By Ted Allen, Director of Publications

Nine months after suing 44 mutual fund managers, investors have negotiated a few settlements, lost a few procedural rulings and may go to state court to pursue allegations that fund companies failed to file claims for securities settlements.

The federal court lawsuits, filed around the country in January, were brought against many of the largest fund companies--including Janus, American Funds, Dreyfus, MassMututal, Putnam, Vanguard, Merrill Lynch, Neuberger Berman, Wells Fargo, and Van Kampen. The suits, which claimed that funds have failed to seek as much as $2 billion in settlement proceeds, prompted the Securities and Exchange Commission to launch a fact-finding probe, asking investment advisers about their claim-filing practices. Many fund managers and advisers scrambled to review their policies and revise client contracts.

“I did not realize what a hornets' nest this would stir up,” Randall Pulliam, a partner with Baron & Budd, a Dallas-based law firm, who is representing the mutual fund investors, said during an Oct. 20 panel at ISS' annual conference in McLean, Virginia.

So far, no court or regulator has ruled on the key question underlying the litigation: do mutual fund managers, investment advisers, institutional investors, and other fiduciaries have a legal obligation to file settlement claims for their underlying accountholders.

Half of the 44 original mutual fund cases have been dismissed, either by the court or after an agreement by the parties, Pulliam said. Fewer than 10 cases are still pending in federal court. In some of the cases, federal courts did dismiss the investors' claims under the Investment Company Act of 1940 on procedural grounds, without ruling on the merits of the state law claims (breach of fiduciary duty and negligence) that are at the heart of the case.

Confidential Settlements
Pulliam has reached four settlements; the terms of which are confidential. He said he is still negotiating with several fund companies. Under those accords, the money will be returned to the fund, rather than to individual investors. The lawsuits were filed as derivative actions on behalf of the mutual fund and its beneficiaries against the fund managers.

Pulliam said he likely will sue the holdout fund managers in state court and may expand the litigation to include other private asset managers. “We will use the mutual fund cases to resolve larger issues concerning the fiduciary duty to file claims,” Pulliam said.

During the ISS panel, Pulliam was asked whether he planned to sue any pension funds. Pulliam said he has considered doing so, but he noted that the Employee Retirement Income Security Act (ERISA), which governs defined benefit plans, poses additional legal hurdles.

(For more details on the mutual fund cases, see the April, March and February 2005 issues of SCAS Alert.)

Unclaimed Money
Class-action lawsuits have generated more than $20 billion in settlements during the past five years, according to SCAS data. This year alone, there will be more than $7 billion in final settlements. Despite that recovery, less than 30 percent of institutional investors with provable losses file proofs of claim, according to research by Professor James Cox of Duke University and Professor Randall Thomas of Vanderbilt University.

In most settlements, the unclaimed money is distributed on a pro rata basis to those investors who did file claims. Pulliam recalled one case in southern Texas where the filing investors recovered 104 cents on the dollar for their losses, even after deducting attorneys' fees.

“An awful lot of money is being left on the table,” Peter Saparoff, who leads the securities litigation practice group at the law firm of Mintz Levin, said at the ISS conference. “It's not just a duty; it's good business,” he added.

While fund managers, investment advisers and custodian banks may say they file claims, they only do so “sporadically,” such as in high-profile class actions (such as WorldCom Inc.) that they see in The Wall Street Journal, Saparoff said. Consequently, they miss many smaller settlements, and they often fail to follow through if their claims are rejected by claim administrators. “Sometimes it takes several attempts to get claims approved,” he noted.

Waiting for the SEC
After the mutual fund lawsuits were filed, the SEC's Office of Compliance Inspections and Examinations sent out a series of letters to mutual fund companies and investment advisers. The SEC sought information on their policies for determining whether to participate in a securities class action against companies they invest in.

After getting responses, the SEC sent out deficiency letters to some of the fund managers and advisers, indicating that they “should consider” having a process in place for filing settlement claims, according to Karen L. Barr, general counsel of the Investment Adviser Association (IAA). However, the SEC staff did not explicitly state that investor advisers are legally required to file claims.

