When Lawsuit Notices Are Hidden

By Ted Allen, Managing Editor

Whenever there's a new corporate scandal, investors will see a flurry of press releases from plaintiffs' lawyers on Business Wire, PR Newswire and other national business wires.

The releases are more than just self-promotion. Investors' lawyers are required by the Private Securities Litigation Reform Act (PSLRA) to publish notice of a securities class-action suit within 20 days "in a widely circulated national business-oriented publication or wire service." After publication of the notice, investors then have 60 days to petition the court for lead plaintiff status.

For instance, at least five investor law firms put out press releases on the business wires to announce their suits against American International Group, one of the many insurers targeted by New York Attorney General Eliot Spitzer. More recently, at least six firms put out press releases announcing lawsuits on behalf of investors in TriPath Technology Inc., which disclosed accounting problems on Oct. 22.

However, not all law firms go out of their way to publicize every lawsuit. After lesser-known incidents of corporate wrongdoing, some firms don't put out press releases on the national wires or in online business publications. Rather, they publish notice in a place where most investors may not think to look for lawsuit notices, such as in the legal notice section of print editions of various investment or trade publications.

It's not that these firms don't have access to the business news wires. These same firms will put out press releases in the well-known cases, but not in other cases.

Avoiding Competition
According to other securities lawyers, firms that use this tactic of "buried" or "hidden" notice are trying to avoid competition from larger firms that typically have more institutional investors as clients. Those larger firms are more likely to represent an institutional shareholder that has the largest investment loss of potential class members. Under the PSLRA, an investor with "the largest financial interest in the relief sought by the class" usually has the best chance of persuading the court that it should represent other shareholders. Once selected as lead plaintiff, the investor then asks the court to appoint its lawyers as lead counsel.

If notice is published where few institutional investors might see it, then that law firm's client has a greater chance of being the only investor to file a request to be lead plaintiff within the required 60 days. If no other shareholder files, then the law firm and its client likely will be appointed to represent the class.

"At this point in time, I think it is clear that the industry standard is to put the notice to class members required under the PSLRA on one of the national business wires," said Bruce Carton, executive director of Securities Class Action Services. "It is hard to fathom why any law firm currently seeking to comply with the spirit of the PSLRA would provide notice in an ‘alternative' way, such as a hard copy in a newspaper."

"`Burying notice' in this fashion may help a law firm's effort to become lead counsel by reducing the competition, but it does so by keeping potential lead plaintiffs in the dark, which undercuts the very purpose of the PSLRA's notice provision," Carton said.

In a few cases, courts have found that the PSLRA's notice requirements were not met and ordered lawyers to republish in a different publication.

In March, U.S. District Judge Deborah Chasanow of Maryland rejected a claim by lawyers for two individual investors that publication in The New York Times was sufficient to comply with the law. In that case, Huang v. Acterna Corp., Joseph De Leo and Stan Andrews were the only shareholders to submit a request for lead plaintiff status. They were represented by Schiffrin & Barroway LLP, a Philadelphia-area firm that filed the original suit, published the notice and sought lead counsel status.

"The PSLRA requires publication in a ‘widely circulated national business-oriented publication or wire service.' Although it does not clearly define this phrase, the publication requirement expresses Congress' intent that the publication be `reasonably calculated to reach, at the least, sophisticated and institutional investors,'" Chasanow wrote, citing Greebel v. FTP Software Inc., a 1996 decision from a federal judge in Massachusetts.

The judge noted that the two individual investors had about $84,000 in losses from the alleged securities violations by Acterna and its executives. "It seems peculiar that, given the public nature of Acterna and its alleged loss of $322 million in goodwill, there are no institutional investors, or other investors at all, with greater financial losses," she wrote.

