Buyer Beware and Hunting Scapegoats is so appropriate for the corporate world. Just another hefty bill for the lawyers.

http://www.businessweek.com/bwdaily/dnflash/june1999/nf90615a.htm?scriptFramed

How the Y2K Bug Could Bite M&A Advisers Morgan Stanley Dean Witter is being sued over the Y2K readiness of a company it helped sell

Forget power outages and errant airliners. As some dooms-dayers see it, the Year 2000 computer bug will inflict its greatest damage in the courts, where thousands of companies will be dragged into a storm of blame-shifting lawsuits.

Though the number of Y2K suits is still minuscule, the dark clouds of litigation are billowing on the horizon. In fact, they've already closed in on Morgan Stanley Dean Witter & Co., which in a suit before a Pittsburgh federal court is being accused of misrepresenting the Y2K-readiness of a company that then-independent Dean Witter Reynolds Inc. helped sell in 1996. As very likely the first of its kind, the little-reported case explores territory that will send New Year's shudders through investment banks: What legal responsibility do they have for companies they represent in mergers or acquisitions that are later found to be afflicted by costly Y2K problems?

In the fall of 1996, it hardly seemed a relevant question. Antrim Corp., a maker of databases used by medical labs and blood banks, appeared to mesh nicely with the larger Sunquest Information Systems, which develops related systems for hospitals. In November of that year, Sunquest scooped up Antrim from its parent -- Compucare Co. -- for $5 million. Dean Witter Reynolds acted as Compucare's adviser, managing the information flow between Antrim and its suitor.

Months after the deal was done, Sunquest now claims, it discovered that Antrim's products were far less reliable than it had been led to believe. Instead of using one single standard, Sunquest found, Antrim clients depended on an incredibly diverse -- and therefore unstable -- collection of computer systems. In fact, the complaint argues, Antrim had developed more than 200 unique software "modules," each requiring "individualized code, maintenance, [and] enhancements" that soaked up "an extraordinary level of engineering time" during system modifications. To make things worse, says the complaint, programmers left behind little or no documentation, boosting repair costs.

CLASSIC SQUABBLE. Antrim's approach meant that it would have to inspect each of its clients' systems for Y2K glitches. And having its programmers slog through millions of lines of computer code meant that they would be diverted from money-making projects. As of this March, according to court documents, Antrim had completed only 25% to 30% of necessary Y2K upgrades. And the company warns that the impact of the fixes will be "a substantial decline in revenues in the future." In its suit, Sunquest is asking for unspecified damages over $75,000.

Despite repeated requests for comment, none of the three parties involved would speak publicly about the case. Originally filed in July, 1998, the suit charges both Dean Witter and Compucare with fraud and breach of contract. In March, U.S. District Court Judge D. Brooks Smith threw out the fraud claims against Compucare (which was acquired in February by California firm QuadraMed), ruling that the case was essentially a matter of contracts. But he left intact the fraud claims against Dean Witter.

While in one sense this case can be viewed as a classic squabble over a business agreement, it could also set some important precedents for what may be a particularly bloody area of Y2K litigation -- mergers and acquisitions. "This case is important because it shows the obligations buyers and sellers have when dealing with companies whose systems aren't Y2K compliant," says Dean Morehous, an attorney at the San Francisco firm Thelen, Reid & Priest. And because the transaction it involves happened three years ago, the case could also help establish the date by which the courts may find that executives were obliged to know about and combat Y2K problems.

The case against Dean Witter hinges on whether Sunquest should have relied on information the bankers conveyed -- or possibly concealed, as the complaint alleges -- about Antrim's Y2K readiness. Sunquest argues that assurances that Antrim was Y2K-ready weighed heavily in its decision to buy the company. For example, Sunquest cites a Dean Witter memo, since made available in court documents, which says Antrim's Computer products were "stable, with excellent references." The complaint says Dean Witter documents also portrayed Antrim as having adequate cash reserves to insulate it against future losses, a notion tested during the recent Y2K repairs, according to the complaint.

BUYER BEWARE. In its fact-finding before the purchase, Sunquest did ask about Y2K, and was allegedly assured by Antrim's then-CEO that compliance was "not a problem." Still, it seems to have been a relatively minor concern, as there appears to be no mention of Y2K guarantees in either the final contract or in Dean Witter's memos pitching the purchase.

Moreover, Dean Witter's memos were filled with nearly two pages of legalese intended to guard it against such lawsuits. Indeed, the memos warn that they are based on "information provided by the Compucare Company" and, in fervent lawyer-speak, are "not to be viewed as facts and should not be relied upon as an accurate representation of future results."

