WorldCom Fraud Was Obvious to Its Banks, Fund Says
By Bloomberg News
Friday, June 25, 2004
J.P. Morgan Chase & Co., Bank of America Corp. and other underwriters of WorldCom Inc.'s securities should have known the long-distance company was engaged in fraud before funding the second-largest bond issue in U.S. history, investors suing the banks said in court papers.
Investors cited WorldCom documents obtained in pre-trial evidence gathering to show discrepancies between actual company expenses and reported expenses. The banks should have noticed the discrepancies before underwriting a May 2001 $10.1 billion bond issue, investors argue. WorldCom, which filed the largest bankruptcy in U.S. history in 2002, restated $11 billion in earnings after disclosing misstatements of its finances.
``If petitioners had asked to see the most basic reports routinely prepared by WorldCom -- such as budgets and periodic reports that tracked such key financial indicators as operating costs and capital expenditures, they would have immediately seen that WorldCom's actual financial results differed wildly from the results that were being publicly reported,'' investor lawyer Sean Coffey argued in a brief filed June 21.
The investors' suit, which alleges securities fraud by WorldCom's former officers, underwriters and accountants, singles out the banks for not having performed ``due diligence'' in evaluating company finances before underwriting the bonds. The filing comes at what U.S. District Judge Denise Cote in New York has called a ``watershed'' moment as the banks face increasing pressure to settle as a trial of the suit approaches.
Denied Wrongdoing
The brief was filed to oppose an appeal by the banks of Cote's rejection of a two-month delay of the trial, which is set to start Jan. 10 in New York. The New York State Common Retirement Fund represents shareholders and bondholders in the class action, which was filed against the banks and other defendants in 2002.
The banks have denied any wrongdoing. WorldCom, which became MCI Inc. after emerging from bankruptcy earlier this year, was not sued.
Investors say WorldCom fraudulently reduced its expenses in 2001 and 2002 by hiding line costs in the capital budget, rather than reporting them as operating expenses. Investment banks that underwrote WorldCom securities are the primary targets of the litigation because they have assets large enough to settle the multibillion-dollar claims or pay a judgment.
On April 20, 2001, the same day of a ``kickoff'' meeting for the May 2001 offering, WorldCom's financial planning office distributed a March 2001 capital expenditure report to WorldCom employees, investor lawyers Coffey and Jeffrey Golan said in the brief. The report showed capital expenditures in the first quarter of 2001 of $1.69 billion, they said.
Should Have Known
Six days later, WorldCom said in a press release that its 2001 first quarter capital expenses were $2.23 billion, the pension fund lawyers wrote.
The brief includes WorldCom documents from 2001 showing discrepancies in company books that the banks could have accessed, according to investors. In an April 1 letter to Cote, the banks' lead lawyer Jay Kasner said he would prove at trial that his clients had relied on WorldCom officers and conducted an investigation into its finances that could have reasonably been expected to reveal any fraud in WorldCom's books.
Under federal law, a bank that underwrites the securities of a company that issues false financial reporting can be held strictly liable for investor losses. The only defense banks have is to show that they couldn't reasonably have been expected to find such fraud in the performance of a due-diligence investigation.
Fraudulent Capitalization
Coffey argued that depositions of WorldCom and bank employees show that the banks had every chance to see WorldCom's fraud.
In a June 4 deposition before both sides, ex-WorldCom treasurer Susan Mayer, who had primary responsibility for dealing with the underwriters in connection with the May 2001 offering, testified that she provided the defendants with ``everything they asked for,'' the pension fund brief said.
J.P. Morgan investment banker Jennifer Nason, in a June 8 deposition conducted by investor lawyers, said she remembers requesting documents from WorldCom ``around '01 capital expenditures.''
Bank of America investment banker Jennifer Bishop, in a June 2 deposition, said WorldCom provided her with all documents that she requested pertaining to the May 2001 bond offering.
``Had petitioners asked any questions about the reasons for this difference, they would have learned that there was no legitimate support for this sudden $544 million increase,'' Coffey wrote in the brief. It was ``an increase resulting from WorldCom's fraudulent capitalization of more than half a billion dollars in line cost expenses that quarter.''
$200 Billion Drop
Kasner, a lawyer with the New York law firm of Skadden, Arps, Slate Meagher & Flom who represents the investment banks, and Coffey, a partner at New York's Bernstein Litowitz Berger & Grossman LLP, declined to comment. Golan, of the Philadelphia law firm Barrack Rodos & Bacine, didn't return an e-mail message seeking comment.
WorldCom, the nation's second-largest long distance company after AT&T Corp., is based in Ashburn, Virginia. It lost $200 billion in value before seeking court protection.
By June 28, the investment banks, including Deutsche Bank AG, Goldman Sachs Group, Lehman Brothers Inc., Credit Suisse Group and UBS Warburg LLC, a unit of UBS AG, must decide whether to accept an offer by Coffey to match the terms of Citigroup's May 11 settlement of its WorldCom liabilities for $2.65 billion.
45-Day Deadline
Plaintiffs lawyers set a 45-day deadline for the banks to choose similar terms, pro-rated to the amount of WorldCom securities they underwrote. The banks are unwilling to settle by the Monday deadline, a person familiar with the matter said.
Coffey has been focusing his court statements on J.P. Morgan. On June 11, Coffey revealed that a J.P. Morgan executive raised questions about WorldCom's line costs weeks before the bank helped underwrite the May 2001 bond issue. J.P. Morgan said the questions were answered before the bonds were sold.
On April 30, Coffey told Cote that J.P. Morgan hedged its own investment in WorldCom bonds by ``several hundred million dollars'' while helping sell the May 2001 bond issue. J.P. Morgan declined to comment on the assertion at the time.
Such hedging would undercut a defense that the bank was sufficiently confident in WorldCom's financial stability to go forward with the bond issue, he told Cote.
Lawyer Concern
Coffey told Cote that he had also found evidence that he said shows that WorldCom's lawyers communicated their concern about bank involvement in the WorldCom bond offering.
The appeal of the trial-delay ruling seeks an extension of time for the banks to prepare, including interviewing star government witness Scott Sullivan, WorldCom's ex-chief financial officer. Sullivan pleaded guilty to criminal fraud charges in March.
Cote has ordered, at the request of prosecutors, that Sullivan and other ex-WorldCom officials who are cooperating with prosecutors not be interviewed by lawyers in the civil case until the end of the criminal fraud trial of former WorldCom Chief Executive Officer Bernard Ebbers, who was charged for his role in the accounting fraud.
The Ebbers trial is expected to last one month, ending in early December, just before the class action trial is scheduled to begin.
Aggrieved WorldCom investors have until the end of August to join the class action, Cote ruled last week.
The case is In re WorldCom Inc. Securities Litigation, 02-CV- 3288, U.S. District Court, Southern District of New York. The appeal is In Re J.P. Morgan Securities Inc., 04-2393, U.S. Court of Appeals for the Second Circuit in New York. |
