Forbes.com

JPMorgan And The $5 Billion Footnote
Dan Ackman, 03.24.05, 10:51 AM ET
Forbes.com


There was once a legend in the law about a bankruptcy filing where a creditor was owed $2 billion but, because of an error in proofreading, only claimed $200 million. This legend--possibly true, but who knows?-- was a boon to the big law firms because it justified all manner of extra billable hours for fear that someone, somewhere, somehow might make an equally trivial error of similarly momentous consequence.

Today, there is a new legend afoot about a footnote that could have cost JPMorgan Chase (nyse: JPM - news - people ) $5 billion--or more, depending on how you count it. The footnote was written not by a lawyer but a U.S. federal judge, Denise Cote, presiding over the WorldCom bondholder lawsuit. Sources close to JPMorgan say it caused the bank to settle the bondholder lawsuit late in the day at a price far higher than that paid by its fellow underwriters.

A source close to the plaintiffs, however, says the bank and its lawyers are using the claim that they were sandbagged by a footnote as an excuse to distract attention from their own repeated miscalculations and a series of legal defeats.

The JPMorgan source (the bank would not comment on the record) says that the footnote means that Cote believed that JPMorgan Chase might have been liable for $10.2 billion to bondholders, not the $5.1 billion that the bank and its lawyers all along believed was the theoretical maximum. That cap was based on the amount of bonds the bank sold.

JPMorgan Chase was ready to go to trial and fight to the death, the source says. The bank has maintained all along that there was no way that it could have known about the fraud perpetrated by WorldCom, its former chief financial officer, Scott Sullivan, and its former chief executive, Bernard Ebbers.

But with this footnote out there, it could not risk it. Instead, it settled the case for $2 billion. (The settlement was first reported by Forbes.com, and the footnote was first mentioned by Bloomberg News.) This amount is far larger proportionally--about $600 million more--than the amount paid by Citigroup's (nyse: C - news - people ) Salomon Smith Barney unit and by other bond-selling banks that settled more recently.

The JPMorgan source, who insists the bank should not have been liable at all, says, "We were willing to roll the dice on $2 billion versus $5 billion, but not $2 billion versus $10 billion."

The footnote in question is footnote 8 to a ruling Cote issued on March 14, two days before JPMorgan threw in the towel. The ruling itself rejected the bank's objections to an earlier settlement agreed to by Banc of America Securities, a unit of Bank of America (nyse: BAC - news - people ).

Reading the footnote's approximately 260 words, it is hard to see it as an agent of possible financial devastation. It refers to the legal provision (Section 11 of the Securities Act) on which JPMorgan says it relied, but notes that JPMorgan itself cited it only in a footnote and "does not use it as the basis for any of its legal arguments. It is therefore unnecessary to explore the precise meaning of the provision."

Cote goes on to cite another section of the Securities Act that may also apply, but says, "[A]gain because J.P. Morgan does not comment on this provision in it [the legal brief], it is unnecessary to explore that issue here."

An article in The Wall Street Journal today [see below] detailing the settlement process says the bank does not fault its lawyers at the firm Skadden Arps or its lead counsel, Jay Kasner, because they were "floored by a footnote." (Full disclosure: Years ago this reporter worked for Skadden and occasionally for Kasner.) But the source in the plaintiffs' camp calls that argument nonsense.

The footnote itself is ambiguous and certainly does not undermine a legal principle that Skadden was convinced was firmly decided already. What really happened was the JPMorgan board was meeting when Ebbers was convicted by a jury in the same Manhattan federal court where the bank's civil case would have been tried. The conviction spooked the board. But more important, JPMorgan had "lost every substantive legal fight they faced," the plaintiffs' group source says. After several other banks all settled, "they fought like a fish on a hook for a week, and then they surrendered."

 
 

The Wall Street Journal

J.P. Morgan's $630 Million Error

It Didn't Settle Over WorldCom,


And Now Bank Pays Much More;
 

The Role of a Skadden Arps Lawyer

By LAURIE P. COHEN and ROBIN SIDEL
Staff Reporters of THE WALL STREET JOURNAL
March 24, 2005; Page C1
 

A series of miscalculations by J.P. Morgan Chase & Co. and the lead lawyer defending it in a class-action lawsuit by WorldCom Inc. investors caused the bank to pay $630 million more than necessary to settle the suit, people involved in the case said.

The nation's second-largest bank behind Citigroup Inc., J.P. Morgan had been the last big holdout in the action against 17 financial firms related to WorldCom's accounting fraud, and it agreed to settle the case last week for $2 billion. The suit alleged that the firms failed to adequately examine the telecommunication titan's financial health when they sold $17 billion of bonds. The collapse of WorldCom, which has re-emerged as MCI Inc., left investors with massive losses; settlements in the class-action case now total a record $6 billion.

J.P. Morgan and the lead lawyer for the Wall Street bond syndicate -- Jay B. Kasner of Skadden Arps Slate Meagher & Flom -- rejected a settlement offer of $1.37 billion last year for Morgan and misjudged the blame and financial exposure the bank could face.

Mr. Kasner, 48 years old, argued that any fault in the case belonged to WorldCom auditors -- a key error, according to John Coffee, a securities-law professor at Columbia University's law school. Mr. Kasner urged his clients to refuse the less-costly accord for the underwriters. On behalf of his clients, he then countered with a low-ball settlement offer. And he openly criticized Citigroup, an original co-lead defendant with J.P. Morgan, for agreeing to an earlier large settlement in the case.

