The Court Of Public Opinion

In April of 1998 Cendant disclosed a restatement of 1997 results, including a reduction in net income of $ 100 million due to various accounting irregularities. Then on July 14, 1998 Cendant announced a further restatement of financial results for 1995, 1996 and 1997, including all quarters due to recognition of fictitious revenues and cookie cutter reserve mismanagement. At the end of August Cendant filed an SEC report indicating a reduction in operating income of $ 500 million; a reduction in net income before taxes of $ 297 million and the effect on earnings per share. As a result, the market price of the stock decreased from a high of $35. in April to $11. per share in August. Normally a 10% drop in stock price following an adverse announcement is enough to trigger a class action suit within 72 hours. Here the drop was precipitous: 69%.

Fifty lawsuits were filed in the U.S. District Court which were consolidated by the judge with several institutional investors as the Lead Plaintiffs. Hundreds of thousands of documents were produced by Cendant, Ernst & Young and the various defendants. An investment banking firm and a forensic team were retained as expert witnesses. Cendant settled for $2.8 Billion. Ernst & Young settled for $ 335 Million. This settlement was followed by even larger valuations in the cases of WorldCom ($ 6.2 Billion) and Enron ($ 7.1 Billion, pending final court approvals).

Enron directors agreed to settle class action against them for $ 168 million as their proportionate share of the settlement. Insurance covered most of the cost, but left them with terms that required the directors to personally pay $ 13 Million. WorldCom directors had a settlement requiring them to pay their proportionate share, $ 54 Million, leaving them $ 18 million owed on a personal liability basis. The directors in the settlement admitted no wrongdoing.

Backdating Stock Options

The backdating scandal we are currently reading about in the Wall Street Journal may, according to academics, affect up to 3,000 publicly-held companies. Defense attorneys, plaintiff attorneys and expert witness are beginning to mobilize. This potentially massive arena of litigation and expert testimony has occurred because of the practice in the last ten years of publicly-held companies granting stock options to key executives which were in-the-money but not properly recorded as compensation expense, thus violating GAAP, and misstating tax liabilities as well over every quarter since the practice began. In other words, dates were assigned to the options using hindsight that were earlier dates than the actual grant date. The SEC has just begun an investigation into approximately eighty companies, and the list is expanding daily. The DOJ and U.S. Attorney offices are making logistic decisions as to how to allocate predicted case load. Several criminal charges have been filed. At a minimum, companies that are involved will face civil charges by the SEC, massive restatements and therefore the virtual guarantee of class action and derivative suits. The suits have as their basis that the companies in question and their top executives as well as boards of directors have engaged in breaches of fiduciary duty, gross mismanagement, unjust enrichment and violations of the SEC Act of 1934. Back-dated options have allowed the defendants to reap millions of dollars in unlawful windfall profits at the expense of the company. One law firm alone recently filed 34 derivative suits. Its the largest area of civil litigation in history that is beginning to unfold before our very eyes.

Shareholder Derivative Suits

Shareholder derivative suits are increasingly filed in connection with class action suits. A primary concern is that directors and officers will find themselves without coverage for defense costs, awards for plaintiffs attorneys fees and a monetary settlement. Director & Officer insurance policies sometimes exclude payments for non-civil litigation, as where certain types of fraud which involve scienter exist. Even if it does, usually the coverage does not begin until an indictment is brought. Another area that contains elements of peril is that often payments are made on a first-come, first-serve basis. In other words, in the order that claims are filed. This can often lead to a shortage in the case of a settlement.

There is an upward trend in filings of derivative suits, which are filed primarily in state courts, as opposed to class action suits, filed in federal district courts. State courts often permit plaintiffs to recover on non-unanimous verdicts (required in the federal system) and some state laws permit lower standards of findings for recovery purposes. These stand-alone derivative suits are normally for breach of fiduciary duty, proxy violations, excessive compensation and breach of the duty of care or duty of loyalty.

The Business Judgment Rule supports active decisions of the Board of Directors, but it does not cover these breaches. For example, breach of the duty of care does not cover unintelligent decisions, ill-advised actions, or illegal breach of federal laws. Failure to question management representations is another example of this type of breach.

