Is the Tyco Class Action Settlement Good?
Tuesday, September 11, 2007 at 12:57PM Will large institutional investors opt out of the proposed settlements in the In re Tyco International Ltd. Securities Litigation MDL Docket No. 02-1335-PB?
Pursuant to the Notice of Proposed Settlement sent to investors, the decision to be excluded from the Class must be made by September 28, 2007:
To exclude yourself from the Settlement, you must send a letter by mail to the Claims Administrator saying that you want to beexcluded from In re Tyco International Ltd. Securities Litigation Settlement. If you wish to exclude yourself from the Class, be sure toinclude your name, address, telephone number, and signature, and mail your exclusion request postmarked no later thanSeptember 28, 2007 to:Tyco International Ltd. Securities Litigation Settlement c/o The Garden City Group, Inc., Exclusions, Claims Administrator, P.O. Box 9199, Dublin, OH 43017-4199. Requests for exclusion should also list the amount and type of all Tyco Securities purchased, otherwise acquired, or sold during the Class Period, the prices paid or received, the date of each transaction and the amount or number of Tyco Securities held as of the beginning of the Class Period on December 13, 1999. You cannot exclude yourself on the website, by telephone or by e-mail. If you do not follow these procedures – including meeting the date for exclusion set out above – you will not be excluded from the Class, and you will be bound by all of the orders and judgments entered by the Court regarding the Settlement. You must exclude yourself even if you already have a pending case against any of the Tyco Settling Defendants’ Releasees or the PwC Releasees based upon any Released Claims.
I believe that situations justifying exclusions from securities fraud class action settlements are the exception and not the norm. But Tyco may be the exception.
Analysis of Settlement:
Procedural History and Settlement
Beginning in February 2002, Tyco and certain former directors and officers Ire named as defendants in over 40 purported securities class action suits. Most of the securities class actions were transferred to the United States District Court for the District of New Hampshire for coordinated or consolidated pretrial proceedings.
On January 28, 2003, a consolidated securities class action complaint was filed in these proceedings. On June 12, 2006, the court entered an order certifying a class:
consisting of all persons and entities who purchased or otherwise acquired Tyco securities betIen December 13, 1999 and June 7, 2002, and who were damaged thereby, excluding defendants, all of the officers, directors and partners thereof, members of their immediate families and their legal representatives, heirs, successors or assigns, and any entity in which any of the foregoing have or had a controlling interest.
On June 26, 2006, Tyco filed a petition for leave to appeal the class certification order to the United States Court of Appeals for the First Circuit. On September 22, 2006, the United States Court of Appeals for the First Circuit denied Tyco’s petition.
On July 6, 2006, the lead plaintiffs filed in the United States District Court for the District of New Hampshire a motion for a permanent injunction against prosecution of the class action styled Brazen v. Tyco International Ltd., et al. that was certified by the Circuit Court for Cook County, Illinois. On October 26, 2006, the court denied plaintiffs' motion for injunctive relief without prejudice.
On May 14, 2007, Tyco settled the 32 securities consolidated class actions. The settlement does not resolve the following securities cases, which remain outstanding: Stumpf v. Tyco International Ltd., New Jersey v. Tyco International Ltd., et al., Ballard v. Tyco International Ltd., Sciallo v. Tyco International Ltd., et al., Jasin v. Tyco International Ltd., et al., and Hall v. Kozlowski, et al. The proposed settlement does not release claims arising under the Employee Retirement Income Security Act of 1974, 29 U.S.C. Sec. 1001, et seq. ("ERISA"), which are not common to all Class Members, including any claims asserted in Overby, et al. v. Tyco International Ltd., Civil Action No. 02-MD-1357-PB.
The Class Action releases all claims against Tyco, the other settling defendants and ten other individuals in consideration for the payment of $2.975 billion from Tyco. PricewaterhouseCoopers has agreed to make a payment of $225 million. L. Dennis Kozlowski, Mark H. Swartz and Frank E. Walsh, Jr., are excluded from the settling defendants, and the class will assign to Tyco all of their claims against defendants Kozlowski, Swartz and Walsh. In exchange, Tyco will agree to pay to the certified class 50% of any net recovery against these defendants.
The Settlement is Facially Attractive
The settlement amount of $3.2 billion is relatively large as far as securities fraud class action settlements go. Plaintiffs claim it is that largest single payment by one company to settle a securities fraud suit.
