Archives For securities litigation

The New York Post is reporting (see here) that a law firm is trying to put together a class action of those who purchased shares in Vonage’s IPO through its directed share program.  As discussed here and here, the marketing of the program ran afoul of some technical SEC requirements.

See here! Skilling was found guilty of 19 counts (incl. conspiracy, fraud, false statements and insider trading). Lay was found guilty on 6 counts (fraud and conspiracy).

I imagine both men will make model prisoners, although Lay might be the better prisoner, since he is very good at closing his eyes to bad things and ignoring signs of trouble. (We are talking about potentially *decades* in jail, as we all know. I will be curious to see how that plays out. For the record, I do not think inmate attire is fitted for cuff-links, such that Lay might want to leave his trademark ‘links at home. Or perhaps he will pawn them to pay for his appeals. . .or fines of some sort . . . or recompense to his investors. . . .)

John Hueston, the prosecutor, made a statement a short while ago in which he said two things in particular that caught my attention:

1. He said something about the verdict proving that a CEO cannot just *not* ask questions. (Forgive the double negative, but one of the compelling points for the jury, in the prosecutor’s eyes, was that Lay failed, in part, by not pushing for information – not asking questions – ignoring the red flag information that was right in his lap – not acting in good faith! See here and here for my “Not in Good Faith” manifesto. Who would have thought that the same sort of the fundamental failings that trouble me about director behavior would translate so well (relatively speaking) to the criminal context when dealing with officers?)

2. In addition, Mr. Hueston emphasized that it is no longer acceptable to hide behind lawyers and accountants. I sure *hope* so! I wonder how long it will be before we have multiple sets of outside lawyers and accountants reviewing financials to ensure that nobody is hiding behind anyone. I see this as akin to when Boards started demanding their own counsel, apart from the GC and apart from the outside corporate counsel. I, for one, would be DELIGHTED if multiple layers of accounting and legal review turn out to be a short-term impact of today’s verdict. Even if the costs are duplicative and significant, those costs are still LESS than the cost to investors of another Enron-esque catastrophe.

As you’ve probably heard, Vonage’s IPO was a flop. It closed down 12.6% from its IPO price of $17. This represented the weakest first day performance of an IPO in nearly two years. It also greatly magnifies the apparent technical violations of the Securities Act I blogged about yesterday (see here). As Voange disclosed in its prospectus, it failed to comply with Rule 433 for its email blast and Rule 134 for its voicemail blast, and as a result these “could be determined to be . . . illegal offer[s] in violation of Section 5 of the Securities Act, in which case recipients could seek to recover damages or seek to require us to repurchase their shares at the IPO price.�

For Vonage, the best “defenseâ€? to any claimed violation would have been a nice first day pop followed by the stock staying above its IPO price until the one year statute of limitations ran. In such an event, there would have been no economic motivation for any investor to bring a lawsuit. Alas, that didn’t happen. If Vonage gets sued, it’s prospectus indicates it will rely on an “insignificant deviationâ€? defense. Per its prospectus: Continue Reading…

You might have noticed that the current Bausch & Lomb product recall is on my list of things to blog about. Let us start in on it:

As you likely know, Bausch & Lomb announced a worldwide recall yesterday of its MoistureLoc product. This recall comes about a month after B&L disclosed concerns about and discussions with the FDA regarding a rare eye infection (Fusarium keratitis) that had cropped up among some number of MoistureLoc users (and users of other products, made by other companies, it is worth noting). At that point, in April, B&L suspended sales in the US of its MoistureLoc product.

The CEO of B&L told us yesterday that investigations have shown that there had been no contamination or tampering with the MoistureLoc product, which leads B&L to deduce that “some aspect of the MoistureLoc formula may be increasing the relative risk of Fusarium infection in unusual circumstances.” To be safe, B&L is recalling the product, while B&L continues to investigate the link between the infection and MoistureLoc.

