Posted Sep 12, 2004 04:34 pm CDT
WorldCom investors brought dozens of securities actions against the banks and other defendants, seeking $54 billion from Citigroup alone.
The deal gets even sweeter because Citigroup will be able to deduct slightly more than $1 billion of the payout from its taxes, meaning it only has to come up with a mere $1.64 billion in cold, hard cash to make the plaintiffs go away.
“What I have done, I think, is to buy an insurance policy for $1.64 billion after tax against a roll of the dice in front of a jury in a few months on a $54 billion claim,” Citigroup CEO Charles Prince said May 10 in announcing the settlement. He said Citigroup wanted to put the WorldCom era behind it.
The WorldCom case offers an MBA-level illustration of a company nearly brought to ruin from within. At the same time, it also opens a window on increasingly frequent parallel proceedings, where different plaintiffs descend on defendants in separate forums with shared gripes but often conflicting goals.
Lawyers negotiated the Citigroup settlement for almost 40 public and union pension funds with claims consolidated into a class action in the U.S. District Court for the Southern District of New York in Manhattan. Dozens of other institutional investors—with and without judicial blessing—are itching to take individual cracks at the WorldCom defendants in state and federal courts across the nation.
Though hardly new, parallel proceedings and the dilemmas they pose have multiplied with the wave of corporate scandals. They are especially common in securities fraud, where the sheer volume of money and countless numbers of victims ensure an almost endless private and government plaintiff procession to federal and state courts, administrative agencies and self-regulating organizations such as the stock exchanges.
Despite Prince’s desire to get rid of unhappy investors once and for all, the WorldCom era doubtless will continue for Citigroup and the remaining investment banks that didn’t settle in May. Plaintiffs in the spin-off securities litigation allege that the defendants failed to adequately investigate the company’s rickety financial health before backing the bonds. The investors also claim that the defendants issued rosy investment prognoses though their analysts knew otherwise.
So Prince may want to consider purchasing additional insurance coverage. Current estimates put the fraud at $11 billion in misstated income. Investment losses likely will total billions more. Plaintiffs say that the fraud artificially inflated WorldCom stock to as much as $96.75 a share, but that the price tumbled to just pennies after the company disclosed the misconduct in June 2002. The bond notes, once trading for as high as $106, sold for $11 after the fraud went public.
Parallel proceedings emerge from a single factual scenario, but plaintiff interests range from redress for financial injuries to criminal prosecution of corporate defendants and individual wrongdoers. They present difficult choices for plaintiffs and defendants alike.
Federal prosecutors especially don’t appreciate standing in line behind civil cases because potential defendants can use liberal civil discovery to obtain sneak previews of criminal evidence against them that they normally wouldn’t have a right to see. Defendants confront a Fifth Amendment conundrum: Whether to testify at civil depositions and risk incriminating themselves or to refuse to answer deposition questions and hazard the prospect of civil plaintiffs lawyers later arguing such refusals to jurors as evidence of liability.
Corporations trying to come clean by cooperating with the government face the added problem of waiving client-lawyer and work-product privileges because enforcement agencies regularly insist on the results of lawyer-conducted internal investigations. Most courts hold that a waiver to a government agency also constitutes a blanket waiver to any private civil plaintiff who may come along.
Besides those concerns, the WorldCom litigation demonstrates how ever keener competition among state and federal government agencies and private plaintiffs can further complicate already highly complex cases. Some plaintiffs lawyers and prosecutors working on the WorldCom case also readily admit two of the more fundamental motives behind parallel proceedings: money and distrust for the other guy.
The New York federal district judge presiding over the securities cases, Denise L. Cote, has wound up playing ringmaster as she tries to keep as many of them as possible consolidated in her court through the pretrial stage. In doing so, she has issued scads of opinions and orders that are both sternly worded and legally bold.
The class action trial is scheduled for Jan. 10 against the remaining defendants. Besides the deep-pocketed investment banks, those defendants include the auditing and accounting firm Arthur Andersen and 16 former officers and directors, including former CEO Bernard J. Ebbers. WorldCom itself was not named as a defendant because the bankruptcy filing entitled it to an automatic stay. Plaintiffs wanting to use other courts will have to wait in line behind the class.
“This has been a fascinating, fascinating case,” says Jay B. Kasner, the lead lawyer for the banks left in the New York-based litigation after the Citigroup settlement. “You’ve got issues by the handful that have never been litigated before.”
