Corporate Governance

Bear Stearns: A Litigation Update

By Rebecca Rian

The Race to the Bottom previously discussed the board of directors' role in Bear Stearns demise.  Bear Stearns' troubles began in 2007 when two of its hedge funds failed.  They culminated in an acquisition of the investment bank by JP Morgan Chase.  August's "Vanity Fair" article covered the reaction of the board of directors during J.P. Morgan Chase's first offer. 

J.P. Morgan?s initial offer came in at two dollars a share, and Bear Sterns President Alan Schwartz gave a half hour presentation to the board on its choices: a J.P. Morgan merger or bankruptcy.  Bankruptcy would have resulted in the seizure of the investment bank's assets by creditors and allowed federal regulators to take over customer accounts.  It would also mean the loss of fourteen thousand employees and likely wiped out the equity interests of shareholders. Shareholders, however, complained about the two-dollar share price (the price had been $27 on the Friday before the offer).  The parties renegotiated, and J.P. Morgan raised its offer to ten dollars a share.  Bear Stearns' board approved the merger. 

Because of the merger, shareholders filed a number of lawsuits, including class action lawsuits under the federal securities laws.  The suits generally focus on the disclosure made by Bear Stearns during the period prior to the merger.  Eastside Holding, Inc. alleged that Bear Stearns' officers and directors violated §10(b) and 10b-5.  The wrongful conduct occurred between December 14, 2006 to March 14, 2008, when the defendants allegedly issued false or misleading statements regarding Bear Stearns' business and financial health. 

The complaint alleged that Bear Stearns knowingly allowed its subsidiaries and high yield fund managers to avoid fully disclosing the risks involved in its underlying hedge fund investments.  In addition, the complaint asserted that the firm failed to "inform the market of the ticking time bomb in the Company?s hedge funds due to the deteriorating subprime mortgage market, which would cause Bear Stearns to have to rescue the funds, cause the Company and its officers possible criminal liability and hurt the Company?s reputation."  The plaintiff alleged it would not have bought Bear Stearns' common stock if it had known defendants? misleading statements had falsely inflated the stock?s market price.  Plaintiff claimed it suffered damages by paying artificially inflated prices for the common stock.  Plaintiff asked for class action certification, damages, and equitable, injunctive, or other relief.  

J.P. Morgan?s S-4 filing stated it would hold harmless and indemnify present and former directors.  This covers "matters" occurring before or at the time of the merger's completion.  The indemnification remains in effect for six years after the merger, with JP Morgan Chase paying for directors' liability insurance coverage during that time.

Subsequent posts will examine the derivative suits against the directors of Bear Stearns. 

The primary materials for this post are available on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on August 30, 2008 (boomark / email).