Opinion
Master File No. 02 Civ. 3288 (DLC).
March 4, 2005
Max W. Berger, John P. Coffey, Steven B. Singer, Chad Johnson, Beata Gocyk-Farber, John C. Browne, David R. Hassel, Bernstein Litowitz Berger Grossman LLP, New York, New York.
Leonard Barrack, Gerald J. Rodos, Jeffrey W. Golan, Mark R. Rosen, Jeffrey A. Barrack, Pearlette V. Toussant, Regina M. Calcaterra, Chad A. Carder, Barrack, Rodos Bacine, Philadelphia, Pennsylvania, for Lead Plaintiff.
Geoffrey S. Harper, Beth Jaynes, Kelly R. Vickers, Autumn J.S. Hwang, Fish Richardson P.C., New York, New York, for Defendant Francesco Galesi.
George E. Ridge, Cooper Ridge Lantinberg, P.A., Jacksonville, FL, for Defendant Bert C. Roberts, Jr.
Pamela Rogers Chepiga, Allen Overy LLP, New York, New York, Liaison Counsel for Director Defendants.
Eliot Lauer, Michael Moscato, Jonathan Walsh, Curtis, Mallet-Prevost, Colt Mosle LLP, New York, NY, for Defendant Arthur Andersen LLP.
Jay B. Kasner, Thomas J. Nolan, Jay S. Berke, Susan L. Saltzstein, Jason D. Russell, Cyrus Amir-Mokri, Steven J. Kolleeny, Skadden, Arps, Slate, Meagher Flom LLP, New York, New York, for Underwriter Defendants.
OPINION AND ORDER
The Underwriter Defendants and defendant Arthur Andersen LLP ("Andersen") in this securities class action arising from the collapse of WorldCom, Inc. ("WorldCom") have moved in limine to preclude reference to certain evidence of corporate wrongdoing at the trial scheduled to begin on March 17. This Opinion assumes familiarity with the Opinions issued in the course of this litigation, including those outlining the allegations against the Underwriter Defendants and Andersen.
See, e.g., In re WorldCom, Inc. Sec. Litig., 352 F. Supp. 2d 472 (S.D.N.Y. 2005) (Andersen's motion for summary judgment); In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004) (Underwriter Defendants' motion for summary judgment).
The Lead Plaintiff has identified three contexts in which it contends that evidence of corporate wrongdoing, apart from that which took place at WorldCom itself, is relevant and admissible. First, the Lead Plaintiff asserts that Andersen's role in the Enron scandal led the internal audit department of WorldCom to alter its audit schedule and thereby led to the discovery of the capital expenditure fraud at WorldCom. Second, to the extent that the Underwriter Defendants intend to argue at trial, as they did in connection with their summary judgment motion, that they were entitled to rely on Andersen's comfort letters, the Lead Plaintiff wants to offer evidence that the Underwriter Defendants were aware as of the May 2001 bond offering of certain litigation and accusations against Andersen. Finally, to the extent that the Underwriter Defendants seek to argue that their spinning of hot IPO stocks to WorldCom executives was widely known and endorsed by the SEC, the Lead Plaintiff seeks to cross-examine witnesses to show that the SEC and the NASD have condemned the practice.See In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2005 WL 375314, at *4 (S.D.N.Y. Feb. 17, 2005).
Enron
The Lead Plaintiff wishes to offer evidence of Andersen's indictment in connection with its role as Enron's auditor. Andersen was indicted on March 14, 2002 and convicted on June 15, 2002 of the crime of obstruction of justice. The Lead Plaintiff argues that Andersen's prosecution is relevant to explain how the fraud at WorldCom was discovered by WorldCom's internal audit department and to explain why KPMG replaced Andersen as WorldCom's auditor in the spring of 2002.
With respect to the issue of how the fraud was uncovered, the parties have offered the following evidence. WorldCom's internal audit department ("Department") decided in 2002 to add a financial statement audit to all of its future work because of,inter alia, the Enron scandal and Andersen's indictment in connection with the investigation of Enron. Specifically, the Audit Committee of the Board of Directors and the Department decided that the Department would pull Andersen's workpapers and do external audit work, even if it meant duplicating Andersen's work, in every internal audit going forward. Meanwhile, Mark Abide, one of the WorldCom internal accountants who had been making fraudulent entries to WorldCom's books decided to stop participating in the fraud and sent the Department an article entitled "Accounting for Anguish." The article described the plight of a former WorldCom employee who asserted that he had been fired because of his strict adherence to ethics. Because of the article, the Department conducted an audit of the company's capital expenditures ahead of schedule, and because of the questions the Department asked during that audit, the WorldCom capital expenditure fraud was uncovered. See In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 642-43 (S.D.N.Y. 2004). It is undisputed that WorldCom retained KPMG to replace Andersen as its auditor because Andersen had been indicted.
This description of the evidence on which the Lead Plaintiff relies may be incomplete because some of the references it makes to supporting exhibits appear to be incorrect.
Andersen argues principally that the fraud was uncovered because of the work that Abide set in motion, and that it is unnecessary to refer to Andersen's criminal problems in describing how the fraud was discovered. With respect to the retention of KPMG, it posits that it would be sufficient simply to inform the jury that KPMG was hired to replace it. Andersen emphasizes that it would by highly prejudiced by any reference to its prosecution.
The Director Defendants, in particular the members of the Audit Committee, have not taken a position on this motion in limine. In order to consider carefully each of the ways in which a party may seek to offer evidence at trial of Andersen's prosecution, the Director Defendants will be given a further opportunity to be heard on this issue.
