State Funds Cooperating in Class-Action Suits

By David Casserly, Staff Writer

State pension funds are beginning to work together to develop strategies and share resources for class-action lawsuits, no matter which fund might serve as lead plaintiff in the case. If this trend continues to grow, it could lead to larger settlements, quicker movement through the court system, and even attachments to the personal assets of directors.

According to Michael Budin, chief counsel for the Pennsylvania Sate Employees' Retirement System, as briefs or motions come up during litigation, funds have reportedly begun contacting out-of-state counterparts that may have already faced similar proceedings in other cases. In short, funds are sharing the legal expertise their staffs have been able to accumulate on such issues as claims processing, when to opt out of a settlement, and how damages are computed, among others.

"The cooperation is beginning to take root," Keith Johnson, chief legal counsel for the State of Wisconsin Investment Board (SWIB), told the SCAS Alert. "There's a lot more that could be done, but it's very encouraging."

Sidney Liebesman, an attorney with Grant & Eisenhofer P.A., told the SCAS Alert that cooperation he's seen so far is limited. "I do, however, see situations where state funds have talked among themselves and agreed ahead of time about matters dealing with lead plaintiff issues."

That alone is significant, Johnson believes. "There's so much involved in being the lead plaintiff," he said. "That's a really big step."

Aiming for Analytic Discipline

Johnson also points to work done by the National Association of Public Pension Attorneys (NAPPA), which has sponsored a securities litigation working group for the last two years.
The not-for-profit group, which consists of attorneys from 47 states, three territories, the District of Columbia, and one Canadian province, represents approximately 65 state as well as 40 municipal pension systems. Its membership is evenly divided between in-house counsel and attorneys in private practice who regularly represent public pension funds.

"Two years ago, the working group started with just an educational focus," Johnson said. "We really just wanted to educate general counsels on class actions and their fiduciary responsibilities."

This year, though, that evolved into two task forces for both public funds and other institutional investors that focused on computing damages and processing claims.

"These task forces," Johnson explained, "are beginning to help funds apply an analytical discipline to when it's in their best interests to opt out of a settlement. This is especially important since the law in this area is being made as we speak, and it will probably be a year or two before we can look to it for guidance."

Johnson also pointed to a conference that the group held earlier this year as an encouraging sign.

"Even the fact that the conference was held and reserved for the staffs of in-house pension fund and institutional investors," he observed, "is a really important development."

The conference was sponsored by DePaul University's College of Law and titled, "Helping Institutional Investors Increase Recoveries in Corporate Fraud Litigation." Conference literature explained:

The goal of the conference is to share collective legal and practical wisdom on how to improve recoveries for investors. The conference will explore new models for the conduct by plaintiffs of corporate fraud litigation.

It appears that state funds are also working with other parties, such as secured and unsecured creditors and bank lenders. Sometimes the parties are combining all claims into one and agreeing beforehand on a formula to share recoveries.

Approximately 30 percent of all settlements dated from the Private Securities Litigation Reform Act, which was enacted in 1995, to the end of 2003 have involved institutions serving as the lead plaintiffs. This represents an increase in institutional participation compared with pre-Reform Act settlements.

Institutional involvement also has meant larger settlements. According to the Cornerstone Research report Post-Reform Act Securities Lawsuits, settlement amounts have been higher--on average, almost twice as much--for cases in which an institutional investor, such as a state fund, serves as the lead plaintiff. The cooperation among state pension funds aims to drive still larger settlements.

Cooperation could also be an attempt to speed up litigation, which has slowed considerably as these cases have become more complex. The average time it takes to reach a settlement has lengthened to more than three years since 1999, according to Cornerstone Research.

The Anicom Settlement

Johnson and others have cited the Anicom Inc. settlement as an example that illustrates this trend.

SWIB served as lead plaintiff in the shareholder litigation against this now-bankrupt wire distribution company. It resulted in an $18 million settlement of the class-action lawsuit against former top officials of Anicom.

"By presenting a united front, we were able to both move more quickly and efficiently and to more effectively present the plaintiffs' case," Johnson said in a press statement.

The three groups of the shareholder class, the banks, and the Anicom bankruptcy estate plaintiffs worked together under a joint recovery agreement approved last fall by U. S. District Judge John Darrah and U. S. Bankruptcy Judge Susan Sonderby.

"This is a victory for all three plaintiff groups," Johnson asserted. "It vindicates the innovative approach we used of cooperatively pursuing Anicom's top officials and outside auditors. Shareholders and bankruptcy creditors usually end up fighting on separate fronts and waste a lot of money opposing each other."