One solution to adequate D & O coverage is a Side A-only policy, which can protect directors and officers from losses not normally indemnified. These policies typically provide coverage even under adverse conditions, including corporate bankruptcy, when the limits of the traditional policy have been exhausted and under cases where the normal policy excludes payments. Some states do not permit corporate indemnification of unsuccessful defense against derivative suits and in these cases as well a Side A-only policy will provide coverage.

The Private Securities Litigation Reform Act of 1995 provided modifications and a safe harbor for corporations in one aspect of derivative suits the forward-looking statement. Tenuous inferences are not permitted in plaintiff pleadings. Allegations must include specificity as to falseness or why the statements made by the company were misleading. Under the safe harbor provisions of the Reform Act, a company is not liable for projections which are inaccurate if such statements are properly identified and accompanied by a cautionary statement which indicates that actual results could differ from projected results, and liability also does not exist if the plaintiff does not prove the forward-looking statement was made with knowledge that it was misleading. Forward-looking statements are often made verbally at analyst conferences, so this provides some measure of assurance to the corporate public relations department. However, as regards the option backdating practice, there is no safe harbor.

Trading Models

The economic basis of these settlements is an area of adversarial tests. In a monograph in the early 1990s, several authors criticized the use of trading models to estimate aggregate damages in class action suits, claiming that the results were not reliable and often overstated damages by as much as 74%. Daubert grounds have been challenged on a variety of proposed models. In Daubert the Supreme Court directed federal courts to consider four factors in evaluating expert testimony under Federal Rule of Evidence 702: (1) the general acceptance of the economic model; (2) potential rate of precision error; (3) peer review or publication; (4) whether the theory has been tested. In finding that various proposed trading models do not meet these standards, the court is concerned about whether the model has been tested and whether the model has been accepted by professional economists.

The Journal of Legal Economics is a good starting point for obtaining solid valuation models. It is a double blind refereed journal. Each manuscript is reviewed by at least three qualified individuals, in addition to the Editor. It was conceived as a forum for contributing authors, both from the profession of lawyers as well as the quantitative professions of accounting, economics and finance, to offer constructive insights to colleagues. It is designed to be a useful research tool for application as well as theory.

In theory, the out-of-pocket loss is the measure of damages in open-market class suits. Therefore a defrauded buyer can recover his share of class members damages, less applicable attorney fees, which can range from 15-30%. However, since this actual trading data is buried in repositories, models have been chosen to produce tangible results. The Private Securities Litigation Reform Act of 1995 leaves it open for the court to select the most reliable method of damages proof that is available. Two-trader models also exist, which assume, probably correctly, that there are passive investors and there are traders. Traders of course have a higher probability of acquiring and selling shares, and thus this model utilizes parameters for damage estimates with the damages estimated using depository record data. One-trader models often significantly overstate damages by 90-98%. Assumptions can therefore lead to bias. Three-trader models also exist which involve high-activity investors, low-activity investors and intraday-traders (who do not utilize overnight positions). Often these traders can account for up to one-third of all trading activity.

Recommendations

One strategy that is sometimes effective is the formation of a special litigation committee (SLC) that has the substance and form of independence. The committee has the responsibility of retaining forensic teams to review thousands of pages of documents and interview hundreds of witnesses. One corporation alone has 2 million documents to review and expects to pay $ 70 Million just to receive a Findings Report. The purpose of the committee is to provide the Court with the business judgment rule confidence to dismiss the derivative action. However, this procedure is not as simple and straightforward as it sounds.

Delaware and other states permit the board of directors to respond to suits by appointing an SLC comprised of independent directors. As long as the SLC is in process, the derivative suit is stayed. However, in the adversarial process that is underway continues, motions are often filed that question the true objectivity of the SLC. Delaware courts often slam the door to the SLC by ruling against them and letting the suit proceed. If the SLC members have significant social ties to the defendants in terms of past or future relationships that is one disqualification. Another is a public statement by the head of an SLC at any time prior to the issuance of the report that illustrates bias. It is hard to believe this would occur but in specific cases it has and it has destroyed the companys defenses from the beginning.

