The opinion of the court was delivered by: DENISE COTE, District Judge[fn*] [fn*] This Corrected Opinion corrects a misstatement in Footnote 14; the word "only" in the original has been changed to "not."
On January 6, 2005, a settlement agreement in the WorldCom,
Inc. ("WorldCom") consolidated securities class action was
reached by the Lead Plaintiff, ten director defendants (the
"Settling Director Defendants"), and seven insurers that provided
excess directors and officers liability policies to WorldCom (the
"Excess Insurers"). This Opinion addresses the objections of
several nonsettling defendants to the judgment reduction formula
("Judgment Reduction Formula") of the requested bar order that
the settling parties included in their revised Stipulation of
Settlement of January 18, 2005 (the "Stipulation").
In light of the rapidly approaching class action trial date of
February 28, 2005, this Court issued a brief Order rather than a
full Opinion on February 2, announcing that it was denying the
application by the Settling Director Defendants and Lead
Plaintiff for approval of the Judgment Reduction Formula insofar
as the "Contribution Credit" included in that Formula was
adjusted to reflect any limitation on the financial capability of
the Settling Director Defendants. The Order cited
15 U.S.C. § 78u-4(f)(7)(B)(i) as the basis for the denial and announced that
the Court's reasoning would be explained in an Opinion to follow.
This is that Opinion. Later on February 2, the Lead Plaintiff
announced in a letter to the Court that it was withdrawing from
the settlement because of the Court's determination.
On June 25, 2002, WorldCom announced a massive restatement of
its financial statements for 2001 and the first quarter of 2002.
Less than a month later, the company entered bankruptcy. A raft
of lawsuits have been filed based on the facts underlying these
events, alleging, among other illegalities, violations of the
federal securities laws stemming from the fraudulent
capitalization of expenses and other accounting regularities.
The Judicial Panel on Multi-District Litigation has transferred
all civil actions involving WorldCom that are pending in federal
court to this Court, where the securities-based actions have been
consolidated for pretrial purposes into the Securities
Litigation. The Securities Litigation includes
numerous class actions as well as actions filed by individual
plaintiffs, generally large institutional investors such as
public pension funds (the "Individual Actions"). The Individual
Action plaintiffs are not parties to the Stipulation.
The consolidated class action is brought on behalf of a class
of all persons and entities, excluding defendants and certain
others affiliated with them or with WorldCom, who were
financially injured after they acquired publicly traded WorldCom
securities between April 29, 1999 and June 25, 2002. The Lead
Plaintiff filed the consolidated class action complaint on
October 11, 2002, and the class was certified on October 24,
2003. See In re WorldCom, Inc. Sec. Litig., 219 F.R.D. 267
(2003). Among the defendants named in the Corrected First Amended
Class Action Complaint of December 1, 2003 (the "Complaint") are
former WorldCom CEO Bernard J. Ebbers ("Ebbers");*fn1 twelve
other individuals who were directors of WorldCom during the class
period (collectively, the "Director Defendants");*fn2
WorldCom's former auditor, Arthur Andersen LLP ("Andersen"); and
a number of investment banks that had underwritten bond offerings
for WorldCom in May 2000 ("2000 Offering") and May 2001 ("2001
Offering") (collectively, the
"Underwriter Defendants").*fn3 Several WorldCom officers
other than Ebbers are defendants in the class action also; their
specific interests are not discussed in this Opinion because they
did not object to the terms of the Stipulation.
Many prior Opinions have detailed the alleged involvement of
the various defendants in WorldCom's collapse.*fn4 This
Opinion assumes familiarity with those allegations. Only the
facts necessary to evaluate the Judgment Reduction Formula are
described here. To place the discussion that follows in context
it is essential to understand the types of liability imposed by
the securities statutes and the potential liability of the
defendants under those statutes.*fn5
The "primary innovation" of the Securities Act of 1933 (the
"Securities Act") was the creation of duties in connection with
public offerings, principally "registration and disclosure
obligations." Gustafson v. Alloyd Co., 513 U.S. 561, 571
(1995). The Securities Act "was designed to provide investors
with full disclosure of material information concerning public
offerings of securities in commerce, to protect investors against
fraud and, through the imposition of specified civil liabilities,
to promote ethical standards of honesty and fair dealing." Ernst
& Ernst v. Hochfelder, 425 U.S. 185, 195 (1976).
Liability under Section 11 of the Securities Act derives from
the requirements for filing a registration statement. Under the
provision, any signer, director of the issuer, preparing or
certifying accountant, or underwriter may be liable if "any part
of the registration statement, when such part became effective,
contained an untrue statement of a material fact or omitted to
state a material fact required to be stated therein or necessary
to make the statements therein not misleading."
15 U.S.C. § 77k(a). Section 11 "was designed to assure compliance with the
disclosure provisions of the Act by imposing a stringent standard
of liability on the parties who play a direct role in a
registered offering." Herman & MacLean v. Huddleston,
459 U.S. 375, 381-82 (1983). It imposes joint and several liability upon
all violators, 15 U.S.C. § 77k(f)(1), with the exception of
outside directors. Under Section 21D(f)(2) of the Securities and
Exchange Act of 1934 (the "Exchange Act"),*fn6 a provision
added by the Private Securities Litigation Reform Act of 1995
("PSLRA"), outside directors are subject to liability solely for
the portion of a judgment for which the jury deems them
responsible. 15 U.S.C. § 78u-4(f)(2)(B)(i). If an outside
director is specifically found to be a "knowing" violator of the
securities laws, however, he or she becomes subject to joint and
several liability. Id. § 78u-4(f)(2)(A).