In addition, according to papers filed in court, Alan Anixter, a Chicago businessman and former Anicom board chairman, is personally paying $12.4 million of the $18 million settlement with the remainder coming from the company's insurance policy.

"This is one of the largest personal payments obtained in connection with allegations of securities and accounting fraud in recent times," Ken McNeil, of Susman Godfrey LLP in Houston, lead counsel for the plaintiffs, told the press at the time.

Additional recoveries for all three groups are still expected from the Anicom bankruptcy, which is still pending in Chicago.

"Collection of personal payments from directors and officers has been rare in these kinds of cases," McNeil said. "However, from the beginning of the case, we sought to get as much personal money from the defendants as possible, rather than just settling for available insurance money. Over 80 percent of the $40 million settlement was from sources other than Anicom's insurance policy.

"We believe this maximizes the deterrent effect of corporate fraud litigation," he added.

Going forward, Johnson is hopeful that state funds will see the benefits of cooperation among themselves.

"To the extent that funds start concentrating on long-term, rather than short-term, interests," he said, "arguably they will see more and more of a benefit from cooperating in the future."

TENTATIVE SETTLEMENTS

Providian Financial Corp.

Providian Financial has agreed to pay $65 million to settle a class-action lawsuit filed October 2001 in U.S. District Court for the Northern District of California. Investors who purchased or acquired the common stock of Providian Financial Corp. between June 6, 2001, and Oct. 18, 2001, are expected to be eligible to take part in the settlement.

The Complaint alleged as follows: During the Class Period, Defendants made materially false and misleading statements and omissions in Providian Financial Corp.'s ("Providian") financial reports and other public documents disseminated to investors, thereby artificially inflating the value of Providian's stock. In particular, with respect to Providian's credit card business, Defendants intentionally or with deliberate recklessness misled the public to the following: Providian's credit losses, understated loan loss reserves, improperly deferred recognition of losses, and overstated income and earnings per share ("EPS"). In addition, Defendants engaged in accounting fraud concerning Providian's revenue, income, and earnings, which resulted in a number of violations of Generally Accepted Accounting Principles ("GAAP").

Headquartered in San Francisco, Providian Financial Corporation is a leading provider of credit cards to mainstream American customers. It is traded on the New York Stock Exchange under the ticker symbol PVN.

Specialty Laboratories Inc.

Specialty Laboratories has agreed to pay $12 million to settle a class-action lawsuit filed May 2002 in U.S. District Court for the Central District of California. Investors who purchased the common stock of Specialty Laboratories, Inc. between Dec. 8, 2000, and April 10, 2002, are expected to be eligible to take part in the settlement.

The complaint alleged that in June and October of 2001, California Department of Health Services (CDHS) representing the State of California and acting as agent of the Centers for Medicare and Medical Services ("CMS") inspected Specialty Labs. As a result of the inspections, Specialty Labs was initially cited by the State of California with 20 deficiencies, and then in a separate statement in February 2002 for 12 overlapping deficiencies by CMS. Specialty Labs was notified that if it failed to correct six of the issues, relating primarily to personnel licensing and the enforcement of regulatory requirements, the Company would face monetary and other penalties, including the possible revocation of its license. Specialty Labs' deficiencies in question relate to two broad areas, both of which focus on the number of licensed personnel in the lab. First, historically there have been required ratios for labs in terms of the number of licensed supervisors per the number of testing personnel. Second, California implemented a requirement for labs performing testing in the areas of cytogenetics and molecular genetics. Specifically, directors of such operations must now be at least at the M.D. or Ph.D. level and must also be Board certified in their area of focus. However, defendants sought to avoid compliance with California's laboratory requirements in order to inflate the Company's revenue and EPS.

Specialty Laboratories, founded in 1975, is a full-service, clinical reference laboratory serving thousands of clients throughout the United States and internationally. Unlike standard reference laboratories, Specialty focuses on cutting-edge research and development of new assays as well as refinement of existing diagnostic tests to produce assays with greater sensitivity, specificity, efficiency and clinical value for reliable and cost-effective patient assessment. With more than 2,500 tests and panels, Specialty is the largest single source of specialized laboratory testing in the United States.

DISMISSALS

Blockbuster Inc.

A class-action lawsuit that was filed in February 2003 in U.S. District Court for the Northern District of Texas has been dismissed. The lawsuit was filed on behalf of all persons who purchased the common stock of Blockbuster from April 24, 2002, to Dec. 17, 2002.

