ANGER MANAGEMENT
Shareholder Lawsuits Have Surged in Past Few Years; OC Companies Face Investors
By CHRIS CZIBORR
Lawyers can thank audit-related scandals for keeping them busy with a spate of securities class action lawsuits.
Accounting restatements are the basis for many of the suits, according to Wayne Smith, Irvine-based co-chair of Gibson Dunn & Crutcher LLP’s securities litigation practice.
“With the collapse of Arthur Andersen, a lot of companies got new auditors who want to scrub everything on the books because of heightened concerns as a result of Enron,” Smith said. “We ended up with quite a few restatements,a whole host of those ended up generating new lawsuits.”
In recent years class action suits were on the increase on pace with disgruntlement among investors in the bear market.
“Two things drive these cases: stock market and economic conditions,” said Todd Gordinier, who chairs Newport Beach law firm Stradling Yocca Carlson & Rauth’s securities litigation practice.
“When the market is going up and economic conditions are bright, people don’t have problems with their stockholdings or with accounting.”
These days accounting related issues are just as likely to be a reason for filing a suit.
In general, class action suits are filed by one or several people on behalf of a larger group. Related to securities, the suits are filed by investors who say they are victimized by alleged fraud committed in connection with the purchase or sale of stock or other securities.
A study from the Stanford University Law School says that the annual number of securities suits that didn’t involve initial public offerings or Wall Street analysts jumped 33% to 227 last year.
Suits related to initial public offerings,very popular two years ago as hot new issues in the late 1990s tanked soon after,totaled just 1 last year, vs. 312 in 2001.
A caveat: New York Attorney General Elliot Spitzer’s office consolidated several dozen cases related to initial public offerings into a single case last year.
The cases can be painful for a company’s bottom line.
“It’s a reflection of continuing economic difficulties that has different forms of fallout for different companies,” Gordinier said. “You’ve got companies struggling and they have to restate numbers for a variety of reasons,many reasons could be perfectly innocent.”
Costa Mesa storage networking products maker Emulex Corp. two weeks ago said it reached a $39.5 million settlement in a securities class action lawsuit brought against the company and some of its directors and officers in 2001.
Plaintiffs alleged that Emulex violated federal securities laws by issuing false and misleading statements regarding the company’s financial results and business. As a result, the price of Emulex common stock traded at “artificially inflated” levels, they said.
Under the settlement, all claims were to be dismissed in exchange for the payment. Emulex was to receive 32% of the settlement thanks to its directors and officers insurance.
The company will take a $16.7 million charge to cover the rest.
Other recent Orange County cases include a suit against Costa Mesa microelectronics gear maker Irvine Sensors Corp.
There, the class action suit claimed the company and some of its officers and directors violated the Securities Exchange Act of 1934.
Shareholders say that Irvine Sensors made false and misleading statements about prospects for its Silicon Film unit in 2000 and 2001. The company said it had developed a canister that turned film cameras into digital ones. But it never got the product into volume production and the company closed Silicon Film in 2001.
The suit alleges Irvine Sensors’ stock price was kept artificially high during the class period. It traded from a high of $14 to a low of less than 1. The case is ongoing.
Meanwhile, the king among class action law firms, New York-based Milberg Weiss Bershad Hynes & Lerach LLP, filed suit in November against Irvine-based Endocare Inc., which makes medical devices to treat prostate cancer.
Some officers and directors also were targeted, as is normal in such suits.
Milberg, Weiss claims Endocare, like Irvine Sensors, violated the Securities Exchange Act by misleading shareholders. As a consequence, Endocare’s stock price was kept artificially high, the law firm said.
“As a result of this inflation, Endocare was able to complete a public offering of 4 million shares, raising proceeds of $68 million on November 16, 2001,” read a Milberg, Weiss statement on the suit.
The company shocked shareholders in late October 2002 with a 42% one-day share price plunge to 3.02 after saying that it was delaying the release of its quarterly results because it needed to review its numbers.
In April, the company hired Ernst & Young LLP as its auditor after terminating KPMG LLP a month earlier. KPMG had withdrawn the company’s 2001 results in December and said Endocare’s first-half 2002 figures couldn’t be relied on.
In December, Endocare fired its vice president of finance for “misconduct,” the company said.
The company’s trouble doesn’t end with Milberg, Weiss. Endocare recently learned that the Securities and Exchange Commission and the Department of Justice are investigating the company’s accounting practices in connection with its 2001 and 2002 financial statements.
Shares of Endocare now trade on the low profile Pink Sheets.
OC attorneys say tech companies are especially vulnerable to securities class action litigation.
“High tech always has been the prime target for such suits,volatility makes for good targets,” said Gibson, Dunn’s Smith. “It’s that sharp drop in the price of the stock that can trigger one of these filings.”
A number of law firms and shareholders jumped on Irvine computer networking device maker Lantronix Inc. last year.
Los Angeles-based Weiss & Yourman, for instance, filed a suit against Lantronix and some directors and officers for shareholders who bought stock between April 25, 2001 and Feb. 6, 2002.
The complaint is based on the company’s Feb. 6 announcement, in which Lantronix said it would retroactively record a charge to its first-quarter financial results, miss its forecasts for the second quarter, and lower its outlook for the rest of the year, due to a change in its method of accounting for revenue.
Soon after, Lantronix fired its chief financial officer. The suit is ongoing.
Lantronix has caused class action lawsuits targeting others, too. Credit Suisse First Boston Corp. was the subject of a suit filed by New York law firm Rabin Murray & Frank LLP.
It said that the Switzerland-based investment bank issued and maintained a “buy” recommendation on Lantronix securities “without any rational economic basis,” according to Rabin, Murray.
Shareholders also complained Credit Suisse “failed to disclose that they were issuing and maintaining these recommendations to obtain investment banking business” and that the firm “concealed significant, material conflicts of interest that prevented them from providing independent and objective analysis,” according to the law firm.
There could be better news for companies in 2003, according to Mike Hornak, a partner with Costa Mesa law firm Rutan & Tucker LLP.
“I expect a general leveling off of (lawsuit) activity,” he said. “The increase in number of non-IPO cases is an indication of the state of the economy. I expect things will stabilize as the economy improves.”
Hornak also said many of the companies targeted by class action suits saw a plunge in their stock prices in the past few years regardless of whether there was any securities fraud.
