Finally Directors Paying For Fraud

It's about time that directors be forced to contribute to settling securities fraud charges. While I have no comment on the adequacy here, it is notable that not all the insurance proceeds were exhausted, yet the directors contributed. This usually means that the insurance company had defenses to paying such as the fraud was intentional, or the insurance was procured with false information. Nevertheless, this is good precedent.

Link: WSJ.com - WorldCom's Ex-Directors Pony Up.

WorldCom's Ex-Directors Pony Up Agreement in Principle To Pay Out Personal Funds Creates Liability Precedent By JONATHAN WEIL Staff Reporter of THE WALL STREET JOURNAL January 6, 2005; Page A3

In an unusual legal move, 10 former outside directors for the former WorldCom Inc. have agreed in principle to pay $54 million -- including $18 million out of their own pockets -- to settle their portion of a class-action lawsuit brought by bondholders and shareholders in the wake of the telecommunications company's massive accounting scandal, according to people familiar with the matter.

The remaining $36 million would be paid by the directors' liability insurers, these people said. Under the accord, the $18 million to be paid by the former directors represents about 20% of their combined personal net worth, excluding their primary residences, retirement accounts and certain joint marital assets. Some of the former directors would pay more than others, though the amounts that will be apportioned to each haven't yet been determined.

The formal agreement is expected to be signed and presented for approval to a federal district judge in Manhattan as early as today. The suit accused the former directors of a variety of securities-law violations, including approving misleading statements about WorldCom's financial condition that they allegedly should have known to be false.

The tentative accord promises to expand the potential liability for corporate directors whose companies commit accounting fraud on their watch. The sheer size of the pact would be unprecedented for a case of this nature. None of the 10 former directors was a direct participant in the accounting machinations of the WorldCom fraud, which totaled $11 billion, and all suffered large losses as a result of the company's collapse. WorldCom emerged from Chapter 11 bankruptcy protection last year and has changed its name to MCI. An MCI spokesman declined to comment; the company today has an entirely different board of directors.

The move comes less than two weeks before jury selection is set to begin in the trial of Bernard Ebbers, WorldCom's former chief executive. Mr. Ebbers is charged with securities fraud, conspiracy and causing the company to make false filings with securities regulators. He could be sentenced to more than 25 years in jail, if convicted.

Although the recent wave of corporate scandals has shown that many companies' boards missed signs of wrongdoing, outside corporate directors have been among the most difficult defendants for private litigants and regulators to target in accounting-fraud litigation. Directors can face liability in securities-fraud cases for oversight failures if their dereliction of duty is both severe and demonstrable. Historically, however, such cases rarely have been successful.

"This is clearly unprecedented and sends a message to directors that their own personal wealth is at risk if they're not diligent in their jobs," said Lynn Turner, research director at proxy advisor Glass-Lewis & Co. in Broomfield, Colo., and a former Securities and Exchange Commission chief accountant. "In the past, directors' personal wealth has not been at risk when they failed in their obligation to investors who elected them. Now, if you don't get the job done, it appears you may very well pay."

To date, the SEC hasn't brought any disciplinary actions against WorldCom's former outside directors. Illustrating the difficulty of bringing such cases, the SEC's enforcement division only rarely has filed civil-fraud charges against individual outside directors in connection with oversight failures in accounting-fraud cases.

For instance, the SEC hasn't brought disciplinary actions against any of Enron Corp.'s former outside directors. Companies whose directors have been sued by the SEC over similar allegations include Ahold NV, Chancellor Corp. and Heartland Advisors Inc.

The latest WorldCom settlement includes all but two of WorldCom's former outside directors: Bert C. Roberts Jr. and Francesco Galesi, who remain defendants in the lawsuit. The lawsuit's lead plaintiff is the New York State Common Retirement Fund. Settlement talks with Messrs. Galesi and Roberts are continuing, a person familiar with the matter said. Lawyers for the two men couldn't be reached for comment last night.

