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Securities class action lawyers are preparing for the next wave of shareholder lawsuits as more companies and their top executives face federal probes and accounting restatements linked to the backdating of their stock options. In the past month, dozens of shareholder suits have been filed on behalf of large institutional shareholders by a number of law firms, including well-known plaintiffs’ firms Bernstein Litowitz Berger & Grossmann of New York and Lerach Coughlin Stoia Geller Rudman & Robbins of San Diego. The suits allege that certain companies backdated stock options granted executives to enhance the profits the executives made when they exercised the options. Backdating stock options is at the heart of recent inquiries by the U.S. Securities and Exchange Commission (SEC) and Justice Department. So far, more than two dozen companies have been targeted, many of which have restated their earnings or ousted their top executives. Meanwhile, lawmakers have been debating in recent weeks whether to seek stricter regulations than those being proposed by the SEC regarding executive compensation. “This is probably the biggest corporate scandal since the Enron days,” said Mario Alba, a lawyer at Lerach Coughlin, which is investigating 30 companies for potential lawsuits over the backdating of stock options. “These companies are manipulating their books to make themselves look profitable.” The suits come at an opportune time for securities litigation firms because one of the most aggressive of such firms, Milberg Weiss Bershad & Schulman of New York, was recently indicted on conspiracy charges. But some lawyers said that the cases will be difficult to prove and face challenges over statutes of limitations. “It’s going to turn a lot on the facts and circumstances,” said Joseph Serino, a partner in the New York office of Kirkland & Ellis. “The plaintiffs are going to have to prove fraudulent intent, and that’s not easy to prove.” A mea culpa The issue of backdating first came to light earlier this year after a series of media reports questioned why top executives at several companies had unusually good luck in obtaining grants of shares just before large upswings in value. Since then, federal authorities have contacted more than two dozen companies including KLA-Tencor Corp., McAfee Inc., Analog Devices Inc. and UnitedHealth Group Inc., which announced in May that it might have to restate earnings by as much as $286 million due to improper stock-option backdating. Other companies have restated earnings or fired executives following their own internal investigations. In the past week, Sycamore Networks Inc. said that it received a grand jury subpoena, and that the SEC has launched a formal investigation into the company’s stock-option practices. Sycamore has since restated its financial reports from 2000 to 2005. Also last week, McAfee’s board fired its general counsel, Kent Roberts, after discovering that he had received improper stock-option grants in 2000. “Anytime you have allegations of regulators and corporations issuing any kind of mea culpa, that is the batphone ringing in the law firms of plaintiffs’ lawyers,” Serino said.Stock-option backdating is a “gigantic issue” for institutional investors, many of which have brought the suits, said Rosemary Lally, an editor at the Washington-based Council of Institutional Investors. “It involves an awful lot of money,” she said. She added, “there was always suspicion that might be going on, but this is confirmation that it was.” Law firms are filing two types of shareholder suits over stock-options backdating: derivative claims and securities actions. Most of the derivative claims allege breach of fiduciary duty and are filed by institutional shareholders on behalf of the company as a whole. They seek the return of the stock options. Last month, Bernstein Litowitz filed a derivative suit in federal court in Minnesota on behalf of five public pension funds alleging that top executives of UnitedHealth regularly received stock options at annual lows. St. Paul Teachers’ Retirement Fund Association v. McGuire, No. 06cv01959 (D. Minn.). The funds are asking that $2 billion in unexercised stock options, which were granted to two of the executives from 1997 to 2002, be returned to the company, said Gerald Silk, a member of Bernstein Litowitz. The UnitedHealth suit is the first filed by Bernstein Litowitz over stock-option backdating, but Silk said he has been in discussions with other clients about additional lawsuits. “I imagine there will be other lawsuits in the near future on behalf of our institutional client base against these companies,” he said. Two other UnitedHealth suits, filed by Grant & Eisenhofer, recently joined with Bernstein’s case and are awaiting the appointment of a lead counsel. But Jay Eisenhofer, managing partner of the Wilmington, Del.-based firm, admitted that proving breach of fiduciary claims could prove difficult. “The rules are set up so that honest directors can operate without shareholders suing them every time they make a mistake,” he said. “Those same rules can also operate to protect dishonest directors and management from being accountable for things like this,” Eisenhofer said. “That is the difficult thing about any breach of fiduciary duty suit.” Calls seeking comment from UnitedHealth were not returned. Anti-fraud statutes Other lawyers have sued companies over backdating stock options by bringing standard securities class actions, citing anti-fraud provisions of the U.S. Securities Exchange Act of 1934. Those suits are seeking the damages caused to individual shareholders who allege that they were misled by statements in the financial reports. Several suits have been filed against Affiliated Computer Services Inc. and Vitesse Semiconductor Corp., which have been contacted by both the SEC and the Justice Department. In May, Lerach Coughlin filed a securities action against Comverse Technology Inc. on behalf of shareholders who purchased stock from Dec. 14, 2004, to March 13, 2006. David Thomas v. Comverse Technology Inc., No. 06cv03445 (S.D.N.Y.). The case alleges that Comverse issued false financial reports because of backdated options granted to two of its executives, founder and Chief Executive Kobi Alexander and Chief Financial Officer David Kreinberg. The suit was filed two days after those executives resigned. Alba of Lerach Coughlin, one of the lawyers handling the case, said he expects the firm to file derivative suits, which require more investigation. He said: “A lot of people have them in the woodwork rather than spinning out one after the other.” Comverse officials declined to comment. The plaintiffs’ bar faces several challenges in both types of suits, however. Serino of Kirkland & Ellis said that companies may claim that low prices on the shares’ exercise dates were a coincidence or innocuous. Also, the damages could be limited. “I’m not sure it’s going to be a huge dollar case,” Serino said, “unless it’s really, really widespread and lots of executives are at one particular company.” Defense attorneys are also quick to point out statue of limitations issues with the recent stock-option backdating cases. Bruce Vanyo, a partner in the Los Angeles office of Katten Muchin Rosenman, said that the statute of limitations under the Sarbanes-Oxley Act of 2002 is two years from the date of discovery and five years from the event, and that many of the suits filed involve options granted more than five years ago. But Vanyo also said defense attorneys could argue that Sarbanes-Oxley, which extended the statute of limitations under the Securities Exchange Act, does not apply retroactively to options granted before 2002. What’s more, plaintiffs’ lawyers have argued that because the backdating was only recently revealed, the suits fall within the two-year discovery time limit.

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