Monday, December 11, 2006

Notes from Around the Web

Lead Enron Plaintiff Moves to Dismiss Vinson & Elkins: In the serial retelling of the Enron collapse, the company’s outside professionals have been popular scapegoats, and among the most prominent targets has been the company’s former law firm, Vinson & Elkins. According to reports (here), between 1997 and 2001, Enron paid the law firm $162 million in fees. The law firm’s relation to the company and possible role in the company’s financial shenanigans has been the subject of extensive media coveage (here). But, according to a December 8, 2006 Houston Chronicle article entitled "Law Firm Could be Cut Free from Suit" (here), the lead plaintiff in the Enron civil action has moved to dismiss the Vinson & Elkins law firm from the lawsuit.

The action is scheduled to go to trial in April against the remaining defendants, including Merrill Lynch, Toronto Dominion Bank, Royal Bank of Canada, and the Royal Bank of Scotland. A spokesman for the lead plaintiff, the University of California, is quoted as saying that the inclusion of V & E at trial "threatened to raise complicated legal issues unnecessarily distracting the jury’s attention away from more culpable defendants – more solvent investment banks – from whom larger recoveries are more likely." The lead plaintiff is represented by the Lerach, Coughlin firm.

The court has not yet ruled on the plaintiff’s motion.

Without commenting one way or other on the merits of the claims against the law firm, The D & O Diary notes that it is a very unusual kind of a case that a 700-lawyer law firm with offices in 12 cities could be viewed as a mere complication or in which there could be other parties against whom "larger recoveries" are sought. The timing seems odd, too. The plaintiff has up to this point struggled vigorously to keep the V & E in the case, strenuously opposing the law firm’s own prior motion to dismiss. Maybe the timing is purely coincidental, but The D & O Diary can’t help but wonder if the plaintiff’s move to dismiss the V & E firm now is somehow related to the same court’s recent award of sanctions (here) against the Lerach Couglin firm in connection with its attempts to pursue a claim against Alliance Capital Management in the Enron civil action.

AOL Time Warner Class Action Opt-Outs Settling Favorably?: According to a December 7, 2006 New York Post article entitled "Time Warner Case Finds a Surprise" (here), the individual plaintiffs who opted out of the AOL Time Warner class action settlement are "faring much better than" those who stayed in the class settlement. The article reports on the settlement last week involving the state of Alaska in the individual state court action it filed against AOL Time Warner in Alaska state court. The state settled its $60 million claimed investment loss for $50 million, amounting to about 83 cents on the dollar, which the state’s attorney said is "far superior to the payout in the national settlement." The same attorney said that their individual settlement is "50 times more than what we would have received if we had remained in the class."

According to the article, about 100 institutional plaintiffs opted out of the class settlement and signed up with Bill Lerach of the Lerach Coughlin firm. When asked if his clients were better off than those who remained in the class, Lerach is reported to have said "there’s no question that we’re getting tons more dollars."

Between the news about the AOL Time Warner opt-outs and the Second Circuit’s decision denying class certification against the underwriter defendants in the IPO Laddering case (here), it has been a tough week for fans of the class action process.

Adam Savett of the Lies, Damned Lies blog has a more detailed comment on Alaska’s AOL Time Warner settlement, here.

For a prior D & O Diary comment on the settlement in the AOL Time Warner shareholders’ derivative action, refer here.

Prosecution Averted, But the Firm Still Failed to Survive: A December 10, 2006 New York Times article entitled "Poisoned by Scandal, Craving an Antidote" (here, registration required), describes the six-year ordeal of Rent-Way and its CEO to avoid the damaging effects of an accounting scandal. Even though the company’s extraordinary level of cooperation managed to avoid corporate prosecution, the company ultimately was forced to sell itself to a rival because of the scandal’s indelible stain.

The company itself discovered the accounting fraud and reported it to the SEC. The Company turned over documents containing attorney-client information and even invited the SEC to set up an office in the Company’s headquarters to conduct an on-site investigation. When the three employees who had perpetrated the fraud were later convicted, the local U.S. attorney’s office put out a press release commending the CEO’s openness as "a good example of how a company can alleviate" the consequences of misconduct "by fully and openly cooperating with the government."

But this extraordinary level of cooperation was still not enough to save the company. The company’s accounting scandal reduced its creditworthiness, which in turn increased its borrowing costs. The increased borrowing costs continued to weigh on the company and its stock price. Ultimately, the company was forced to sell itself to its largest competitor. The company was not able to survive the loss of investor confidence from the accounting scandal.

Much has been made recently of the costs of complying with regulatory burdens, but the costs of compliance pale by comparison with the consequences from undisciplined practices. As Professor Ellen Podgor notes in the White Collar Crime Prof blog (here), "the best lesson that can be learned from this story is the importance of having good solid controls in place to detect fraud in one’s midst. Having a proper corporate compliance program may assist to avoid the sad consequences of the innocent CEO who detects the fraud and has to deal with how best to handle the matter."

Bury Bonds: A December 7, 2006 article in the Boston Globe entitled "Left Holding the Bond," (here) details "a new minefield in the surging market for leveraged buyouts" – that is, the huge negative impact that the leveraged buyout has on the target company’s existing publicly traded debt. According to the article, when take over companies acquire publicly traded target companies, they pay off shareholders but they don’t redeem existing bonds. Instead, the successor company assumes the old bonds and continues making the interest payments. The problem is that the private-equity borrowers borrow most of the funds for the acquisition, loading the business with new debt, which erodes the company’s creditworthiness and makes the old bonds less highly valued in the debt marketplace.

Thus, for example, in connection with the recent HCA acquisition, public shareholders got a 20% premium for their shares, but HCA’s public debt holders saw the value of their securities decline by 15%. Bond holders in Clear Channel Communications saw the company’s bonds lose about 11% of their value following the company’s recent leveraged buyout. The article points out that even rumors of buyouts can be enough to cause the price of public debt to decline.

Everybody else involved in the takeover transaction is making money, but the bondholders are left with diminished investment value. They would be better protected if the debt instruments required accelerated repayment of the principal amount upon a change of control, but that is a relatively rare provision, precisely because it might discourage potential suitors. The large amounts of money involved in leveraged buyouts and the extent of the detriment to bondholders may well encourage bondholders to try to look to the company or its management to make up their investment loss. Bondholders may well consider whether legal action of some kind is in their interests.

Options Backdating Litigation Update: With the addition of the action filed against Agile Software (here) , the number of companies that have been named as nominal defendants in shareholders' derivative lawsuits raising options timing allegations is now 121. The number of companies sued in securities fraud lawsuits stands at 21. See The D & O Diary's running tally of options backdating lawsuits here.

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