Although the $2.575 billion settlement finalized late last year with Citigroup in the In re: WorldCom Securities Litigation was of historic proportions, the tentative $54 million settlement reached January 5 with 10 former members of WorldCom’s board may have far greater repercussions.

In its amended complaint in the massive securities class action attacking the financial fraud at WorldCom, lead plaintiff New York State Common Retirement Fund alleged that WorldCom’s board of directors had been “utterly derelict in carrying out its most basic functions,” provided “no internal checks and balances on WorldCom management,” and was “completely beholden to management.”  For the 10 settling former members of WorldCom’s board, the trial on those charges set for February 28, 2004, will no longer occur following their agreement to pay $54 million collectively, including $18 million out of their own pockets, to settle the case.  Two former members of the board have not settled.  The settlement agreement is subject to the approval of the federal court handling the case.

Although $54 million is not itself an extraordinary amount in the context of the hundreds of billions of dollars lost in the WorldCom case, the fact that $18 million will be paid by the directors themselves is a watershed event in the securities class action world.  It is virtually unheard of for directors to be personally responsible in class action settlements, as such settlements are routinely covered by the company’s D&O insurance.  In a highly unusual move, however, the New York State Common Retirement Fund reportedly insisted from the beginning of negotiations that there would be no settlement with the WorldCom directors without their agreement to personally pay a significant portion of the proceeds.  Indeed, the $18 million dollars reportedly will come in varying amounts from the directors, with each individual payment accounting for a full 20 percent of that director’s aggregate net worth excluding their primary residences and retirement accounts.

Particularly coming on the heels of the SEC’s recent proclamations that the penalties it imposes must be paid by individual wrongdoers rather than their employer or insurance company, this settlement with members of the WorldCom board will likely have a jarring effect on anyone serving, or considering serving, on the board of a public company.  Never before has it been so apparent that the consequences of failing in your duties as a board member may well include a significant loss of your own personal wealth.  In the WorldCom case, for instance, directors who were compensated approximately $35,000 per year are now responsible, due to their alleged failings, for the payment of millions of dollars.

We expect that this most recent development in the WorldCom case will serve as an important deterrent to fraud for officers and directors who run public companies.  It has been a common and long-standing complaint that class action settlements paid solely by public companies and/or their insurers do little to deter the individuals who actually commit such fraud.  We hope that the emerging prospect of multi-million dollar hits to individuals’ bank accounts will be enough to give would-be fraudsters pause.  We also hope, however, that worthy directors will not look at this settlement and conclude that service on a board of directors simply is not worth the risk.