While the settlement notice does not state the amount of estimated aggregate damages, I can estimate that Lead Plaintiff’s Counsel has estimated it to be $10.8 billion. The Settlement Notice states that:
[I]f all Class Members make a claim against the Settlement Fund, the average payment to Class Members will be $1.474 per share of Tyco common stock, after taking into consideration the relative average payment that would be paid to purchasers of Tyco Notes during the Class Period (estimated at approximately 8% of total damages). Of this amount, fees and expenses requested by the attorneys will not exceed $0.30 per share of Tyco common stock.
To put this in perspective, the Settlement Notice also states:
The Class Representatives estimate that the approximate average amount of recoverable damages to members of the Class who purchased Tyco common stock were this case to go to trial would be approximately $5.423 per share based upon an estimate of 1.997 billion outstanding Tyco shares as of the last day of the Class Period.
This implies that the recovery represents 32% of the total losses, not including the notes. This percentage recovery is not a trivial amount, but is not great, considering the nature of this particular case where certain of the defendants Int to jail and the ability to collect on a judgment is not an issue.
By way of comparison, in 2005, the California Public Retirement System, (“CalPERS”), California State Teachers’ Retirement System (“CalSTERS”), and the Los Angeles County Employee Retirement Association (“LACERA”) announced a combined opt out settlement of $257.4 million in WorldCom. The settlement appears to be part of a larger settlement of $652 million by a group of state and local retirement funds and insurance companies, which its attorneys claimed was 83% higher than the class action settlement. For some of the funds involved, this opt-out settlement purportedly represented more than 70 percent of their losses. Five New York pension funds announced a combined settlement with a multiple of three times over the class action. Moreover, the funds claimed that this settlement represented over 60% of their losses.
In 2007, in AOL Time Warner, CalSTERS claimed a 6.5 multiple on a settlement of $105 million out of damages of $135 million. The State of Alaska claimed a multiple of 50. The University of California claimed a multiple range of 16-24 on a settlement of $246 million out of a loss of $550 million. The State of Ohio also claimed a multiple of about 16 after attorneys’ fees. The Ohio funds settled for $144 million, which it claims, is $138 million more than it would have received under the class action settlement, and represents 36% of its losses. A separate group of smaller investments represented by the same counsel did not fare as Ill with settlements of only about 15% of damages compared to the class recovery of a purported 1.4%.
While the recovery in this case purportedly represents 32% of Lead Plaintiffs’ Counsel estimated damages one must look at their damage model and consider the alternatives they discarded.
More important, one needs to consider an institutional investor’s transactions in light of the Plan of Allocation attached to the Notice and the estimated inflation. The range of damages to class members is set out in the Plan of Allocation and shows, depending on what date the purchase took place, damages (or inflation per share) range from $0 to $8.29 per share. It may be that damages allocated to the securities purchased by a particular institutional investor will represent more or less than the average based on factors considered by Lead Plaintiffs’ Counsel. For example if an investor acquired shares in the Mallinckroft acquisition or in the June 6, 2001 secondary public offering, you will get a 10% premium. A 10% premium on a Section 11 claim is not large and would be worthy of further exploration if those are the shares purchased by you.
Similarly, if an investor purchased notes issued during the Class Period, the investors claims may be stronger than that of the Class as a whole.
The Settlement Amount Appears Low In The Light of the Public Facts.
Based on stock data reviewed that needs to be adjusted for various splits, Tyco stock dropped from over $235 per share ($58.75 before adjustment) in December 2001 to as low as $109 ($27.25)per share in January 2002, when questions arose about the accuracy of Tyco's bookkeeping and accounting. Bad news continued to come out over the next few months concerning the fraud and the theft. By the end of the Class Period the stock had dropped to $40 ($10)per share, though over the next 90 days (the 90 day lookback period) the stock had risen to as high as $65 per share with a moving average (or mean) on the 90th day of $53.896 per share. ($14.974 pre-split).
Based on 1.997 billion shares outstanding, the loss in market capitalization from the end of December 2001 to the end of the Class period, thus, was $95 billion. Sixty percent of Tyco’s value was lost in January alone as the NASDAQ and the S&P 500 held their value resulting in a market capitalization drop of $71.19 billion.
When compared against the S&P 500, the NASDAQ Index and the Dow Jones Index, it does not appear that market drops were the causation of any of the drops.
A simple event analysis shows Tyco’s stock closed at $235 ($58,75) per share on December 31, 2001, before the bad news began to come out to $140.6 by January 31, 2002 and $92.4 ($23.1)by the day after the first class action lawsuits Ire filed on February 4, 2002.
By the end of the Class Period, on June 7, 2002, the stock had fallen to $40 dollars a share ($10) .