Informing Institutional Investors
To bolster her point, the judge quoted a 1999 decision, Yousefi v. Lockheed Martin Corp., from a California federal judge that emphasized the important role of institutional shareholders in leading securities litigation: "Ideally, courts will appoint institutional investors with large holdings in the stock as lead plaintiff. As Congress and academics have noted, institutional investors have incentives to monitor their suits closely because of their substantial stakes in the stock at issue, thereby eliminating frivolous tactics and settlements that inflate attorneys' fees."

Chasanow ordered the investors and their lawyers to republish a notice in an "appropriate publication" and send the notice directly to the largest financial and institutional investors identified by the company.

Circumstantial evidence suggests that many firms may employ the "hidden" notice tactic. A cursory review of recent securities lawsuit filings and the press releases on the Bloomberg News wire found several instances where a suit was filed but no press release was issued.

In some cases, lawyers who complain about the practice are not above trying it in other cases. For instance, in a 2003 dispute over attorneys' fees in a suit by Independent Energy Holdings PLC shareholders, Rabin, Murray & Frank LLP complained that lead counsel Bernstein Litowitz Berger & Grossmann LLP had published notice in Investor's Business Daily, rather than on Business Wire, "with the obvious intention of attracting the least attention legally possible so as to eliminate competition for the office of Lead Counsel."

U.S. District Judge Shira Scheindlin in New York concluded that this was: "a rather disingenuous argument given that I. Stephen Rabin himself used the Investor's Business Daily in a case in which his then current law firm, Rabin & Peckel LLP, was appointed lead counsel. See Seamans v. Aid Auto Stores, Inc., No. 98-CV-7395, 2000 WL 33769023, at *4 (E.D.N.Y. Feb. 15, 2000) (finding notice published in the Investor's Business Daily to satisfy the statutory requirement that notice to the class be published ‘in a widely-circulated national business oriented publication') . . . The phrase ‘what's good for the goose is good for the gander' comes to mind and based on its rationale, Rabin Murray's objection is summarily dismissed."

When a Dollar (of Disgorgement) Is Worth Millions By Bruce Carton, Executive Director

More and more often, SEC settlements for odd-looking amounts like "$150,000,001" or "$50,000,001" have been generating questions and interests among our clients: Are these typos? What's up with the extra dollar? The answer is that this one dollar of "disgorgement" is the difference between investors receiving hundreds of millions of dollars a year from SEC enforcement actions or absolutely nothing.

Defendants who settle SEC enforcement actions typically agree to pay disgorgement, civil penalties or both. Disgorgement is the surrender of a defendant's "ill-gotten gains," such as the profits made by a person who has engaged in insider trading. Civil penalties are additional fines imposed by the SEC. Using the insider trading example, a person settling an SEC action who made $100,000 in illegal profits would typically be required to pay an additional $100,000 as a "1X" civil penalty, i.e., one times the amount of the ill-gotten gains. Thus, the defendant would pay $100,000 in disgorgement plus a $100,000 civil penalty, for a total of $200,000.

Prior to the Sarbanes-Oxley Act (SOX), the SEC distributed disgorgement funds from settlements to investors, but sent civil penalties to the U.S. Treasury. Thus, in the example above, the $100,000 paid in disgorgement would have gone to investors and the $100,000 in civil penalties would have gone to the Treasury. If a case involved only a civil penalty, investors received no money from the settlement.

Section 308 of SOX ("Fair Funds for Investors") changed this practice in an important way. Under this Fair Funds provision, if a settlement involving a civil penalty also contains disgorgement, "the amount of such civil penalty shall, on the motion or at the direction of the Commission, be added to and become part of the disgorgement fund for the benefit of the victims of such violation." In cases falling under the Fair Funds provision since its enactment as part of SOX in July 2002, the SEC has routinely directed that the entire civil penalty be distributed to investors.

