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US: A WorldCom Settlement Falls Apart

by Gretchen MorgensonNew York Times
February 3rd, 2004

A landmark settlement last month that had 10 former WorldCom directors agreeing to pay $18 million from their own pockets to investors who lost money in the company's failure was scuttled yesterday.

The settlement fell apart after the judge overseeing the case ruled that one aspect of the deal was illegal because it would have limited the directors' potential liability and exposed the investment banks that are also defendants in the case to greater damages. The lead plaintiff in the case said it could not proceed with the settlement with that provision removed.

When the settlement was announced, it was hailed as a rare case where an investor held directors responsible for problems occurring on their watch. Because yesterday's ruling turned on one technical aspect of the settlement with the former WorldCom directors, it is not expected to deter restive shareholders from trying to make corporate board members accountable.

The ruling by Judge Denise Cote of Federal District Court in Manhattan - who is presiding over the shareholder suit against directors and executives from WorldCom, its investment banks and Arthur Andersen, its auditor - sided with lawyers for the banks, who objected to the deal almost immediately after it was announced.

The judge's ruling means that the 10 directors will remain as defendants in the case. As such, they face the possibility of paying significantly more than they had agreed to in the settlement if they are found liable by a jury for investor losses.

Federal law states that in cases involving the sale of securities, as this one does, defendants found liable for losses by a jury are responsible for the entire amount of the damages. But in 1995, the Private Securities Litigation Reform Act provided that directors involved in such a case are responsible only for their part of the fault, as determined by the jury. This law was intended to protect directors from staggering damages in such cases.

The settlement with the former WorldCom directors was unfair to the investment bank defendants, their lawyers argued, because with the board members no longer named as defendants in the case, the banks could not reduce their own liability in a verdict by the amount of the investors' losses that the jury concluded was the responsibility of the company's former directors.

For example, under the terms of the settlement, the banks would have been limited to a reduction in damages of $90 million, the estimated net worth of the directors. A jury might find the directors responsible for far less.

The settlement, had it gone through, would also have prevented the banks from being able to sue the directors and possibly recover money from them. Sixteen banks are named as defendants, including J. P. Morgan Chase, Deutsche Bank and Bank of America.

George Sard, a spokesman for the investment banks, said: "The bond underwriters have no objection to the WorldCom directors entering into a lawful settlement with investors. However, the plaintiffs wanted to include a judgment reduction formula in the settlement that we believe is clearly unlawful and we are pleased that Judge Cote has agreed."

Alan G. Hevesi, trustee of the New York State Common Retirement Fund and the lead plaintiff in the lawsuit, said in a statement that he respected the judge's ruling. But the provision at issue, he said, "was a necessary part of the settlement with the settling director defendants so that any judgment we obtain on behalf of WorldCom investors at trial against the remaining defendants, including the investment banks and Andersen, would not be reduced disproportionately when compared to the amounts that the settling director defendants could afford to pay."

Mr. Hevesi, the New York State comptroller, is seeking $13 billion in damages for investors who bought WorldCom securities in the two years before it filed for bankruptcy protection in 2002. The case is scheduled to go to trial on Feb. 28.

Mr. Hevesi's lawyers had argued that under the terms of the settlement, the amount of liability assigned by a jury to the remaining defendants should not be reduced by a percentage of blame assigned to the directors, but rather by the directors' net worth or their ability to pay. The ability-to-pay concept is based in common law, while the percentage of blame is a factor in securities laws.

The directors' personal payments were required before any negotiations began, Mr. Hevesi said when the settlement was announced. Typically, directors who pay to settle such cases use funds supplied by directors' and officers' insurance.

The former WorldCom directors who had agreed to the settlement are Clifford L. Alexander Jr., secretary of the Army under President Jimmy Carter and later chief executive of Dun & Bradstreet; James C. Allen, former chief executive of Brooks Fiber Properties, a telecommunications company acquired by WorldCom; Judith Areen, a former Georgetown Law Center dean.

Also, Carl J. Aycock, an early investor in WorldCom; Max E. Bobbitt Jr., a private investor who was also chief executive of Metromedia China; Stiles A. Kellett Jr., a private investor who led WorldCom's executive compensation committee; Gordon S. Macklin, a former president of the National Association of Securities Dealers; John A. Porter, a private investor who has filed for personal bankruptcy in Florida; and Lawrence C. Tucker, a partner at Brown Brothers Harriman.

The estate of John W. Sidgmore, a former WorldCom executive and director who died in 2003, also agreed to the settlement. All were WorldCom directors from 1999 to 2002.

The judge's ruling in the case came as Francesco Galesi, another former WorldCom director who was not a party to the January agreement, was preparing to settle with the New York fund. Mr. Galesi, according to a lawyer involved in the case, was about to make a multimillion-dollar payment to strike a deal with the fund.

Paul C. Curnin, a lawyer who represents the directors, did not return a phone call seeking comment.

Sean Coffey, a lawyer at Bernstein Litowitz Berger & Grossmann, lead counsel to the plaintiff, said: "We of course would have preferred to have this historic settlement stand, but it does not distract in the slightest from our focus on the trial and proving our case concerning the banks' central role in the WorldCom debacle."

Securities lawyers said it was paradoxical that the 1995 law, meant to protect directors from huge damage claims, had in this case made the former WorldCom board members more vulnerable to such damages. Investment bank defendants in the WorldCom case now have an incentive to make the former company directors appear to be more culpable in the investor losses because the greater the liability a jury assigns to the directors, the greater the reduction in the banks' possible damages.

While Judge Cote sided with the investment banks yesterday, she has sometimes disappointed defendants. In December, for example, she said that it was not enough for banks selling securities to investors to rely on so-called comfort letters from companies' accounting firms stating that unaudited financial statements, like quarterly results, were accurate.



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