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In re Worldcom, Inc. v. Securities Litigation

    Brief Fact Summary. Main plaintiffs in a securities class action alleged, inter alia, that underwriters did not implement sufficient due diligence, as deemed necessary by § 11, in assembly with two short-form registration bond offerings by Worldcom, Inc.

    Synopsis of Rule of Law. A plaintiff broaches substantial issues of fact in a § 11 action, alleging that an underwriter did not implement plausible due diligence in assembly with an offering made through short-form registration, when the plaintiff proclaims that the underwriter has made the superficial inquiries, has not looked into the practicallystandardresponses given to inquiries, and has not asked about concerns of specificimportance in the underwriter’s own internal assessments of the issuer’s financial state or in the financial press.

    Facts. Central plaintiffs in a securities class action claimed, inter alia, that underwriters did not implement ample due diligence, as required by § 11, in assembly with two short-form registration bond offerings made by Worldcom, Inc. Plaintiffs claimed that the underwriters made cursory inquiries, did not probe into any of the practically standard responses provided to inquiries, and did not ask about concerns of specific importance in their own internal assessments of Worldcom Inc.’s financial state or in the financial press.

    Issue. Will a plaintiff broach substantial issues of fact in a § 11 action, if an underwriter did not implement plausible due diligence in assembly with an offering made through short-form registration, when the plaintiff proclaims that the underwriter has made the superficial inquiries, has not looked into the practically standard responses given to inquiries, and has not asked about concerns of specific importance in the underwriter’s own internal assessments of the issuer’s financial state or in the financial press?

    Held. (Cote, J.) Yes. A plaintiff broaches substantial issues of fact in a § 11 action, alleging that  an underwriter did not implement plausible due diligence in assembly with an offering made through a short-form registration, when the plaintiff proclaims that the underwriter has made superficialqueries, has not probed into any of the practically standard responses provided to queries, and has failed to ask about concerns of specific importance in the underwriter’s own internal evaluations of the issuer’s financial state or in the financial press. The device of incorporation by situation and the growth of shelf registration considerably lessened the time required to make public offerings, thus allowing more “rapid access to today’s capital markets.†The Securities and Exchange Commission (SEC) has acknowledged that these changesconsiderablycondensed the time in which underwriters could accomplish the investigations of an issuer. Seeing as an issuer can chose from competing underwriters when offering securities through a shelf registration, some have asked if an underwriter can “afford to devote some time and expense necessary to conduct a due diligence review before knowing whether it will handle an offering and that there may not be sufficient time to do so once it is selected.â€Due to issues like these, the SEC presented Rule 176 in1981 “to make explicit what circumstances may bear upon the determination of what constitutes a reasonable investigation and reasonable ground for belief†as these terms used in § 11(b). The SEC’s own observations on Rule 176 makes clear that the Rule failed to alter the central nature of an underwriter’s due diligence requirements, and the SEC has explicitlyexcluded the consideration of competitive timing and pressures when calculating the reasonableness of an underwriters investigation, Although the SEC acknowledged that varied investigatory methods necessary in the setting of short-form registrations, it stressed that the methods of directing due diligence investigations of registrants qualified to utilize short-form registration must be comprehensive. The SEC recommended that underwriters could utilize “anticipatory and continuous†due diligence programs, use one law firm, hold Exchange Act report drafting meetings, and hold periodic due diligence assemblies. Some observershave stated that the underwriter liability administration under § 11 no longer achievableinside the time constraints of shelf resignation. Although, while there has been anappeal to revise § 11 law, that call is an understoodacknowledgment that present law keeps putting a burden upon an underwriter to organize a rational investigation of non-expertised statements in a registration statement, with an issuers interim financial statements. The main plaintiff’s statements, particularly due to the magnitude of offerings at issue, with regard to the current law, have elicited questions of fact necessitating a jury trial regarding if the defendant underwriters implementedrational due diligence. Motions for summary judgment denied in part and affirmed in part.

    Discussion. The Worldcom bond issuances calculated close to $17 billion. The plaintiffs declared that “red flags†existed that should have put the underwriters on notice of the obligation of more inquiries, likeWorldcom’s expense-to-revenues ratio being considerably less than its main competitors. The court concentrated on these “red flags†when denying the underwriters’ motions for summary judgment; after the court issued its opinion, the underwriters settled for roughly $6 billion.



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