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Press Reports Did Not Put Investors on Notice of Potential Fraud at WorldCom

The District Court for the Southern District of New York has refused to dismiss the claims of an Ohio pension fund in the WorldCom case based on the argument of defendant, Salomon Smith Barney, that investors were placed on notice of the alleged fraud by virtue of press reports about the allegedly “illicit relationship” between WorldCom, Salomon Smith Barney and telecommunications analyst Jack Grubman. The court reasoned that as a matter of law, the press reports are simply too vague to support the conclusion that plaintiffs were on notice as to possible claims that Salomon's financial reporting on WorldCom was tainted. Public Employees Retirement System of Ohio v. Ebbers (In re WorldCom, Inc. Securities Litigation), No. 02cv03288 (Nov. 25).

In this consolidated class action, WorldCom and its former chief executive, Bernie Ebbers, allegedly committed massive accounting fraud and violated securities laws by making false statements and filings. Among the other defendants are investment banks, such as Salomon, who were responsible for handling WorldCom's bond offerings. Salomon, specifically, has been singled out as having an improper relationship with the company. Grubman allegedly worked in tandem with Ebbers to disguise WorldCom's troubles, and in return, Salomon, as well as Grubman, were rewarded handsomely with tens of millions of dollars in fees. In its attempt to have some of the claims dismissed, lawyers for Salomon and Grubman argued that a series of news articles about conflicted analysts amounted to “storm warnings” that should have alerted a reasonable investor as to the conflicts.

The district court rejected this argument, noting that the defendants had relied, in part, on a recent decision in the Southern District, In re Merrill Lynch & Co. Research Reports Securities Litigation. There, the court dismissed suits against Merrill Lynch for failure to plead loss causation, ruling that investors who speculated in the market and were exposed to ongoing press coverage of Wall Street analyst conflicts could not blame the drop in their share price on Merrill. The instant case, however, was distinguishable. “The revelations in the press that were sufficient in Merrill Lynch to support dismissal of those claims for failure to plead loss causation are of no assistance to the [Salomon] Defendants here.” The court found a major flaw in the defendants' argument, that none of the claims at issue were based solely on analyst reports. Also, the plaintiffs are seeking to hold the Salomon defendants liable for representations made in registration statements for the public offerings. In addition, the press accounts cited by defendants “address the conflicts which existed on Wall Street generally, and do not discuss WorldCom and [Salomon] in particular.” It was not until revealed until much later that Ebbers received hundreds of millions of dollars in loans from Salomon “that were secured by WorldCom stock and that gave [Salomon parent Citigroup] an additional financial stake in WorldCom's stock price.” Moreover, the court noted the irony in the defendants' contention “that the conflicts of interest that they have so vigorously argued are insufficient to sustain fraud allegations were sufficiently reported in the business press to put plaintiffs on notice of their fraud claims as early as 2000.”

Securities Fraud and Obstruction Charges Against Stewart Upheld

The District Court for the Southern District of New York has refused to dismiss a securities fraud charge brought against Martha Stewart for allegedly lying publicly about her role in the ImClone insider trading scandal. The court acknowledged the count was an unquestionably novel application of the securities laws, but nevertheless properly alleged that Stewart made material misrepresentations in public statements about her sale of ImClone Systems Inc. shares in an effort to boost the share price of her own company, Martha Stewart Living Omnimedia (MSLO). United States v. Martha Stewart 03cr717 (MGC) (Nov. 18).

Stewart had argued that the securities charge was an unprecedented and dangerous expansion of criminal liability under the securities laws and that Stewart was being punished simply for claiming her sale of stock was innocent. The court disagreed, finding that the indictment “does not charge Ms. Stewart with lying by asserting her innocence.” Further, that the question of whether Stewart made material misrepresentations in connection with the purchase or sale of MSLO stock was one for the jury to decide. The court also rejected Stewart's argument that she was being punished for speaking freely, in violation of the First Amendment, stating that, “the Constitution does not prohibit the prosecution of lies that are part of a course of criminal conduct.”

Letter to U.S. Attorney Did Not Waive Privilege

The Second Circuit has ruled that the sending of a letter of explanation to the U.S. Attorney, citing conversations with various federal agents did not serve to waive the work product privilege. John Doe Co. v. United States (In re Grand Jury Proceedings), No. 01-6079 (L) (Oct. 30).

Upon learning that the corporation was the subject of a grand jury investigation, corporate counsel sent the U.S. attorney a 46-page letter of explanation, including the names and telephone numbers of various federal agents who had assured the company that its actions were proper. The letter further stated that it was not intended as a waiver of any applicable privilege. After receiving the letter, the U.S. attorney subpoenaed the notes of the corporate lawyers and their agents who spoke with these government officials. The corporation objected.

The Second Circuit ruled that forfeiture of privilege turns on considerations of fairness to the adversary. Here, it would not be unfair to the government to withhold from the grand jury the corporation's lawyers' notes about the conversations with the federal agents. The appellate court rejected the reasoning of the district court that by putting its good faith belief at issue, the corporation impliedly waived attorney work-product protection. By accepting this logic, the court stated “it would follow that whenever a suspect in a criminal proceeding told the prosecutor or an investigating agent that he believed he had done nothing wrong, or whenever a party to a brewing civil dispute made a statement to his adversary to the same effect, he would thereby forfeit his privileges. That is not the law.”