Although plaintiffs can opt out of class actions and pursue their claims solo, Cote exercises considerable authority over them for now. Defendants removed their actions from state courts to the federal system, where the Judicial Panel on Multidistrict Litigation assigned them to Cote to handle as a single proceeding through the pretrial phase. Cote explained her goals in a March 2003 opinion denying one plaintiff’s motion for a remand to state court:
“If this court were to … remand the litigation originally filed in state court, motion practice and discovery would proceed separately in many jurisdictions. The litigation that would ensue in the various fora would be entirely duplicative and wasteful. It would eat into the funds available to pay the alleged victims identified in this litigation. As deep as some of the pockets in this action may be, they are in all likelihood not limitless. A remand would encourage a race for the assets, a race that may deprive many victims of the alleged fraud of their fair share of any recovery.” In re WorldCom Inc. Securities Litigation, 293 B.R. 408.
Measures taken by Cote to accomplish that include:
• Authorization of a curative notice, a seldom-used device to correct misrepresentations. She approved the notice after the lead plaintiffs firm last fall accused a rival firm of misleading dozens of clients into filing separate claims in state courts instead of joining the consolidated cases.
• Use of a bankruptcy statute to keep the cases before her and to blunt some plaintiffs’ attempts to remain in state court by filing claims under the 1933 Securities Act, which forbids removal of state court actions. In a case of first impression, the 2nd U.S. Circuit Court of Appeals at New York City affirmed Cote on May 11, the day after the Citigroup settlement.
• An injunction issued in April to prevent an Alabama state court from resolving a separate lawsuit by summary judgment or trial until the federal litigation ends. An unfavorable verdict or adverse legal rulings in Alabama could damage the defendants down the road if later courts consider them binding.
On the criminal side, Oklahoma Attorney General W.A. Drew Edmondson openly angered federal prosecutors in New York last August after he obtained indictments against WorldCom, former CEO Ebbers and five other ex-employees. Neither the company nor Ebbers had been federally charged at the time. Federal prosecutors complained that Edmondson didn’t tell them of his plans and could have jeopardized a federal criminal case already under way.
“In the name of cooperation and coordination, we are disappointed that we were not told that charges were imminent,” the U.S. attorney’s office in Manhattan said in a rare rebuke of another public official.
Edmondson insists that he sent a letter to then-U.S. Attorney James B. Comey notifying Comey of his intention to seek the indictments. Citing his experiences first as a local prosecutor and later as attorney general, Edmondson also says he had little faith the Justice Department could satisfactorily prosecute the matter, given its track record in other federal investigations in his state.
“When the federal government was done, there were people who weren’t indicted who should have been, and our statute of limitations had run,” Edmondson recalls. “When we looked at WorldCom, we watched and we waited and we saw these investigations going on—but no one indicted. And we saw our statute of limitations ticking away.”
Edmondson backed down at an April meeting with Comey’s successor, David N. Kelley, just days after Ebbers was federally charged. Ebbers’ federal criminal trial is scheduled for November, and Edmondson says Oklahoma will revive its prosecutions of individuals after that. The feds haven’t charged the company, and WorldCom, now renamed MCI, in the meantime reached a deal with the state that requires it to add 1,600 jobs over the next 10 years at a facility it operates in Tulsa.
To be sure, few parallel proceedings approach the maddening complexity of those engulfing WorldCom and other major companies that fell victim to the corporate excesses of the late 1990s. More commonly, parallel proceedings involve a single defendant targeted criminally by the Justice Department and civilly by the Securities and Exchange Commission. Then it’s usually just a matter of which agency goes first.
Typically, with tacit support from prosecutors, criminal defendants move to stay all or part of private and government civil proceedings against them. Stays mean defendants can’t be deposed in the civil action, which at least temporarily solves their Fifth Amendment problems. As they did in the WorldCom criminal proceedings, prosecutors also can ask civil trial courts to place certain documents off-limits and to protect key witnesses from depositions. Both requests aim to keep a lid on sensitive evidence and avoid leaving a record that criminal defense lawyers may exploit later for impeachment purposes.
“Securities class-action lawyers piggyback off what we do,” says one prosecutor in Manhattan. “If you’re in civil discovery, it can often totally derail an ongoing prosecution.”
Competing state criminal prosecutions also can be deadly to federal cases, the prosecutor says, because they may chill critical testimony from cooperating defendants once they realize that others will turn their cooperation against them and bring still more charges.
Though it’s not bound by prosecutors’ wishes, the SEC usually defers to the criminal side, citing public policy goals served by the deterrent effect of convictions and prison sentences. In some cases, however, trial courts may trim back stay requests and allow cases to continue at least partially, especially if judges find that public interest, such as the prompt return of ill-gotten gains, outweighs prosecutors’ interest in speedily taking criminal charges to judgment.
