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February 14, 2005.


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"). Page 2

  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.

  I. Background

  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 Page 3 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 Page 4 "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 Page 5 the securities statutes and the potential liability of the defendants under those statutes.*fn5

  A. The Securities Act

  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 Page 6 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 Page 7 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.

  B. The Exchange Act

  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 Page 8 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 several Page 9 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 liable. Id.

  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. ("Kellett").

  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 The Page 10 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 ...

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