Until recently, all but one of the Director Defendants expected to be entering a settlement with the Lead Plaintiff prior to trial. See In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2005 WL 335201 (S.D.N.Y. Feb. 14, 2005). Since the collapse of that settlement, the Director Defendants have been working extremely hard to prepare for trial. In these circumstances, it is appropriate to give them another opportunity to be heard on a motion that may have a direct impact on their interests.
Litigation Concerning Andersen
The Lead Plaintiff intends to offer evidence of Andersen's prior legal problems in response to evidence offered by the Underwriter Defendants that they relied on Andersen's comfort letters. Specifically, the Lead Plaintiff seeks to offer evidence that in 1998, Waste Management and Andersen agreed to pay $220 million to settle a shareholder lawsuit; that in January 2001, the Arizona Attorney General filed a lawsuit against Andersen arising from the bankruptcy of the Baptist Foundation of Arizona, in which it charged that Andersen had been a willing participant in a Ponzi scheme that cost retired Baptists several hundred million dollars; and that Andersen had agreed on April 27, 2001 to pay $100 million to settle class action claims brought in 1998 for its work at the Sunbeam Corporation.
Andersen's motion to exclude this evidence is granted. Andersen represents that none of the Andersen employees who will be testifying at trial was involved in the auditing work that led to these lawsuits. The limited probative value of this evidence is substantially outweighed by the burden that the admission of this evidence would place on Andersen to explain the circumstances at issue in these other lawsuits, by the waste of time that would accompany such explanations, and by the danger that admission of this evidence will create unfair prejudice against Andersen. Rule 403, Fed.R.Evid.
Spinning of IPO Shares
The Lead Plaintiff contends that a conflict of interest existed between a lead underwriter and WorldCom, and that the Underwriter Defendants, if they wished to remain underwriters for WorldCom's bond offerings, were required by law to insist that WorldCom disclose that conflict to investors in the registration statements for the two massive bond offerings they underwrote (the "Offerings"). The offerings are the predicates for the Securities Act claims in this lawsuit. The conflict of interest allegations include the spinning of "hot" IPO shares by Salomon Smith Barney ("Salomon") to Bernard J. Ebbers, WorldCom's CEO, and to other WorldCom executives in order to obtain investment banking business, including the opportunity to be the lead underwriter for the Offerings. See In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 392, 404-06 (S.D.N.Y. 2003).
The parties dispute the extent to which the practice of spinning hot IPO shares to Ebbers and other WorldCom executive was publicly disclosed during the class period. In rejecting the Underwriter Defendants' motion for summary judgment, it was determined that the Lead Plaintiff had presented sufficient information to raise questions of fact as to the adequacy of disclosures concerning the conflict of interest issues.WorldCom, 346 F. Supp. 2d at 689-90. "The jury will have to determine whether press reports about such topics as the spinning of IPO shares and bankers' dual roles as analysts and underwriters were sufficient to make it unnecessary to provide further disclosure within the Registration Statement." Id. at 689.
In 1997, the Chairman of the SEC discussed the issue of spinning in a speech that the Underwriter Defendants characterize as generally approving spinning. Later events reflect government disapproval of the practice, although the government investigations of spinning were not reported in the press until well after the May 2001 Offering, which is the second of the two Offerings at issue in this case. For instance, Congress began its investigation into spinning by Salomon in the summer of 2002. New York State's Attorney General filed lawsuits regarding spinning in September 2002.
In their summary judgment papers, the Underwriter Defendants characterized spinning as a "prudent, and entirely proper, business practice, endorsed by the Chairman of the SEC."
The Underwriter Defendants now argue that the legality of spinning is not relevant to the issues to be tried. They contend that the only issue to be decided is whether the spinning of shares to WorldCom executives was adequately disclosed.
Accepting the Underwriter Defendants' implicit representation that they do not intend to offer at trial any defense of the legality of the practice of spinning, it would seem that their motion in limine to preclude the Lead Plaintiff from demonstrating through cross examination of the Underwriter Defendant witnesses that the SEC and the NASD have condemned the practice should be granted. The Lead Plaintiff has a second argument, however, to support its line of cross examination.
The Lead Plaintiff also argues that evidence of the willingness of Salomon to engage in an illegal practice is admissible. A core issue at trial will be whether the facts underlying the conflict of interest allegations should have been disclosed in the registration statements for the Offerings. If a person understood that he or his firm were engaged in an illegal practice, that understanding could help to explain a reluctance to disclose the practice. Therefore, to the extent that the Lead Plaintiff were able to show that a person with knowledge of the spinning and with responsibility for the contents of the registration statements also understood that the practice of spinning was illegal, then the Lead Plaintiff could use this fact to explain why the spinning was not disclosed and to undercut any testimony that the person did not disclose the practice for some other reason, such as a belief that it was immaterial to investors or already adequately disclosed to the public.
The parties have not addressed whether any witness at trial will present such an opportunity for cross examination. If there were such a witness, then it would be necessary to address the Rule 403 arguments presented by the Underwriter Defendants and to analyze the relevance of the motive evidence in the context of a strict liability statute and the due diligence defense that will be actively pursued at trial.
A definitive ruling is also not appropriate at this time for an entirely separate reason. One of the WorldCom directors who benefitted from the spinning of the shares is co-defendant Stiles Kellett, Jr. WorldCom, 294 F. Supp. 2d at 403, 405, 419. Kellett has not weighed in on this motion in limine, for instance by disclosing whether he intends to argue that the spinning of shares was legal. For each of these reasons, decision is reserved. Conclusion
The civil litigation against Ebbers and Scott Sullivan, who also received IPO shares through spinning, is stayed because of their criminal prosecutions. As a result, they will not be participating in the March 17 trial.
Andersen's motion to preclude reference to the Sunbeam, Baptist Foundation, and Waste Management matters is granted. Decision is reserved on the issue of Andersen's prosecution and the legality of the spinning of IPO shares.
SO ORDERED.