Directors often share institutional and social connections based on board service. This makes it particularly difficult to find objective third parties. Warren Buffet explained it this way: Why have intelligent and decent directors failed so miserably? The answer lies not in inadequate laws its always been clear that directors are obligated to represent the interests of shareholders but rather in what Id call boardroom atmosphere. Board membership requests are being declined in record numbers due to the perception of risk of being a director in this environment. However, corporate governance provisions are being taken much more seriously and since Sarbanes-Oxley mandates them, these recent revelations almost guarantee its place in history.

BACKDATING STOCK OPTIONS: CORPORATE REMEDIATION

As of August 17th the Wall Street Journal posted a study of 87 companies that have initiated probes, announced restatements, had executive resignations or Department of Justice inquiries into their stock options practices. The SEC has filed civil charges against executives of public companies, alleging that they engaged in a decade-long fraudulent scheme to grant undisclosed, in-the-money options to themselves and to others by backdating stock option grants to coincide with historically low closing prices of their stock. These complaints have alleged that former executives collectively realized millions of dollars of ill-gotten compensation through the exercise of illegally backdated option grants and the subsequent sale of related common stock.

In a separate matter, U.S. Attorneys Offices have unsealed criminal complaints charging executives with conspiracy to violate the antifraud provisions of the federal securities laws, wire fraud and mail fraud. It has been alleged that backdated option grants and secret option slush funds were deceits of the highest order upon shareholders. Executives, according to the SEC, have repeatedly used hindsight to select dates when the closing price of their common stock was at or near a quarterly or annual low. The complaints further allege that under well-settled accounting principles, in effect at the time, companies that granted in-the-money options were required to record a corresponding compensation expense and disclose such amounts in filings with the Commission. The executives have also been charged with violations of the Sarbanes-Oxley officer certification provisions of the federal securities laws. Injunctive relief, civil penalties, disgorgement, with prejudgment interest, and officer and director bars against each of the defendants has been requested.

HOW THE BACKDATING OCCURRED

It is helpful to review how the practices originated in order that remediation of ones own internal control policies can effectively take place. The executives directed and controlled the option grant process and initiated the backdating schemes. Among other things, they specifically selected the backdated grant dates by interfacing with the Compensation Committee. Grant documents with false grant dates were approved by the Compensation Committee. Unscheduled grants were the modus operandi. A spreadsheet contained lists of proposed grantees. At some point, the executives cherry-picked the grant date by looking back at their historical stock prices and, with the benefit of hindsight, chose a grant date that corresponded to a date on which the common stock was trading at a relative low. The master list was then submitted to the Compensation Committee for approval.

Unanimous written consent forms pertaining to the proposed grant were sent to Compensation Committee members for signature. It was known among the executives that these dates were the low-ball look-back dates they had previously chosen. Compensation Committee members were generally not aware of an impending grant prior to receiving the master list. The Committee members then signed, but did not date their copies of the consents and returned them. Based upon their involvement in the option grant process, each of the defendants knew, or were reckless in not knowing, that the unanimous written consents were false because the as of dates that were inserted into the consents and reflected in the companys books and records did not represent the true grant dates.

The executives knew that no corporate action to approve the options grants had actually occurred on the as of date. They knew this because they were the ones who had picked the grant dates by use of the look-back tables, with the benefit of hindsight. They had examined historical trading prices and selected a date with a low trading price. Options with backdated dates in effect also accelerated the vesting schedule because the Company used the backdated date for vesting purposes, not the date of the actual Compensation Committee approval. A large number of grants were grants at or near the lowest price for the fiscal quarter or year. In an article published by the Wall Street Journal, the patterns of stock options grants were analyzed and astronomically high odds, some approaching one is six billion, were determined to exist that such grants would have fallen on dates just ahead of sharp gains in the related corporate stock price by chance.

The secret backdating schemes allowed the defendants to disguise the fact that the Company was paying higher compensation to executives and employees by awarding them in-the-money options, and to avoid having to expense the in-the-money options as compensation expense, thus avoiding reductions to the companys net income and EPS. In addition, certain large institutional investors have long been opposed to stock option plans that allowed grants of options at below the fair market value of the underlying stock at the time of the grant. This is the basis for the tens of billions of dollars of derivative suits filed in recent weeks against related corporations by law firms on behalf of large institutional investors.

