Friday, July 29, 2005

Mirant Sues Andersen, Claims Audits Flawed

Mirant Corp. filed for reorganization under Chapter 11 of the federal bankruptcy code more than two years ago, but litigation continues to swirl around the company's past and future value. The Atlanta-based energy producer recently filed suit in Fulton County State Court against its one-time auditor, Arthur Andersen, claiming the accounting firm's negligent work led Mirant to overstate its value by millions during the company's go-go years from the late 1990s to 2001. Meanwhile, in a Texas courtroom, Mirant shareholders have been arguing that the company's restructuring plan undervalues the future worth of the enterprise by several billion dollars. A low valuation could cause the shareholders to lose their investments in the company. "The shareholders are in a fight for their life, but we think that there is sufficient value for equity to survive," said L. Matt Wilson, an Atlanta attorney who represents one of several groups of Mirant shareholders in the Texas valuation hearings. The litigation in Atlanta and Texas comes as Mirant struggles to emerge from Chapter 11 bankruptcy and regain some of its former luster. It's been a long road for a former Wall Street darling that once touted astounding profit growth. These days, instead of counting profits, Mirant stakeholders are fighting over the company's remaining assets. And, the company has begun filing complaints against a long list of parties who allegedly contributed to its bankruptcy woes -- including Andersen, which, as a result of its role in the fall of Enron, is now a shell of its former self. $2 BILLION SUIT Mirant's most prominent claim is a $2 billion suit filed last month in Texas against its former parent company, Atlanta-based Southern Co. In that suit, Mirant says Southern stripped it of cash and burdened it with debt before unloading the insolvent subsidiary through an initial public offering and subsequent spin-off. That complaint also cites Troutman Sanders for a possible conflict of interest in its work for both sides of Mirant's initial public offering and spin-off. Following up on the suit against Southern Co., Mirant and a committee of its unsecured creditors asserted claims in Texas this month against approximately 70 parties who participated in the disastrous spin-off -- several former executives, members of the board of directors and its own general counsel, Douglas L. Miller. Six days after filing the suit, the creditors committee dismissed the claims against Miller without explanation. But lawyers for the creditors' committee and a special committee of Mirant directors led by Atlanta native and former undersecretary of State, Stuart E. Eizenstat, continue to investigate how Mirant became insolvent and had to file for Chapter 11 protection within two-and-a-half years of going public. The lawyers for the committees will likely examine the roles of almost everyone involved in Mirant's dealings with the Southern Co. and the IPO and spin-off. STARTED AS SUBSIDIARY Mirant traces its roots to a subsidiary of the Southern Co. created in the early 1990s to take advantage of business opportunities in the unregulated sector of the energy industry. According to its Web site, Mirant produces and sells electricity in the United States, the Caribbean and the Philippines. In addition, the company operates a commodities trading center in Atlanta that deals in electricity, natural gas, coal and oil. During the last half of the 1990s, Mirant grew rapidly: Its reported net income from trading operations rose from $18 million in 1995 to $372 million in 1999. According to court documents, acquisitions fueled much of that growth. In one year alone, the company's reported consolidated assets increased by $6 billion, the complaint against Andersen states. But the go-go years at Mirant were undermined by financial arrangements that benefited Southern Co. at the expense of its budding subsidiary, the suit states. In the suit filed last month against Southern Co., Mirant states that Southern forced its subsidiary to pay it dividends and other payments totaling about $1.9 billion, while inducing Mirant to pay inflated prices for acquisitions. The Mirant suit against Southern further claims Southern kept its plans for Mirant's IPO and spin-off secret from the subsidiary's senior management for about two years. In a press release, Thomas E. Lauria, a Miami-based partner at White & Case who is lead counsel for Mirant in its Chapter 11 case, said: "Without informing Mirant's management, Southern developed a strategy to capitalize on the then white-hot merchant energy sector to raise billions of dollars of financing, much of which Southern caused Mirant to flow upstream, only to then spin-off the debt-burdened subsidiary before its latent problems could come home to roost." IPO COMPLETED IN 2000 On Oct. 2, 2000, Mirant completed an initial public offering of 19.7 percent of its common stock. Six months later, the Southern Co. distributed the remaining Mirant stock to its shareholders, each of whom received 0.398 Mirant shares for each Southern Co. share they owned. Mirant began experiencing liquidity problems soon after the spin-off and, on Dec. 19, 2001, Moody's downgraded the energy company's credit rating to junk status. That same month, the Enron scandal further fueled Mirant's credit problems by causing bankers to re-evaluate the industry's risk. Mirant subsequently filed for Chapter 11 bankruptcy on July 14, 2003. TROUTMAN ROLE QUESTIONED Lauria and the other lawyers investigating the Mirant case against Southern also want to examine the role of Troutman Sanders' attorneys in the dividend payments and subsequent divestiture. Troutman, who has been Southern's primary outside counsel for years and served as Mirant's primary outside counsel prior to the bankruptcy case, represented both companies during the IPO and spin-off. Mirant, however, may not have had a choice in the matter. Mirant's lawyers say a March 24, 2000, memorandum by Steven A. Wakefield, the former senior vice president and general counsel for Southern, indicates that Troutman should be the only firm used in the IPO and spin-off. "The only law firm we are using at this time is Troutman Sanders," Wakefield wrote in the memorandum. "They are respecting the enterprise and understand that their role is not to be an advocate for either side, but rather to provide objective legal advice and to document agreements reached between executives." Wakefield, who continues to serve as senior vice president and senior counsel at Southern, referred questions to his lawyer, Kenneth E. Carroll at Carrington, Coleman, Slowman & Blumenthal in Dallas. Carroll declined to answer questions for this story. TROUTMAN DOCUMENTS SOUGHT Lawyers working on behalf of Mirant