To recap, adjusted for the 4 for 1 split on July split, that is a decrease from $58.75 to $10. But pursuant to 15 U.S.C. Section 78u-4(e)(1) damages can be no more than the purchase price in Class Period and the 90 Look-Back median of $14.974.
Thus, absent other causation factors, the average payment to Class Members of $1.474 per share appears fairly small in comparison to the $43.776 recoverable drop of the stock price. The settlement represents only 3% of the drop in market capitalization over the Class Period.
Why Lead Plaintiffs’ Counsel believes that at most there is at most $8.06 dollars worth of inflation, or damages, for those who bought before January 29, 2002, and why those who bought in betIen January 29, 2002 and January 6, 2002 have only $0.96 in damages is unexplained.
One can only surmise that they have calculated damages assuming that nearly the entire fraud for those who bought before January 29, 2002 was revealed on or about that date, and that the latter drops were actionable only based on statements made after that date. Based on an event study,, that does not seem plausible. Also unexplained is the failure to account for the remaining $23 in stock drop in January alone.
12/31/2001- 58.9
1/11/2002- 50.25
1/14/2002- 52.4
1/15/2002- 47.95
1/28/2002- 42
1/29/2002- 33.65
2/4/2002- 29.9
2/5/2002- 23.1
In essence, Lead Plaintiffs’ Counsel has discounted almost $27 of the $35.716 in potential damages in estimating losses to the portion of the Class, which bought before January 29, 2002. They discount further to settle for an average of $1.474 per share.
Liability Appears Extremely High
Liability in this case is almost uncontestable. We know from the SEC press release of April 17, 2006 , concerning its action, which Tyco settled for $50 million, that:
· Tyco inflated operating income by at least $500 million from its many acquisitions by undervaluing acquired assets while overvaluing acquired liabilities. Tyco also manipulated various reserve accounts to meet earnings forecasts, according to the complaint.
· TYCO inflated operating income by $567 million betIen 1998 and 2002 through the recording of fees that Tyco's ADT Securities Services Inc. subsidiary charged to dealers but that had actually been offset by ADT's purchase of security monitoring contracts from them. The transaction lacked economic substance, the SEC said, and should not have been recorded as income.
· Tyco violated the anti-bribery provisions of the Foreign Corrupt Practices Act when employees of its Earth Tech Brasil Ltda. subsidiary paid Brazilian officials to obtain business in that country.
· "The Tyco accounting fraud was orchestrated at the highest levels of the company, but carried out at numerous operating units and management levels of the company," Scott W. Friestad, associate SEC enforcement director, said in a statement. "'Push down' frauds like this are especially difficult to detect and investigate."
· Tyco failed to disclose in its proxy statements or annual reports the executive compensation, indebtedness and "related party" transactions that Ire widely reported and led to the demise of the management team led by CEO L. Dennis Kozlowski.
Further, Kozlowski and former CFO Mark Swartz Ire convicted of grand larceny, falsification of business records and conspiracy as a result of their scheme to loot the company through multimillion-dollar "loans" that Ire ultimately forgiven, as Ill as unauthorized bonuses and exorbitant corporate perks. They are serving eight-and-a-half to 25 years in prison for their roles in the fraud.
Other Lawsuits
The Class Action settlement does not resolve all securities cases, and several remain outstanding. On November 27, 2002, the State of New Jersey, on behalf of several state pension funds, filed a complaint, New Jersey v. Tyco, in the United States District Court for the District of New Jersey against Tyco, our former auditors and certain of our former officers and directors. In addition, the proposed settlement does not release claims arising under ERISA, that are asserted in the consolidated ERISA class action, Overby, et al. v. Tyco International Ltd.
According to a press release dated June 13, 2007, a judge has refused to dismiss lawsuits by three smaller groups of former Tyco International Ltd. shareholders, a month after the company agreed to settle most shareholder claims arising from mismanagement and looting by former top executives. Still alive are lawsuits :
“by the state of New Jersey, former shareholders of AMP Inc. and former shareholders of a one-time Tyco subsidiary, TyCom Inc. U.S. District Judge Paul Barbadoro on dismissed some counts and defendants, but kept alive most of their claims against Tyco, its former executives and directors and the company's former auditor, PricewaterhouseCoopers LLP. ... [Barbardoro] also refused to dismiss most of New Jersey's securities fraud and racketeering claims -- valued at $100 million -- on behalf of its pension and other investment funds, including one that helps fund the state's public schools. ...”
