One Year Later

In February 2005, we wrote an article (included on this site) analyzing a startling development in Corporate America: the outside directors of two companies (Enron and WorldCom) had agreed to settle the securities class action cases involving those companies by paying some of their personal funds, in excess of the contributions from their respective directors and officers insurance policies. In Enron, all eighteen outside directors settled, and the ten directors who had sold Enron stock agreed to contribute $13 million to a total $168 million settlement (with the remaining $155 million to be paid by insurers). In WorldCom, ten of the twelve outside directors had agreed to contribute $18 million, representing approximately 20% of their aggregate wealth, to a $54 million settlement (with the remaining $36 million to be paid by insurers). Subsequently, the settlement was amended after its judgment reduction provision was stricken, with the remaining two outside directors (and an additional $6.75 million in personal contribution) added to the deal.

Our article took a different approach than some comments on the settlements. While we noted the unique aspects of Enron and WorldCom, we opined that the wiser course for directors was not to disregard the cases as aberrations, but rather to ask what lessons they taught about the risks of serving on a company's Board of Directors. To develop these propositions, we examined the public record of the allegations of the cases, which had been developed through discovery and Congressional investigation, and identified four factors common to the cases that directors should consider in assessing their liability exposure.

It is now one year later. Additional settlements pushed the total payments in WorldCom to over $6 billion, and the settlements in Enron are now $7 billion and counting. Beyond these cases, there is new evidence - the public record of securities decisions and settlements across the federal courts - by which to assess of our analysis from last February. Have the reasons we identified for directors to be concerned about individual liability persisted? Our answer is a qualified "yes": while there has not been a spate of reported settlements with individual defendant contribution, and most securities cases do not name outside directors as defendants, the factors leading to liability in WorldCom and Enron remain very much alive. Are the risks to outside directors (and, for that matter, officers) that we identified last February still relevant? Again, our answer from the new evidence is yes. The case law, however, also shows some of the steps that directors and officers may take to reduce their companies' exposure to securities lawsuits and their own personal liability.

Reasons For Concern Continue

Our February 2005 article identified three reasons why directors should not automatically dismiss the Enron and WorldCom settlements as completely aberrational products of notorious cases. One year later, it is evident that while directors' pocketbooks have not turned into settlement sluices, these reasons for concern remain valid.

One reason why we believed that WorldCom and Enron should not be disregarded was that the settlements may create expectations about the contours of future settlements. We speculated that plaintiffs' firms and their institutional clients would look to these settlements as benchmarks and increase the pressure for individuals to contribute personal funds to settlements. According to the public record, this factor has not materialized. The last remaining non-settling individual defendants in WorldCom - the two hold-out outside directors, and the former officers sentenced to lengthy prison terms - settled with the class following the publication of our article. Other than this, individual defendants, including directors and officers, did not made further personal contributions to settlements in 2005, not even in the largest settlements announced during the year: AOL TimeWarner ($2.5 billion), Royal Ahold ($1.1 billion), and McKesson HBOC ($960 million). However, the record may be incomplete. It is possible that individual defendants contributed to settlements, but their contributions were not reported publicly. Other large cases are still working their way through the judicial system.

Our article also opined that WorldCom and Enron should not be disregarded because, while the facts were extreme, by and large the legal theories used to sue the directors in those cases were not. Directors always have had duties under the Securities Act to see that their corporations issue truthful registration statements when conducting public offerings, duties under the Exchange Act to not issue false or misleading statements to investors, and duties of due care and loyalty to the shareholders under corporation law. These duties, and hence potential liability, remain the law. Indeed, a subsequent opinion in WorldCom illustrates the risks of a particular form of individual liability: control person liability under Exchange Act Section 20(a). In denying a motion for summary judgment by an outside director not alleged to have been involved in the accounting fraud in that case, the court held that plaintiffs did not need to prove any degree of culpable participation or scienter; rather, all they needed to show was that the company was liable, at which point it was the director's burden to prove his good faith. In several other decisions from the past year, courts simultaneously dismissed Section 10(b) fraud claims against officers or directors, while retaining them as defendants in §20(a) control person claims. While other courts have dismissed control person claims, especially where liability is predicated solely on one's status as a director, the prospects of broad §20(a) liability remains.

A third reason why we wrote that WorldCom and Enron should not be disregarded was that the heightened scrutiny of corporate governance practices produced by those scandals had not abated. Instead, the scrutiny has been written into law by the Sarbanes-Oxley Act, and magnified by subsequent investigations into other purported scandals (such as those involving mutual funds and insurance brokers). This reason for concern has intensified. The mutual fund investigations have produced substantial private securities litigation, as has the investigation into late trading by specialist firms. As corporate governance activism and regulatory zeal have increased, so have the opportunities for investigation, whistleblowing and muckraking. Once a whiff of impropriety emerges from any of these sources, a company's stock price may fall and precipitate a lawsuit - even if the concern giving rise to the adverse news eventually proves not to be a problem. Thus, in 2005, courts considered lawsuits precipitated by announcements of government investigations, threats or raids; government lawsuits or settlements; employee lawsuits; and delayed financial statements. Courts also considered securities fraud lawsuits accompanied by allegations of document destruction.

