VideoWhen 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.
The Gamble
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.
JDS Uniphase, on the other hand, had the deck stacked against it from the start. The trial took place in liberal and diverse Oakland, California, close to JDS Uniphase's headquarters, which meant that the jury would most likely be hostile to business. Getting the defendants to connect with a jury could also be a challenge, as former CEO Jozef Straus had a thick Hungarian-Slovak accent that made him difficult to understand. Plus, there were those niggling hints of insider trading that made the executives look bad no matter what may have actually transpired. CFO Muller sold $35 million worth of stock months before it lost 99 percent of its value; other former executives made hundreds of millions selling the stock before it tanked.
"Those are the things you would look at and think were important but in the end didn't matter," says Adam Savett, head of securities class-action services for RiskMetrics.
What did matter? JDS Uniphase lead attorney Jordan Eth, a partner at Morrison & Foerster LP, credits his win to the credibility of his defendants. "They came across as they were: hardworking veteran execs, one of whom was a co-founder, who had spent their careers building up companies."
The company's basic defense was that none of the executives foresaw the collapse of the telecom industry that brought down JDS's stock starting in late 2000, and therefore did nothing improper by not warning shareholders (or by selling their own stock). Muller's turn on the stand allowed him to show appropriate passion for his former company — he "loved" his job at JDS Uniphase — and drop a mention of an altruistic retirement pursuit, helping low-income youth go to college. He also had a chance to turn on the charm, poking fun at himself as the "company worrier."
As to the insider trades, the defense highlighted that Muller's sales represented less than 20 percent of his total holdings, and that he'd had a practice of selling in the same month in previous years. "The fact that people kept to their previous practices is what you'd actually expect, rather than being suspicious," says Eth. No doubt the jury was also sympathetic to the reasons that Muller stated for selling: he wanted to diversify his holdings, since more than 90 percent of his net worth at the time was in JDS Uniphase stock, and plan for his impending retirement, since JDS didn't have a retirement plan or retiree health benefits.
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