The California Public Employees Retirement System (CalPERS) is the largest U.S. public pension fund, with over $ 200 Billion in total assets. They have recently written an open letter to the Chairs of the Compensation Committees of a number of portfolio companies related to inquiries on employee stock option backdating practices. Their letter contains implications of allegations, including lack of oversight by the Board of Directors, weak internal controls, weak internal and external audit practices, poor accounting, significant income tax consequences for persons implicated for backdating options, and problems with the Executive Compensation Plan Administrator.

Senator Chuck Grassley of Iowa, Chairman of the U.S. Senate Committee on Finance, has publicly stated: Its one thing for an executive to make big profits because hes improved his company, but its a whole different thing to make big profits because hes playing fast and loose with the dating of stock options. Outside the corporate suite, Americans dont get to pick and choose their dream stock price. The market dictates the price.

The CFA Institute recently published an open letter to the SEC stating In the case of Post-Dating, senior executives (and possibly directors) used inside information or post-closing market prices to determine when to retroactively set the effective date of share-based awards in order to enhance the return of such awards. This practice also appears to have involved falsified accounting, may circumvent financial reporting requirements for variable option grants, may conflict with governance requirements related to the pricing of stock options, and may ultimately lead to criminal and tax penalties against companies engaged in these activities, thereby harming shareowner value even more.

REMEDIATION

In the real world, the best stance is one of pro-active remediation before any investigation by third parties begins. Materiality thresholds need to be considered according to SEC Bulletin No. 99 and Sarbanes-Oxley thresholds. If the materiality threshold is not breached, then no restatements will occur. If a restatement occurs, it almost guarantees an SEC investigation and also a finding of a Material Weakness by ones third-party auditors. Material Weakness findings can cause the loss of significant blocks of market capitalization upon disclosure.

The problems are not restricted to Information Technology companies. Their excess returns in the studies performed by the academics at the University of Iowa and others were what caught initial attention to the issue, but the scope is beyond IT companies. It is estimated that close to 3,000 companies are involved. In many of these cases undoubtedly management has retained its integrity, and the element of scienter does not exist. The rest of the public companies need to study and research adequate Sarbanes procedures to assure they are not affected in the future. The initial studies of proxy statements for statistics on options before the implementation of Sarbanes Oxley changed the reporting requirements to 2 trading days following August of 2002 indicated the problem existed as early as 1996 with the majority of companies. Grant patterns on excess return post-option pricing began largely in the mid-1990s. One company alone has close to two million documents that need to be examined to determine the extent of the backdating issues. I understand investigative, forensic and related professional costs in this one case alone are targeted and budgeted for $70 Million dollars. This does not include defense or settlement costs for related class-action and derivative lawsuits.

Without going into specific detail what is referred to as the Tone at the Top must be re-established at Compensation Committees throughout the world today. Directors and particularly Audit Committee and Compensation Committee members need to be re-educated as to governance requirements that comply with both the spirit and letter of the law. Compensation programs should not be driven by competitive surveys but by superior performance over the long-term. Full disclosure is necessary in proxy statements. Independent directors are a major necessity. Experts have to be added to Compensation Committees. If they are not there, then third parties must be hired who are expert consultants. Issues of Incentive Compensation, Dilution, Performance Options and Structures, Repricing, and a variety of tax and governance issues have to be addressed. Steps have to be taken to ensure that Board and Committee evaluations of compensation are equitable and it would be advised to refrain from using company resources to satisfy legal and tax liabilities for executives who are implicated in wrongdoing. This could lead to further derivative suits. Independent detailed investigations on a case-by-case basis with strong Board of Director backing need to be undertaken. The implications of Sarbanes need to be fully understood and addressed. Lying to auditors is now a federal offense. Insider manipulation is now not being tolerated by the market, nor by enforcement authorities who have oversight. Justice officials have made it clear that executives can face possible prison time for backdating stock options. Serious change and corporate governance must now follow.

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When you talk about the health risks caused by asbestos, mesothelioma is at the top of the list. It is a sad story with a very unhappy ending.

A Quick Guide to Mesothelioma

Beginning in 1926, various studies started revealing that the wide spread use of asbestos for its fire resistant properties might not be such a good thing. The problem? Dust from asbestos materials was easily ingested into the lungs, but was nearly impossible for the body to expel. This resulted in a host of health problems of which Mesothelioma undoubtedly is the worst.