In sum, while Enron and WorldCom may be history, the legacy of scandal left by the companies remains as strong as ever. Hence, so too does the concern of director liability under the securities laws. The remainder of this article considers factors that may increase liability risk, as revealed by Enron and WorldCom and as updated by recent developments.

The Company's Presence in the Securities Markets

Our February 2005 article identified the first risk factor for directors to assess in considering the potential for personal liability as the defendant company's presence in the securities markets. We noted that both Enron and WorldCom were actively traded stocks with huge market capitalization, and hence the theoretical value of the claims of investors who lost practically everything when the companies entered bankruptcy was substantial. Both Enron and WorldCom also had conducted public offerings during the periods in which their financial statements were fraudulent, which exposed their directors to claims under Sections 11 and 15 of the Securities Act, which allows liability without pleading or proving an intent to defraud. Hence, in assessing their liability risks, directors should consider where their company stands on this risk factor, including whether the company's stock prices is volatile and whether it is engaged in public offerings or other transactions that involve registration of corporate stock.

The potential for Securities Act liability arising from a corporation's participation in securities offerings remains a risk factor for corporations and directors - ironically, most often against those directors not alleged to have engaged in fraud. For example, in Knollenberg v. Harmonic, Inc., No. 03-16238, 152 Fed.Appx. 674 (9th Cir. Nov. 8, 2005), the Ninth Circuit affirmed the dismissal of fraud claims against a corporation and its officers arising from a registration and proxy statements used to effect a merger, as those claims had not been pleaded with the particularity required by Rule 9(b) and the Reform Act; but reversed the dismissal of the Securities Act claims against the company and an officer arising from essentially the same allegations, as particularity was not required to state those claims. In another case, Securities Act claims were stated against the chairman of the defendant corporation's board because plaintiffs' allegations against him, as distinguished from the company and officer defendants, did not sound in fraud and hence did not invoke Rule 9(b). Moreover, regardless of whether Rule 9(b)'s particularity standards apply to directors, plaintiffs may be able to state a Securities Act claim against a corporation, and in turn include directors as control person defendants under Section 15 of the Act. This was an avenue by which the outside director of WorldCom who did not settle faced liability before he joined in the settlement.

A recent SEC announcement also highlights the importance of participation in the securities markets. On January 4, 2006, the Commission issued a policy statement discussing the circumstances in which it would seek civil penalties from corporations under investigation for violation of the securities laws. The policy statement announced that the presence or absence of a direct and material benefit to the corporation itself as a result of the violation was one of the two most significant factors to be considered. On the same day, the SEC announced two settlements - one with a civil penalty against a corporation, and one without a penalty - that illustrated the application of the policy statement. In the settlement that contained the penalty, the SEC's complaint alleged that the corporation had raised nearly $350 million in offerings conducted via registration statements that included false financial statements, and had made several acquisitions using stock whose price had been inflated by the false statements. In the other settlement, a corporation that was not alleged to have conducted offerings or made acquisitions was not assessed a penalty. These settlements suggest that a corporation's benefit from its participation in the securities markets during a period in which false statements were made will be viewed as an indicator of sanctionable fraud.

In sum, directors (and officers) still face increased liability risks when their corporations participate in the securities markets via offerings or acquisitions. However, in most courts, it remains the case that corporate offerings or acquisitions alone do not plead scienter for purposes of stating a fraud claim.

Too Good To Be True

Our February 2005 article identified another risk factor for directors to assess in considering their potential personal liability: whether a corporation engages in transactions, or reports numbers, that at first glance (or in hindsight) seem just too good to be true. A report commissioned by the United States Senate asserted that Enron's directors should have been suspicious and demanding of further inquiry and disclosure when they observed two types of transactions that fit into this category: limited partnerships created by Enron to engage in transactions with the company that had produced fantastic benefits in a very short period of time, and "hedging" transactions with other off-balance sheet entities that were collateralized by Enron stock and hence did not actually hedge risk. One reason why the underwriters did not win summary judgment in WorldCom was that they did not show that they had investigated further upon learning that the company's reported ratio of its line cost expenses to revenues "was significantly lower than that of the equivalent numbers of its two closest competitors, Sprint and AT & T." We noted that this risk factor presents a quandary to directors, for most companies hope and expect that they will succeed and grow and success should not signal a red flag per se. At the same time, Enron and WorldCom taught that directors should monitor the key metrics of the company's business, divisions and segments, and assure themselves that any tremendous increases in success are the result of understandable accounting and business judgments that can be defended in the light of full disclosure.

This risk factor was a major theme in securities decisions in 2005. Claims were allowed in several cases based on allegations that companies reported or predicted results that were impossible to reconcile with the actual state of affairs at the company, or were otherwise too good to be true. For example, in In re ProNetLink Sec. Litig., No. 03 Civ. 2298 (RO), ___ F. Supp. 2d ___, 2005 WL 3358665 (S.D.N.Y. Dec. 9, 2005), the court denied a motion to dismiss by the former officers of a bankrupt Internet commerce company, where a key allegation was that the company had no inside sales force or customers whatsoever at the same time that it represented that it was succeeding. The Fifth Circuit reinstated part of a securities case against an Internet company which had represented that it had received large purchase orders from a creditworthy customer, when the alleged customer declared bankruptcy only a short time thereafter. Another case credited allegations that a company had reported strong sales increases achieved only because it had financed its customers' purchases; and another case allowed a claim against a company that understated revenue in some quarters, presumably so that subsequent quarters would appear to continue the pattern of success.

