Public Company – The Long Tail (Tale) of Litigation

Recently legal documents with the header pictured above were mailed out.

ITXC went public in 1999.  There were relatively few stockholder lawsuits as stocks raced ever upwards in the beginning of 2000.  It wasn’t long after the bubble collapsed in the Spring of 2000, that a flood of lawsuits began.  This particular suit is part of a consolidation of 298 class action suits which were brought against almost every company which went public in 1999 and 2000, the officers of those companies including me, and the underwriters (bankers) who took the companies public. If you bought stock in any of these companies before December 7, 2000, you should have received a notice like this one.  If you didn’t, go to www.iposecuritieslitigation.com and you’ll see what to do. This is also where you can see the full documentation of this case.

About FIVE years after the initial suits were filed, a preliminary and partial settlement has been reached between the plaintiffs and the issuing companies (those that aren’t bankrupt) and the officers of those companies including me.  Of course this settlement was actually negotiated between the class-action attorneys who purport to represent the shareholders and the insurance companies who insure public companies and their officers against suits like this in return for ever-increasing premiums.

As things stand at the moment, if you bought ITXC stock during that period, you could receive $.04 of settlement for each share you bought.  But that number could go up considerably – or could go down.  But you won’t get any money now.

I’m going to try to explain what the suit is about and what the partial settlement means but first a note of caution:  I am not a lawyer; I have not consulted any lawyer in preparing this blog; and no one should mistake anything I say for legal advice of any kind.  It is quite possible that I do not understand some of the law that is invoked here.  I also have a biased point of view since I was named as a defendant and since this settlement, should it be approved by the court, essentially ends the case as far as I’m concerned.

To quote the documents that were sent out:

"The Actions in the IPO Litigation allege that the Underwriters violated federal securities laws by manipulating the prices of the Issuers’ shares, and that they and the Issuers and the Individual Defendants also violated these laws by failing to disclose that conduct to the public. Among other things, Plaintiffs allege that, in order to obtain allocations of shares in initial public offerings, investors were required or induced to commit to purchase additional shares after the IPO. Plaintiffs also allege that, in order to obtain allocations in initial public offerings, investors were required to pay excessive, undisclosed commissions to the Underwriters of the shares. In addition, Plaintiffs allege that stock analysts, who were employed by the Underwriters and had undisclosed conflicts of interest, made “buy recommendations” for the shares. Plaintiffs allege that these undisclosed and manipulative activities caused investors to pay artificially inflated prices for the shares during the Class Periods and to sustain damages. The Defendants deny they did anything wrong."

The “Issuers” are the companies like ITXC; “Individual Defendants” are their top officers; and the “Underwriters” are the investment bankers.

One specific allegation here is of a practice called “laddering”.  Remember that in the days of the bubble you could often double or triple your money in one day if you could only get shares of a newly issued stock at the IPO price.  If you bought later on the open market (or sold), the price was much higher.  ITXC came public at $12.  It closed the first day around $26 as I remember.

You could only get those shares through one of the underwriters handling the IPO.  Small amounts were allocated by the issuing company to “friends and family” but the bulk of stock was sold by the underwriters to large mutual funds. 

If, at the end of the company’s roadshow, there weren’t orders for at least four times as much stock as was actually being sold, the roadshow was considered a failure.  Since the orders far exceeded the supply, the underwriters had discretion to decide how much stock they were going to allocate to each buyer.  An allegation is that they gave better allocations to those who promised to buy more stock after the IPO which resulted in “artificial” demand which drove prices higher (laddering). 

In an IPO, unlike most other stock transactions. Commissions are paid by the selling company but NOT by the purchasers.  The amount of commission is disclosed in the prospectus.  The plaintiffs allege that “excessive, undisclosed” commissions were paid by the purchasers of the stock to the underwriters in order to get lucrative allocations of IPO stock.

You might ask, as I certainly did, when these suits were first brought, why the issuing companies and their officers are defendants.  After all, if money was diverted to the underwriters, the companies who were selling stock were victims, not beneficiaries. If funds were willing to pay extra to get more stock, the offering price should just have been increased – it isn’t set until the last possible minute – and the company would net more from its IPO.  We would have hollered loud and long if we knew this was going on.  If it happened, it didn’t happen in front of us.

The legal answer to my question, I was told, was that, since we signed the prospectus which said what the commission was, we “could be” liable if there is an undisclosed extra commission EVEN IF WE DIDN’T KNOW ABOUT IT.  Wow! The pragmatic answer was that we were being sued in order to bring our insurers into the equation.

For five years the various plaintiffs and defendants have been wrangling.  The current agreement – subject to ratification by the court – is that the insurers for the non-bankrupt companies and their officers will “guarantee” a minimum settlement amount of one billion dollars covering all 298 suits as resolution of the claims against them.  The companies also agree that anything they might have recovered from the underwriters will be assigned to the plaintiffs.  The settling defendants DO NOT admit to any of the allegations against them.

It is from this billion dollars that you would get your approximately $.04 per ITXC share assuming that class-action lawyers are awarded expenses and one-third of the proceeds.

But the case against the underwriters goes on. And likely will for a long time.  The documents says:  "Plaintiffs’ Executive Committee contends that the Underwriter Defendants bear a greater responsibility for these damages than the Settling Defendants." Their total claims are $55.05 billion.

Every dollar which is eventually recovered from the underwriters reduces the one billion dollar guarantee by the insurers of the companies.  If at least a billion is collected from the underwriters, then the insurers for the companies are off the hook.  If more than five billion is collected, the companies even get back some of what they originally spent on defense (essentially the deductible).  The issuing companies have intentionally been given incentives to cooperate with the plaintiffs.

In the proposed settlement, buyers of the stock don’t get any money until the fat lady sings.  Meanwhile, the documents reveal, some of the billion is sure to go to the further expense of continuing action against the underwriters.  That’s why you might not get $.04.  On the other hand, if the underwriters settle for a lot – or get hit by a big judgment – then you could get more.

The legal purpose of the documents that were sent out is to give purchasers of the stock an opportunity to opt out of the class action – presumably to retain the freedom to bring other suits of their own - or to present arguments to the court opposing the settlement.  On those issues I have absolutely no advice to give.

If you are thinking of bringing your company public, you do want to remember about the long tail and high cost of litigation.  Also, if I were writing a new prospectus, I’d be asking my lawyers about a clause in the risk factors that says:

“Underwriters may be making side deals which the Company and its officers do not know about.  They may be receiving undisclosed compensation.  Were these events to occur, it would be to the detriment of the Company and its stockholders.”

I don’t think anyone pays much attention to the risk factors in a prospectus but they’re supposed to be as effective proof against lawsuits as garlic is against witches.

Recently legal documents with the header pictured above were mailed out.

ITXC went public in 1999.  There were relatively few stockholder lawsuits as stocks raced ever upwards in the beginning of 2000.  It wasn’t long after the bubble collapsed in the Spring of 2000, that a flood of lawsuits began.  This particular suit is part of a consolidation of 298 class action suits which were brought against almost every company which went public in 1999 and 2000, the officers of those companies including me, and the underwriters (bankers) who took the companies public. If you bought stock in any of these companies before December 7, 2000, you should have received a notice like this one.  If you didn’t, go to

www.iposecuritieslitigation.com and you’ll see what to do. This is also where you can see the full documentation of this case.