State retirement system leads the charge in AT&T suit
The New Hampshire Retirement System, that sleepy holder of pension funds of state functionaries, schoolteachers and municipal police, has been quietly playing a key role in the national effort for monetary damages and corporate governance reform against a variety of corporations in the last five years.
In fact, it is now on the front lines of an epic legal battle against AT&T itself, a case that could go to trial as early as this fall.
The team of more than 20 attorneys charge that the Wall Street anchor – once known for corporate reliability — was acting like some fly-by-night scam artist. They charge that AT&T concealed massive service failures to its major corporate long-distance customers while making up bogus wireless accounts, all in a desperate attempt to artificially inflate revenues before spinning off its wireless division for billions of dollars in cash.
In addition, the retirement system recently settled a class action suit against Ashworth Co., a golf-inspired sportswear firm headquartered in San Diego, Calif., for more than $15 million. The suit charged that while selling off some $27 million in stock options, corporate executives concealed inventory problems caused by its rush to ship work overseas.
The fund also has served as lead plaintiff in three other class action suits, all of which have led to multimillion-dollar settlements for investors over the past four years.
“We are doing this not only to secure adequate and just money damages for the investor class but to press for corporate governance changes in the interest of the shareholders so it won’t happen again,” said Alan Cleveland, a Manchester attorney who represents the retirement system, which holds more than $4.5 billion in assets.
The retirement system’s interest in litigation during this era of corporate scandal is not unique, nor particularly surprising. Institutional investors are often the largest shareholders and get burned the most when a company’s stock plummets.
Shrinking portfolios and vanishing dividends mean a benefit crunch for participants in the system. Besides, litigation doesn’t actually cost anything, aside from the attention and time of the system’s officials, since plaintiff’s attorneys get paid a percentage of the settlement.
In addition, in 1995 Congress passed the Private Securities Litigation Reform Act, which instructed courts to give preference to institutional investors. The concern was that an individual investor might be tempted to strike a quick settlement, selling out other members of the class, whereas an institutional investor can afford to hang in there, and go for larger settlements.
As time went on, corporate reform became important, said Cleveland.
“Typically corporate governance is part of the settlement. It was not the norm, but now it is,” said Cleveland.
The retirement system started getting a piece of the litigation action in the fall of 1998, becoming the lead plaintiff in three suits: against SmarTalk Teleservices of California; United Healthcare Corp. of Minnesota; and PhyCor of Tennessee.
United Healthcare, the first to settle in February 2000, allegedly (in almost all such settlements there is no admission of guilt) misled investors about its Medicare business. The company failed to convince seniors to accept an HMO arrangement because it couldn’t expand its provider network thanks to low reimbursement rates, the complaint alleges, resulting in losses in two-thirds of its markets.
Corporate executives, who by that time had cashed in $22 million of their stock, surprised the investor world in August 1998 by announcing a $900 million loss, causing the stock to fall 30 percent in one day.
Although the plaintiffs were seeking $12 million in damages, the final settlement – while undisclosed – was relatively small, said Cleveland, and there were no corporate governance reforms stipulated.
In PhyCor’s case, the plaintiffs accused the company – another health-care business – from withholding from investors the failure of its business acquisition strategy while selling off $17 million worth of stock. In this case, the company took a $65 million loss, and the stock plummeted nearly 40 percent. PhyCor eventually filed for bankruptcy.
In April 2002 the plaintiffs won a $10 million settlement. This time there were corporate governance reforms, though unlikely to be implemented by the bankrupt company.
SmarTalk also allegedly concealed that it had trouble integrating the business it acquired and inflated revenues it was getting from prepaid phone cards and was up front about expenses.
After executives pocketed some $50 million from stock sales, the company announced that it would postpone releasing its quarterly results because of an internal audit. Share prices plummeted 60 percent, and the company was delisted by the Nasdaq exchange.
The SmarTalk case, which was eventually relocated to the Southern District of Ohio, was settled for $11 million in August 2003. (A $15 million settlement also was reached with the company’s accounting firm.)
Not just the money
The $15.25 million settlement with Ashworth – announced July 7 and yet to be approved by the court – would be the retirement system’s first substantial monetary settlement with a company that is not in financial trouble. Indeed, the same day he settlement was announced, Ashworth, which sold roughly $150 million in sportswear last year, had just plunked down $24 million to buy Gekko Brands, another apparel company.
The state retirement system joined the class action in March 1999, and volunteered to become lead plaintiff later that year. The company, the suit claimed, was trying to cut costs by moving half of its production capacity overseas. The problem was that the quality of products suffered, and inventory built up. Company officials allegedly concealed these failures and repeatedly assured worried investors that it had multiple production sources overseas, whereas it usually relied on a single source. The company also improperly capitalized material overhead and stuffed distribution channels with goods that would be returned, all in an effort to boost revenue.
Executives, meanwhile, touted the stock to various analysts and business media. The Wall Street Journal bought the hype, saying at the beginning of 1998 that the company “started to find its game last year. … The company is in the middle of a nifty turnaround.”
Executives allegedly did this because they reportedly received more than $100,000 in bonuses, the complaint alleged, and sold off three-quarters of their stock, reaping about $20 million in “illegal insider-trading profits.”
