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With challenges to the backdating of executive stock options proliferating, plaintiffs attorneys are jockeying for control of potentially lucrative litigation. More than 60 companies are being investigated by the U.S. Department of Justice and/or the Securities and Exchange Commission, and executives or directors from at least six of those companies have left as a result of allegations of improper conduct. The U.S. Attorney’s Offices in the Southern and Eastern Districts of New York have both issued backdating subpoenas. But plaintiffs attorneys are not waiting for indictments. They have already filed billions of dollars in lawsuits, and more are in the pipeline. “It’s the biggest thing going on in my field,” Eric L. Zagar, an associate at the Pennsylvania-based law firm Schiffrin & Barroway who specializes in shareholder derivative litigation and whose firm has filed at least 34 suits as the result of backdating. Gerald H. Silk, a partner at Bernstein Litowitz Berger & Grossman, said that “since this scandal has erupted, I’ve had dozens of calls from potential plaintiffs looking for some kind of recourse.” The firm has filed 10 suits, including eight derivative actions and two class action claims. Backdating complaints are pending in both the Southern and Eastern Districts and in state court. For example, in the Southern District, individual shareholder Ruthy Parnes filed a derivative suit on behalf of Monster Worldwide accusing 12 current and former top executives and the current members of its board of directors of breaches of fiduciary duties, gross mismanagement, unjust enrichment and violations of ��10(b) and 14(a) of the Securities and Exchange Act of 1934 between 1997 and the present. “The Options Defendants have engaged in … the exercise of back-dated options to reap millions of dollars in unlawful windfall profits at the expense of the company,” Parnes asserted in her complaint filed last month. Ruthy Parnes v. Andrew J. McKelvey, 06cv4622. Meanwhile, investor Bruce Braverman filed a derivative suit in the Eastern District on behalf of Comverse Technology against certain of the company’s senior executives and directors. He charged that, as a result of decisions by company directors and executives, the exercise dates for stock options were set “at times that allowed the holders to reap extraordinary and improperly obtained profits.” Braverman v. Kobi Alexander, 06cv2017. Braverman also listed Comverse as a nominal defendant in the case. HOW IT BEGAN The backdating scandal came to light as the result of research last year by Erik Lie, an associate professor at University of Iowa’s Henry B. Tippie College of Business. Lie noticed that many executives had made significant profits from their stock option grants and concluded that their gains could be explained only by backdating. Lie compared the backdating of stock option grants by executives to insider trading. He said that stock options are usually set to equal the market price of the underlying stock on the grant date. Since the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest. Then, they can sell the shares they acquire when prices rise. “Backdating, or marking a document with a date that precedes the actual date, allows executives to choose a past date when the market price was particularly low, thereby inflating the value of the options,” Lie said in a telephone interview. He stressed, however, that backdating is not illegal if it is clearly communicated to the company’s shareholders and is properly reflected in earnings and tax filings. A recent paper by Lie and his colleague Randall A. Heron of Indiana University estimates that, from 1996 to 2002, 23 percent of “unscheduled, at-the-money option grants” to top executives were backdated or otherwise manipulated. That translates to more than 2,000 companies. PLAINTIFFS ATTORNEYS RESPOND As these allegations have unfolded, some plaintiffs attorneys are courting large institutions when filing derivative suits, while others have snatched up mom-and-pop investors. “This is a make-or-break issue,” said Silk of Bernstein Litowitz. “You are talking about who controls the destiny of the cases in this potentially massive arena.” Attorneys for institutions argue that businesses have the financial means and capability to oversee this type of litigation, while attorneys for individuals say that their clients also have a right to accountability. Jay W. Eisenhofer, a partner at Grant & Eisenhofer, said that “institutions have the largest economic stake, so it seems only sensible that they serve as lead plaintiffs.” Eisenhofer said that most courts, if given a choice, will appoint an institutional investor to be lead plaintiff. But Jacob Zamansky, a partner at Zamansky & Associates in New York, argues that individual investors should serve as lead plaintiffs in these circumstances because “individual investors are the ones who have been cheated” by corporations whose executives have improperly backdated stock options. Zamansky, admits, however, that the average investor rarely has the financial wherewithal, in comparison with institutional investors, to bring derivative suits. “Institutional investors have the resources to fight like hell to make sure that corporations be held accountable,” he said. Jeffrey S. Abraham, a partner at Abraham Fruchter & Twersky who represents Braverman in the Comverse action in the Eastern District, said in an e-mailed statement that, unlike institutions, Braverman is “not distracted by the need to litigate any other shareholder actions and, as a result, he is more than adequate to advance the interests of his fellow Comverse shareholders in the shareholder derivative litigation.” WHY DERIVATIVE SUITS Silk said that most backdating litigation involves derivative actions, not securities class action suits. He said that derivative actions are more common in these backdating cases because, in order to have a securities class action under Rule 10-b(5), the stock has to fall and an investor has to demonstrate harm. This has not always been the case when it comes to the backdating scandal. A derivative suit is a civil lawsuit filed by shareholders on behalf of a corporation. In these suits, shareholders are looking to enforce corporate rights against directors or other insiders. Derivative lawsuits differ from class action lawsuits, in which a large group of plaintiffs — either shareholders or other entities — bring a suit in their own right. In the class action arena, the law specifically favors having institutions serve as lead plaintiffs. But there is no law that governs who should be a lead plaintiff in a derivative suit, in part because derivative suits are governed by state law. And, unlike in class action lawsuits, plaintiffs are not forced to wait 60 days before filing an action. As a result, attorneys for institutions in these cases have expressed concern that their counterparts who represent individual investors are hastily rushing to file as many backdating cases as possible. “Their business model is predicated on getting to the courtroom steps as soon as possible,” Silk said. He added that, unlike individuals, institutions are going to be diligently involved in a case, instead of being a “nominal plaintiff.” “Institutional investors have the fiduciary experience, sophistication and independence to make demands from defendants that have real teeth, and would likely not carry the same weight coming from a small individual shareholder who is controlled by counsel,” he said. This is important because, according to Federal Rules of Civil Procedure �4, Rule 23.1, a derivative action may not be maintained if “it appears that the plaintiff does not fairly and adequately represent the interests of the corporation or association.” But attorneys for individual investors argue that their clients are performing an important service. “We sometimes file on behalf of individuals because it is not always easy to get institutions interested in devoting their litigation resources to a specific case,” said Zagar of Schiffrin & Barroway. He also stressed that, unlike in securities class action suits, in derivative cases any recovery goes directly back to the company. “The benefit to the shareholder is indirect,” Zagar said. As a result, if an institution or corporation is focused specifically on the “bottom line,” filing a derivative suit might not be appealing. Zagar said that some individual investors represented by his firm in these cases own a large number of shares (“as many as several thousand”), while others have a small stake but are “concerned enough to step up and do the right thing.” He also explained that if a plaintiffs attorney is successful in this kind of derivative suit, the attorney will apply to the court for a fee. That court-governed fee is based on “a percentage of whatever the recovery is.” DEFENSE LAWYERS MOBILIZE Defense lawyers have also taken action to cash in on the backdating scandal. Mark J. Biros, a partner at Proskauer Rose who heads the firm’s corporate defense practice area, said his firm has contacted present clients through “internal marketing” to notify them of backdating enforcement trends so they they can identify how to react or respond. The firm has established what Biros describes as a multidisciplinary task force that can help corporations understand the backdating issue from a “variety of frames of references.” Other firms, like O’Melveny & Myers, have offered to conduct internal investigations for corporations into possible backdating irregularities. O’Melveny is representing Mercury Interactive in its multimillion-dollar internal backdating investigation.

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