With no clear guidance from the SEC, Barr said she has advised IAA members to “go back to each of their clients to clarify these duties and responsibilities.”

(For more on this topic, see Bruce Carton's commentary in this month's issue of SCAS Alert.)

“Eventually, everyone will take care of this by contract,” Barr said. “Why not resolve this now and look at your contracts, rather than risk litigation and hope the courts back you up?”

Commentary: A Call for Clarity By Bruce T. Carton, Vice President, ISS' Securities Class Action Services

When it comes to filing claims in securities class action settlements, the question that comes up over and over again is also the most basic one:

Whose responsibility is it?

There will be over $7 billion in final securities class action settlements in 2005--who is responsible for recovering that money for the underlying accountholders of institutional investors and asset managers? Is it the clients themselves? The investment adviser? The custodian? None of them? All of them? The unsettling answer is that no one knows definitively, and this uncertainty combined with the threat of lawsuits, ambiguous messages from the SEC, and an increasing barrage of questions from clients is causing institutions a fair amount of heartburn.

This question was, not surprisingly, a topic of discussion at the securities class action panel that was part of the ISS annual conference on Oct. 19-21. After debating who, if anyone, has the fiduciary duty to file claims in securities class action settlements, the panel consisting of Baron & Budd's Randall Pulliam, Mintz Levin's Peter Saparoff, and the Investment Adviser Association's Karen Barr tried to answer an equally important off-shoot of this issue: Given the current state of confusion, what will need to occur for there ever to be clarity?

Our panelists offered different opinions on this. Mr. Saparoff offered the most startling solution, stating that he expects that eventually “some state securities regulator or attorney general will find an egregious case with millions of dollars not claimed and then pursue a criminal case,” which will in turn create enormous pressure for the SEC to engage in rule-making.

Ms. Barr, general counsel of the IAA, optimistically stated that she believed that “eventually, everyone will take care of this by contract.” In the meantime, Ms. Barr urged investment advisers to go back to each of their clients to clarify these duties and responsibilities. Ms. Barr added that to the extent the SEC is imposing expectations upon investment advisers in this area (as it has done implicitly through its “fact-finding” and deficiency letters), “we think the SEC should have done a notice-and-comment rulemaking rather than a back-door rulemaking through the inspection process.”

Finally, Mr. Pulliam, whose law firm filed the forty-plus lawsuits against mutual fund advisers in January 2005 over their alleged failure to file claims, stated that he expects the ultimate solution will be a “combination of litigation and regulation.” He added that he is “cautiously optimistic that the SEC will continue down the road to expressly say that all investment advisers have an obligation to [file claims.]”

I agree with the common thread coming from these panelists--the ultimate solution to the current confusion is for the SEC to engage in rule-making to clearly determine who is, and who is not, responsible for filing claims in securities class action settlements. My sense is that the uncertainty that surrounds responsibilities in this area is one of the primary reasons that billions of settlement dollars are now being left on the table each year by institutional investors.

Clear rules will help blow the smoke away from what should be a “no-brainer” way for institutional investors to help themselves and their accountholders. As Mr. Saparoff stated, “It's not a just a duty; it's good business. For every penny spent [on filing claims], you get a dollar back.”

TENTATIVE SETTLEMENTS

Allegheny Energy Inc.
Allegheny Energy has agreed to pay $15.05 million to settle the securities class action lawsuit filed in the U.S. District Court for Maryland. Investors who purchased the company's securities between April 23, 2001, and Oct. 8, 2002, are expected to be eligible to take part in the settlement.

Allegheny Energy, an investor-owned utility company for more than 100 years, provides electric and natural gas service to its customers.

For more details, see the SCAS website by clicking here.

Tropical Sportswear International Corp.
Tropical Sportswear has agreed to pay $8 million to settle the securities class action lawsuit filed in U.S. District Court for the Middle District of Florida. Investors who purchased the company's securities between June 27, 2001, and Jan. 14, 2004, are expected to be eligible to take part in the settlement.