Still, just as success does not automatically signal fraud, not all cases predicated on allegations of results that are too good to be true succeed. If such allegations are not made with factual specificity, they will not suffice to state a claim. For example, in Freed v. Universal Health Services, No. Civ. A. 04-1233, 2005 WL 1030195 (E.D. Pa. May 3, 2005), plaintiffs alleged that a hospital company had reported lower bad debt ratios even as other hospital companies were struggling with non-paying and uninsured patients due to tightened insurance and government payment standards. At the end of the class period, the company increased its reserves, a step that plaintiffs characterized as a "catch up" charge that admitted that reserves in prior quarters had been understated. The court, however, found that there were no specific allegations that the company as a whole, as distinguished from particular facilities, had experienced poor performance with customer payments. It also remains the case that management's setting of aggressive growth targets, by itself, does not signal fraud.

A few decisions from 2005 also illustrate that the "too good to be true" factor applies to plaintiffs too: if an alleged fraud seems too good to be true - that is, implausible or impossible to execute as alleged - a securities claim may be dismissed for lack of falsity or scienter. For example, in In re Sawtek, Inc. Sec. Litig., No. 603 CV 294 ORL31 DAB, 2005 WL 2465041 (M.D. Fla. Oct. 6, 2005), plaintiffs alleged that a wireless communications company had issued positive results and forecasts only because it had engaged in aggressive sales practices that had stuffed its distributors with excess products for several quarters, leading inevitably to lower sales in the future. The court dismissed because, inter alia, the complaint did not explain how the company repeatedly could have overloaded its large and sophisticated customers with excess inventory they should not have purchased. Another court rejected allegations that a start-up company failed to disclose or write off $2 million in uncollectible accounts receivable, where the company's total revenues since its inception had been only $1.03 million. Another court found that it would have been impossible to fool investors in the manner alleged in the complaint, where investors easily could have learned of truth of the matter discussed by the company by consulting the public record. As the court succinctly explained: "Surely if such alleged misbehavior is incapable of defrauding investors, that, in itself, negates the inference of intent to defraud." Another court dismissed a claim against a financial firm that was the counterparty to some of the pretextual swap transactions engaged in by Enron, as it was implausible to conceive that the firm would have lent billions of dollars to Enron if it knew that the company was a sham and in trouble, when the fees it stood to gain from participating in the transactions were only in the tens of millions of dollars.

The most important cases from the past year for directors illustrate how companies can minimize the liability risks presented by the quest to attain rapid success. One step is to disclose the challenges of meeting steep goals. For example, in Davidoff v. Farina, No. 04 Civ. 7617 (NRB), 2005 WL 2030501 (S.D.N.Y. Aug. 22, 2005), plaintiffs alleged that an Internet backbone and services company failed to disclose that its initial public offering would not raise sufficient funds for the company's ambitious business plan. The court dismissed with prejudice, however, because the ambitious plans and the need for a large capital infusion to fund them had been disclosed in the registration statement for the offering. Another step is to report on the progress - or lack thereof - in achieving plans for success. Thus, in In re Best Buy Co., Inc. Sec. Litig., No. C 03-6193 ADM AJB, 2005 WL 839099 (D. Minn. Apr. 12, 2005), plaintiffs alleged that an electronics retailer had misrepresented the benefits and understated the difficulties of revitalizing its newly acquired chains of music stores. The court dismissed because, inter alia, the company had announced in an analyst call that it expected music store operating results to decline by $40 million in the upcoming year. If investors hear the adverse news from a company itself, it will be difficult for them to claim that they were ignorant of the risks or injured when the success was not attained. Directors should keep this in mind in assessing and guiding their companies' disclosures.

Executive Risk

Another risk factor to directors identified in our February 2005 article was the presence of issues regarding executive compensation. This factor manifested itself in Enron because a report from Congress had faulted the company's directors for allowing or ignoring several examples of excess officer compensation: substantial trading profits from the exercise of stock options; substantial cash bonuses; a revolving credit line for the CEO; and the substantial profits made by limited partnerships owned by the company's CFO and his undisclosed investment partners from the partnerships' purportedly arms-length transactions with the company. We concluded that the ultimate lesson from these criticisms was that the failure to prevent excess executive compensation and disclose it when it is evident will subject directors to criticism regarding what other problems they would have discovered had they inquired more about why the executives were earning so much compensation.

One year later, allegedly excess management compensation is perhaps the hottest topic in corporate governance. Recognizing the importance of this issue, the SEC recently proposed disclosure requirements that it hopes will provide greater transparency on executive compensation. Several types of officer compensation issues also arose in securities cases adjudicated during the past year. For example, the Fifth Circuit reversed (in part) the dismissal of a lawsuit challenging financial statements and forecasts by a voice response system company. One of the allegations which, when considered with the other allegations of the complaint, pleaded scienter was that the CEO had received a 175% bonus for hitting targeted earnings. In another case, the court denied a motion to dismiss a lawsuit alleging that a retailer had engaged in financial fraud by entering into side agreements with its vendors. A significant allegation in the complaint was that the company's former CFO had received a bribe for entering into one of the deals. In another case, a claim was stated against a company whose initial public offering registration statement allegedly understated compensation expenses. Another court considered, and dismissed, a securities lawsuit filed after a company disclosed that an officer had been persuaded to assume the CEO position by a $10 million payment from the chairman, which the company had not declared as a compensation expense.

