Originally published in: Pensions and Investments
Issue Date: May 17, 2004
By Keith L. Johnson and Ken McNeil
Investors are being ill-served by the legal system when it comes to addressing corporate fraud. Hundreds of class-action lawsuits are filed each year, but recoveries come slow and are a fraction of what was lost. Many investors are not even claiming their share of the lawsuit recoveries.
A record $5 billion was committed last year by defendants to payment of securities class-action settlements, up from $3.1 billion in 2002, according to Securities Class Action Services. Yet, at least two-thirds of institutional investors fail to even file claims, despite the fiduciary duty to do so, according to a recent Washington University Law Quarterly study. Securities Class Action Services estimates $2 billion was left on the table by those institutions since 2001.
When public pension funds have led securities class actions in the last two years, settlements averaged more than $87 million, while the average recovery in other cases was only $13 million. Still, the median across-the-board recovery is still less than 5% of damages.
Recent cases led by institutional investors also have obtained corporate governance reforms and payments from defendants from personal assets, both of which should deter future frauds.
Research suggests that plaintiffs fare considerably better in jury trials than settlements.
Despite these accomplishments, “securities class actions rarely, if ever, go to trial,” according to an American Bar Association study, which noted some 2% of civil cases went to trial in 2002, down from 11% in 1962. Professor Samuel Gross of the University of Michigan Law School noted civil trial procedures are “way too expensive, if actually employed.”
Most investment professionals have been unwilling to voluntarily participate in the legal system to recover losses in corporate fraud, even when they have a fiduciary duty to file claims and when some public pension funds have demonstrated that active client involvement substantially improves the result. They seem to view the securities litigation system as inefficient, ineffective, expensive, slow and frustrating — a sign it is not functioning appropriately.
Alternative models for the conduct of securities litigation are beginning to evolve that eliminate many of the deficiencies keeping sophisticated investors from participating. One such model grew out of the Anicom Inc. case, a securities fraud class action in Chicago that involved a classic accounting misrepresentation fraud and subsequent company liquidation in bankruptcy.
The Anicom litigation started out in the usual manner. After a financial restatement in 2000, a shareholder class action was filed, the company went into bankruptcy, and secured lenders began grabbing all the assets they could claim.
At this point, the usual protracted and expensive shoving match among the shareholders, bank lenders and unsecured creditors did not occur. Instead, the three plaintiff groups worked out a new approach to litigation. The Anicom model differs from the traditional approach to securities class action litigation by emphasizing:
- a litigation strategy to get the case to trial as quickly as possible, while spending as little time and effort as possible on pre-trial motions;
- immediate investigative work to capture as much evidence as possible without relying primarily on document discovery and depositions that occur late in the litigation process;
- cooperation among law enforcement authorities, shareholders, creditors and other investors seeking remedies for damages caused by the fraud; and
- aggressive efforts to recover assets from culpable third parties and personal assets of corporate officers and directors involved in the fraud.
The State of Wisconsin Investment Board was Anicom’s largest shareholder and saw its entire $23 million investment in the company evaporate after discovery of the fraud. SWIB filed to be named lead plaintiff in the ensuing litigation and was appointed to head up the shareholder case. SWIB engaged in a competitive lead-counsel selection process, winding up selecting Susman Godfrey LLP.
SWIB negotiated a contingency fee for the lead counsel, aimed at aligning the interests of class members and their counsel. To encourage aggressive pursuit of recoveries from the company’s auditors and from personal assets of wealthy directors and officers that engaged in egregious conduct, SWIB built in a 5% fee bonus for money obtained from sources other than the company and its directors’ and officers’ insurance carrier. SWIB also approved a litigation plan that was specifically designed to get the case to trial as quickly as possible, without wasting time on taking long and duplicative depositions, engaging in unnecessary discovery fights and filing motions designed more to position the case for settlement than for trial.
