Friends in high places

North Carolina state treasurer Janet Cowell hopes to salvage something out of her office’s spectacularly bad bet on Facebook stock: She wants to be the lead plaintiff among all other Facebook investors who say the company misled them about its financial health just before the company’s initial public offering in May.

But Cowell may not even get that shred of redemption. Other investors say she’s unfit to be the face of a unified Facebook class action, largely thanks to her friendship with one of the people being sued. And thanks to that dispute, the public now gets a rare look into the usually private jockeying that goes on among plaintiffs in messy, high-profile class action lawsuits.

In the case of Facebook, there are 19 class actions lawsuits pending after the company’s share price started dropping almost immediately after its IPO. Now, with the share price almost exactly half of its opening price, the plaintiffs want to know whether important financial information was deliberately withheld from them.

The $75 billion North Carolina Retirement System took a $4 million hit, the largest of the institutional investor group, after it bought 685,737 shares on May 17 at the opening price of $38 a share. Within five days, when the first class action was filed, the shares had dropped to $31 a share. By last week the stock had been trading in the $19 per share range.

The class actions are expected to be consolidated, though the plaintiffs in each comprise distinctly different groups — including institutional investors like the state pension fund run by Cowell, and investment funds which bought Facebook for personal investment portfolios. And at least one group of those personal investors doesn’t think Cowell has any business representing their interests.

‘Conflicts of interest pervade’

In Facebook parlance, they think she friended too many of the defendants.

“Conflicts of interest pervade the institutional investor group,” wrote David Rosenfeld of New York’s Robbins Geller Rudman & Dowd, counsel to the personal investor group challenging Cowell. The most serious of those conflicts is the alleged cozy relationship between Cowell, the N.C. treasurer and fund trustee, and Erskine Bowles, former Clinton White House chief of staff, former head of the University of North Carolina system — and one of the defendants in the Facebook cases.

At the heart of the litigation are claims that lead underwriter Morgan Stanley cut revenue forecasts just before the IPO and shared that information with clients but not with the public at large. Facebook itself had filed an amended prospectus with the U.S. Securities and Exchange Commission earlier in May in which it cautioned that advertising revenues were not keeping pace with users’ rapid shift to mobile applications.

Cowell acts as the sole trustee of the state fund and, according to the personal investors, has a longstanding personal and financial relationship with Erskine Bowles, who serves on the boards of both Facebook and Morgan Stanley. Furthermore, his wife, Crandall Bowles, is a director of J.P. Morgan Chase & Co, the parent company of another underwriter defendant, J.P. Morgan Securities.  The personal investors say that as treasurer Cowell uses Bowles’ investment firm, Carousel Capital, to manage millions in fund investments and that Bowles and his wife have contributed to Cowell’s re-election campaign – holding a fundraising event at their home in Charlotte.

“In other words, the sole trustee of NCRS – acting on behalf of NCRS and seeking to represent the plaintiff class – just recently received financial support in her re-election campaign from one of the defendants in this action,” Rosenfeld wrote.

But Cowell says that any relationship with Bowles has no bearing on her determination to sue him and others to recoup the state’s losses from the Facebook IPO investment.  She knew Bowles was a defendant in the case and authorized the department to go forward with the action against him anyway. “My view is that all of the defendants responsible for the alleged violations of the federal securities laws in this matter, including Mr. Bowles, should be held accountable for any and all misconduct,” she said in court filings last week.

Cowell added that Carousel is just one of the state fund’s 200 investment managers and had no role in deciding to purchase Facebook shares.

It matters who leads

In the past, lead plaintiffs were little more than ciphers, doing the bidding of class counsel who drove the litigation. That resulted over time in plaintiff-and-counsel teams popping up in class actions around the country.  It was not uncommon to find the same lead plaintiff showing up in different actions, said Press Millen, a partner with Womble Carlyle in Raleigh with experience in class actions, mostly on the defense side.

But reforms in the mid-1990s sought to eliminate those cozy relationships and cut down on frivolous actions, in part by strengthening the role of lead plaintiffs and encouraging investors with large losses and a large stake in the outcome – institutional investors, for example – to take an active role in class actions.  Now, said Millen, a lead plaintiff often plays a significant role in the litigation.

“Lead plaintiffs are involved in selecting the lead counsel and can play a role in determining the appropriateness and fairness of the settlement,” Millen said. “You still have the court there for protection and which has to approve any settlement, but when you actually have a good, strong, interested lead plaintiff, that’s part of the role that they play.  And if I’m in the class I want a strong, interested, appropriately incentivized lead plaintiff.”

Plus, Millen added, if the lead plaintiff has actually played a significant role, it can get an additional payment at the close of the case.

Class counsel, too, will get paid at the close of the case — handsomely.

The state-led institutional investors have proposed two experienced class action firms from New York as class counsel — Bernstein Litowitz Berger & Grossman, and Labaton Sucharow.

The NC treasurer’s general counsel and senior policy advisor Jay Chaudhuri said in court filings that Cowell selected those firms from a pool of securities litigation firms previously approved by the state, issuing a request for information to four of those firms for proposals to represent the fund’s interests in the case.

“In issuing the RFI and analyzing the responses thereto, North Carolina [treasurer’s] primary considerations were the experience and excellence of counsel, which it believes will provide the class with the best chances of maximizing its potential recovery,” Chaudhuri said in a statement joined by representatives of the other institutional investors.

But neither firm is a stranger to the treasurer.  Over the past year and a half, attorneys from the Labaton firm have donated $5,000 to Cowell’s re-election campaign, and attorneys from Bernstein Litowitz, more than $30,000.

‘Indicative of larger problems’

The fund’s performance came under attack even before the Facebook investment, most recently during the spring primary race between Cowell and challenger Ron Elmer, a former investment manager from Cary. Elmer said at the time that the fund was performing poorly when compared to other state pension funds and could save millions in investment management fees paid to outside firms if the that management was done in-house.

“The $4 million loss is relatively small compared to the $75 billion fund,” Elmer said in an email, referring to the Facebook loss, “but it is indicative of the larger problems that have resulted in an increasingly poor investment performance relative to other state pension funds.”

“The pension fund has two important vacant positions that likely contributed to this poor investment — the chief investment officer and the director of equities. Both positions have been vacant for much of Janet Cowell’s tenure,” Elmer added.  “With an average salary of over $200,000 per year for the top eight investment professionals within the treasurer’s office, our state pensioners should expect better results.”