Press Reports Did Not Put Investors on Notice of Potential Fraud at WorldCom

The District Court for the Southern District of New York has refused to dismiss the claims of an Ohio pension fund in the WorldCom case based on the argument of defendant, Salomon Smith Barney, that investors were placed on notice of the alleged fraud by virtue of press reports about the allegedly “illicit relationship” between WorldCom, Salomon Smith Barney and telecommunications analyst Jack Grubman. The court reasoned that as a matter of law, the press reports are simply too vague to support the conclusion that plaintiffs were on notice as to possible claims that Salomon's financial reporting on WorldCom was tainted. Public Employees Retirement System of Ohio v. Ebbers (In re WorldCom, Inc. Securities Litigation), No. 02cv03288 (Nov. 25).

In this consolidated class action, WorldCom and its former chief executive, Bernie Ebbers, allegedly committed massive accounting fraud and violated securities laws by making false statements and filings. Among the other defendants are investment banks, such as Salomon, who were responsible for handling WorldCom's bond offerings. Salomon, specifically, has been singled out as having an improper relationship with the company. Grubman allegedly worked in tandem with Ebbers to disguise WorldCom's troubles, and in return, Salomon, as well as Grubman, were rewarded handsomely with tens of millions of dollars in fees. In its attempt to have some of the claims dismissed, lawyers for Salomon and Grubman argued that a series of news articles about conflicted analysts amounted to “storm warnings” that should have alerted a reasonable investor as to the conflicts.

The district court rejected this argument, noting that the defendants had relied, in part, on a recent decision in the Southern District, In re Merrill Lynch & Co. Research Reports Securities Litigation. There, the court dismissed suits against Merrill Lynch for failure to plead loss causation, ruling that investors who speculated in the market and were exposed to ongoing press coverage of Wall Street analyst conflicts could not blame the drop in their share price on Merrill. The instant case, however, was distinguishable. “The revelations in the press that were sufficient in Merrill Lynch to support dismissal of those claims for failure to plead loss causation are of no assistance to the [Salomon] Defendants here.” The court found a major flaw in the defendants' argument, that none of the claims at issue were based solely on analyst reports. Also, the plaintiffs are seeking to hold the Salomon defendants liable for representations made in registration statements for the public offerings. In addition, the press accounts cited by defendants “address the conflicts which existed on Wall Street generally, and do not discuss WorldCom and [Salomon] in particular.” It was not until revealed until much later that Ebbers received hundreds of millions of dollars in loans from Salomon “that were secured by WorldCom stock and that gave [Salomon parent Citigroup] an additional financial stake in WorldCom's stock price.” Moreover, the court noted the irony in the defendants' contention “that the conflicts of interest that they have so vigorously argued are insufficient to sustain fraud allegations were sufficiently reported in the business press to put plaintiffs on notice of their fraud claims as early as 2000.”

Securities Fraud and Obstruction Charges Against Stewart Upheld

The District Court for the Southern District of New York has refused to dismiss a securities fraud charge brought against Martha Stewart for allegedly lying publicly about her role in the ImClone insider trading scandal. The court acknowledged the count was an unquestionably novel application of the securities laws, but nevertheless properly alleged that Stewart made material misrepresentations in public statements about her sale of ImClone Systems Inc. shares in an effort to boost the share price of her own company, Martha Stewart Living Omnimedia (MSLO). United States v. Martha Stewart 03cr717 (MGC) (Nov. 18).

Stewart had argued that the securities charge was an unprecedented and dangerous expansion of criminal liability under the securities laws and that Stewart was being punished simply for claiming her sale of stock was innocent. The court disagreed, finding that the indictment “does not charge Ms. Stewart with lying by asserting her innocence.” Further, that the question of whether Stewart made material misrepresentations in connection with the purchase or sale of MSLO stock was one for the jury to decide. The court also rejected Stewart's argument that she was being punished for speaking freely, in violation of the First Amendment, stating that, “the Constitution does not prohibit the prosecution of lies that are part of a course of criminal conduct.”

Letter to U.S. Attorney Did Not Waive Privilege

The Second Circuit has ruled that the sending of a letter of explanation to the U.S. Attorney, citing conversations with various federal agents did not serve to waive the work product privilege. John Doe Co. v. United States (In re Grand Jury Proceedings), No. 01-6079 (L) (Oct. 30).

Upon learning that the corporation was the subject of a grand jury investigation, corporate counsel sent the U.S. attorney a 46-page letter of explanation, including the names and telephone numbers of various federal agents who had assured the company that its actions were proper. The letter further stated that it was not intended as a waiver of any applicable privilege. After receiving the letter, the U.S. attorney subpoenaed the notes of the corporate lawyers and their agents who spoke with these government officials. The corporation objected.

The Second Circuit ruled that forfeiture of privilege turns on considerations of fairness to the adversary. Here, it would not be unfair to the government to withhold from the grand jury the corporation's lawyers' notes about the conversations with the federal agents. The appellate court rejected the reasoning of the district court that by putting its good faith belief at issue, the corporation impliedly waived attorney work-product protection. By accepting this logic, the court stated “it would follow that whenever a suspect in a criminal proceeding told the prosecutor or an investigating agent that he believed he had done nothing wrong, or whenever a party to a brewing civil dispute made a statement to his adversary to the same effect, he would thereby forfeit his privileges. That is not the law.”