As players on more or less the same team, lawyers from the Justice Department and the SEC do try to cooperate. But grand jury secrecy poses a formidable roadblock even for government agencies working together. That’s because, with narrow exceptions, the Federal Rules of Criminal Procedure forbid prosecutors from sharing grand jury information with their civil counterparts.
To get around the prohibition, prosecutors can arrange informal witness proffers for other government lawyers. The only records typically available from the sessions are FBI summaries, called 302 reports. Lawyers from other agencies say growing concern over the integrity of criminal cases today makes the reports more difficult to obtain, as they also may hold information valuable to defendants.
“Several years ago, there was no problem sharing 302s,” recalls Wayne M. Carlin, who served as SEC Northeast regional director from 2000 until ’04, when he entered private law practice. “But in the last couple of years or so, the criminal authorities are being more restrictive in the way they share 302s.”
Though the policy-making commissioners haven’t taken a position, enforcers want legislation that would give them some grand jury materials with judicial permission. They also would like to make their jobs easier with more legislation that would allow defendants to hand over privileged material to the SEC without fear of waiving the protection to private plaintiffs waiting in the wings.
“An easier flow of information means we can get things done more quickly with less duplication,” says Linda C. Thomsen, SEC deputy enforcement director in Washington, D.C. “We are interested in getting information and getting it quickly so we can use it.”
Life becomes more difficult for defendants with the addition of state agencies and still more parallel proceedings. Most recently, New York Attorney General Eliot Spitzer has riled federal enforcement agencies by using state law to go after corporate crooks on his own. But state-federal tension carries a much longer pedigree.
Before the federal government ever considered getting into the securities regulation business, states began enacting “blue sky” laws nearly a century ago to combat increasingly shady trading in overvalued, speculative and fraudulent stocks. The laws draw their moniker from one legislator’s reported beef that “some securities swindlers were so barefaced that they would sell building lots in the blue sky.”
Congress didn’t enter the field until four years after the 1929 market crash with passage of the 1933 Securities Act. Among other provisions, the 1933 act punishes fraud by companies issuing securities for public sale. It also confers dual state and federal jurisdiction and, in most cases, bars removal of state court claims to the federal system.
The following year, Congress passed the more comprehensive 1934 Securities Exchange Act. Besides establishing the SEC, the 1934 statute extended federal regulation to the markets and the various players who trade in securities. The later act gives federal courts exclusive jurisdiction. State regulators view themselves as neighborhood beat cops of sorts, who can respond to ongoing frauds and other complaints more rapidly than the creaking machinery of the SEC. They say they can go to court on a moment’s notice, say, to obtain an injunction against a swindle in progress. They also say it can take the SEC up to two months to respond, especially in matters that aren’t making national headlines.
“If I’ve got a case going on, I may not be able to wait that long if I need to stop the bleeding,” says Joseph P. Borg, Alabama Securities Commission director. “The state agencies are usually much more nimble and quicker to move.”
A former president of the North American Securities Administrators Association, Borg also serves as a member of a working group the trade organization formed last fall with the SEC to improve coordination between state and federal regulators.
If competing state and federal agencies aren’t enough, a few warring private plaintiffs lawyers really can spice up parallel proceedings. In the WorldCom matter, the lawyers began lining up months before the company in July 2002 sought protection from creditors under Chapter 11 of the U.S. Bankruptcy Code. Like San Diego-based William S. Lerach, plaintiffs lawyers relish the ability to go into state court with both nonremovable federal complaints under the 1933 act and state claims under statutes and common law that often deal more harshly with scammers.
Lerach was the West Coast head of the ubiquitous national securities class action firm Milberg Weiss Bershad Hynes & Lerach until its 2003 breakup. He is attempting to chart his own course in the WorldCom case, filing some 50 individual actions in numerous states for more than 120 plaintiffs.
Defendants in the meantime are trying to keep Lerach in the New York federal courts so they can avoid fighting the same war on multiple fronts. Though Lerach’s clients are for now participating in depositions and other pretrial matters in the consolidated federal action, he has spurned the Citigroup settlement. Instead, he’s gambling on larger payouts—and consequently higher attorney fees—in later state trials or settlements. Lerach figures the Citigroup deal forged in New York is worth just pennies on the dollar.
