The Worldcom Class Action Settlement: Major Historical Ramifications

WorldCom, Inc., once the second-largest long-distance telephone company in the United States, filed for bankruptcy in July 2002 after revelations that it had overstated billions of dollars in earnings. The company admitted to booking billions in line cost expenses as capital investments, an accounting gimmick that hid expenses, inflated cash flow, and allowed the company to falsely report profits instead of losses1. This improper and fraudulent accounting treatment constituted a blatant violation of Generally Accepted Accounting Principles (GAAP).

Discovery of Fraud and Legal Proceedings

The fraudulent activities came to public attention in June 2002 when WorldCom announced a significant restatement of its earnings, wiping out $3.8 billion of profits since 1999. This announcement triggered an investigation by the Securities and Exchange Commission (SEC) and subsequent federal probes1. By July 2002, WorldCom filed for Chapter 11 bankruptcy protection.

Numerous lawsuits were filed against WorldCom's executives, including CEO Bernard Ebbers, CFO Scott Sullivan, and other top executives, who were accused of securities fraud, insider trading, and conspiracy. The scandal not only brought down WorldCom but also led to the dissolution of Arthur Andersen, WorldCom's accounting firm, which was found guilty of obstructing justice by shredding thousands of documents related to WorldCom audits.

Class Action Settlement

  • Total Settlement Amount: $6.2 billion

  • Attorney Fees: $688 million plus interest

  • Eligible Shareholders: Individuals and entities who purchased WorldCom stock between April 29, 1999, and June 25, 2002

  • Average Payout: $6.79 per share for common stock, $168.50 per share for preferred stock

The settlement process was complex and involved numerous defendants, including several large financial institutions that were accused of aiding and abetting WorldCom's fraudulent activities. Notable defendants included Citigroup, JPMorgan Chase, and Canadian Imperial Bank of Commerce (CIBC).

Legal Proceedings

  • Lead Counsel: Bernstein Litowitz Berger & Grossmann LLP, led by Max W. Berger

  • Judge: Hon. Denise Cote of the U.S. District Court for the Southern District of New York

  • Final Approval Date: September 21, 2005

Distribution Plan

The distribution plan for the settlement proceeds was carefully designed to ensure fair and equitable compensation to all eligible shareholders. Approximately 1.5 million individuals and entities were slated to receive payments, including pension funds, institutional investors, and individual shareholders1. The plan faced some opposition, particularly from shareholders who purchased stock outside the eligibility period, but the court ultimately approved it.

The settlement funds were distributed based on the number of shares held and the timing of purchases. A significant portion of the settlement was allocated to cover attorney fees and administrative costs, with the remaining funds distributed to shareholders on a pro-rata basis1. The average payout was $6.79 per share for common stock and $168.50 per share for preferred stock, although individual payments varied based on the specifics of each claim.

Additional Settlement in 2012

In October 2012, an additional settlement of $38 million was reached with Arthur Andersen, WorldCom's former auditor. This settlement satisfied a contingent clause inserted into the 2005 settlement agreement, entitling the class to additional future payments if Andersen ever distributed money to its former partners on certain subordinated notes2. This brought the total settlement amount to $6.2 billion, making it the second-largest recovery in history at the time.

Significance

The $6.2 billion settlement stands as one of the largest ever in U.S. securities litigation, highlighting the importance of corporate governance, transparency, and accountability in the financial markets. The WorldCom scandal also led to significant regulatory changes, most notably the Sarbanes-Oxley Act of 2002, which introduced stringent new rules for corporate governance and financial reporting.

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