Recoverable Assets
The ability to collect on any judgment does not appear to be an issue. The company has about $20 billion in annual revenues and, but for the Class Action settlement would have been profitable this last quarter. It has over $1.3 billion in cash and over $15 billion in shareholder revenue as of June 29, 2007.
Conclusion
It is difficult to second-guess a settlement when onw has not participated in the litigation. Missing for review are defendants arguments and plaintiffs discovered weaknesses, if any. Nevertheless, based on the above preliminary analysis, an investor with large losses that stands a good chance of increasing recovery against Tyco and other defendants if it opts-out of the settlement. Comments and criticism of this analysis can only be helpful.
Reader Comments (6)
In a recent internet “blog” called Reed Kathrein’s News on Corporate Fraud, Mr. Kathrein sets forth an opinion piece entitled “Is the Tyco Class Action Settlement Good?” Mr. Kathrein asserts that the settlement is too low because he claims the loss in market capitalization is large: “the loss in market capitalization from the end of December 2001 to the end of the Class period, thus, was $95 billion. Sixty percent of Tyco’s value was lost in January alone as the NASDAQ and the S&P 500 held their value resulting in a market capitalization drop of $71.19 billion.” Based upon this loss in market capitalization, and a claim the plaintiffs’ damages model ignores certain events that occurred in January 2002, he asserts that Tyco may be a good case for investors to file their own opt-out action. As we explain below, Mr. Kathrein confuses the issues of “out-of-pocket” losses or “market losses” with the true level of “recoverable damages” in this action. We are providing this memo in the hopes of curing the misinformation and to give a brief summary of the true damage issues that were faced in this action.
Allegations against Tyco related to accounting improprieties have a long and convoluted history. Beginning in 1999, certain analysts associated with short-sellers alleged that Tyco was engaged in a process referred to as “spring-loading.” Tyco was alleged to have made accounting changes to its acquisition targets immediately prior to the acquisition that depressed their financial performance and then reversed those changes after the deal closed making it appear as though Tyco management had effected a significant improvement. The allegations resulted in an investigation of Tyco’s accounting by the Securities and Exchange Commission (“SEC”) and a class action under the federal securities laws. The SEC found no wrongdoing and closed its investigation in 2000. The class action subsequently was dismissed in March 2002.
Shortly after the dismissal of the first lawsuit, a number of disclosures occurred regarding Tyco’s management’s compensation practices, as well as other forms of illegal conduct by Tyco’s CEO (primarily related to taxes). These allegations resulted in an internal investigation, a renewed SEC investigation, the criminal convictions of Dennis Kozlowski and Mark Swartz, and the recently settled Tyco Securities lawsuit.
Between January 2 and June 6, 2002, Tyco’s stock declined by more than $50 per share, resulting in a loss of market capitalization of nearly $100 billion. This decline was the result of a number of factors: (1) poor performance by Tyco’s electronics and telecommunications divisions/subsidiaries; (2) a very poorly received plan by Tyco management to break Tyco in to three parts; (3) a credit crunch that resulted in Tyco being unable to sell commercial paper; and (4) renewed concerns about Tyco’s accounting and management integrity resulting from certain improper compensation paid to a director, CEO Dennis Kozlowski’s indictment on tax fraud charges and at least one false report in a newsletter. While these events resulted in a significant decline in market capitalization, only the portion of the decline relating to item (4) can be attributed to fraud. This was a fraction of the total market loss.
In the latter half of 2002 and 2003, through a series of reports from David Boies and his law firm and through a restatement, Tyco disclosed that its CEO and CFO had taken, without board approval, hundreds of millions of dollars in compensation for themselves and a few close associates that was not approved by the Tyco board. The reports also disclosed certain accounting issues relating to approximately $1.5 billion over a four year period. In response, Tyco’s share price only declined by pennies a share.
To establish damages, our damages expert in Tyco, Mark Zmijewski, the Leon Carroll Marshall Professor of Accounting and Deputy Dean at the University of Chicago, Graduate School of Business, used a plaintiff-style event study methodology. He calculated damages for Tyco stock at $10.83 billion and for bonds at $900 million, for total damages of $11.7 billion. In calculating this damages amount he concluded that there were eight (8) days on which Tyco’s stock price declined as a result of information that could be causally related to the fraud that was alleged in the action. Although there were many more days upon which Tyco’s stock price moved downward as a result of company-specific information, it was only these eight days that could be causally linked to the lack of integrity in Tyco’s accounting and its management. The Professor further refined his analysis for these eight particular corrective disclosure days by weighting the likelihood that such disclosures were sufficiently related to the fraud so that they could legitimately be included within a damage analysis that would be accepted by a jury, with disclosures most closely related to the fraud receiving the heaviest weights and those disclosures further removed from the fraud receiving the lightest weights. This damages methodology underlies the plan of allocation that we have submitted to the Court. Of course, Tyco had its own damages analysis and their expert claimed damages of less than $500 million, based upon numerous conclusions we were prepared to challenge vigorously at trial.