“You recover more money,” Lerach says of separate state actions. “You have your own lawsuit, and you settle it on your own terms. People aren’t satisfied with a penny on the dollar, or even 8 or 9 cents on the dollar. There’s absolutely no reason why they should be satisfied.” Citing continuing negotiations with the remaining defendants, lead class plaintiffs lawyer John P. Coffey declined to discuss the case in detail. He does hint that lowball estimates by Lerach and others may be way off.
“The notion that this is a few pennies is ludicrous,” says Coffey, who represents the New York State Common Retirement Fund. “It appears to be the result of fuzzy math.”
Lerach’s tactics haven’t exactly tickled judge cote. Coffey complained to Cote in October 2003 that Lerach had misled clients through a letter-writing campaign that left the impression they could recover their losses only if they retained Milberg Weiss and filed individual state claims. (The New York pension fund also had approached Milberg Weiss about representing it in the class action, but the firm had to decline because of Lerach’s possibly conflicting pursuit of individual claims. Lerach has since started a new firm, Lerach Coughlin Stoia & Robbins, and remains lead counsel in a similarly consolidated class action against Enron Corp. in Houston federal court.)
Lerach told letter recipients that he wanted to assemble a coalition of institutional investors with WorldCom losses of $2 billion to $3 billion “to pursue a series of cases in a coordinated litigation throughout the United States and achieve a very significant recovery for them, apart from whatever happens in the class action on behalf of all purchasers of all securities of WorldCom in New York.”
In a Nov. 17 opinion, Cote said Lerach failed to present “a forthright description of the advantages and disadvantages of both the individual action and class action options.” She listed several deficiencies, including the letters’ failure to describe impediments that statutes of limitations may pose for individual claims and inadequate discussion of her duties to ensure the fair distribution of any award and to entertain objections to attorney fees. Cote found that Lerach’s firm had “engaged in an active campaign to encourage pension funds not to participate in the class action” and was “running the coordinated individual actions much as a de facto class action.”
As the routine notices went into the mail to alert potential class members of the action, Cote ordered separate curative notices to set the record straight sent to plaintiffs who had lodged individual claims. Then she set about dismissing some of their claims by the handful. The first to go were two filed by the Alaska Department of Revenue and the Alaska State Pension Investment Board. Cote found one 1998 bond purchase beyond the statute of limitations and a second 2000 purchase ineligible because the bonds were privately sold to select buyers and not the public at large.
Elimination of those two purchases could cost Alaska nearly 40 percent of its claimed $26 million in WorldCom losses. The dismissals, with prejudice, left Alaska officials wondering whether to join the class with two other bond claims Cote let stand or to try to shop their entire package in state courts inexperienced in securities cases.
“For me, I’m having a hard time seeing the fairness of being pushed back into the class when it doesn’t cover our claims,” says Michael A. Barnhill, an Alaska assistant attorney general representing the state agencies. Despite questions Cote raised about Lerach’s strategy, Barnhill says in hindsight that Alaska probably wouldn’t have done things any differently had it hired other lawyers.
“There was never any danger of any deception because these are sophisticated clients with their own lawyers,” Lerach says. “I think the proof’s in the pudding. If people had believed they had been misled, then they would have taken a different course.”
Lerach says he’s only lost one minor client as a result of the controversy. That may be. But perhaps hedging their bets, a steady stream of plaintiffs with individual claims have taken up an invitation from Cote to voluntarily dismiss their individual actions in exchange for admission to the class. None had opted out as of early summer.
Lerach no doubt believed he was on safe footing by drafting the individual actions under the 1933 act with its ban on removal to federal court. He and other reluctant class plaintiffs learned otherwise in May, when a 2nd Circuit panel affirmed Cote’s use of bankruptcy law to keep the cases before her.
The 2nd Circuit was the first federal appeals court to consider the issue, which the panel described as a close question pitting equally clear statutes against each other. While the 1933 act helps plaintiffs remain in state court, the second statute, 28 U.S.C. § 1452(a), just as forcefully permits removal of claims “related to” a bankruptcy.
The nod went to the bankruptcy statute after the panel suggested that the Securities Act and its potential for scattershot judgments could interfere with reorganization efforts, especially in large Chapter 11 cases where debtors must marshal all their assets and pay off creditors before emerging. (Because WorldCom was in Chapter 11, civil proceedings against it were automatically stayed and the case proceeded against the investment banks and other defendants.)
“In its every detail, section 1452(a) is designed to further Congress’ purpose of centralizing bankruptcy litigation in a federal forum,” wrote Judge Jose A. Cabranes. California Public Employees’ Retirement System v. WorldCom Inc., 368 F.3d 86.