Then, in July 1998, the company disclosed its manufacturing problems, causing the stock to plummet 30 percent.
The retirement system, which bought nearly 63,000 Ashworth shares, lost more than $313,000, Cleveland said. If the court approves the settlement, the system expects to recover more than a third of that amount, which is a much higher percentage of losses than plaintiffs normally receive, he added.
But it isn’t just the money, said Ed Theobald, the retirement system’s chairman, who stressed yet-to-be-disclosed corporate governance reforms agreed to by Ashworth.
“The corporate therapeutics that are part of the settlement represent a significant step forward for governance at Ashworth and are in accord with the movement toward greater board independence and more effective corporate management in America,” he said in a written statement.
Ashworth, as is customary, admitted no wrong doing.
“Although the Company was fully prepared to defend the litigation, the Company decided to settle in order to put this 5-1/2-year-old case behind us and allow management to focus on running and growing the business,” said Terence W. Tsang, Ashworth executive vice president, chief financial officer and chief operating officer, in a prepared statement.
When it comes to damages, Ashworth is small potatoes compared to the AT&T litigation, also first filed in a federal court in New Jersey in 1999, and has involved (on both sides) at least 33 attorneys from 20 law firms around the country.
The damages sought are in the billions of dollars, though spread over a much larger class. What the plaintiffs actually wind up with is anyone’s guess.
AT&T is apparently taking the case seriously. It heads a long list of litigation disclosures in the company’s annual filing with the Securities and Exchange Commission. While all the other cases listed are “without merit,” AT&T claims, the New Jersey case was not similarly dismissed, though it does say it has a “meritorious defense” that it will employ “vigorously.”
The plaintiff’s amended 116-page complaint alleges that AT&T concealed the financial mess it was in, partly due to restructuring, acquisitions and massive layoffs in the late 1990s. The company, following the downsizing trend, cut 20,000 white-collar positions and borrowed some $60 billion to acquire new technology. The idea was to reposition itself in the new emerging communication world: the broadband bundling of cable, telephone, Internet and wireless technologies.
But in doing so, the company neglected one of its most profitable business — servicing of corporate overseas markets. In addition to cutting the business service unit staff, AT&T transferred many incorporate accounts to its new acquisition, Concert Communications, and simply stopped serving them.
Major corporate clients started to complain that they could not get AT&T reps on the phone for 15 to 20 minutes, that the calls were handed over to an 800-number pool or farmed out to e-mail, and that new orders and bids for routine contracts and response to complaints would take a week or more.
About half of the company’s customers had serious problems, and corporations such as Pepsi and Chase switched to AT&T’s growing competition.
To try to recover from this “disaster,” AT&T put together a special task force called “Raiders of the Lost Revenue,” the complaint said.
AT&T also was experiencing problems with smaller customers, the complaint alleges. An attempt to bundle services fell short because AT&T had difficulty integrating new acquisitions.
“One-stop shopping was a mirage at AT&T,” the complaint alleges. “At the end of 1999, customer services representatives were told to cancel 12,000 local service orders that were long past their installation due dates.”
All this, the complaint said, led to a serious revenue decline just at the time that AT&T needed more cash to build out its broadband.
To get that cash, the complaint alleges, it hoped to spin off its wireless division for $10 billion, but it had to keep up the value of the company stock and conceal or downplay these problems, particularly in the wireless division, where the service was “so terrible that customers were refusing to sign up,” says the complaint. Others were dropping service, creating a churn rate that “was the worst in the industry.”
To pump up the revenue from its wireless division, the company employed various tactics to create the appearance of new sales, including shutting down and opening accounts under a different name in a matter of minutes, the complain alleges. The customer would just notice that service was shut off briefly and resumed under the name of a related company. The transaction was counted as a new account, according to the complaint. Sometimes not even the name was changed. Accounts were just regularly shut off and reactivated, the complaint charges.
“By created bogus TOAs (transfers of authorization) the account executives were able to be ‘number one’ sales performers and receive bonuses of ‘thousands’ of dollars. Some AT&T wireless account executives were making ‘300 percent’ of their sales quotas using this scam,” the complaint charges.
Finally, it’s alleged that AT&T held off releasing results of its poor performance in a quarterly report until the day the wireless IPO closed, May 2, 2000. The 21-day delay, the complaint says, was the largest delay by the company in releasing such results in the last 10 years.
When the quarterly statement was finally filed, AT&T analysts were shocked, says the complaint. The New York Times reported that the company “dropped a bomb” on investors by admitting that it “dropped the ball with some of AT&T’s biggest accounts.”
The stock price plummeted, and by the end of the year it lost $154 billion in value. The breakup of AT&T (which the complaint alleges was secretly considered during this time) was the ultimate admission of failure.
In a summary judgment in June, Judge Garrett Brown ruled that most of the wireless scam charges and bundling problems were not relevant to the losses, but he left the charge that AT&T concealed the problems in its corporate divisions. Even if those other charges are not reinstated, the resulting class damages would still be far greater than the retirement system has dealt with before, according to retirement system attorney Cleveland.