What's more, asks Dean Witter, why would a court expect Sunquest to base its buying decision on information supplied by the seller's investment bankers? In nearly all buying situations, legal experts say, due-diligence obligations fall on the buyer. "The buyer has to take primary responsibilityfor determining whether or not [a deal] is a legitimate business risk," says Kirk Ruthenberg, head of the Y2K practice at Sonnenschein, Nath & Rosenthal in Washington, D.C. "In general," adds Morehous, "the rule is buyer beware unless there is active concealment."

Sunquest argues that Antrim and Dean Witter did in essence conceal the truth, by establishing strict rules on how Sunquest could collect information during its 30-day due-diligence period. For example, Sunquest says it was barred from viewing the computer code installed at client sites. Thus, it contends, it was prevented from observing the level of customization in the systems of each Antrim client. Sunquest also claims that it was not permitted to interview Antrim customers until one week before the deal closed. Even then, the complaint states, conversations were limited to a script approved by Dean Witter's chief deal-maker.

HUNTING FOR SCAPEGOATS. Therefore, Sunquest concludes, it had no choice but to rely on Dean Witter's reports. It's an argument that Judge Smith seems willing to explore. His March opinion stated that "[I]t may well be that Dean Witter will be shown to have been in the business of supplying information about Antrim that potential buyers, such as Sunquest, could be expected to rely upon." Dean Witter would not comment on the status of the litigation.

Even if Dean Witter did not hide the Y2K breakdowns, Sunquest claims the investment bank should be held to a different standard, which requires that financial advisers -- including investment bankers and accountants -- candidly report what are called "material events," a legal term for problems that substantially affect a company's fortunes. That standard may prove difficult for Sunquest to establish with respect to Dean Witter, with whom it had no formal relationship. "Usually a banker owes its responsibility to people who pay it," says Jack Auspitz, partner at Morrison & Foerster, a law firm to many high-tech companies.

Establishing such a connection becomes easier when an adviser is in the direct employ of a company, however, and that may have implications for future suits. Advisers "can be held to a certain standard in investigation," says Auspitz. "If they don't perform up to that standard, it's like malpractice for doctor or lawyer." He's quick to add that in practice, "very few people go around suing underwriters." Still, that could change, considering the number of mergers and acquisitions that occurred in the 1990s. How many buyers inherited costly Y2K problems that, had they known about them, would have killed mergers? If desperate directors and officers start hunting for scapegoats, they may yet pin blame on cash-rich advisers and accountants.

Which leads to the next question: When should have executives and their merger-and-acquisition advisers first known of -- and publicly addressed -- the Y2K problem? In the 1960s, when many of the legacy mainframe systems were first installed? Or at a specific date during the mid-to-late 1990s, when the approaching millennium finally raised public awareness?

FEW PRECEDENTS. The Sunquest deal occurred just as knowledge of Y2K began to spread. Sunquest could argue however, that the problem was widely discussed inside the software industry, and that any appraisal of a company's systems would surely include a Y2K check-up. Business Week, for instance, ran its first story on the topic in November, 1995.

Still, relatively few businesses were making preparations in 1996: Accountants weren't issued official guidelines from the American Institute of Certified Public Accountants on how to treat Y2K expenses until October, 1997. And the Securities & Exchange Commission began demanding Y2K check-ups only in 1998.

"A year and a half ago, not only were we not seeing this addressed in documents, people were saying 'what's this?'" explains Cathleen C. Judge, co-chair of the information technology law group at Philadelphia law firm Ballard Spahr Andrews & Ingersoll, who has helped draft Y2K language in contracts. "I think this is going to be mostly an issue in deals done in 1997 and 1998, not 1999."

With few precedents to go on, no one is quite sure where courts will ultimately come down on these varied issues. Morgan Stanley Dean Witter may be the first -- but not the last -- investment bank to find out first-hand.

By Dennis Berman in New York _ _ _

-- y2k dave (xsdaa111@hotmail.com), June 16, 1999

Answers

Mississippi files suit against American management Systems over inability to correctly update tax systems they've been working on for *3 years*. $900 MILLION dollar suit. Bump in the road? Federal *mission critical* departments have moved their deadlines to December. Three day snow storm? Is anybody HOME?

-- Will continue (farming@home.com), June 16, 1999.

Here's a thought: If TEOTWAWKI does happen -- if it's a Milnesque, Infomagical "10+" and millions of people die, etc. -- there will at least be ONE good result: No more lawsuits.

-- looking at (the@bright.side), June 16, 1999.

How are they going to "collect" their $900m after rollover???

Even now, with this lawsuit, they have no clue.... sad really

-- Andy (2000EOD@prodigy.net), June 16, 1999.

I know it, Andy! Find it hard to believe the awakening has just begun in *JUNE 1999*.....pitiful. That 900 MILLION amount is one "whopper sized" wake up call!

-- Will continue (farming@home.com), June 16, 1999.

Andy:

If they can't collect $$$, they'll settle for ration coupons.

-- Randolph (dinosaur@williams-net.com), June 16, 1999.