Liability under Securities Act Section 12(a)(2) flows from the
requirement to distribute prospectuses. The provision allows a
purchaser of a security to bring a private action against a
seller that "offers or sells a security . . . by means of a
prospectus or oral communication, which includes an untrue
statement of a material fact or omits to state a material fact
necessary in order to make the statements . . . not misleading."
Id. § 77l(a)(2). Section 12(a)(2) "prescribes the remedy of
rescission except where the plaintiff no longer owns the
security." Randall v. Loftsgaarden, 478 U.S. 647, 655 (1986).
Securities Act Section 15 is a control-person liability
provision. It imposes liability on "[e]very person who, by or
through stock ownership, agency, or otherwise, or who, pursuant
to or in connection with an agreement or understanding with one
or more other persons by or through stock ownership, agency, or
otherwise, controls any person liable under section 11 or 12."
15 U.S.C. § 77o. Section 15 claims are "necessarily predicated on a
primary violation of securities law" by the controlled person.
Rombach v. Chang, 355 F.3d 164, 177-78 (2d Cir. 2004). The
provision renders the controlling person liable "to the same
extent as such controlled person." 15 U.S.C. § 77o. The
controlling person is held jointly and severally liable with the
controlled person for whatever liability the controlled person
ultimately faces. Id.
In contrast to the Securities Act, the Exchange Act "for the
most part regulates post-distribution trading." Central Bank of
Denver, N.A. v. First Interstate Bank of Denver, N.A.,
511 U.S. 164, 171 (1994). It "was intended principally to protect
investors against manipulation of stock prices through regulation
of transactions upon securities exchanges and in over-the-counter
markets, and to impose regular reporting requirements on
companies whose stock is listed on national securities
exchanges." Ernst & Ernst, 425 U.S. at 195 (citing S. Rep. No.
792, 73d Cong., 2d Sess., 1-5 (1934)).
Courts have implied a private cause of action for securities
fraud into Exchange Act Section 10(b) and Securities and Exchange
Commission ("SEC") Rule 10b-5. See id. at 196. Section 10(b)
creates civil liability for those who "use or employ, in
connection with the purchase or sale of any security . . . any
manipulative or deceptive device or contrivance in contravention
of such rules and regulations as the [SEC] may prescribe as
necessary or appropriate in the public interest or for the
protection of investors." 17 U.S.C. § 78j. Rule 10b-5,
promulgated by the SEC under the authority of Section 10(b),
imposes liability on those who "employ any device, scheme, or
artifice to defraud," "make any untrue statement of a material
fact or to omit to state a material fact necessary in order to
make the statements made, in the light of the circumstances under
which they were made, not misleading," or "engage in any act,
practice, or course of business which operates or would operate
as a fraud or deceit upon any person, in connection with the
purchase or sale of any security." 17 C.F.R. § 240.10b-5.
Like Section 15 of the Securities Act, Exchange Act Section
20(a) is a control-person liability provision. It imposes
liability on "[e]very person who, directly or indirectly,
controls any person liable under any provision of this title or
of any rule or regulation thereunder." 15 U.S.C. § 78t(a). The
controller is liable "jointly and severally with and to the same
extent as such controlled person is liable." Id.
Under Section 21D(f)(2)(B), all Exchange Act claims result in
proportionate liability for all defendants. Id. §
78u-4(f)(2)(B)(i). This proportionate liability scheme for
Exchange Act claims was, like the proportionality rule for
outside directors facing Section 11 claims, introduced by the
PSLRA; prior to that legislation, violators faced joint and
liability. The exception to the proportionate liability rule
applies when a defendant is specifically found to have "knowingly
committed a violation of the securities laws." Id. §
78u-4(f)(2)(A). Knowing violators are jointly and severally
C. Potential Liabilities of the Class Action Defendants
1. The Director Defendants
The claims that survive against all Director Defendants are
those arising under Sections 11 and 15 of the Securities Act and
Section 20(a) of the Exchange Act.*fn7 The Director
Defendants face liability under Section 11 because they endorsed
the registration statements for the 2000 and 2001 Offerings; the
Section 15 and 20(a) claims would impose liability stemming from
the directors' role in controlling the WorldCom corporate entity.
In addition, a securities fraud claim under Exchange Act Section
10(b) survives against director Stiles A. Kellett, Jr.
Most, if not all, of the Director Defendants are subject only
to proportionate liability for the Section 11 claims against them
if they did not have actual knowledge of the accounting
malfeasance afoot at WorldCom during the class period.*fn8
Director Defendants face joint and several liability for the
Section 15 claims, however, as WorldCom itself would be jointly
and severally liable for its underlying Section 11 violation.
15 U.S.C. § 77k(f)(1). For the Section 20(a) claims, the Director
Defendants face the same liability as the controlled corporation
or employee that is an underlying violator of the Exchange ...