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Commentary: Smoke, Mirrors, And Shareholder Settlements


To hear the lawyers tell it, the decision by Applied Micro Circuits Corp. (AMCC) to settle a shareholder class action in June was nothing short of monumental. After three years of litigation, Applied Micro signed off on what is known as a "therapeutic" settlement: It would add two new independent directors, eliminate insiders from three key committees, and make dozens of other corporate governance changes. That, said Darren J. Robbins, the shareholders' lawyer, "substantially enhances the value of the company and bodes well for AMCC and its shareholders."

Really? It's hard to see how. Some of the company's changes, such as requiring a shareholder vote to reprice options, are already required by NASDAQ. Others were modest improvements at best. For instance, NASDAQ requires "independent oversight" of pay decisions; the settlement calls for the company to maintain its already completely independent compensation committee. Still other provisions, such as naming a lead director to coordinate meetings of independent board members, were already in the works, according to CEO David M. Rickey. Richard A. Bennett, a governance expert who helped craft the Applied Micro settlement, counters that several provisions, such as splitting the roles of chairman and CEO, are real advances. Still, shareholders didn't get a dime, though a separate class action is still pending. Company officials, meanwhile, denied the allegations in the lawsuit, which included artificially inflating the stock price and engaging in insider trading.

It is just another example of how there's as much bluster as big bucks behind the recent wave of such therapeutic shareholder deals. Governance experts and the lawyers who push the lawsuits laud them for forcing boards closer to true independence and pressuring executives to be more accountable. But while some financial payouts have been impressive, the governance changes, with few exceptions, have not. Worse, the settlements are taking some of the pressure off companies to make more substantive changes. Even the appearance of shareholder involvement is mostly a technicality -- rather than being agreed on by shareholders, these deals get hammered out by a handful of lawyers behind closed doors. Says Henry T.C. Hu, professor of corporate and securities law at the University of Texas School of Law: "I don't think this is a particularly good mechanism for dealing with flaws in corporate governance."

Whacking management

Driving the recent spate of therapeutic settlements are two key facts: the desire of companies to put their legal problems behind them and the desire of plaintiffs' lawyers to make their clients happy. Shareholder lawsuits have long been the bane of public companies that get in trouble and see their shares plummet. The explosion of accounting scandals and executive-pay abuses in recent years gave the handful of law firms that specialize in these suits, such as Lerach Coughlin Stoia Geller Rudman & Robbins, yet another hammer with which to whack management. Their routines are much the same: identify companies mired in controversy, locate institutional investors to serve as lead plaintiffs, and file a suit. Even if the case never makes it to court, some companies pay up just to avoid bad press and lengthy legal battles. But whereas the old-fashioned investor suits demanded just restitution for shareholders, the new cases seek both money and governance protections -- giving the lawyers the kind of shareholder-friendly track record they need to snare lead plaintiffs in future cases. Companies are all too eager to agree.

To be sure, some of the resulting payouts are impressive: Cendant Corp.'s (CD) 1998 settlement netted shareholders a staggering $3.3 billion. The plaintiffs' lawyers also did just fine, thank you, receiving $55 million. The Honeywell International Inc. (HON) and Hanover Compressor Co. (HC) settlements earlier this year paid out $100 million and $80 million, respectively, to shareholders, including millions for the plaintiffs' lawyers. Some of the governance changes attached to these big cases actually were worthwhile, too. At HealthSouth Corp. (HLSH), the law firm of Grant & Eisenhofer succeeded in removing five longtime directors on whose watch ousted CEO Richard M. Scrushy allegedly engineered a $2.7 billion accounting fraud, which Scrushy denies. Broadcom Corp. (BRCM) and Hanover Compressor put shareholder-nominated directors on their boards -- a notable advance that comes as business interests fight a similar proposal at the Securities & Exchange Commission.

But in many other cases, the "therapy" is simply window dressing to make management look like it has cleaned up its act. In July, as part of a $90 million settlement, FirstEnergy Corp. (FE) agreed to split the roles of chairman and CEO; it had already done so six months earlier. It also agreed to maintain a board with two-thirds independent directors -- which is hardly a problem, since there's only one insider on its 14-member board now.

Honeywell's settlement requires execs to retain the bulk of the stock they acquire via options for one year -- a major change. But it also requires the audit committee to approve consulting work performed by the external auditor -- language lifted almost verbatim out of the two-year-old Sarbanes-Oxley Act. Says Peter H. Mixon, general counsel for the California Public Employees' Retirement System: "If a company is already required by law to enact certain corporate governance reforms, I'm not sure that including it in a settlement accomplishes much."

Not unless you're a lawyer. By striking deals that look like a great result for shareholders, plaintiffs' attorneys get the kind of public-relations lift that money just can't buy, for an industry that's sometimes difficult to defend. But if lawyers truly want to protect shareholders, they should force companies to adopt real reforms. Anything less is a waste of time.

By Louis Lavelle


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