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The litigation over WorldCom Inc.’s historic accounting fraud took a major step forward Dec. 15 as a federal judge decided summary judgment motions in the case. Judge Denise Cote of the Southern District of New York set the stage for a Feb. 28 trial that pits aggrieved investors against 16 investment banks defending their role in bond offerings totaling $17 billion that the telecommunications giant made in 2000 and 2001. Investors allege that both the 2000 $12 billion offering, the largest in history, and the $5 billion offering the following year were successful because public filings on the offerings contained material omissions about the financial health of the soon-to-be bankrupt company. Those omissions, they claim, hid enormous financial problems at WorldCom. Thus, J.P. Morgan and the other banks that underwrote the offerings should be held liable for their losses, they say. The company’s true financial picture was revealed to the public in June 2002, when WorldCom announced it would have to restate its financial reports because an internal audit revealed that billions of dollars in expenses associated with leasing the communications lines of third-party carriers, so-called line costs, had been buried in the capital accounts portion of the budget. The alleged aim of the shift of line costs to capital accounts was to paint a rosy picture of the company’s financial condition and boost its stock price. One result, in addition to the company’s bankruptcy, was the filing of criminal charges against WorldCom Chief Executive Bernard Ebbers and several top executives, including former Chief Financial Officer Scott Sullivan. Among other executives, Sullivan has pleaded guilty in the case and is expected to be a key witness for the government when Ebbers goes on trial in January. Another result was a wave of investors’ lawsuits consolidated before Judge Cote by the Panel on Multidistrict Litigation under Master File 02 Civ 3288. The lead underwriters for the two key bond offerings players, Citigroup and its investment banking arm, Salomon Smith Barney, as well as Salomon’s lead telecommunications analyst, Jack Grubman, agreed earlier this year to pay $2.57 billion to settle the allegations. That left J.P. Morgan and the remaining banks in a case where the plaintiffs are seeking as much as $9 billion in damages. Last Wednesday, Cote pared the case down for trial in issuing a 155-page opinion. She granted the lead plaintiffs’ motion for summary judgment on the 2001 registration statement for the bond offering “insofar as it reported line costs in Worldcom’s first quarter financial statement for 2001,” finding that the company’s interim financial statements were false and misleading. But Cote also granted summary judgment for the defendants on some of a series of omissions in the 2000 and 2001 registration statements — omissions of facts about WorldCom’s financial condition that plaintiffs claim would have changed investors’ minds about buying the company’s bonds. KEY OMISSIONS An attorney for the plaintiffs says the alleged omissions that Judge Cote kept in the case were the key ones they fought for on summary judgment. “We are obviously pleased with the grant of partial summary judgment in our favor,” says John Coffey of New York’s Bernstein Litowitz Berger & Grossman, which along with Barrack, Rodos & Bacine of Philadelphia is counsel for the lead plaintiff in the action. “We look forward to laying out at trial the role of underwriters in the WorldCom debacle.” Coffey points to the section of Cote’s opinion in which she said that underwriters cannot simply rely on audited statements or so-called comfort letters from accountants to satisfy their obligation to investigate a company’s financial condition before they underwrite an offering. “If red flags arise from a reasonable investigation, underwriters will have to make sufficient inquiry to satisfy themselves as to the accuracy of financial statements, and if unsatisfied, they must demand disclosure, withdraw from the underwriting process, or bear the risk of liability,” Cote wrote. The underwriters claim that they will be able to demonstrate at trial that they showed continuous due diligence with respect to WorldCom and therefore made a reasonable investigation of both bond offerings. Attorneys for the defendants could not be reached for comment. Mark Hamblett is a staff writer for the New York Law Journal , the ALM newspaper where this article first appeared.

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