SIA) has observed. The Eighth Circuit has agreed with the Ninth Circuit in its liberal interpretation of the law. Meanwhile, the Third, Seventh and Eleventh Circuits have required that the plaintiff prove that the share price declined when the concealed information was disclosed, and that any damages be limited to the decline that followed the disclosure.

"Across the mass of securities cases, the two conflicting approaches affect hundreds of millions of dollars in damage awards, settlements, attorneys' fees, and costs imposed on the federal judicial system," SIA lawyers wrote in a friend-of-the-court brief asking the Supreme Court to take on the case.

If the liberal interpretation were to prevail, the SIA claimed, it might have a chilling effect on the securities industry. Investment firms might be discouraged from taking business for fear of being seen as "guarantors that investments will be successful." Meanwhile, investors suffering losses due to market conditions would "pick through offering memoranda with a fine-tooth comb in the hope of uncovering a misrepresentation."

Federal authorities also opposed the liberal interpretation in a friend-of-the-court brief: "[I]t cannot be said that an investor in a fraud-on-the-market case who purchases a security at an inflated price has suffered any loss at the time of purchase" because the security could still be sold at the inflated price, said the brief, signed by officials at the Department of Justice and Securities and Exchange Commission.

Securities lawyers are closely watching the case, said Donald Langevoort, a securities law scholar at the Georgetown University Law Center.

"The question is what is the level of proof you need to have at the beginning of a case," Langevoort said. "The SEC says you should be prepared to show that when there is a [corrective disclosure], there's a perceptible market impact, so the market had been deceived. Whereas the Ninth Circuit said all the plaintiffs have to prove is that the price was pumped up. To litigators, it's a big issue. So many factors can explain why stock prices move on a given day or given week that whoever has the burden of disentangling that has a heavy burden."

Langevoort said he was surprised the Court had agreed to take on such a technically complex issue. "Frankly, it makes me nervous that the Supreme Court doesn't have experience with the securities market and doesn't have a lot of expertise," he said.

Langevoort said he would expect the Court to hear the case in the winter and announce a decision by June 2005.

(The Ninth Circuit Court of Appeals ruling is available on the Court's website, http://www.ca9.uscourts.gov/ca9/newopinions.nsf/91F6A4F45EB825EA88256D780079B727/$file/0157136.pdf?openelement)

Broadcom Pledges Governance Reforms in Tentative Settlement

Broadcom Corp., a major provider of broadband and other communications chips, agreed to sweeping governance reforms in a tentative settlement announced July 21. The settlement does not provide any money for shareholders, but does guarantee that the firm will provide shareholders the right to nominate at least one candidate for its board of directors, among other requirements.

The Broadcom settlement appears to be the continuation of a small, if growing, trend of incorporating governance reforms into settlements of securities lawsuits. Applied Micro Circuits Corp. reached a similar settlement earlier this month, as did Honeywell International in June.

On July 28 Italian dairy giant Parmalat Finanziaria agreed to governance reforms but not fines in a settlement accord with the Securities Exchange Commission. The SEC claimed the company defrauded institutional investors in a $1 billion debt offering. (The case was not a class action.) Parmalat agreed to be governed by a shareholder-elected, majority-independent board of directors, among other reforms. The SEC is continuing to investigate Parmalat.

“This started as a trickle in 2002, and now we’re seeing more and more,” said Bruce Carton, executive director of Securities Class Action Services (SCAS). “It’s a direct result of the increasing participation of institutional investors as lead plaintiffs.”

Institutional investors became common lead plaintiffs after the reforms of the Private Securities Litigation Reform Act of 1995, which aimed to discourage frivolous lawsuits led by “professional” plaintiffs.

“Institutions are much more interested in corporate governance reform than individual investors,” Carton said. “They see themselves as long-term owners of business and they’re seeking to influence the way the business is run through the litigation process.”

Governance reforms are still relatively rare in settlements. There have been five such settlements out of 63 settlements so far this year, according to SCAS figures. Still, that’s more than the previous two years, when only five of 346 settlements produced governance changes.

In a July 27 article, Associated Press writer Bruce Meyerson suggested that governance changes might have a longer-lasting impact on companies than cash settlements. Meyerson cited a Cornerstone Research finding that the median recovery for shareholders from a settlement amounts to just 4 percent of their losses.

Governance-related settlements may have a long-term payoff for attorneys as well, Meyerson wrote. “The legal fees from a governance settlement can be a pittance compared with the payoff from a big damage award, often totaling between $500,00 and $1 million. But since firms such as Lerach Coughlin and Grand & Eisenhofer are also eagerly courting the same institutional investors as the lead plaintiffs for big-money class action suits, they may see governance-oriented lawsuits as a way to please the client--a loss leader of sorts for the securities bar.”

The Broadcom suit is notable because of the company’s size--it has a market capitalization of nearly $11 billion--and the broad scope of the announced reforms. In addition to the guaranteed shareholder right to nominate a director, the settlement mandated:

• Strengthened independence standards for membership on the Broadcom board

• The election of a lead independent director “with broad authority and power”

• Enhanced internal controls, including mandatory quarterly financial reviews and the implementation of an internal audit function

• Shareholder approval of executive stock option plans or for repricing options already held by directors and executives.

The agreement also imposes restrictions upon the adoption of anti-takeover devices absent shareholder approval.

Broadcom’s stock crashed after revelations that up to half of the company’s sales growth projections were based on warrants to customers in exchange for purchase orders.

Applied Micro Circuits also agreed to governance reforms in lieu of a cash payout in its shareholder suit. The reforms called for splitting the chief executive and chairman jobs, appointing a lead independent director and adding two new independent directors, according to a July 14 article in the San Diego Union-Tribune. (The case is not counted in SCAS statistics because it is a derivative action; i.e., shareholders sued the board of directors on behalf of the company.) A separate class-action suit is pending in federal court.

Honeywell International agreed to governance reforms along with a $100 million cash settlement. The company agreed to adopt provisions relating to executive compensation, performance of internal audits, and the independence of the board and outside auditor. Further details of the settlement were not available.