Judge Rejects Landmark WorldCom Settlement

The landmark settlement between class action plaintiffs and 10 former WorldCom directors fell apart yesterday after a federal judge rejected a key aspect of the deal. Directors had agreed to pay US$54 million, including $18 million of their own money, to settle the suit.

U.S. District Judge Denise Cote of the Southern District of New York, presiding in Manhattan, ruled that a provision of the agreement was illegal because it would have limited the ability of non-settling parties to reduce the amount they would have to pay if a jury found them liable. Cote said the arrangement violated a portion of the 1995 Private Securities Litigation Reform Act.

“While we respect the decision rendered by Judge Cote today, we are disappointed that it invalidated what was an integral provision in the settlement agreement,” New York Comptroller Alan G. Hevesi, the lead plaintiff in the class-action case, said.

Deal Withdrawn

Following the ruling, he canceled the deal with the 10 former directors. “As a result, we are constrained to terminate the settlement, and we are continuing to prepare for trial against any and all defendants remaining in the case,” he said.

WorldCom filed for bankruptcy in 2002 after revealing accounting fraud. The class-action case was filed by shareholders and bondholders, who lost billions of dollars in the wake of the bankruptcy filing.

Cote’s ruling targeted one provision of the WorldCom settlement. The order did not address the concept of directors paying settlement money from their own resources rather than counting on insurance. That is one point that Hevesi emphasized in a press statement.

“To be clear, the judge did not rule against the personal payments by settling director defendants, and that is not the reason for the termination of the settlement,” he said.

A group of Wall Street investment banks named as defendants in the case, including J.P. .Morgan Chase and Bank of America, asked the judge to reject the settlement because it would have limited their ability to deduct damages attributed by a jury to the settling directors if there were a judgment against them.

Impact on Future Settlements

“The bond underwriters have no objection to the WorldCom directors entering into a lawful settlement with investors,” Jonathan Gasthalter, a spokesman for the banking defendants, said. “However, the plaintiffs wanted to include a judgment reduction formula in the settlement that we believe is clearly unlawful, and we are pleased the judge has agreed with us.”

Securities attorneys are divided about the potentially far-reaching implications of the judge’s decision. Some believe it could make future settlements in which directors pay out of their own pockets harder to reach.

However, Thomas E.L. Dewey, a securities litigator at Dewey Pegno & Kramarsky in New York, told the E-Commerce Times that cases in which the scale of the alleged fraud is so enormous and the liability so significant are rare.

“For a WorldCom or an Enron, the law as applied may make it difficult to cap outside directors’ liability,” Dewey said. “But in the usual securities fraud case, the numbers are not going to be such that this situation is going to arise.”

What happens next is anyone’s guess. Unless another settlement deal isreached, the directors are scheduled to stand trial along with the banks on February 28.

“You would have to think that everyone is going to try and resolve this case rather than put something of this complexity before a jury,” Dewey said. “But you never know.”