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The $54 million settlement between class action plaintiffs and 10 former WorldCom directors collapsed Wednesday. Southern District of New York Judge Denise Cote rejected a provision of the agreement that would have limited the ability of the non-settling parties to reduce the amount they would have to pay should they be found liable by a jury. Cote issued a one-page order that did not explain her reasoning. That will come when she issues an opinion. Despite the brevity of the order, it may have far-reaching consequences. WorldCom filed for bankruptcy in 2002 amid news that it had committed an $11 billion accounting fraud. It emerged last year under its former name, MCI, after shedding billions of dollars in debt. Its former CEO, Bernard Ebbers, is currently on trial facing multiple counts of securities fraud and related actions. Other former executives have pleaded guilty to similar violations. In early January, 10 former directors settled shareholder suits agreeing to pay $18 million out of pocket, and their insurers agreed to pay another $36 million. The settlement came as the parties were preparing for trial set to begin on Feb. 28. The remaining defendants were underwriters of WorldCom bonds issued before the company failed. They were accused of failing to fulfill their duty to learn of and disclose the problems. Of the lead underwriters, Citigroup had settled last year, paying out $2.5 billion to injured shareholders and bondholders. J.P. Morgan Chase, Bank of America and 14 others that had not settled objected to the directors’ settlement. They said a portion of the settlement violated the joint and several liability provisions of the Private Securities Litigation Reform Act. One provision of the settlement allowed the non-settling parties — the underwriters — to reduce the amount they would have to pay out should they lose at trial by $54 million or the total financial net worth of the settling directors. If a jury’s ruling turned out to be in the billions, the reduction would be minor. That induced the underwriters to ask Cote to reject this provision, claiming it violated the securities act. The act provides for co-defendants in a securities setting to pay according to the proportion of their guilt as determined by a jury. The act further states that the reduction for the remaining defendants would be as high as the percentage of liability ascribed to the settling defendants. In other words, if the jury found that the defendants should shoulder 50 percent of the blame, then the non-settling parties would pay only 50 percent of the damages, not 100 percent minus the $54 million or total net worth of the directors. Cote’s ruling was limited to this provision but capsized the entire deal. “Regrettably, we have no choice but to terminate the settlement as historic as it is, because we cannot take the risk that a jury verdict against the investment banks might be reduced by an amount substantially higher than the settling directors’ ability to pay,” said John Coffey of Bernstein Litowitz Berger & Grossman, attorneys for the plaintiffs. “We look forward to trying the case against all the defendants starting at the end of this month.” The decision compounds the importance of apportioning blame for the collapse of one of the nation’s largest companies between the deep-pocketed underwriters and the directors who oversaw its demise. In a recent hearing, Cote had declined to sever the settling directors from the case, positioning all the parties to prepare for trial. Should the case proceed to trial, it will be the largest securities class action to go before a jury.

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