The Complaint alleged the following: Defendants issued statements during the Class Period that failed to disclose that business was being negatively impacted by declining DVD sale prices. As the prices of DVDs declined, consumers began to purchase DVDs from a variety of retail outlets, instead of renting them, thereby causing Blockbuster to experience declining rental sales. Blockbuster was unable to effectively compete with other retailers of DVDs as many of those retailers offered DVDs as loss leaders -- selling the DVDs below or at cost -- in order to entice shoppers into the store. Same-store growth rates that defendants had promised investors would not be realized. In addition, Blockbuster was accused by Buena Vista of breaching the terms of its revenue sharing agreement with it.

Blockbuster Inc. (NYSE: BBI), founded in Dallas, Texas, in 1985 is one of the world's leading providers of videos, DVDs and video games, with worldwide revenues topping $5.9 billion in 2003. During 2003, nearly 80 percent of Blockbuster's revenues were generated in the U.S., where the Company has tens of millions of member accounts.

Rural Cellular Corp.

A class-action lawsuit that was filed in December 2002 in U.S. District Court for the District of Minnesota has been dismissed. The lawsuit was filed on behalf of all shareholders who purchased, converted, exchanged or otherwise acquired the common stock of Rural Cellular from May 7, 2001, to Nov. 12, 2002.

The complaint alleged that defendants were liable as a participant in a fraudulent scheme and course of conduct that operated as a fraud or deceit on purchasers of Rural Cellular common stock by disseminating materially false and misleading statements and/or concealing material adverse facts. The scheme allegedly (i) deceived the investing public regarding Rural Cellular's business, operation and management and the intrinsic value of Rural Cellular common stock, (ii) permitted Rural Cellular to sell and register debt securities valued at $300 million, and (iii) caused Plaintiff and members of the Class to purchase Rural Cellular common stock at artificially inflated prices.

Since its inception in 1990, Rural Cellular Corporation (RCC) has recognized the opportunities that existed in rural cellular communications and realized its vision to capture those markets. Today, RCC is a full-service wireless company, with strategic operations in the Midwest, Northeast, Northwest and the Southern regions of the United States. The acquisition of Triton Cellular extended operations into the South and Northwest regions.

• First Alliance Corp.
• Purus, Inc.
• THQ Inc.
• Imaging Technologies Corp.
• Select Comfort Corp.
  

Sources familiar with the negotiations in the WorldCom Inc. class action suit report that major bond underwriters for the former telecommunications giant are unwilling to settle the pending investor lawsuit. At least, not under the terms already agreed to by Citigroup Inc.

The deadline passed June 28 for J.P. Morgan Chase & Co., Bank of America Corp., and other banks to reach a settlement in a lawsuit over their securities underwriting for the company now known as MCI Inc. With no settlement announced as of 5:00 pm, it seemed likely the trial would continue. On Monday, a spokesman for New York State Comptroller, Alan Hevesi, said that if there were no settlement by the end of the day, the settlement offer would be "off the table" and the litigation would proceed.The lawsuit is currently scheduled to go trial in January.

Under the terms of the Citigroup agreement, the plaintiffs--investors in bonds of WorldCom--gave the remaining defendants 45 days to settle under a formula used to calculate the size of the Citigroup payment.

At the end of June, prosecutors in the Martha Stewart case urged the judge case to reject the defendant's motion for a new trial, saying an ink expert's alleged perjury had no bearing on her conviction.

In a 45-page filing, prosecutors said they presented "overwhelming evidence of guilt" during Stewart's trial. That, they insisted, should trump false statements allegedly made by government witness, Larry Stewart. The Manhattan U.S. Attorney's office accused Mr. Stewart, laboratory director for the U.S. Secret Service, of lying when he testified in the case.

Stewart's lawyers asked for a new trial earlier in June, saying the ink expert's testimony was vital to the government's case and resulted in a "miscarriage of justice." Codefendant Peter Bacanovic filed a similar motion. U.S. District Judge Miriam Goldman Cedarbaum has delayed sentencing in the case by about three weeks, to consider the request for a new trial.

Former New York Stock Exchange (NYSE) Chairman Richard Grasso's response to the New York state lawsuit challenging his $187 million compensation package has been delayed. The postponement, which also affects co-defendant Kenneth Langone, follows a motion by Grasso last week that transferred the case from state to federal court. New York Attorney General Eliot Spitzer has promised to fight the transfer.

Spitzer filed suit against the two on May 24 seeking the return of more than $100 million from Grasso and $18 million in damages from Langone. Spitzer accused Grasso of hiding elements of his pay package from the NYSE board of directors. Langone is the former chairman of the board's compensation committee. Both men have vigorously denied the charges.