Apart from compensation issues, securities lawsuits have been precipitated by other types of scandals concerning the histories or practices of officers, directors, or other important persons associated with a corporation. The securities lawsuit filed against Martha Stewart Omnimedia arising from the company CEO's stock trading in an unrelated company is the leading example of this phenomenon. In 2005, securities claims were stated against a company and some of its directors when it was revealed that one director had twice been sanctioned by the SEC, and that a major shareholder was a convicted felon barred from the securities industry for life. In another case, scienter was pleaded against a health care company on the allegation that it had been "willing to profit from a physician who was a known danger to the public" by allowing that doctor to perform unnecessary surgery. The court concluded that this created a high probability that the company knew there would be related problems with the quality of care, workers compensation claims, bad receivables, and the overall integrity of its operations. The lesson from these cases is that in light of the continuing focus on corporate governance, investors are less tolerant than ever of any tinge of scandal concerning the personal character and background of corporate officers and directors. Directors are well advised to know who they are doing business with, so to speak, when they decide to join a corporation's board.

Structural Barriers to Effective Board Oversight

The final risk factors identified in our February 2005 article concerned structural barriers to the directors' effective oversight of a company's critical accounting and disclosure decisions. Both Enron and WorldCom's boards of directors were large, and there is evidence that the Enron board was too large and fractionalized in its committee structure to enable its directors to perform their duties. The Senate Report on Enron demonstrated, for example, that it was not the Audit Committee, but rather a separate Finance Committee, that reviewed the limited partnership, off balance sheet, and other complex transactions that eventually caused the company's collapse. We drew the lesson that directors should make sure that their authority and capabilities are commensurate to their duties: management and board structures cannot hinder directors from performing their jobs, and directors should increase their attention and use of experts and legal counsel proportionately to the complexity of the transactions and business engaged in by the company. With great responsibility must come great power.

This lesson was the product of a detailed Congressional analysis of Enron, and to our knowledge there have not been similar reports issued in the past year from which to draw guidance about board structures that hinder director effectiveness. However, a few cases from the past year illustrate a related type of problem: remote directorship. A significant caveat to the warnings set forth in this article is that in most securities cases, outside directors are not sued. Thus, it also is significant that some of the rare recent cases in which outside directors companies were sued involved companies headquartered outside of the United States that had experienced problems in their American operations. In the Royal Ahold case, a food company headquartered in the Netherlands experienced accounting improprieties in its United States retailing operations, leading to a lawsuit that recently settled for $1.1 billion. Among the individuals named as defendants were non-resident members of the company's Supervisory Board. In the pending Alstom litigation, a manufacturing company headquartered in France experienced accounting improprieties with its United States railcar division, which led to a restatement and governmental investigations. A fraud claim was stated based on those allegations, and the France-based directors of the company were dismissed from a claim under Section 18 of the Exchange Act (which does not require scienter) only because the SEC filings at issue did not concern the subject matter of that particular fraud. Other recent securities cases have considered the opposite situation: American companies that experienced problems in their foreign operations or divisions.

These cases suggest that where the geographical scope of a corporation's operations are broad, directors should engage in extra vigilance against impropriety. Earlier in this article, we advised that directors also should take additional precautions when their companies engage in ambitious plans or attain results that seem too good to be true, and when their companies engage in complex transactions and business. Are there specific measures that directors can take to effect this additional vigilance and precaution in these situations? Some securities decisions from the past year illustrate that there are.

One measure that directors can take to address complex or critical issues and transactions is to seek out multiple sources of information. It should be the case that even if the sources' assessments disagree and the officers and directors credit the sources that ultimately proves to be wrong, the fact that the corporate officials sought and obtained the information in the first place negates an inference that they intended to remain ignorant of the facts and hence reckless to any negative outcome. Thus, in In re Vertex Pharmaceuticals, Inc. Sec. Litig., 357 F. Supp. 2d 343 (D. Mass. 2005), plaintiffs alleged that a pharmaceutical company failed to disclose toxicity problem with a key drug under development. Several scientists who had worked at the company served as sources for the complaint, alleging that they had indicated to senior management that based on pre-clinical testing the drug was doomed from the start. The court concluded that while these allegations suggested that the company was aware of some problems with the drug, they did not plead a strong inference of scienter, even when combined with allegations of motive. As the court wrote, "[t]he existence of scientific disagreement within a company as to the potential viability of a drug in development, without more details about the substance of the debate, cannot provide the necessary strong showing of scienter." Likewise, in In re Bristol-Meyers Squibb Sec. Litig., No. Civ. A. 00-1990 (SRC), 2005 WL 2007004 (D. N.J. Aug. 17, 2005), summary judgment was granted as to certain statements, where the company's officers were give "conflicting assessments" about the potential for a drug in development, and could not be reckless in making optimistic statements based on the favorable assessments.

