When it comes to class-action securities lawsuits, the operative question is usually when, not whether, to settle. Last fall, however, two companies and their executives ignored that dictum and chose a different path: they called their shareholders’ bluff and went to trial.
One, JDS Uniphase, put former CFO Anthony Muller and other former executives on the stand amid shareholder claims of fraud and insider trading related to the telecom’s 2001 loss of $50.6 billion, still one of the largest in history. The second, Apollo Group Inc., had former executives, including CFO Kenda Gonzales, defend their 2003 decision to initially conceal a preliminary — and negative — Department of Education (DoE) report against the private education company. The total at stake for both companies: up to $20 billion in alleged stock losses.
Few companies have the fortitude to gamble on a judge and jury. Only 20 federal class-action shareholder lawsuits (including these 2) out of the 2,682 filed since 1995 have gone to trial, according to RiskMetrics Group, and 7 of those settled before the juries could reach their verdicts (see the chart link at the end of this article).
The road to the courthouse is starting to look more attractive, however, as the price of settling skyrockets. “The tremendous increase in the dollar value of settlements has greatly altered the economics of securities class cases,” says Steven Scholes, a partner with McDermott Will & Emery. The average settlement spiked from $24.6 million in 2004 to $105 million in 2006, according to Cornerstone Research, and many top the $1 billion mark. “You can see how the balance would tip toward going to trial, if you have a good defense,” says Scholes.
For all those CFOs who sincerely believe they have a good defense against a frivolous shareholder lawsuit, last fall’s trials serve as both inspiration and warning. JDS Uniphase walked away from the courthouse exonerated. Apollo Group faces a verdict in the full amount of damages sought, plus the risk of losing its insurance.
Why did one company win and the other lose? A look behind the scenes reveals how complex and unpredictable these cases can be. In addition, they illustrate that even when the preponderance of evidence appears to favor the company, there is no guarantee the outcome will. But one thing is clear: win, lose, or settle, there’s no such thing as a cheap class-action suit.
If you had placed bets on the outcomes of the trials, Apollo would have been a clear favorite to win. Phoenix, the home of Apollo’s corporate headquarters and its trial, is known as a business-friendly jurisdiction. Lead attorney Wayne W. Smith, a partner with Gibson, Dunn & Crutcher, felt sure that the jury was impartial and intelligent, based on pretrial interviews. The issue seemed fairly simple to explain, there were no charges of insider trading to defend, and the company had the analyst who broke the news of the DoE report lined up in a videotaped deposition to explain why her downgrade wasn’t linked to that assessment.