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Mary Pat Gallagher

New Jersey Law Journal

01-15-2008

A federal judge approved a settlement Monday in a shareholders' derivative suit against Schering-Plough Corp. with no award of damages but a $9.5 million fee to plaintiffs counsel and a company pledge to reform its governance.

Though attorney fees are usually awarded from financial recoveries, U.S. District Judge Katharine Sweeney Hayden found them justified in suit because it led the Kenilworth drug maker to make sweeping changes.

She said the fees were also justified by the complexity and risk of the litigation, which involved "the wholesale restructuring of a major corporation's governance and compliance functions."

The fees will be split among the plaintiffs' lawyers, Morris & Morris in Wilmington; Squitieri & Fearon and Abraham Fruchter & Twersky, both in New York; and the law offices of Bernard Gross in Philadelphia.

The fee award was based on a lodestar of $6.95 million, enhanced by a multiplier of 1.37. Hayden noted that a 350 percent increase in governance and compliance spending prompted by the litigation "demonstrates the complexity and breadth of the changes to Schering's corporate governance structure attributable to the efforts of plaintiffs' counsel."

The changes include replacing staggered terms for the board of directors with annual elections for every seat; replacing the meeting and committee fees used to compensate board members with an annual retainer; enhancing communication between the board and management; and centralizing global compliance and audit functions.

The litigation was sparked by Schering-Plough's Feb. 15, 2001, announcement that the Food and Drug Administration had delayed approval of Clarinex because of continued manufacturing deficiencies at plants in New Jersey and Puerto Rico despite several warning letters from the agency.

Clarinex was slated to fill the void created by the imminent loss of patent protection for Claritin, the company's blockbuster allergy drug. The plaintiffs allege that the delay caused a drop in stock prices and harmed the company's reputation.

Schering-Plough agreed to pay the FDA $500 million and tighten quality controls under a May 2002 consent decree, but litigation over the manufacturing issues was already under way.

Blaming the board's lack of oversight, the plaintiffs sued the directors in 2001 for breach of their fiduciary duty to Schering-Plough and its shareholders.

The directors ignored repeated and clear warnings that essential production facilities were plagued by manufacturing and quality control system breakdowns that threatened the company's ability to manufacture and market its products and its standing with regulatory authorities, alleged the plaintiffs.

They asked for changes in corporate governance, such as a separate compliance committee made up of independent board members authorized to engage outside consultants and professionals and a new corporate department reporting to the board to serve as the liaison with the FDA.

They also sought a refund of the directors' salaries, disgorgement of the proceeds of alleged insider trading and indemnification for any losses from lawsuits and regulatory actions.

The parties began negotiations in early 2003, aided by mediator Edward Infante, a retired U.S. magistrate judge. Their efforts culminated in a stipulation of settlement filed last October.

Though no money damages were recovered, the plaintiffs accomplished the "fundamental aim of the litigation ... to correct the Board's failure of oversight, and the resulting damage to Schering," held Hayden.

"The monetary losses and the regulatory troubles with the FDA are the fruit of the same tree, stemming directly from a breakdown in Schering's managerial structure. Thus, the most important motivation for maintaining this action was to prevent future losses of this ilk by changing how the corporation's directors oversee the running of the corporation."

The changes were likely to do that, said Hayden. For example, eliminating a staggered board would reduce the risk of director entrenchment, ending fees for committee work would promote transparency and centralizing global compliance and audit functions would facilitate direct reporting of compliance issues to the board, she pointed out.

Professor Gregory Mark, who teaches business associations at Rutgers Law School-Newark, says the settlement "looks like an expensive way to get things that probably ought to have happened anyway."

It has become much more common in recent years for derivative action settlements to provide for changes in corporate governance, he says.

Incentives other than lawsuits are also at work, he notes. For example, he cites Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), which recognized that failure to ensure a company has effective compliance and control systems can expose a director to liability.

Of all the changes agreed to by Schering-Plough, the end of the staggered board is likely to have the biggest effect, in his view. "For better or worse, it will make the corporation's management more sensitive to immediate shareholder concerns."

Plaintiffs counsel Karen Morris and Olimpio Squitieri did not return calls for comment and Jeffrey Abraham referred calls to Morris.

Defense counsel Douglas Eakeley, of Roseland's Lowenstein Sandler, referred a request for comment to company spokeswoman Rosemarie Yancosek, who says the approval puts "another litigation matter from the past behind us."

The company "continues to believe it complied with all applicable laws with respect to this litigation," she adds.

The case is In re Schering-Plough Corp. Shareholders Derivative Litigation, 01-Civ.-1412.