In order to fairly present the recovery per share and the maximum recovery per share under the Settlement in accordance with the PSLRA, we first determined the amount of damages attributable to Tyco stock compared to the overall damages ($10.83 billion in stock damages / $11.7 billion overall damages) and applied the resulting percentage (92%) to the recovery of $3.2 billion to calculate a stock recovery of $2.944 billion. We then took the outstanding shares as of the end of the class period (1.997 billion shares) and divided that into the stock recovery in order to obtain the gross recovery per share of $1.474 per share, presuming that 100% of possible Tyco share purchasing claimants were to file claims. Lastly, we calculated the gross damages per share by dividing the stock-related damage figure of $10.83 billion by the shares outstanding on the last day of the Class Period (1.997 billion) to arrive at a best recovery per share of $5.423. In comparing the two figures, we believe we have achieved a 27% recovery, even presuming that all eligible shareholders file claims.
Furthermore, our expert has not discounted his damage analysis to account for the fact that most large institutional investors typically have holdings purchased prior to the commencement of a class period that are subsequently sold during the class period. Tyco argued vigorously throughout the case that an “offset” should be applied against any Class Period losses to account for sales of pre-Class Period purchases at allegedly inflated prices. It is our expert’s opinion that such “offsets” can reduce overall damages up to 40% and thus, if Tyco was successful with this argument, our expert’s overall damage figure of $11.7 billion would have to be reduced to $7.4 billion, while the stock portion of the damages would have been reduced to $6.5 billion, thereby resulting in a maximum recovery per share of $3.25. Under such an analysis, the $3.2 billion settlement becomes even more impressive, potentially representing a recovery in excess of 43% of recoverable damages for shareholders ($1.47 / $3.25), even presuming a 100% claims filing rate. At the more likely 50% claims rate, that same class member would receive approximately 50% of recoverable damages. At a 35% claims filing rate, that same class member would receive approximately 66% of recoverable damages. While recognizing that the claims’ filing rate is a significant variable, we believe that even a 25% recovery compares very favorably to the recovery in other mega-fund cases.
We are extremely proud of what was accomplished in this litigation. Tyco was a strong case, albeit one with many difficult factual and legal issues, only some of which are discussed here. But it was a $10 billion case, not a $40, $50 or $100 billion one. This memorandum is merely a brief summary of the damage issues we have litigated and overcome over the past five years. A more detailed summary of the litigation and the settlement is set forth in the Court-approved Notice. For a full copy of the Notice and Proof of Claim form, any interested person can either contact our firm directly or our co-lead counsel or visit the Tyco settlement website at http://www.tycoclasssettlement.com, where all forms are available for downloading and printing.
In looking at an event analysis, Dura causation issues do loom large. However, experts do and can often look at the same facts and come up with different conclusions. Mr. Eisenhofer asserts that the main causative factors of the drop were: "(1) poor performance by Tyco’s electronics and telecommunications divisions/subsidiaries; (2) a very poorly received plan by Tyco management to break Tyco in to three parts; (3) a credit crunch that resulted in Tyco being unable to sell commercial paper; and 4) renewed concerns about Tyco’s accounting and management integrity resulting from certain improper compensation paid to a director, CEO Dennis Kozlowski’s indictment on tax fraud charges and at least one false report in a newsletter. While these events resulted in a significant decline in market capitalization, only the portion of the decline relating to item (4) can be attributed to fraud. This was a fraction of the total market loss."
Missing from explanation is any discussion as to any causal break between the fraud (4) and the other stock drops (1-3). These other factors which caused the stock to continue its plummet may in fact have been caused by, aggrevated by, or made less important by the hidden facts. For instance, the inability to get commercial paper was certainly impacted by managements fraud.
Also missing is any discussion concerning the accounting fraud that the SEC found to be about $1 billion (if I remember correctly).
It is also clear that the BAD news slowly slipped into the market. Defense counsel call that "walking the stock price down." In this case, the walk appears more of a slow crumble of the dam, with large chunks popping out every few days.
I simply suspect that a jury will not parse the fraud out so easily.