The result hurt Mr. Kasner, as well as his financial clients. A year ago, he represented all 17 bond underwriters in the case. By last week, Mr. Kasner no longer formally represented any of them. While the financial firms bear responsibility -- for they had input into settlement decisions -- Mr. Kasner's counsel resulted in J.P. Morgan and other underwriters paying a total of $677 million more in settlement costs than they would have paid had they accepted the earlier offer, people involved in the case said.

Mr. Kasner says he can't comment on any specifics of the litigation strategy, citing attorney-client privilege. He says only: "I'm zealous in representing our clients." J.P. Morgan executives don't fault Mr. Kasner's advice, say people familiar with the matter; rather, they blame a number of rulings that went against them, including an unexpected footnote in a judge's opinion early last week that raised the big bank's liability in the case.

Mr. Kasner is an experienced litigator. He previously represented Merrill Lynch & Co. in defending more than 150 shareholder actions relating to analyst reports. He is one of three lawyers ranked in the top tier for securities litigation in "Chambers USA: America's Leading Lawyers for Business 2004-2005."

The stakes in the case grew in May 2004, when Citigroup, in a move that surprised other bond-syndicate members, agreed to pay $2.575 billion to settle the case. The remaining underwriters represented by Mr. Kasner, including J.P. Morgan, Deutsche Bank AG and Bank of America Corp., then rejected settlement offers, which totaled $2.87 billion based on the Citigroup formula.

Several syndicate members, worried about being surprised by further unexpected defections, retained "shadow" counsel, or attorneys from other prestigious law firms.

Meantime, Mr. Kasner believed that Citigroup overpaid -- and wasn't shy about saying that, even to Citigroup lawyers, according to Sean Coffey, a lawyer for the WorldCom plaintiffs, and four defense lawyers involved in the matter. He said other banks didn't have as big a problem as Citigroup, whose former star analyst Jack Grubman was a huge booster of WorldCom stock amid unusually close ties with the company's management.

Plaintiffs lawyers say Mr. Kasner angered them by countering with an offer they thought was insulting: less than $100 million, according to lawyers in the case.

Of course, Mr. Kasner didn't make solo decisions. He had dozens of Skadden lawyers on his team, and J.P. Morgan's co-general counsel, William McDavid, was heavily involved in guiding strategy, say lawyers for other syndicate members. These lawyers say the syndicate was paying Skadden some $13 million in monthly legal fees, a figure that Mr. Kasner declined to comment upon.

The defense strategy also had the support of William Harrison and James Dimon, J.P. Morgan's chief executive and president, respectively. Mr. Dimon and other J.P. Morgan executives balked at the size of the Citigroup settlement and supported taking the case to a jury, because they believed the firm had conducted adequate due diligence. "This guilt by association will eventually have to end," Mr. Dimon told investors in a conference call in July.

Mr. Kasner prepared for trial, litigating to narrow the syndicate's potential exposure if a jury ruled against them.

Starting in December, however, almost nothing went as the syndicate hoped or predicted. That month, federal Judge Denise Cote rejected the syndicate's motion to dismiss the case, and ruled that the banks could be held accountable for failing to disclose WorldCom's problems when they underwrote the bonds.

The judge indicated that the underwriters should have seen red flags in WorldCom's financials that should have caused them to beef up due-diligence efforts.

Other cracks developed in the syndicate. On March 3, Bank of America settled for $460.5 million, using the same formula as was applied to Citigroup. Four more underwriters settled for a total of $100 million a day later, again on the Citigroup formula's terms.

Even so, Mr. Kasner continued to push ahead on behalf of J.P. Morgan and the remaining banks.

Lawyers from Skadden and J.P. Morgan were preparing for trial early last week in separate offices when they were floored by a footnote in an opinion from Judge Cote. The judge, in an unexpected development, intimated that the anticipated $5 billion maximum cap on any potential jury award might not be in place at all -- bringing a potential jury award to $10 billion.

On Tuesday morning of last week, Skadden lawyers held a conference call with J.P. Morgan's in-house lawyers, Joan Guggenheimer and Mr. McDavid. Also on the call were Mr. Harrison and Mr. Dimon.

The J.P. Morgan team advised Skadden that it wanted to have direct discussions with the plaintiffs. Later Tuesday, Ms. Guggenheimer placed a call to Max Berger, one of the plaintiffs lawyers, and made an offer.

The two sides haggled back and forth in a series of intermittent discussions on Tuesday and Wednesday. Skadden wasn't involved in those conversations. The two sides reached a settlement around midday Wednesday, just a few hours before a previously scheduled court hearing. The pact was unveiled at that hearing.

Lawyers for the plaintiff, New York state Comptroller Alan G. Hevesi, say their aversion to Mr. Kasner's actions could have cost J.P. Morgan in the end.

"His threats to introduce evidence suggesting plaintiffs lawyers were selected because they'd contributed to [Comptroller] Hevesi's campaign didn't advance the cause of trying to resolve this case," says Mr. Coffey, the plaintiffs lawyer.

Mr. Kasner says he believes a newspaper article about the plaintiffs lawyers' contribution to Mr. Hevesi "was germane to issues in the case."