In many SEC settlements of financial fraud cases, however, there is no clear or calculable element of "disgorgement." As the SEC explained in a January 2003 report to Congress, "some issuer financial fraud and reporting cases do not result in any disgorgement orders because no defendant received a tangible profit causally connected to the fraud." For this reason, the SEC recommended that Congress amend Section 308 so that the SEC may distribute civil penalty monies to injured investors regardless of whether disgorgement is ordered. To date, Congress has elected not to do so.

Recent Settlements
The SEC, however, appears to have found a way around the limitations of the Fair Funds provision to the benefit of investors. In mid-2004, the SEC began to order disgorgement of $1.00 in many cases involving large civil penalties that otherwise would not have benefited injured shareholders, thereby triggering the Fair Funds provision. Indeed, $1.00 disgorgements can be found in high-profile SEC cases including Symbol Technologies ($37,000,000 civil penalty; $1.00 disgorgement), i2 Technologies ($10,000,000 civil penalty; $1.00 disgorgement), Royal Dutch Petroleum ($120,000,000 civil penalty; $1.00 disgorgement), Bristol-Myers Squibb Co. ($150,000,000 civil penalty; $1.00 disgorgement) and Qwest Communications ($250,000,000 civil penalty; $1.00 disgorgement). Thus, as a result of the combined five dollars of disgorgement in these five cases alone, the SEC will be able to distribute a total of $567 million to investors.

So, keep an eye open for those odd-looking SEC settlement amounts--often they will be your cue that big money is on the way to investors.

TENTATIVE SETTLEMENTS

Lehman Brothers/Enron Corp.
Lehman Brothers has agreed to pay $222.5 million to settle a class-action lawsuit filed by Enron Corp. shareholders in federal court in Texas. Investors who purchased Enron stock between Sept. 9, 1997, and Nov. 27, 2001, are expected to be eligible to take part in the settlement.

Lehman, the fifth-biggest U.S. securities firm, was one of the investment banks that underwrote Enron debt offerings before the energy company collapsed into bankruptcy in December 2001. The investors accused Lehman of failing to investigate whether Enron was issuing accurate statements about its finances as part of the debt offerings. According to the lawsuit, Enron hid debt in off-the-book partnerships and disguised billions of dollars in loans as energy transactions.

Elan Corp.
Elan Corp. has agreed to pay $75 million to settle a class-action lawsuit filed by shareholders in federal court in New York. The settlement is open to investors who purchased the company's American depository shares between Feb. 7, 2000, and July 1, 2002. Investors who obtained shares as a result of Elan's mergers with Liposome Co. and Dura Pharmaceuticals Inc. are also eligible to join the settlement. The proposed settlement is subject to court approval.

The lawsuit accuses Elan and its officers of issuing misleading financial statements and press releases about the company's revenues and earnings. The suit claims the company reported favorable financial results, while concealing expenses through joint ventures and recognizing income from companies in which Elan had invested. Dublin-based Elan is Ireland's largest drugmaker.

Endocare Inc.
Endocare Inc. has agreed to pay $8.95 million to settle a shareholder lawsuit filed in federal court in California. Investors who purchased company shares from Oct. 23, 2001, to Oct. 30, 2002 may seek to join the class settlement, which requires court approval.

The lawsuit claims the company inflated its share price by issuing false and misleading financial statements. These statements enabled Endocare to complete a public offering of 4 million shares that raised $68 million in November 2001.

Endocare, based in Irvine, California, sells technology to urologists for the treatment of prostate and renal cancer.

Descartes Systems Group Inc.
Descartes Systems Group Inc. has agreed to pay $1.5 million to settle a class-action lawsuit filed by shareholders in federal court in New York. Investors who purchased the company's stock from June 4, 2003, to May 6, 2004, are eligible to take part in the settlement.

The lawsuit claims that the company issued a series of material misrepresentations about its financial condition. Specifically, investors claim that the company inflated its financial results, maintained insufficient reserves for doubtful accounts and overstated revenue by at least $1.1 million by recognizing revenues from a contract that it knew had been impaired.

Descartes Systems, based in Waterloo, Ontario, is a provider of supply-chain software.