Another measure that corporate officials can take to handle complex or critical corporate issues is to attempt to identify and fix any problems that emerge. This, too, is the converse of deliberate ignorance and hence recklessness. In Dresner v. Utility.com, Inc., 371 F. Supp. 2d 476 (S.D.N.Y. 2005), for example, a claim that a company misrepresented its success in customers satisfaction was not stated where, inter alia, the complaint acknowledged that after customers started complaining the company had engaged all of its employees to respond to the complaints. Likewise, in In re American Business Financial Services, Inc. Sec. Litig., No. 04-0265, 2005 WL 1324880 (E.D. Pa. June 2, 2005), plaintiffs did not state a claim by allegations that a company misstated the delinquency status of its loan-based portfolio where, inter alia, the complaint alleged that the company had attempted to cure loan delinquencies prior to foreclosure. However, it is important that as a corporation identifies and the attempts to remedy its problems, it not represent that they already have been fixed. Instead, the better course (if any disclosure is to be made) is to acknowledge the issues as the work to analyze or remedy them takes place. The American Business Financial Services court noted that the company had publicly disclosed its loan delinquency work-out efforts; and in In re BellSouth Corp. Sec. Litig., 355 F. Supp. 2d 1350 (N.D. Ga. 2005), scienter was not pleaded as to a claim that a company delayed a write-down of goodwill for its Latin American operations, where the company both initiated a goodwill analysis of the operations in the first place and disclosed problems in those operations.

Conclusion

Our conclusion remains the same as in February 2005: the Enron and WorldCom settlements do not mean that directors should abandon their positions or squirrel their assets in judgment-proof jurisdictions, but they do give rise for concern. At the same time, the circumstances of those cases, as well as subsequent securities litigation, provide examples of how directors can recognize and reduce their liability risks.

Footnotes

[1] UC reaches $168-million settlement with Enron directors in securities fraud case (Jan. 7, 2005) (www.universityofcalifornia.edu/news/2005/jan07.html). Eight other directors also participated in the settlement without contributing personal funds. Id.

[2] Hevesi Announces Historic Settlement, Former WorldCom Directors to Pay From Own Pockets (Jan. 7, 2005) (www.osc.state.ny.us/press/releases/jan05/010705.htm).

[3] In re WorldCom, Inc. Sec. Litig., 388 F. Supp. 2d 319 (S.D.N.Y. 2005).

[4] Former CEO Bernard Ebbers paid $5,636,543.69 in cash plus the proceeds of sale of assets expected to fetch between $18 million and $28 million - substantially all his remaining assets, save some money reserved for legal fees. Former CFO Scott Sullivan agreed to pay $200,000, which was 90% of his 401(k) plan, plus the proceeds of sale of assets expected to fetch between $4 million and $5 million. Two other former officers did not pay any money because they lacked assets. In re WorldCom, Inc. Sec. Litig., 388 F. Supp. 2d at 334-35.

[5] In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2005 WL 638268, *13 (S.D.N.Y. Mar. 21, 2005). This decision may be questioned on the basis of the Supreme Court's opinion that Section 20(a) liability requires a state of mind of something more than negligence. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 209 n.28 (1976); see also id. at 211 n.31.

[6] See In re Stone & Webster, Inc, Sec. Litig., 414 F.3d 187, 201 (1st Cir.), rehearing denied, 424 F.3d 24 (1st Cir. 2005); In re BISYS Sec. Litig., 397 F. Supp. 2d 430, 451-52 (S.D.N.Y. 2005); In re HiEnergy Technologies, Inc. Sec. Litig., No. SAC04-1226 DOC (JTLX), 2005 WL 3071250, *13 (C.D. Cal. Oc. 25, 2005); In re Netopia, Inc., Litig., No. C-04-03364 RMW, 2005 WL 3445631, **7-8 (N.D. Cal. Dec. 15, 2005).

[7] Two decisions from 2005 are noteworthy in this regard because they emphasize the legal and practical limits of directorial control. In Sorkin, LLC v. Fischer Imaging Corp., No. Civ. A. 03-CV-00631-R, 2005 WL 1459735, *12 (D. Colo. June 21, 2005), the court rejected a §20(a) claim against a director because, inter alia, under applicable Delaware law, control of a company rests with the entire Board of Directors, not the individual directors. In In re Flag Telecom Holdings, Ltd. Sec. Litig., 352 F. Supp. 2d 429, 458 (S.D.N.Y. 2005), Verizon had designated 1/3 of the directors on the board of the company whose stock was the subject of the lawsuit, and had been alleged in a bankruptcy trustee's complaint as having directed the company to enter into transactions that benefited Verizon and not the company. The court reasoned that if the Verizon-affiliated directors had persuaded the company to enter into unduly speculative transactions in order to benefit Verizon, it would have been due to their power of persuasion rather than their "control," as these directors were only 1/3 of the board.

[8] See In re Mutual Funds Investment Litig., 384 F. Supp. 2d 845 (D. Md. 2005).

