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IPOs

IPO Lawsuits Multiply

In these jaded, litigious times, yet another securities lawsuit is hardly news. But a class action complaint filed this week that names Stratos Lightwave LLC (Nasdaq: STLW) turned the spotlight on a particular form of litigation that's gotten considerable attention in recent months.

Documents filed Wednesday in a New York district court allege that underwriters bilked Stratos investors by pumping up the stock in a scheme that involved so-called "laddering" and paying fund managers excessive commissions (see Stratos Socked With Suit).

According to SEC filings, the underwriters for Stratos's IPO were Credit Suisse First Boston, Fidelity Capital Markets, Lehman Brothers, Robert W. Baird & Co., Tucker Anthony Cleary, and U.S. Bancorp Piper Jaffray.

Stratos will not comment on the case. And a spokesperson for one of the underwriters, Credit Suisse First Boston, says, "All of these allegations have no merit and we will defend ourselves vigorously against them."

Laddering happens when underwriters require potential customers of an attractive IPO to pledge to buy more shares at specific times and prices, going forward. Experts say laddering has been widely practiced for years on Wall Street, but only recently entered the realm of class-action litigation, after the SEC began investigating claims made in the press last winter.

"It's the dark side of Wall Street," says James Newman, executive director of Securities Class Action Services LLC, a New York firm that publishes the Securities Class Action Alert. Newman says the practice of laddering has resulted in approximately 120 suits since last December.

Laddering and commission kickbacks usually go together, Newman points out: "The underwriter may say to the customer, 'You can have 1,000 shares of a hot IPO on the condition that you pay $1 per share commission instead of your typical 3 to 5 cents.' " The deal also might call for the customer to buy another 1,000 shares at 20 points higher just after the IPO, then – awhile after that – another 1,000 shares at 40 points, and so forth.

The result is the creation of artificial demand for shares in new companies. And there is increasing evidence that the practice went wild during the dotcom heyday in late 1999 and 2000, contributing to the speculative mania that drove many networking stocks sky-high.

The fallout from collapsing share prices has been heavy. A glance at the record shows that Stratos is only one of many companies that have been named in suits this year. Others whose underwriters allegedly engaged in laddering include Avanex Corp. (Nasdaq: AVNX), Avici Systems Inc. (Nasdaq: AVCI; Frankfurt: BVC7), Brocade Communications Systems Inc. (Nasdaq: BRCD), Covad Communications (Nasdaq: COVD), and McData Corp. (Nasdaq: MCDT).

Indeed, according to The Securities Class Action Clearinghouse of Stanford Law School, "high technology," which includes computer networking, is the "most frequently sued" industry segment since passage of the U.S. Private Securities Litigation Reform Act of 1995.

There's lots of argument back and forth about the relative merits of all this litigation, but many believe it is worth the trouble. "Class action lawsuits often are the only way for a lot of small investors to recoup their losses," says James Newman. For individuals, it's not cost-effective to hire a lawyer to get back an investment of a few thousand dollars, but in a group they have a chance.

Meantime, it can be tough for investors to get information about the impact of pending lawsuits on particular companies. Lawyers, who issue press statements only to cull more litigants for their motions, refuse to talk to anyone else. And analysts puff self-righteously when asked to comment. "I never comment on lawsuits," said one. "There's lawyers involved. I'm much too experienced to do that."

The reality seems to be that, while laddering lawsuits are never desirable, they'll probably have little or no material impact on many of the companies whose IPOs may have set the stage for trouble.

There are several reasons for this. For one thing, like most litigation, the current crop of laddering cases will take a long time to settle. "It's probably going to take two to three years for each case to work its way through the courts," Newman says. And after that, assessment of damages will take even more time.

Some companies may prove to have little direct exposure in the case. A firm's underwriters, not its directors, may ultimately be found at fault. And Newman points out that in these litigious times, most companies carry insurance to cover directors' legal fees and settlement costs, just in case.

Stratos confirmed that it has such insurance, even though none of its directors is named in the lawyers' statement.

Ultimately, laddering litigation may have more impact on the underwriters involved in technology IPOs than on the companies they sponsor. But that is another story.

- Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com
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