DISMISSALS

Troy Group Inc.
A class-action lawsuit by Troy Group Inc. investors has been dismissed. The suit was filed in July in state court in Orange County, California.

The lawsuit claims that the officers and directors breached their fiduciary duties in their efforts to complete the sale of the company to Dirk Inc., a company controlled by Troy's founder, Patrick Dirk, and his family. Instead seeking the highest price for shareholders, the officers and directors conspired to engineer a sale to only to the Dirk family, the investors claimed.

Troy, based in Santa Ana, California, sells products that allow customers to transfer funds between bank accounts.

Parametric Technology Corp.
A class-action lawsuit against Parametric Technology Corp. has been dismissed. The suit was filed in February 2003 in federal court in Massachusetts on behalf of investors who purchased company shares between Oct. 19, 1999, and Dec. 31, 2002.

The investors claimed the company issued materially false and misleading statements about its finances and had overstated its revenue since fiscal 1999. The Needham, Massachusetts-based company sells software that is used for product development and product lifecycle management.

• DPL Inc. (Federal)
• DPL Inc. (State)
• Contrarian Funds
• FPA Medical Management Inc.

Time Warner Inc. may have to pay more than $500 million to settle U.S. government claims over how its America Online unit accounted for advertising sales.

The Washington Post reported on Nov. 23 that the company was close to an agreement to pay about $750 million to settle claims by the Securities and Exchange Commission. The next day, Bloomberg News reported that Time Warner and government officials are discussing a $500 million settlement, but they could not agree on whether any company employees would be accused of wrongdoing. The media giant announced Nov. 3 that it had set aside $500 million to resolve claims by the SEC and the Justice Department.

On Nov. 19, an Alabama state judge declared a mistrial in a state pension fund's lawsuit against Bear Stearns Cos. over its sale of bonds backed by WorldCom Inc.

The jury deadlocked over the Retirement Systems of Alabama's claims that Bear Stearns sold $10.3 million in bonds despite knowing that WorldCom was collapsing. The bonds were originally issued by Intermedia Communications, which was acquired by WorldCom in 1999. With WorldCom's backing, the bonds' rating was raised from junk to investment grade.

The pension fund earlier negotiated a $111 million settlement with Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp. over the banks' underwriting of WorldCom bond offerings. See the November issue of the SCAS Alert for more on this story.

A new trial is scheduled for Jan. 10. Bill Kelley, the pension fund's general counsel, told Bloomberg News that: "We are confident we will win the retrial."

In other WorldCom news, a federal judge in New York delayed the trial in the federal securities class-action case against the company's underwriters from Jan. 10 until Feb. 28.

WorldCom, the No. 2 U.S. long-distance phone company, lost $200 billion in market value before filing for bankruptcy in 2002. The company emerged from bankruptcy in April as MCI Inc.

Qwest Communications International Inc. is negotiating a class-action settlement with investors that might exceed $700 million, the Rocky Mountain News reported on Nov. 18.

The newspaper reported that a spokeswoman for the California State Teachers' Retirement System confirmed that the parties met for a mediation session in San Francisco.

Qwest, based in Denver, is the largest local phone-service provider in the western U.S. The company agreed in October to pay $250 million in a settlement with the SEC. The agency claimed in a lawsuit that the phone company improperly booked $3.8 billion in revenue over three years through network capacity swaps and other transactions.

American International Group Inc. announced Nov. 24 that it would pay $126 million to settle claims by the SEC and the Justice Department over transactions that clients used to inflate their earnings.

The government claims stem from transactions with PNC Financial Services Group and Brightpoint Inc., which distributes cell phones. According to the government, PNC used AIG products to remove bad loans from its books, while Brightpoint used an insurance policy to avoid telling investors about a one-time loss that was $11 million higher than expected.

AIG still faces a probe by New York Attorney General Eliot Spitzer into collusion between insurers and insurance brokers.