Three things are interesting to me:

1. The wires tell us that the FDA just released a report chastising B&L for not reporting in a timely fashion 35 cases of eye infections reported by its MoistureLoc users in Singapore and for not notifying the FDA immediately when B&L withdrew its product from the Singapore market in February (well before B&L pulled the product in the US). (I could not get my hands on the FDA report, hence my introduction “the wires tell us.�)

2. The MoistureLoc solution has apparently been used since late 2004. In December of 2005, a class-action suit was filed against B&L by a woman who claimed that she suffered an eye infection as a result of using B&L’s solution, and the infection ultimately required her to get a corneal transplant.

3. The RiteAid and Target directors have not yet responded to a fax (or e-mail) I sent to them last month, asking whether I should stop using their generic eye care products (in the event that their products were made by B&L and/or Alcon).

Allow me to expand on these three things: Points two and three above are interesting to me because they would make good facts for an exam question. Specifically, I view B&L’s disclosure failures and the fact that B&L was on notice of potential problems months ago as raising fun securities fraud and director liability (for good faith failures) issues.

On the issue of securities fraud, B&L appears to have been holding off on filing 10Qs and 10Ks for months. Initially, the reason given was unrelated to the MoistureLoc eye infection issues. My question is “at what point did B&L know enough about the eye infection potential that it became material disclosure that *had* to be made, such that the failure to make the disclosure while making *other* disclosure constituted securities fraud?�

Remember the balancing test from Basic v. Levinson – essentially balance the contingency against the impact it would likely have if it came to pass? It seems to me that (a) getting sued by a bunch of folks who have serious eye problems (including blindness- God forbid), (b) having to pull a relatively significant product, and (c) losing consumer confidence in other unrelated products are all things that I would peg as “material enough� (for lack of a better phrase) under Basic to merit disclosure sooner rather than later. I understand that making disclosure sooner rather than later raises the risk of alienating investors if it later turns out that the fungal infection issue is a non-starter. But we are talking about eyes here, people; not toenail fungus infections.

On the director liability front, I would love to know how much the B&L directors knew about the potential MoistureLoc concerns and when they knew it. I see this as a policy sort of exam question – “if you are called by your friend Sue, a director for Generic Eye Care Inc., and she tells you that the COO of Generic mentioned something while on the links with her about a class action suit related to eye infections but the COO said this sort of litigation was de rigeur in the medical products world, and Sue asks you if she needs to raise a red flag with her fellow directors, what do you tell her? Remember that the modern board is a ‘monitoring board,’ at best.�

With respect to point three above, I faxed (or e-mailed) letters to the Boards of Directors of both Target and Rite-Aid back in April when I heard about B&L’s product recall, asking whether either of their private label eye solutions (which I use) were actually B&L products about which I should be concerned. I also asked in the letter what I should do, in terms of using the products and/or getting my eyes examined.

In a *shocking* turn of events, I have not yet heard back from even a single director.

Option backdating was on page one of the W$J again yesterday (here). The story was spurred by comments made by UnitedHealth’s CEO, William W. McGuire, during UnitedHealth’s First Quarter 2006 Results Teleconference on Tuesday. UnitedHealth’s option grants to Dr. McGuire were among those cited as suspicious by a March 18 page one W$J (article here; earlier blog post here).

The Journal’s analysis raises questions about one of the most lucrative stock-option grants ever. On Oct. 13, 1999, William W. McGuire, CEO of giant insurer UnitedHealth Group Inc., got an enormous grant in three parts that — after adjustment for later stock splits — came to 14.6 million options. So far, he has exercised about 5% of them, for a profit of about $39 million. As of late February he had 13.87 million unexercised options left from the October 1999 tranche. His profit on those, if he exercised them today, would be about $717 million more.

The 1999 grant was dated the very day UnitedHealth stock hit its low for the year. Grants to Dr. McGuire in 1997 and 2000 were also dated on the day with those years’ single lowest closing price. A grant in 2001 came near the bottom of a sharp stock dip. In all, the odds of such a favorable pattern occurring by chance would be one in 200 million or greater. Odds such as those are “astronomical,” said David Yermack, an associate professor of finance at New York University, who reviewed the Journal’s methodology and has studied options-timing issues.