Tropical Sportswear designs, manufactures and markets major-label and private-brand sportswear that is sold through large retail distribution channels including department and specialty stores.

For more details, see the SCAS website by clicking here.

DISMISSALS

Blue Coat Systems Inc.
A securities class action lawsuit filed by Blue Coat Systems investors has been dismissed. The lawsuit was filed in April 2005 in the U.S. District Court for Northern California.

For more details, see the SCAS website by clicking here.

Sawtek Inc.
A securities class action lawsuit by Sawtek investors has been dismissed. The lawsuit was filed in April 2005 in the U.S. District Court for the Middle District of Florida.

For more details, see the SCAS website by clicking here.

Funds have been recently disbursed (or approved for disbursement) in the following cases:

• iXL Enterprises Inc.
• Jennifer Convertibles Inc.
• Lucent Technologies Inc. Debt Securities
• Network Associates Inc.

Latest WorldCom Settlements Spark More Debate Over “Opting Out”
By Ted Allen, Director of Publications

A group of 68 institutional investors that opted out of the WorldCom Inc. class action announced Oct. 27 that they had negotiated a $651 million settlement over their bond and stock losses from the telecommunications company's $11 billion accounting scandal.

The settlement, along with a separate $78.9 million accord unveiled Oct. 18 by New York City's five pension funds, has rekindled the debate over whether institutions fare better when they bring their own lawsuits. In the past, few institutions have left class actions to sue on their own because of concern that they would not recover more and would have to wait until the class settlement was reached.

The $651 million settlement was reached with Citigroup Inc., J.P. Morgan Chase & Co. and 12 other investment banks; former WorldCom auditor Arthur Andersen; and ex-WorldCom directors. The banks, which underwrote WorldCom bond offerings, were accused of failing to investigate the accuracy of the company's financial statements. As part of the settlement, Citigroup and J.P. Morgan agreed to urge regulators to issue rules requiring more information about loans in securities offering prospectuses. Of the total settlement, $639 million is to be paid by the banks.

The 68 investors, which include the California Public Employees' Retirement System (CalPERS) and the State Universities Retirement System of Illinois, were represented by Lerach Coughlin Stoia Geller Rudman & Robbins.

“It shows how institutional investors can, in certain instances, use vigorously prosecuted individual actions to greatly enhance their recoveries beyond those obtained by passive reliance on class action suits,” William Lerach, lead counsel for the 68 investors, said in a press release.

The New York City pension funds, which were represented by the city's law department and outside counsel Lowey Dannenberg Bemporad & Selinger, reached their settlement with six investment banks, Andersen, former telecommunications analyst Jack Grubman, and former WorldCom directors.

Both groups of institutional investors claimed that they fared better by leaving the class action case, which has so far has resulted in $6.1 billion in settlements.

“We are pleased with this settlement, which allows the New York City pension funds to recover for their members a substantial portion of their WorldCom investment losses at levels we believe significantly exceed what the funds would have recovered if they remained in the federal class action,” Michael A. Cardozo, the city's corporation counsel, said in a press release. “The [pension] funds will also receive payment within the next few weeks, in contrast with the class action settlement, where payment is dependent upon a lengthy claims administrative process."

Likewise, Lerach said, “Our clients' net recoveries on their WorldCom bond losses are substantially higher than the estimated recovery for the same bond losses in the WorldCom class action. . . . They will also get a higher recovery than what class members are estimated to receive for their WorldCom stock losses.”

These statements were not well received by the lead investor plaintiff, the New York State Common Retirement Fund, which claimed that Lerach unfairly disparaged the class action settlement in a conference call with reporters.

“We got a good return. Mr. Lerach got a good return,” New York State Comptroller Alan G. Hevesi, who is trustee of the state pension fund, said in an Oct. 27 press release. “It's sad he has to distort what we accomplished to try to promote himself.”

The New York State fund claimed that Lerach's “manipulated the amount of the class' damages and the anticipated claims rate for the class, and he presented figures for his own group's damages that are a fraction of what he has previously claimed in court and in writing.”