When confronted with an attempt by the company’s bankruptcy creditors to delay the shareholders’ case so the creditors could gain priority access to the directors’ and officers’ insurance policy proceeds, SWIB persuaded the creditors they would be better off joining the shareholders’ aggressive strategy rather than fighting it.
A joint prosecution agreement was negotiated among the bank lenders, unsecured creditors and shareholders to combine all of their claims and pursue them together, splitting the proceeds in accordance with a formula that reflected the value of each party’s claims. The creditors decided to jointly retain the shareholders’ lead counsel under the fee schedule negotiated by SWIB.
This innovative approach allowed the cooperating parties to reduce their individual costs of litigation through the sharing agreement, gave them increased leverage with the defendants, streamlined the process for getting all of the claims to trial, and avoided diminution of the defendants’ assets and increase of the plaintiffs’ costs from prolonged fights between the shareholders and creditors.
The plaintiffs also communicated with law enforcement agencies investigating the situation. Within the bounds imposed by confidentiality and protective orders and other considerations, the civil case and law enforcement cases were able to coordinate their efforts. This avoided the situation that arises in some cases, where the civil case is stayed pending completion of criminal proceedings or criminal prosecutions provide the insurer with grounds to avoid payments under the directors’ and officers’ policy. Criminal charges were eventually filed against six former Anicom officials, including two former CEOs, Carl Putnam and Scott Anixter. Mr. Putnam, Ron Bandyk, Darryl Spinnell, and Renee Levault pleaded guilty to the federal criminal charges. Don Welchko and Mr. Anixter, both of whom pleaded not guilty, have not yet gone to trial.
In addition, the Anicom case resulted in a series of settlements, first with the company’s former auditors, PricewaterhouseCoopers, and then with the individual defendants and their insurer, shortly before trial was scheduled to begin. PwC paid the plaintiffs $21.5 million, called one of the largest settlements paid by that audit firm in a securities action. Former Anicom Chairman Alan Anixter, who was not indicted, and CEO Scott Anixter, both without admitting any liability, paid $12.4 million of their personal assets, and the insurance company paid $5.6 million. (Alan Anixter is the father of Scott Anixter.) Other claims are still being collected from some creditors in the bankruptcy court and will be shared among the plaintiffs under the joint prosecution agreement.
The plaintiff groups made out far better than they would have without using a cooperative approach. All in, the shareholders’ recovery is expected to constitute from about 28% of the plaintiffs’ estimate of damages to 110% of the defendants’ estimate of plaintiffs’ damages on a pre-fee basis, in a situation where the company went into bankruptcy and was liquidated. This compares with the median recovery of less than 5% in securities class actions. In addition, fees paid by the shareholders were cut to 22.5% of the pre-fee recovery, significantly less than the 32% median for similar cases.
The client-centered approach used in the Anicom case provides a new model that demonstrates how the securities class action process can be made more effective and efficient. The following client goals were achieved:
- Recoveries were substantially enhanced and costs of litigation were reduced.
- Through cooperation with other plaintiff groups, the case was moved to trial as quickly as possible, increasing settlement pressure on the defendants.
- Deterrence of future fraud was maximized through recovery of personal assets from corporate officers and substantial contributions from the company’s former auditors.
- Criminal charges were brought against those alleged responsible for the fraud and convictions were obtained.
Greater focus on alternative models for recovery of losses to corporate fraud, like the Anicom model, could help bring more institutional investors into the process and improve the functioning of both our capital markets and legal system. Lead plaintiffs, lead counsel and courts involved in other securities class actions would be well-served to consider approaches like those used by the plaintiffs in Anicom. What the Anicom model makes clear is that parties can maximize recoveries and deterrence of future fraud when the plaintiffs focus on: l) client control and participation; 2) cooperation between plaintiff groups; and 3) getting to trial quickly.
Keith L. Johnson is chief legal counsel of the State of Wisconsin Investment Board, Madison, and Ken McNeil is a partner in the Houston office of Susman Godfrey LLP. The views expressed in this article are those of the authors and should not be attributed to SWIB.