[9] See In re NYSE Specialists Sec. Litig, No. 03 Civ. 8264 (RWS), 2005 WL 3411776 (S.D.N.Y. Dec. 13, 2005); In re LaBranche Sec. Litig., No. 03 Civ. 8201 (RWS), 2005 WL 3411771 (S.D.N.Y. Dec. 13, 2005); In Van der Moolen Holding N.V. Sec. Litig., No. 03 Civ. 8284 (RWS), 2005 WL 3410763 (S.D.N.Y. Dec. 13, 2005).

[10] See Menkes v. Stolt-Nielsen S.A., No. 3:03 CV 409 (DJS), 2005 WL 3050970, *2 (D. Conn. Nov. 10, 2005) (lawsuit alleging that liquid chemical transportation company rigged bids and rates with its competitors in violation of the antitrust laws, and shipped to adverse countries such as Iran in violation of a trade embargo, based on allegations from newspaper accounts and an FBI affidavit accompanying a criminal complaint); City of Austin Police Retirement Sys. v. ITT Educational Services, Inc., 388 F. Supp. 2d 932, 934-35 (S.D. Ind. 2005) (lawsuit alleging that post-secondary education company misrepresented enrollment, attendance, grades, graduation rates, and job placement, filed one day after a raid by federal law enforcement authorities, which was followed by announcements of investigations by the SEC and the California Attorney General); In re Business Objects S.A. Sec. Litig., No. C 04-2401 MJJ, 2005 WL 178860, *1 (N.D. Cal. July 27, 2005) (lawsuit filed after software company disclosed an informal SEC inquiry and then a Wells notice regarding an accounting topic not related to the accounting allegations of the complaint); Carlson v. Xerox Corp., No. 3:00 CV 1621 (AWT), 2005 WL 1645960, **2-3 (D. Conn. July 13, 2005) (lawsuit alleging that copier company engaged in "a smorgasbord of methods" to engage in accounting fraud, based on prominent SEC and internal investigations and press reports of a whistleblower's complaint); In re American Business Financial Servs., Inc. Sec. Litig., No. 04-0265, 2005 WL 1324880, *4 (E.D. Pa. June 2, 2005) (lawsuit alleging stock price decline following disclosure of civil subpoena investigating company's securitization practices); In re NovaStar Fin. Sec. Litig., No. 04-0330-CV-W-ODS, 2005 WL 1279033, **3-4 (W.D. Mo. May 12, 2005) (lawsuit alleging that nonconforming mortgage loan company misrepresented that it was following all applicable regulations, when two States were investigating it and eventually prohibited it from doing business therein and company paid $105,000 fine); Higginbotham v. Baxter Int'l, Inc., Nos. 04 C 490 etc., 2005 WL 1272271, *5 (N.D. Ill. May 25, 2005) (lawsuit alleging false statements due to company's participation in price-fixing cartel, following administrative proceedings and a police raid).

[11] See In re Royal Dutch Shell Transport Sec. Litig., 380 F. Supp. 2d 509, 537-38 (D. N.J. 2005) (lawsuit alleging that energy company overstated proved oil and gas reserves and the future cash flows they would generate, filed after company entered into SEC consent decree and settled SEC lawsuit in which it paid $120 million); JHW Greentree Capital, L.P. v. Whittier Trust Co., No. 05 Civ. 2985 HB, 2005 WL 3008452, *1 (S.D.N.Y. Nov. 10, 2005) (non-class action lawsuit alleging criminal investigation of alleged billing fraud by defendants' private metal tool and cutting company); In re Apollo Group Inc. Sec. Litig., Nos. CV 04-2204 PHX EHC etc., 2005 L 2655275, **10-11 (D. Ariz. Oct. 18, 2005) (lawsuit alleging that secondary educational institution failed to disclose serious ongoing regulatory investigation, filed after company disclosed completion of Department of Education investigation that resulted in large fine); Joffee v. Lehman Bros., Inc., No. 04 Civ. 3507 RWS, 2005 WL 1492101, **3-4, 10-11 (S.D.N.Y. June 23, 2005) (falsity and scienter alleged based on allegations from the complaint in the global settlement with the SEC regarding analyst conflicts); Clark v. Nevis Capital Mgmt, LLC, No. 04 Civ. 2702 (RWS), 2005 WL 488641, *2 n.1 (S.D.N.Y. Mar. 2, 2005) (lawsuit alleging that investment fund failed to disclose that its past success had been achieved only via flipping IPO shares, and denied the same in some interviews; the allegations tracked an SEC consent decree, which also alleged an undisclosed plan to allocate IPO shares only to certain funds and not to others).

[12] See JHW Greentree Capital, 2005 WL 3008452 at *2 (lawsuit based in part on allegations in wrongful termination lawsuit filed by son of founder against CEO); In re Cree, Inc. Sec. Litig., No. 01:03 CV 00549, 2005 WL 1847004, *1, *6 (M.D.N.C. Aug. 2, 2005) (lawsuit alleging accounting fraud via undisclosed related party and round trip transactions, filed after company's co-founder alleged same in lawsuit against company); Taubenfeld v. Career Education Corp., No. 03 C 8884, 2005 WL 350339, *5 (N.D. Ill. Feb. 11, 2005) (lawsuit alleging that post-secondary education provider falsified student statistics and financial statements, precipitated by reports of wrongful termination suits, which led to an SEC inquiry).