Lerach Coughlin responded with another press release. “When the numbers are properly understood, our clients' recovery is substantially better than what they would have recovered in the class action. We have attempted to be as transparent and accurate in our analysis as possible,” the firm stated.

Earlier, Sean Coffey, a lawyer with Bernstein Litowitz Berger & Grossmann, one of the two lead firms that represented the class, also took issue with some of the claims by the New York City pension funds.

“I would be very skeptical of any claim that an individual plaintiff did better than a class member, given the representations that had been made to the federal court about the individual plaintiff's damages and the significant disparity in attorneys' fees,” Coffey told Reuters.

Not all the class members have submitted claims yet, Coffey said, so that those investors who do file may recover larger shares of the class settlement, Bloomberg News reported.

Coffey and the other class attorneys are to receive $363 million, or 5.5 percent of the $6.1 billion class settlement. The New York City pension funds are to pay $11.8 million, or 15 percent of their settlement, Reuters reported.

Lerach said the bank defendants have agreed to pay his firm a $84.6 million fee for representing the 68 investors, in addition to the $651 million settlement, Bloomberg News reported. In other words, Lerach's fee would amount to 11.5 percent of the overall $735 million in payments from the defendants.

Another investor that opted out, the Retirement Systems of Alabama, negotiated a $111 million settlement last year with three of WorldCom's underwriters after a U.S. appeals court refused to block the pension fund's lawsuit from going to trial in state court before the trial in the federal class action. (For more details, see the November 2004 issue of SCAS Alert.)

WorldCom, now known as MCI Inc., is being acquired by Verizon Communications Inc.

Ebbers Appeals Fraud Conviction
In other WorldCom news, former CEO Bernard Ebbers is seeking to overturn his conviction on securities fraud and conspiracy charges.

In court papers filed Sept. 29, Reid Weingarten, a lawyer for Ebbers, asked the U.S. Court of Appeals for the Second Circuit to throw out the charges, arguing that the former CEO didn't get a fair trial, according to Bloomberg News.

Weingarten argued that the trial judge should have forced prosecutors to grant immunity to former Chief Operating Officer Ronald Beaumont and other ex-company executives. Weingarten said he didn't call them as witnesses for Ebbers' defense, because they would have invoked their right against self-incrimination and refused to testify.

Ebbers, who was accused of orchestrating the $11 billion accounting fraud that drove WorldCom into bankruptcy, is also challenging his 25-year prison term. His lawyers argue that the sentence was “unreasonable” and “grossly disproportionate,” given the five-year term received by former Chief Financial Officer Scott Sullivan, who testified for the government at Ebbers' trial.

Former Cendant Chairman on Trial
Walter Forbes, Cendant Corp.'s former chairman, went on trial again in Hartford, Connecticut, on charges that he misled investors to meet the earnings projections of Wall Street analysts.

The federal court trial, which started with opening statements on Oct. 17, is expected to last three months. Forbes' first trial ended after jurors deadlocked after 33 days of deliberations.

Forbes has been accused of overstating the earnings of CUC International, which merged with HFS Inc. in 1997 to form Cendant. The company's shares lost $14 billion in value in one day in April 1998 after the accounting problems were disclosed. Investors sued and eventually negotiated a $3.27 billion class-action settlement, which was then a record.

German Class-Action Law Takes Effect
In Germany, legislation took effect Nov. 1 that would allow the aggregation of securities claims by multiple investors.

The legislation does not create U.S.-style securities class actions, but it would lower the obstacles for investors to claim damages. Under the law, investors may request a model proceeding to resolve common issues of fact or law concerning a company's disclosure of allegedly misleading information. Such a request would be posted in an online public litigation register and other plaintiffs would have a chance to join the model proceeding. A Higher Regional Court would select a lead investor plaintiff and then make legal and factual determinations that would be binding on all potential plaintiffs, including those who did not join the model proceeding.

Germany does not permit contingency fees, and the law does not provide any additional incentives to law firms that represent investors.