in the bankruptcy case earlier sought documents from Troutman with limited success: Troutman had turned over approximately three banker's boxes of documents along with a 67-page privilege log. But last month, the judge presiding over the case, D. Michael Lynn of the U.S. Bankruptcy Court for the Northern District of Texas, ordered Troutman to produce all documents sought by Mirant's lawyers. "It is well established that, in a case of a joint representation of two clients by an attorney, one client may not invoke the privilege against the other client in litigation between them arising from the matter in which they were jointly represented," Lynn wrote. The bankruptcy judge also permitted Mirant's lawyers to interview members, counsel, associates and employees of Troutman, including John T.W. Mercer, the attorney primarily responsible for the joint representation of Southern and Mirant. Mercer, a partner who has been with Troutman since 1978, could not be reached for comment. It is common practice for one law firm to represent two corporations affiliated by virtue of common ownership or because one is a subsidiary, said Daniel H. Kolber, a securities attorney at Gambrell & Stolz who served as general counsel at the now-defunct Air Atlanta. "If there's a conflict then the attorneys will make disclosure of that and give the parties an opportunity to get separate counsel," he said. "But I can't remember a situation where the entities choose to get [separate] counsel, and I've been in that situation myself." The Southern Co. still has until Aug. 17 to file an answer to the complaint. However, a company spokesman provided the Daily Report with a written statement rebutting Mirant's claims. "Knowing that Mirant was financially healthy at the time of its initial public offering and at the spin-off, we do not believe there is any meritorious basis for a claim against Southern Company," said Todd Terrell, a company spokesman. The statement noted that prior to the spin-off, three major credit rating agencies rated Mirant's debt as investment grade. Some of the largest commercial banks in the world scrutinized Mirant's credit, loaned money to the company and consented to the spin-off, the statement added. Also, the underwriters of the deal called Mirant financially healthy; the Federal Energy Regulatory Commission gave its blessing to the company going public; and the Securities and Exchange Commission approved the spin-off and the manner in which Mirant paid dividends to Southern Co. "We know that Mirant was financially healthy at the point of the spin-off, so we will defend ourselves vigorously," Terrell said. ASSESSING FUTURE Meanwhile, Mirant's common and preferred shareholders are fighting to retain their equity. The shareholders fear Mirant's plan to convert its debt into equity stakes for creditors will cancel the shareholders' positions in the company and evaporate their investments. The shareholders have argued that the energy producer still has profit potential and should maintain its ownership structure. After hearing more than 25 days of testimony about the dueling valuation plans, the Texas bankruptcy judge, Lynn, issued a letter June 30 instructing Mirant and its financial analysts from The Blackstone Group, to recalculate the company's value using figures he deemed to be fair. If the company's value exceeds $11 billion, Lynn said he would consider Mirant's common shareholders to be "in the money," or still viable owners of the company. If the value is less, the role of the shareholders in the Chapter 11 case will be limited to the extent they can be expected to recover their investment. As for the preferred shareholders, Lynn said he will consider them "in the money" if Mirant's value exceeds $10.65 billion. The company, which is expected to emerge from bankruptcy after Sept. 30, has not yet finished recalculating the value, a spokesman said. According to Wilson, the Atlanta attorney representing some of the shareholders, the company and the creditors' committee assigned Mirant a value of between $7 billion and $9 billion. But, the shareholder groups said there was an additional $4 billion to $6 billion worth of value to the company. "So, it was a huge spread," Wilson added. The bankruptcy petition in Texas is In re: Mirant Corporation, et al, No. 03-46590-DML. ANDERSEN'S WORK A year before filing for bankruptcy, Mirant replaced Arthur Andersen with KPMG. The new auditors discovered significant errors contained in previous years' financial statements, according to the Fulton suit. KPMG ultimately had to completely re-audit Mirant's books for the years 2000 and 2001. Among the financial errors that emerged was one that caused Mirant to reduce its income from continuing operations for 2001 by $171 million. The same year's net income was lowered by $159 million, or 28 percent less than the figure Andersen previously certified. Securities fraud litigation and an investigation by the Securities and Exchange Commission followed Mirant's disclosure of the errors. The suit, filed July 12, accuses Andersen of negligence and breach of fiduciary duty. "We are suing ... because the investigation indicates that the quality of Andersen's work fell below the minimum acceptable standard for professionals," said Lawrence B. Schreve of Andrews Kurth in Houston who is acting as lead counsel in the case. Mirant's proxy statements for 2000 and 2001 show that Arthur Andersen received $5.2 million for its audit work, $21.3 million for consulting work, including financial systems information design and implementation, work related to SEC registration statements and Mirant's IPO, tax consulting, financial due diligence related to acquisitions and financial controls testing and reporting. Mirant later paid KPMG $7.4 million to re-audit its financial statements for 2000 and 2001. 'LACK OF INDEPENDENCE' The Fulton suit also accused Andersen of "an extreme lack of independence and a tremendous conflict of interest" by serving as Southern Co.'s auditor at the same time it worked for Mirant, a one-time subsidiary of Southern. The conflict of interest prevented Andersen from rendering "objective, independent" advice to Mirant with regards to "sham debt repayments" Southern received from Mirant, according to the complaint. The suit went on to say the dual role of auditor at both companies "hamstrung Andersen's performance of its watch dog functions as a protector of Mirant's creditors in particular and investors in general." Mirant v. Arthur Andersen, No. 05-EV-000130 (Fult. St. Ct., filed July 12, 2005) The lawyer representing Andersen, Richard H. Sinkfield of Rogers & Hardin in Atlanta, declined to comment on the case. "We're reviewing it and I'm not authorized to speak to the merits," he said.

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