IT Braces Against New Enron Aftershock

Call it the Enron double whammy. First, companies with accounting questions saw investors dump millions of shares in an Enron-inspired sell-off. Now, these
same firms, face a related, and potentially more serious, threat — class action lawsuits.

“My suspicion is that in light of the Enron debacle, there will be a lot more accounting-oriented class actions,” said Gordon P. Katz, a partner with the
Boston law firm Holland & Knight.

You needn’t tell Enterasys Networks . Two weeks ago, the Portsmouth, N.H., networker and Cabletron progeny was making strides after a train wreck year for telecom gear makers.

Enterasys’ stock, which had dipped has low as $6 in October, regained double digits as it prepared to launch its Aprisma subsidiary as a separate public company.

Then it discovered “inconsistencies” in a $4 million Asia-Pacific contract. Hours later, the Securities and Exchange Commission wanted to see its books, apparently on an unrelated matter.

Company officials scrambled to reassure stakeholders. A “forensic” accounting team had been dispatched to determine the scope of the problem. And, of course, Enterasys is cooperating fully with the SEC (neither will discuss the focus of the federal probe).

But despite textbook crisis management, the damage has been done. The stock was halved, the spinout shelved indefinitely, and the company sued by four law firms.

Enterasys isn’t alone. Tyco , an Exeter, N.H., maker of fiber-optic cable among other things, has been slapped with a shareholders’ suit claiming it used accounting tricks to mask its financial health.

And elsewhere, there are red flags going up among both old and new economy stalwarts that could trigger litigation.

Editor’s note: Please see page 2 for ways to protect against class actions

So far this year, there have been 25 securities class actions filed in the U.S., according to research from Stanford Law
School
. Without an “Enron effect,” that projects to about 217 for the year.

That lags behind the 487 filed in last year, but 2001 was extraordinary because of “IPO allocation” suits that came in the wake of the dot-com crash. These
measures, 181 in all, alleged underwriters engaged in undisclosed practices when distributing IPO shares. Better comparisons are: 2000, 216 suits; 1999, 209; and
1998, 236.

Regardless of the number of filings, defending against such actions is “a very significant headache for the officers of a company,” said Katz, who represents defendants in such cases.

Preparation time, depositions, court appearances and damage control press conferences are poor uses of a highly paid executive’s time. Enterasys president and CEO Enrique Fiallo received salary and bonuses of $496,000 in fiscal 2001, according to Multex.

Class action suits can drag on for years, and cost $1 million in legal fees alone. If settled, which many are, add damages and plaintiff’s attorneys’ fees to the bill, Katz
said.

In November, Critical Path , the San Francisco Internet service provider, settled a class
action suit for $17.5 million in cash, issuance of new stock options, and payment of lawyers’ fees. In some cases, a company’s insurance carrier covers at least a
portion of the cost.

Given the scrutiny placed on accounting procedures and insider stock deals, Katz said companies should do their best to avoid even the appearance of impropriety.

“The directors and officers of a company need to be very proactive when it comes to financial situation,” Katz said.

Otherwise, like Enterasys and others are finding, they could find their time monopolized by lawyers and their progress impeded by lawsuits.

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