[13] See Alaska Elec. Pension Fund v. Adecco S.A., 371 F. Supp. 2d 1203, 1209 (S.D. Cal. 2005) (lawsuit filed after stock price decline following disclosure of delayed financials and discovery of material weakness; auditors eventually signed off on financials without qualification, restatement or discovery of irregularities); Morgan v. AXT, Inc., Nos. C 04-4362 etc., 2005 WL 234125, *4 (N.D. Cal. Sept. 23, 2005) (lawsuit filed after stock price decline following disclosure of delayed financials and internal investigation; auditors eventually signed off on financials without qualification or restatement, although there was material weakness); see also In re Omnivision Techs., Inc., No. C-04-2297 SC, 2005 WL 1867717, *1 (N.D. Cal. July 29, 2005) (lawsuit filed after company announced restatement that would increase reported earnings).

[14] See Zack v. Allied Waste Industries, Inc., Nos. CIV. 04-1640 PHX MHM etc., 2005 WL 3501414, *7 (D. Ariz. Dec. 15, 2005) (alleging that executive ordered employee to rewrite forecast to be more optimistic and "get rid of" prior draft); ITT Educational Services, Inc., 388 F. Supp. 2d at 938 (alleging in securities lawsuit that two offices of company had "carried out systematic and orchestrated document destructions."); In re Recoton Corp. Sec. Litig., 358 F. Supp. 2d 1130, 1151 (M.D. Fla. 2005) (allegations that some officers had knowledge of large document shredding did not save the claims against those officers, but it was a part of the factual mix that pleaded the scienter of the CFO who allegedly ordered the shredding).

[15] See In re Friedman's, Inc. Sec. Litig., 385 F. Supp. 2d 1345, 1368 (N.D. Ga. 2005). Other courts also allowed Securities Act claims to proceed because Rule 9(b) pleading standards did not apply, either as to all defendants or as to those individuals not alleged to have engaged in fraud. See In re Tellium, Inc. Sec. Litig., No. Civ. A 02 CV5878 FLW, 2005 WL 1677467, *10 (D. N.J. June 30, 2005); In re JDS Uniphase Corp. Sec. Litig., No. C 02-1486 CW, 2005 WL 43463, *9 (N.D. Cal. Jan. 6, 2005).

[16] In re WorldCom, Inc. Sec. Litig., 2005 WL 638268 at *16; see also In re Exodus Communications, Inc. Sec. Litig., 2005 WL 2206693 at *1 (same, for CEO); In re Global Crossing, Ltd. Sec. Litig., No. 02 Civ. 910 (GEL), 2005 WL 2990646, *8 (S.D.N.Y. Nov. 7, 2005) (same, for certain defendants); In re Royal Ahold N.V. Sec. & ERISA Litig., 384 F. Supp. 2d 838, 844 (D. Md. 2005) (allowing amendment to add individuals as §15 defendants).

[17] See Statement of the Securities and Exchange Commission Concerning Financial Penalties, https://www.sec.gov/news/press/2006-4.htm.

[18] Securities & Exchange Comm'n v. McAfee, Inc., No. 06-009 (PJH) (N.D. Cal.) (Jan. 4, 2006).

[19] In the Matter of Applix, Inc., Administrative Proceeding No. 3-12138 (Jan. 4, 2006).

[20] See In re Synovis Life Technologies, Inc. Sec. Litig., No. Civ. 04-3008 ADM AJB, 2005 WL 2063870, *15 (D. Minn. Aug. 25, 2005) (complaint did not plead scienter notwithstanding company's expressed intent to grow by acquisitions; indeed, the company already had made some deals, rendering it less suspicious that it would try to do more during class period); Higginbotham, 2005 WL 1272271 at *7 (stock offerings conducted by the company during the time frame did not plead scienter: "Apparently, plaintiffs simply listed all significant transactions that Baxter engaged in during the time period. That can never be sufficient."); but see In re Omnicom Group, Inc. Sec. Litig., No. 02 Civ. 4483 (RCC), 2005 WL 735937, *13 (S.D.N.Y. Mar. 30, 2005) (scienter pleaded as to some allegations against advertising holding company where on the basis of a motive to make acquisitions, combined with recklessness allegations).

[21] 2005 WL 3358665 at *1. Similarly, another court allowed a claim to go forward based on an allegation that at the same time a company announced an "overwhelming response" for its new service, it was taking only 80-90 orders per day. In re Gilat Satellite Networks, Ltd., No. CV-02-1510 (CPS), 2005 WL 2277476, *7 (E.D.N.Y. Sept. 19, 2005).

[22] Plotkin v. IPaxess, Inc., 407 F.3d 690, 698 (5th Cir. 2005).

[23] In re Alstom SA Sec. Litig., No. 03 Civ. 6595 (VM), ___ F. Supp. 2d ___, 2005 WL 3534469, *9 (S.D.N.Y. Dec. 22, 2005).

[24] In re Omnivision Techs., Inc., 2005 WL 1867717 at *3.

[25] 2005 WL 1030195 at **1, 3, 11.

