GEORGIA NORTH CAROLINA SOUTH CAROLINA VIRGINIA WASHINGTON, D.C.
WORLDCOM DIRECTORS PAY SETTLEMENT FROM PERSONAL ASSETS January 20, 2005 This month, 10 of the 12 former outside directors of WorldCom, Inc. (“WorldCom”) reportedly agreed to settle In re WorldCom Securities Litigation, a class action lawsuit against them alleging violations of federal securities laws that was brought by WorldCom’s bondholders and stockholders following WorldCom’s collapse. Pursuant to the proposed settlement, the 10 directors agreed to pay an aggregate of $56 million to the plaintiffs. One of the unusual aspects of this proposed settlement is that it was supposedly reached only after each defendant director agreed to pay an amount equal to 20% of the director’s net worth, excluding the value of the director’s primary residence, retirement accounts and certain other assets. The total settlement to be paid by the settling directors is reported to be $18 million, with the remainder of the settlement amount being funded from insurance proceeds. In addition, the same week that the proposed WorldCom settlement was reported, it was also reported that 10 of the 18 outside directors of Enron had agreed to pay a total of $13 million from their personal assets to settle claims brought against them. Although these proposed settlements are subject to the approval of the federal courts handling the cases, they have raised fears among many outside directors that serving on the Boards of Directors of public companies may no longer be worth the risk. Background Following WorldCom’s bankruptcy in 2002, a special investigative committee of WorldCom’s newly-appointed Board of Directors was appointed to investigate the alleged accounting fraud. The special committee released a report in June 2003 that found, among other things, that the accounting fraud perpetrated by WorldCom’s management was a consequence of the corporate culture cultivated by WorldCom’s Chief Executive Officer and that “[t]he Board and its Committees did not function in a way that made it likely that they would notice red flags. The outside Directors had little or no involvement in the Company’s business other than through attendance at Board meetings.” The plaintiffs, led by the New York State Common Retirement Fund, filed suit against WorldCom’s management and Board of Directors in 2002 for violations of federal securities laws resulting from the inclusion of fraudulent financial data in the prospectuses relating to certain debt and equity offerings prior to the bankruptcy. The defendant directors suffered a setback when the judge in the case ruled last month that a certain WorldCom prospectus contained materially false and misleading information.
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Impact of Proposed Settlement on Outside Directors The significance of the WorldCom directors’ proposed settlement is not the legal theories of the directors’ liability; rather, it is the recent trend of lead plaintiffs insisting in cases such as WorldCom and Enron that payments made in settlement come from directors’ personal assets. It has been reported that the New York State Common Retirement Fund has consistently taken the position since the complaint was filed that any settlement of the charges against the defendant directors would be conditioned on the directors personally paying a significant portion of the settlement amount. Due to the attention that these two settlements have received, it is likely that future lead plaintiffs in securities fraud cases will demand that director defendants contribute some of their personal funds toward a settlement. In addition, in 2003, the Securities and Exchange Commission (“SEC”) policy to include provisions in settlement agreements requiring settling parties to forego their rights to indemnification and reimbursement by insurers for payments of civil fines. In addition, Stephen Cutler, Director of the SEC’s Division of Enforcement, recently warned that the conduct of outside directors would receive increased SEC scrutiny, stating “[o]ver the next year, we intend to continue focusing closely in our investigations on whether outside directors have lived up to their roles as guardians of the shareholders they serve.” Since the enactment of the Sarbanes-Oxley Act and related reforms in the aftermath of the collapse of WorldCom and Enron, the importance of effective oversight has been impressed upon outside directors. Although these reforms may make the kind of fraud perpetrated by Enron and WorldCom less common, the consequences to outside directors of failing to identify and prevent such fraud now appear even more serious. The measures that outside directors need to take in order to diligently fulfill their obligations in identifying and preventing fraud are obviously specific to the company in question. However, the following suggestions are general steps that should benefit anyone currently serving or considering serving as an outside director: • Due Diligence. Conduct a thorough due diligence investigation of a company and its management prior to accepting an offer to join a Board of Directors. Consult with legal counsel to ensure that the company’s directors’ and officers’ insurance and the indemnification provisions of the company’s governance documents are sufficient. Corporate Culture. Ensure that the “tone at the top” is consistent with the highest ethical standards and that management is dedicated to an ethical corporate culture in which management leads by example. Ensure that the Company has adopted and is monitoring and enforcing strong corporate governance policies and controls. Proactive Governance. Dedicate the time and attention necessary to make thoughtful and informed decisions on issues brought before the Board of Directors. Thoughtful analysis is possible only if directors are diligent in reading all materials distributed to the Board and thoroughly discussing such issues with relevant members of management and other directors. Any issues or problems that come to a director’s attention should be brought before the Board and discussed in detail. Transparency. Insist that management be completely accessible to directors and willing to let directors challenge them. If management is not open and candid with directors and does not allow them to ask difficult questions, it will be very difficult
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for the Board of Directors to be comfortable that it has the complete picture of what is going on with the company. Independence. Directors should be conscious of any act or relationship that would suggest that they are acting in the interests of anyone other than the company and its shareholders. Where appropriate, directors (especially audit committee and compensation committee members) should not hesitate to obtain the advice of separate legal counsel and other experts in making decisions.
Conclusion The foregoing discussion is intended to be only a summary of the issues raised by the proposed WorldCom and Enron settlements. If you would like to discuss the implications of the WorldCom and Enron settlements or corporate governance issues generally, please contact the Womble Carlyle attorney with whom you work or any one of the lawyers listed below. Garza Baldwin, III Glenn A. Brown Meredith P. Burbank Elizabeth O. Derrick Jeffrey C. Howland Leigh R. Johnson (704) 331-4907 (404) 962-7515 (704) 331-4949 (404) 888-7433 or (864) 255-5415 (336) 721-3516 (919) 484-2345 Jane Jeffries Jones G. William Joyner III Clifford J. Lawrence Alonzo L. Llorens Keith J. Mendelson Ross H. Parr Kenneth N. Shelton (704) 331-4953 (336) 721-3579 (864) 255-5418 (404) 888-7353 (703) 394-2246 (704) 331-4925 (919) 484-2319
Womble Carlyle client alerts are intended to provide general information about significant legal developments and should not be construed as legal advice on any specific facts and circumstances, nor should they be construed as advertisements for legal services.
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