Dr. McGuire addressed the issue during Tuesday’s teleconference (click here for the transcript). Among other things, he recommended that that UnitedHealth: Continue Reading…

In today’s W$J, Holman Jenkins stands up for short-sellers, and rightly so. Those folks have taken a bit of a beating lately. They’ve been sued by companies like Biovail and Overstock.com and trashed on talk shows like CBS’s 60 Minutes.

[NOTE: I originally linked to the 60 Minutes segment, but I just realized that the segment includes a warning that unauthorized Internet display is prohibited. The segment is available on Overstock’s website here. Just scroll down to the event on March 26, 2006 — “Biovail Story on CBS’s 60 Minutes.”]

Attacks on short-sellers are nothing new. Those investors — who borrow the stock of companies they believe is overvalued, sell it, and then repurchase it (hopefully at a lower price) before the date by which it must be returned — make their money by betting against companies. This, many believe, is evil. Indeed, Malaysian law deemed short-selling to be grounds for caning (yes, getting smacked with a cane) until just two weeks ago!

Those who reflexively jump on short-sellers for, as Jenkins puts it, “push[ing] down stocks owned by widows, orphans, and other helpless shareholders” assume that higher stock prices must always be better for investors than lower ones. Tell that to the folks who bought Enron at $90/share. They certainly wish there had been more shorting of Enron stock.

In addition to the “investor reliance” losses occasioned by overvaluation, such mispricing can lead to destruction of significant corporate value. Harvard Business School Professor Michael Jensen has recently explained why this is so in his fantastic paper Agency Costs of Overvalued Equity. Jensen shows that a higher stock price is not always better for investors. Indeed, a high but unjustified price can be downright bad for holders of a stock.

Short-sellers play a crucial role in sniffing out those stocks that are priced higher than they ought to be and helping to bring their prices down. In theory, corporate managers and professional stock analysts would take steps to correct overvaluation, but there are good reasons to believe that neither group is up to the task. (For why this is so, see below the fold.) Continue Reading…

An article in today’s W$J reports on former Qwest CEO Joseph Nacchio’s planned defense in a criminal insider trading action brought by the SEC. The defense is perplexing.

The SEC has accused Nacchio of selling $101 million of Qwest stock while in possession of inside information that the firm wasn’t doing as well as its public statements would suggest. The Journal reports that

Mr. Nacchio’s attorneys have said in court that his defense will rest partly on a claim that he expected the company to do well despite its difficulties because he had secret information about classified, national security-related contracts he believed Qwest would win.

Come again? Is Nacchio claiming that it was OK for him to sell while in possession of material non-public bad news regarding company prospects because he also possessed material non-public good news? Is this a “two wrongs make a right” theory? Or is Nacchio saying that he shouldn’t be liable because he was really attempting to (irrationally?) hurt himself by selling while in possession of material non-public good news? The defense is odd.

In an attempt to figure out what Nacchio’s strategy is, I took a look at some recent filings in the case. In a document filed on January 18, Nacchio’s lawyers state:

The “material” information Mr. Nacchio is alleged to have possessed at the time of the stock sales in question (January 2 – May 29, 2001) related to the company’s ability to achieve its quarterly earnings targets. Thus, in order to prove the charged offense of insider trading, the government must prove not just that securities fraud was taking place at the company in the release of misleading financial information to the public, but that it was taking place with Mr. Nacchio’s knowledge prior to his sales of Qwest stock. This alleged inside information must be “material.”

Based on this statement (which is itself perplexing), I surmise that Nacchio’s defense (or this part of it, at least) is that two “wrongs” do make a right because the second piece of non-public information to which Nacchio was privy when he traded (i.e., the likelihood of the lucrative defense contracts) would make the first piece (i.e., various bits of bad news at the company) immaterial. In other words, the theory seems to be that the totality of non-public information of which Nacchio was aware would not be something a rational investor would consider important in deciding how to invest (and thus would not be material), for Nacchio’s private negative information was counterbalanced by private positive information.

Interesting. We’ll see where it goes. (I’m not optimistic for Nacchio.)

If anyone has other theories regarding Nacchio’s planned defense or knows of any decisions evaluating this “two wrongs” theory, please let us know.