Mesothelioma is a nasty form of cancer. It is almost always caused by exposure to asbestos dust. This primarily occurs when a person has worked directly with or around asbestos materials. For example, a person who works on older buildings with asbestos materials or a person in the ship building industry to mention only a few. The disease can also impact secondary individuals who come in contact with such people, particular said peoples clothes.

On the medical side of things, Mesothelioma is a cancer that attacks the mesothelium. This anatomical term refers to the lining found around most organs of the body including the lungs and chest cavity. The cancer can also attack the sack encompassing the heart as well as other areas of the body. In short, it is a devastating form of cancer.

The truly horrific thing about Mesothelioma is the fact it takes a long time to appear. Gestation periods can be from twenty to fifty years. Even when it begins to show symptoms, it is very difficult to diagnose because it shares many symptoms common to aging and other health issues. These can include chest pain, coughing, shortness of breath, wheezing and blood clotting.

Unfortunately, Mesothelioma is deadly once it fully presents. A variety of treatment methods have been tried, but nothing has worked. The average person presenting with the cancer has a life span of less than a year. Radiation, surgery and pharmaceutical approaches have failed to significantly extend this time.

Mesothelioma is terminal cancer caused by exposure to asbestos dust that takes a long time to manifest, but a short time to kill.

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For many people, the court system might as well be a maze. When it comes to a business dispute over a contract, the court system works in a particular manner.

What Courts Hear Contract Disputes?

The court system in the United States actually makes a lot of logical sense if you understand the terminology used. Well, if you are an attorney. The system is broken down by subject matter and then categorized by objective issues like the amount of damages being claimed. Common court branches include criminal, civil and family law divisions to mention just a few.

What court hears business contract disputes? Contract issues are covered under a set of laws known as civil law. If you have been in a lawsuit, you know it is rarely civil! The term, instead, refers to the matter being monetary in nature. At its root, the dispute has money at issue. Contract disputes fall within the business law and civil court jurisdiction. Ah, but there is more.

While civil courts hear contract disputes, the specific court is determined by the amount of money at issue. The exact amounts differ by state, but generally there are three levels. Small claims civil courts decide matters under $5,000 or so and you are not allowed to use an attorney. These are the disputes you see on television. Municipal civil courts usually hear contract disputes that have monetary values above small claims levels but below $25,000. If the claim involves an amount over $25,000, then it is heard in superior court.

Before heading off to court, it is important that you first read the contract in question very closely. Most contracts these days contain arbitration clauses. Arbitration is an effort to resolve things without taking up the time and resources of the court system. If you have such a clause, the parties typically agree to have a retired judge here the dispute and render a judgment in favor of one party.

Business contract disputes happen each and every day. Civil courts are usually going to handle them, but make sure you to check for arbitration clauses.

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As you hear and see over and over in the media, there are a lot of bizarre lawsuits filed in our country. So, what are the options when dealing with frivolous lawsuits?

Your Options with Frivolous Lawsuits

When talking about frivolous lawsuits, it is important to understand a few things first. Simply put, the question of what is frivolous is not as easy to answer as it may seem at first glance. We have all heard about the judgment against McDonalds for three million dollars for serving coffee that was to hot. In that case, however, the lawsuit was not frivolous per se. Instead, it was the judgment returned by the jury that was frivolous and way out of line.

In our justice system, practically anyone can file a lawsuit as long as they have the money to do so. It costs a couple hundred dollars depending on the location. In filing such a lawsuit, the person makes various claims against the defendant. If the claims are so outlandish as to be considered frivolous, the court does not deem them illegal. Lawsuits are a matter of civil law, not criminal law. In short, a civil lawsuit decides fault, not whether something is illegal.

While a judge will not rule a frivolous lawsuit to be illegal, he or she can take another step. As the case proceeds, the defendant can file a motion called a summary judgment. In that motion, the defendant argues that even if all the facts supported by the evidence offered by the plaintiff are presumed to be true, the defendant still has done nothing wrong. If the judge agrees, the lawsuit is over. Depending upon the state, the judge may also be able to award costs and fees to the defendant. The defendant, however, has another bullet in his arsenal.