U.S. District Judge Leonard Sand has given final instructions to the jury in the case against Adelphia Communications Corp.'s elderly founder, John Rigas. It is about to begin deliberations on whether he, two of his sons, and a former employee conspired to loot one of the nation's largest cable companies and mislead investors.

All four are accused of conspiring to lie to investors, to hide more than $2 billion in debt, and to divert more than $100 million in corporate funds to personal use. Defense lawyers claim the four were borrowing from Adelphia and intended to repay.

According to sources familiar with the case, Pimco Funds reportedly is expected to pay $18 million to settle civil fraud charges by New Jersey state regulators. The company had been accused of allowing Canary Capital Partners LLC, a Secaucus, N.J., hedge fund, to rapidly trade shares in Pimco stock and bond funds--in violation of the firm's own rules.

In February, New Jersey Attorney General Peter Harvey accused Pimco, based in Newport Beach, Calif., of allowing Canary to engage in so-called market-timing trading of several Pimco Funds in exchange for placing millions of dollars in a separate fund.

Canary has been at the center of the mutual fund trading scandal and settled civil fraud charges last year with the New York attorney general over improper trading practices.

Davenport & Co., a Richmond, Va. broker-dealer, will pay $738,000 in fines and restitution to settle NASD allegations that it helped hedge funds make improper trades within variable annuities that forbid such activity.

The firm also helped hedge funds buy new annuities under new names after being barred by life insurers because of the rapid trading, the regulatory organization said. In addition, the firm allowed clients to place trades until 4:30 pm, using that day's price. This is a violation of rules requiring trades placed after 4 pm to receive the next day's closing price.

PWC Settlement Highlights Auditor Independence Issues
By David Casserly, Staff Writer

PriceWaterhouseCoopers LLP (PwC) has tentatively agreed to pay $50 million to settle all claims against the firm for its role as the outside auditor at Raytheon Inc.

That settlement, which still must be approved by the court, is emblematic of continuing scrutiny of auditor independence by class action litigants, federal regulators, and shareholders.

PriceWaterhouseCoopers

The class action suit, filed by the New York state comptroller, Alan Hevesi--sole trustee of the New York State Common Retirement Fund and court-appointed lead plaintiff in this action--alleged PwC "turned a blind eye to the company's [Raytheon's] improper accounting practices, and to have issued a clean audit opinion on the company's 1998 financial statements despite numerous red flags that should have alerted the auditor to underlying difficulties."

The suit claimed the company's independence was compromised by a contract for non-audit consulting work that has since been "limited by the Sarbanes-Oxley Act."

Earlier this month, Raytheon itself had agreed to pay a total of $410 million in cash and warrants to settle all claims against it and its former top executives in the same action. [See SCAS Alert, June 2004.]

"This settlement sends a strong message to auditors and other gatekeepers," Hevesi said in a press release, "that they will be held to a high level of accountability and integrity in matters that impact the investing public. Investors depend on these third parties to guard them from corporate corruption and fraud. Auditors must be independent and diligent in overseeing public companies in order to protect shareholders whose savings and retirements are vulnerable to corporate wrongdoing."

The suit asserts that the clean audit opinion from PwC was materially false and that it misled the investing public by keeping the value of Raytheon's stock artificially inflated. Raytheon later disclosed its true financial condition, which allegedly caused the value of its stock to plummet and resulted in investors losing hundreds of millions of dollars.

"We stand behind our work and would note there have not been any restatements pertaining to this litigation," PWC spokesman Steven Silber said in a press statement. "However, we recognize that lawsuits of this nature and the need to settle them in order to avoid the costs and distractions of protracted litigation are unfortunate realities in today's business environment."

Another E&Y Investigation

Meanwhile, the Securities and Exchange Commission (SEC) has started an informal investigation of Ernst & Young LLP (E&Y). Only three months ago, the Commission had barred the firm from accepting new audit clients for six months.

The latest SEC investigation focuses on payments E&Y made to Mark Thompson during 2002 through 2004, ending about the time of the previous judgment against E&Y by an SEC administrative-law judge. [See SCAS Alert, May 2004.] Thompson's work was described as "leadership development" consulting, for which the Big Four firm paid more than $377,000.

During this time, EY served as the outside auditor to three firms--Korn/Ferry International, Best Buy Co., and TeleTech Holdings Inc., while Thompson sat on the boards of all three companies.

The federal agency must now decide if the money paid Thompson impaired the accounting firm's independence.