On Nov. 17, the SEC announced it had reached a settlement with Harold Baxter and Gary Pilgrim in the mutual fund market-timing scandal. They each agreed to pay $80 million, which includes $60 million in disgorgement and $20 million in civil penalties.

Their money-management company, Pilgrim Baxter and Associates, already paid $90 million in July to resolve SEC allegations. Pilgrim and Baxter also will be banned from working in the securities industry and associating with investment advisers or investment companies, the SEC said.

"The amounts being paid in this settlement are virtually unprecedented for individuals in civil cases," Stephen Cutler, the SEC's enforcement director, said in a press release.

The commission, which is seeking restitution for investors, has reached more than a dozen settlements with mutual fund companies. See the October SCAS Alert for more on the other settlements.

Frank Quattrone, the former Credit Suisse First Boston technology banker, has been barred for life from working in the securities industry.

The ban was imposed Nov. 22 by the National Association of Securities Dealers' National Adjudicatory Council, which overruled an earlier NASD panel ruling that had barred him for a year. Quattrone refused to cooperate with the probe and argued that providing testimony to the NASD while criminal charges were pending would violate his constitutional right against self-incrimination.

Ken Hausman, a lawyer for Quattrone, told the Associated Press that his client would appeal the ban to the SEC.

Quattrone was convicted in May on charges of obstructing justice. Those charges stem from a federal probe into CSFB's allocation of highly coveted shares from initial public offerings of technology companies. He took dozens of Internet companies public in the late 1990s. He faces 18 months in prison if his conviction is upheld.

A former Enron Corp. executive and three ex-Merrill Lynch & Co. officials were convicted of fraud and conspiracy charges for helping Enron inflate earnings.

The Nov. 3 verdicts in Houston came in the first criminal cases to go to a jury that arose from Enron's accounting scandal. The charges stem from Enron's 1999 sale to Merrill of a $7 million stake in three Nigerian energy-generating barges. Enron, which promised to pay the money back, booked the sale as a $12 million profit so it could meet earnings estimates.

In a statement, Assistant U.S. Attorney General Christopher Wray said the case was "a milestone in bringing both an Enron executive and Merrill Lynch executives who aided and abetted the fraud at Enron to justice."

Enron, once the world's largest energy trader, collapsed into bankruptcy in December 2001, wiping out $68 billion in market value and $800 million in employee pension investments.

The SEC, in a brief filed with the U.S. Circuit Court of Appeals for the Ninth Circuit, argued that investors should be allowed to sue business partners and vendors and others who are indirectly involved in securities fraud by a company.

The SEC made this argument in a supporting brief filed Oct. 21 in a case involving online home-listing company Homestore.com Inc., which allegedly used transactions with business partners to inflate its revenue. The Ninth Circuit is considering whether to allow investors to also sue Time Warner, Cendant Corp. and MaxWorldwide over their roles in those transactions. The U.S. Supreme Court ruled in 1994 that private actions under SEC Rule 10(b)(5) may only be brought against "primary violators."

"This brief is the SEC's latest attempt at persuading the courts to accept a broad definition of primary responsibility for securities law violations," David Becker, former SEC general counsel, told Bloomberg News.

The Sarbanes-Oxley Act has led to a surge in whistleblower complaints by corporate employees, the Associated Press reported.

The law, which included numerous corporate reforms, prohibits public companies from firing or retaliating against employees who complain about financial fraud. Since the law took effect in July 2002, at least 331 employees have filed whistleblower complaints. During the fiscal year that ended Sept. 30, 181 employees filed complaints, making Sarbanes-Oxley cases the fastest growing category of whistleblower claims, the U.S. Labor Department said.

Lawyers for companies say most of the claims are unfounded and often are attempts by underperforming employees to get better severance packages and settlements, AP reported. Intel Corp. and commuter airline Flyi are among the companies that have been accused in these whistleblower complaints.