Court: Shareholder suit against EDS can proceed

FRAMINGHAM (01/14/2004) - A court in the Eastern District of Texas Wednesday denied a motion filed by Electronic Data Systems Corp. to dismiss a class-action shareholder lawsuit alleging that two former top executives knowingly misrepresented company earnings and the health of the multibillion-dollar Navy/Marine Corps Intranet contract.

In a 27-page ruling, district judge Leonard Davis concluded that lawyers for the EDS shareholders presented "strong" evidence that former EDS Chairman and CEO Richard Brown and former Chief Financial Officer Jim Daley misrepresented earnings and facts related to the troubled N/MCI contract. That, among other things, allowed the company's stock to be traded at falsely inflated prices.

"Having established that defendants knew of problems that existed on the N/MCI contract, the court concludes that plaintiffs have pled sufficient facts to show that defendants made misrepresentations or omissions to investors," wrote Davis. "The court also finds a strong inference that defendants were extremely reckless in continuing to recognize any revenue on the project when they were allegedly pursuing a tactic of intentionally providing goods that did not meet contract specifications."

Kevin Lightfoot, a spokesman for Plano, Texas-based EDS, said, "We're clearly disappointed with this, but not completely surprised by the judge's ruling." Lightfoot said that the company "continues to believe that the allegations against it are without merit" and that EDS plans to defend itself vigorously.

The shareholder complaint stems from a Sept. 18, 2002, EDS announcement that it expected its third-quarter 2002 earnings to fall short of the company's prior guidance by approximately 80 percent. A week later, securities analysts discovered that EDS hadn't disclosed certain financial obligations related to the sale of "put" contracts on its own stock, which would require EDS to pay US$225 million. As a result, the price of EDS's stock tumbled, and shareholders lost about $11.8 billion in value.

Last May, EDS reported a quarterly net loss of $126 million, blaming it on "problem contracts" and a whopping $334 million pretax loss stemming from difficulties with the N/MCI program.

In a 10K statement filed with the Securities and Exchange Commission in March 2003, EDS acknowledged, among other things, that "material delays in the assumption of responsibility for or installation of additional seats under (the N/MCI) contract could negatively impact the financial performance of this contract and significantly reduce our earnings and operating cash flow during the quarter in which any such delays occur."

Lawyers for the shareholders presented a significant number of documents that the court upheld as evidence supporting the allegations against EDS. Among the documents was a May 6, 2002, e-mail from the N/MCI transition manager at the Naval Air Systems Command that outlined various software problems, a failure to provide remote access for 61 percent of the users that were testing the new intranet, and a lack of secure Web access and help desk support.

In addition, lawyers for the plaintiffs produced results from a study of N/MCI conducted in the spring of 2002 by the Institute for Defense Analysis that detailed a laundry list of management and performance oversight problems. Among the more serious problems documented by the IDA study was "ineffective coordination" of desktop deliveries that led to unavailability rates of 20 percent to 50 percent.

N/MCI is an IT outsourcing contract, often referred to as a seat management deal, designed to give the Navy and Marine Corps secure, universal access to integrated voice, video and data communications. It is also designed to provide pier-side connectivity to Navy vessels in port and, when completed, link more than 310,000 desktops across the U.S., Puerto Rico, Japan and Cuba.

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