"We are cooperating fully with the SEC's inquiry into this matter," E&Y spokesperson Charles Perkins said in a statement. "We revised our procurement policies in March and conducted an extensive review of all procurement relationships. As a result of that review, we notified the companies in question of the work that Mr. Thompson's company had done for us."

In a filing with the SEC on June 7, Korn/Ferry noted that the SEC had informed it of the inquiry on May 20. It also stated, however:

The Company has been advised by E&Y that it has conducted an internal review concerning its payments to the company affiliated with Mr. Thompson, and whether such payments impaired E&Y's independence as the Company's outside auditor. Based on its internal review, E&Y has delivered to the Company's audit committee a written confirmation of its independence, and its belief that the payments made to the company affiliated with Mr. Thompson did not impair E&Y's independence. Based on this written confirmation from E&Y, and based upon the Company's current knowledge of the facts and circumstances, the Company believes that E&Y's independence was not impaired as a result of its payments to the company affiliated with Mr. Thompson.

Korn/Ferry said it intends to cooperate fully with the SEC ongoing inquiry.

The SEC must determine if the payments were made by E&Y as a consumer in the ordinary course of business, which is an exception to the agency's general rule that auditors not enter into business relationships with their clients.

Thompson served on the nominating and governance committee at both Korn/Ferry and Best Buy, but he has now either resigned or did not stand for reelection at all three companies.

Meanwhile, the Royal Bank of Canada (RBC), which lists on the NYSE, announced in a press statement that it had received an SEC subpoena--also focusing on PricewaterhouseCoopers. In a press statement, the company said:

As previously disclosed, in September 2003 PricewaterhouseCoopers LLP
resigned as one of our auditors because of issues relating to its independence
under U.S. rules. We recently received a subpoena from the U.S. Securities and
Exchange Commission related to PricewaterhouseCoopers' resignation, the
provision of non-audit services by our auditors and our policies and
compliance procedures regarding auditor independence. We are in the process of
responding to the SEC subpoena.

RBC must comply with U.S. securities regulations because it lists on the NYSE.

Audit Watchdog Sets Priority

The Public Company Audit Oversight Board (PCAOB) has also declared auditor independence one of its top issues to be addressed this year. In particular, board members have reportedly said they want to focus on whether corporate auditors should continue selling tax-planning services to their audit customers.

"It's one of our priorities among a fairly large number of priorities," George Diacont, director of registration and inspections for the PCAOB, recently stated.

The Sarbanes-Oxley Act expressly prohibits some non-audit services by auditors to their clients. These include, for example, bookkeeping, financial information systems design or implementation, actuarial services, and certain management functions.

Other services are permissible, but must be approved by the corporate board audit committee of the client. It is these services that the PCAOB will be investigating. In general, the newly created agency will seek to identify those business relationships between the audit companies and their customers that create a mutuality of interest.

Section 104 of the Sarbanes-Oxley Act directs the PCAOB to conduct a continuing program of inspections, which it must use to assess the compliance of firms with the new law, rules of the board, and professional standards. PCAOB plans to inspect those firms that issue audit reports for more than 100 U.S. public companies each year. Currently, that applies to eight firms.

It will also inspect other firms no less than once every three years, which would account for about 740 more firms. In addition, the newly formed agency plans "special" inspections.

The Board expects that special inspections may be commenced, based on information that comes to the attention of the Board or its staff in any way, including public company filings with the Commission, news reports and matters brought informally to the attention of the Board's staff by other regulators, professional associations, informants, and members of the public. A registered public accounting firm may be subject to a special inspection irrespective of the timing of such firm's regular inspection schedule.

In a presentation to the Practising Law Institute in New York, Chris Mandaleris and Paul Bijou, PCAOB deputy directors, stated that in its inspections, the agency would focus on:

• "Tone at the top"
• Partner compensation
• Independence and non-audit services
• Client acceptance and continuance
• Firms' internal inspection programs
• Audit policies and methodologies
• Utilization of foreign affiliates for audits of foreign subsidiaries

Progress on Corporate Audit Fees

Auditor independence also remains an important issue at shareholder annual general meetings. The California Public Employee Retirement System (CalPERS) generated controversy this year by adopting a zero-tolerance policy on non-audit services by outside auditors. CalPERS announced in late June that it would reconsider the policy.

On the other hand, audit-to-non-audit fee ratios have improved markedly. That improvement is reflected in ISS's recommendations to clients on voting their proxies. ISS recommendations against auditor ratification fell from seven percent last year to four percent this year.