WorldCom came out of Chapter 11 on April 20 under the new MCI name. With that, Lerach says, any reason to keep the cases in Cote’s court disappears.
“There’s no way any of these cases can affect the bankruptcy,” Lerach maintains. “The bankruptcy case is over.”
Equally disdainful of class actions, but luckier than Lerach, are the lawyers for the Retirement Systems of Alabama. While the defendants were able to remove most of the WorldCom securities litigation to Cote’s court, yet another federal judge in Alabama saw the bankruptcy-securities connection as shaky and sent the RSA back to state court.
Alabama also had succeeded in getting a similar pension fund case against Enron Corp. returned to state court, but still another federal judge thwarted that effort last year and bounced it back to Houston. The WorldCom litigation, however, appears destined to remain in state court following refusals to get involved by the 11th U.S. Circuit Court of Appeals at Atlanta and the U.S. Supreme Court.
At a March hearing before Montgomery County Circuit Judge Charles Price, Retirement Systems of Alabama lawyer J. Michael Rediker belittled defense attempts to get his clients to join the rest of the plaintiffs in negotiations on a global settlement.
“You know what happens in global settlements?” Rediker asked. “You get 5 to 10 cents on the dollar. I believe we’ll get 100 cents on the dollar, not counting punitives. And we’re under a statute. They don’t have a statute in federal cases. We’re under a statute here that gives us our attorney fees on top, and interest at 6 percent on top. Neither of those are involved in any federal rule or statute. … We don’t care about global public interest. We care about the public interest here.”
Rediker’s partner, Thomas L. Krebs, is intimately familiar with Alabama’s blue sky laws. He’s a former state securities director who helped write many of them. Besides the advantages Rediker cited over federal law, Krebs says that in state court the RSA only needs to prove negligence instead of the specific fraudulent intent federal law demands. Alabama law also relieves plaintiffs of the burden of proving third parties directly caused their injuries, which lawyers in the state say should make their case easier against the investment banks.
Home field advantage also is key. In a state where juries are known for doling out stratospheric punitive damages, the Alabama plaintiffs lawyers would rather make the short drive to Montgomery from their offices in Birmingham any day rather than take their chances in a colder environment in New York.
“Everyone’s going to speak Southern when we get down here,” Krebs says. “Those who can’t will be easily identified.”
Though other states have managed to wriggle free of New York and keep their WorldCom claims to themselves, remarks like Rediker’s haven’t endeared the Alabama lawyers to Cote. Inaction by other federal courts means Cote can’t drag the Southerners kicking and screaming to New York. But push came to shove this spring after Alabama Judge Price set an Oct. 18 trial date, three months before the federal trial. The difference is crucial because rulings and the outcome in an earlier case can wipe out defenses in subsequent trials through the doctrine of collateral estoppel, which precludes repeated litigation of decided issues.
Law and custom both curb federal judges from prying into state court business in all but the most extreme circumstances. The threatened Alabama trial fit the bill for Cote, who wasn’t about to let some state judge scuttle the highly complex consolidated cases, themselves already speeding to trial well ahead of expectations. So on April 23, Cote dusted off the 1793 All Writs Act, which she read as allowing her a narrow window to enjoin the Alabama trial until the federal one concludes. In re WorldCom Inc. Securities Litigation, 315 F. Supp.2d 527.
Besides Rediker’s comments, Cote appeared equally unimpressed by another contention that the Alabama case had to go to trial first because the RSA’s $300 million in claimed WorldCom losses would bury the state in a budgetary grave if it had to dip into its general revenues to pay retirees’ pensions. The plaintiffs abandoned that tack after Price rejected it. But they gave Cote plenty of ammunition. She extensively quoted both arguments from state court transcripts.
“It is worth observing that the Alabama plaintiffs have not been able to articulate any valid reason why their action should be tried in 2004, particularly when such a trial date will necessarily disrupt the schedule of the federal litigation,” Cote wrote in issuing the injunction. Brushing off the budget argument, Cote tore into Rediker.
“Their second proffered reason—that a 2004 trial date will extort a larger settlement—is not a legitimate reason for a trial date, and particularly not for one that creates such friction between the state and federal courts,” Cote wrote. “As the Alabama plaintiffs acknowledged when describing their purpose, their desire to obtain a settlement that will benefit them at the expense of all the other victims of the WorldCom fraud is at odds with the general public good.”
Though he doesn’t shy away from extolling the virtues of staying put, Krebs says the plaintiffs aren’t the ones holding up the show. “It isn’t me,” he says. “The judge in Alabama has the right to arrange his own docket and trial schedule. I can’t fault him for that.”