[26] See In re Alamosa Holdings, Inc. Sec. Litig., No. Civ. A. 5:03 CV 289-C, 2005 WL 712001, *15 (N.D. Tex. Mar. 28, 2005).

[27] 2005 WL 2465041 at *13.

[28] Dresner, 371 F. Supp. 2d at 500.

[29] In re Geopharma, Inc. Sec. Litig., No. 04 Civ. 9463 SAS, 2005 WL 2431518, *11 (S.D.N.Y. Sept. 30, 2005) (dismissing lawsuit alleging that company misrepresented precise nature of FDA approval status, where that was public information and defendants would have known that reporters would check on any assertion about the status and hence deflate any misrepresentations within five days).

[30] In re JP Morgan Chase Sec. Litig., 363 F. Supp. 2d 595, 621 (S.D.N.Y. 2005).

[31] 2005 WL 2030501 at **10-11.

[32] In re Best Buy Co., Inc. Sec. Litig., No. C 03-6193 ADM AJB, 2005 WL 839099, *5 (D. Minn. Apr. 12, 2005).

[33] See also Schleicher v. Wendt, No. 1:02 CV 1332 DFHTAB, 2005 WL 1656871, *4 (S.D. Ind. July 14, 2005) (dismissing lawsuit alleging that the former officers of bankrupt financial services company misled investors about the success of their turnaround efforts, where the company's SEC filings during class period had been "replete with other bad news" separate from accounting issues later raised in bankruptcy and by plaintiffs); In re Acterna Corp. Sec. Litig., 378 F. Supp. 2d 561, 577 (D. Md. 2005) (dismissing lawsuit alleging that bankrupt network services company failed to write down goodwill from two acquisitions dismissed, where company disclosed "abysmal financial results" during the class period, results it attributed in part to the acquisitions).

[34] See SEC Votes to Propose Changes to Disclosure Requirements Concerning Executive Compensation and Related Matters (Jan. 17, 2006) (https://www.sec.gov/news/press/2006-10.htm).

[35] Barrie v. Intervoice-Brite, Inc., 397 F.3d 249, 261 (5th Cir.), order modifying opinion to correct inadvertent errors, 409 F.3d 653 (2005).

[36] Greater Pennsylvania Carpenters Pension Fund v. Whitehall Jewellers, Inc., No. 04 C 1107, 2005 WL 61480, *2 (N.D. Ill. Jan. 10, 2005).

[37] Primavera Investors v. Liquidmetal Technologies, Inc., No. 8:04 CV 919 T 23EAJ, ___ F. Supp. 2d ___, 2005 WL 3276291, *2 (M.D. Fla. Dec. 2, 2005). In a related topic, two securities cases have been brought against companies that allegedly misstated or lacked internal controls regarding compensation expenses, arising from issues concerning employee stock options. Smajlaj v. Brocade Communications Sys. Inc., No. C 05-02042 CRB (N.D. Cal.); Singhal v. Mercury Interactive Corp., No. 3:05-cv-04036-PJH (N.D. Cal.).

[38] In re Ariba, Inc. Sec. Litig., No. C 03-00277 JF, 2005 WL 608278, *1 (N.D. Cal. Mar. 16, 2005).

[39] In re HiEnergy Technologies, Inc. Sec. Litig., 2005 WL 3071250 at **1, 4.

[40] Simons v. Dynacq Healthcare, Inc., No. Civ. A. H-03-5825, 2005 WL 1801946, *5 (S.D. Tex. July 28, 2005).

[41] In re Alstom SA Sec. Litig., 2005 WL 3534469 at *31.

[42] See, e.g., Securities & Exch. Comm'n v. KPMG LLP, No. 03 Civ. 671 DLC, 2005 WL 3540252, **6-7 (S.D.N.Y. Dec. 28, 2005) (motion for summary judgment by remaining individual defendants granted in part and denied in part in lawsuit arising from accounting practices that were most egregiously wrong at company's foreign subsidiary); Higginbotham, 2005 WL 1272271 at *4 (lawsuit alleging false financials by pharmaceutical company, filed following restatement caused by, inter alia, a price-fixing cartel in its Brazil subsidiary).

[43] 357 F. Supp. 2d at 355.

[44] 2005 WL 2007004 at *56.

[45] Id. at 499.

[46] 2005 WL 1324880 at *17; see also Alaska Elec. Pension Fund v. Adecco S.A., 371 F. Supp. 2d at 1213 (claim that company improperly delayed write-off of uncollectible receivables not stated where, inter alia, complaint alleged that management directed all branch offices to collect receivables).

[47] 55 F. Supp. 2d at 1376 ("That Defendants generally disclosed the troubles in its Latin American operations urges against an across the board inference of scienter, as does the fact that Defendants, and not some outside entity, initiated the inquiry into the impairment of the goodwill that resulted in the write down."); see also In re Stonepath Group, Inc. Sec. Litig., 397 F. Supp. 2d 575, 581-83 (E.D. Pa. 2005) (dismissing lawsuit against company that issued three restatements following problems in welding together the legacy systems of acquired companies that had led to accounting errors, where management admitted one of the mistakes and said that it was working on fixing them in the course of Sarbanes-Oxley compliance, and the company was unusually explicit in disclosing the reasons for the errors).