The 10 settling former outside directors are: James C. Allen, a longtime telecom-industry executive; Judith Areen, a former dean of Georgetown Law School; Carl J. Aycock, a former motel-industry executive; Max E. Bobbitt, a longtime telecom consultant and executive; Clifford L. Alexander, president of consulting firm Alexander & Associates Inc.; Stiles A. Kellett Jr., chairman of Kellett Investment Corp.; Gordon S. Macklin, former president of the National Association of Securities Dealers; John A. Porter, a former WorldCom chairman and vice chairman; Lawrence C. Tucker, a partner at Brown Brothers Harriman; and the estate of the late John W. Sidgmore, who took over as WorldCom's chief executive in April 2002 shortly before the company's accounting problems surfaced publicly.

The 10 former directors are being represented by Paul Curnin, an attorney at Simpson Thacher & Bartlett LLP in New York. Mr. Curnin declined to comment yesterday.

The $36 million to be paid by their insurers wouldn't fully tap out the company's director-liability insurance coverage, according to a person familiar with the matter. However, regardless of how much the insurers would pay, New York State Comptroller Alan Hevesi, the New York retirement fund's sole trustee, has insisted that the directors each personally pay a significant portion of the settlement proceeds.

In their most-recent amended complaint, the New York fund wrote that "WorldCom's board of directors was utterly derelict in fulfilling the most basic functions of a true board." A spokesman for Mr. Hevesi declined to comment last night.

Under the agreement in principle, the settling directors are expected to deny wrongdoing and state that they are settling the case to eliminate the uncertainties and expense of further litigation.

The planned settlement comes about two months after U.S. District Judge Denise Cote approved Citigroup Inc.'s $2.58 billion settlement in the same lawsuit, in connection with the bank's role as one of WorldCom's leading bond underwriters. The plaintiffs also are seeking billions of dollars in damages from 17 other bond underwriters, including J.P. Morgan Chase & Co., Deutsche Bank AG and Bank of America Corp. A trial on that portion of the case is set to begin next month. The class action includes investors that purchased WorldCom securities from April 1999 to June 2002.

Meanwhile, legal maneuvering is starting to escalate ahead of Mr. Ebbers's trial. In court filings, Mr. Ebbers's attorney, Reid Weingarten, is seeking, among other things, to have Judge Barbara Jones bar jurors from hearing about the company's $70 billion earnings restatement for 2000 and 2001.

"The sheer magnitude of the restatement ... would inflame the jury's passions," Mr. Weingarten wrote in a filing. "The bulk of the adjustments in the restatement have nothing to do with the fraud."

Jury selection is scheduled to begin Jan. 19 in U.S. District Court in New York, and the trial is expected to start around Jan. 24.

In motions with the court, Mr. Ebbers's attorney has also sought to keep the jury from seeing transcripts of conference calls made in 2000 and 2001, in which Mr. Ebbers commented about earnings to Wall Street analysts. Mr. Weingarten said the transcripts are incomplete and contain inaccuracies.

Mr. Ebbers, 63 years old, is expected to argue that he was never an accounting expert, and that he relied in good faith on those who were, including former Chief Financial Officer Scott Sullivan, who has pleaded guilty to fraud.

Mr. Sullivan, who initially insisted that he was innocent, is now the prosecution's star witness. Facing a possible lengthy sentence if convicted, Mr. Sullivan last year cut a deal with prosecutors and agreed to testify against Mr. Ebbers.

Mr. Sullivan is expected to claim that Mr. Ebbers goaded underlings into falsifying financial results in order to meet unrealistic earnings targets. The defense is expected to argue that Mr. Sullivan's testimony is not credible because he has a vested interest in implicating Mr. Ebbers to save himself.

--Shawn Young and Almar Latour contributed to this article.

Write to Jonathan Weil at jonathan.weil@wsj.com1

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