Upon successfully defending a claim, a defendant has the option to file a malicious prosecution lawsuit. These are sometimes called slap lawsuits in certain states. In such a lawsuit, the defendant argues that the plaintiff filed a frivolous lawsuit for the pure purpose of harassing or causing the defendant to spend money on attorney fees. If the defendant is successful in bringing the claim, he or she can often recover the fees spent on an attorney and other damages dependent upon the relevant state law.

Frivolous lawsuits are a fact of life in our modern society. A determined defendant in a civil lawsuit, however, has the ability to turn around and come back at the plaintiff for filing them.

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1. Lawsuits seek to compensate you for your injuries.

a. They compensate you for:
i. Your lost wages, and your future lost wages,
ii. Your medical expenses, both past and future, and
iii. Your pain and the suffering it caused in the past, and for the future

2. Lawsuits do not directly seek to harm anyones reputation.

3. A doctor who is sued will not lose their medical license if the lawsuit is successful.

4. A lawsuit attempts to compensate the injured victim, and at the same time, try to ensure that the same type of bad treatment is not repeated in another patient.

5. A lawsuit is not a lottery.

a. This phrase is often used by defense attorneys during jury selection to remind jurors that their job is not simply to allow the injured victim to hit it big and award huge amounts of unjustified money.

b. A more realistic approach to a lawsuit is for reasonable, full and fair compensation to allow you to recover all of your past and future expenses, and all of your past and future pain and suffering compensation.

6. You dont have to pay any money upfront to an attorney to handle your case. There is no hourly fee.

a. Medical Malpractice and injury cases are generally handled on contingency.

b. That means that the attorney fee depends upon you winning your case. If you lose, the attorney loses as well, and receives no fee.

c. The expenses that the attorney pays to prosecute your case are technically supposed to be repaid by the client in the event the case is lost. However, as a personal matter, I have never asked a client to reimburse me for my expenses if I lose a case. It just doesnt make sense to do so, and in my personal opinion, its bad business. However, some attorneys do require this, so make sure you ask first before you make your decision.

7. Not every attorney has the same experience.

a. Ask your attorney how many years theyve been in practice,

b. Ask the attorney what percentage of medical malpractice or accident cases he handles compared to other types of cases,

c. Ask whether he/she tries cases in the Supreme Court (its the trial level court for New York,

d. Ask whether hes ever lost a case;

i. If he tries cases, and claims hes never lost a caseId suggest either that the attorney is not being accurate, or simply only accepts clear-cut cases that he cannot lose- thats extremely rare.

ii. The majority of trial attorneys will have lost a case from time to time. Unfortunately, its the nature of the beast.

e. Ask whether the attorney you meet with will be the one handling your case on a day to day basis. If not, who will be your attorney? Whom will you call with questions? How quickly will the attorney call me back? How often can you expect to receive correspondence from the attorney about the status of your case?

8. A lawsuit takes time to come to a conclusion.

a. The average time is 2-3 years from start to finish.

9. How often do I have to come into the attorneys office during this time?

a. Once to meet the attorney in an initial meeting,

b. Once to sign documents that start your lawsuit (often this can be done by mail),

c. Once to have your deposition (where you are asked questions by the other sides attorney),

d. At least once to prepare you for trial, and sometimes two or three additional times to prepare you.

10. As in life, there are no guarantees to winning. However, with good experienced counsel and thorough preparation, you stand a much better chance of being fully informed about your prospects and achieving a good result.

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No one can deny that there are more than enough lawyers in the world choking our nation’s economic engine and industrial capacity. The efficiencies of all sectors of our financial markets are burdened from a nation which is over lawyered, where lawsuits are more common that rat births. Each year thousands of lawyers are accepted into the bar and released into the wild to do their damages on our economic vitality.

But I have some good news and it does not involve saving a bunch of money on my car insurance by switching to Gieko. In fact I am grateful to alert you to the fact that lawyers are on their way out. They will soon be replaced by Holographic Images and robotic humanoids to help you with your case, which is fitting indeed, as many say that lawyers have no souls in fact there is no empirical evidence ever presented in any court of law in the 200-years of United States History showing that they are human at all?

Whether the rumors and stories about Lawyers having no soul are correct or not is immaterial because soon such Holographic Technologies will become a virtual or augmented reality and Lawyers will no longer be needed at all. Now then how do we get rid of the Politicians? Think on this.

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