The opinion of the court was delivered by: Stewart Dalzell, J.
Five weeks after learning of a partial class action settlement that did
not include them, the former Chief Executive and Chief Financial Officers
of Rite Aid Corporation filed a motion to disqualify the law firm of
Ballard Spahr Andrews & Ingersoll. Ballard Spahr had, from late March of
1999 until the fall of that year, represented all defendants in what is
now the consolidated multi-district litigation involving alleged
violations of § 10(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78aa, in the purchase and sale of Rite Aid securities.
After extensive briefing on the instant motion, we also received
objections from, among others, Martin L. Grass (the former CEO) and Frank
Bergonzi (the former CFO) to the terms of the partial settlement itself.
*fn1 Their objections are, in part, based on the motion to disqualify
and argue in that regard that the settlement is the fruit of a tree
poisoned by the allegedly unethical participation of Ballard Spahr in its
negotiation and consummation.
After we concluded the April 6, 2001 fairness hearing on the class
action and derivative settlements, we on April 11 and 12 heard testimony
in connection with the motion to disqualify.*fn2 After Bergonzi's
counsel expressed his Fifth Amendment concerns about being subjected to
questioning on the motion, he elected to withdraw his motion with
prejudice, which we allowed by Order of April 11, 2001. Grass, on the
other hand, expressed no such concerns, and presses his motion to
disqualify, which we decide here.
When Rite Aid on March 12, 1999 publicly announced disappointing
earnings results, the market immediately punished its stock price for
it. In the first day of trading after the announcement, according to the
pleadings, Rite Aid lost $14.44 from its prior closing price of $37, for a
loss in market capitalization on that day of about $3.7 billion. As is
the custom in such matters, these events triggered litigation the next
day, March 16. Most of the putative class action suits were filed in this
district, and eventually those cases and litigation from outside this
district were consolidated in the pending multi-district litigation.
On the filing of the first suits, Elliot S. Gerson, Senior Executive
Vice-President and General Counsel of Rite Aid, after consulting with
Franklin Brown, Vice-Chairman of Rite Aid, retained Alan Davis, Esquire,
of Ballard Spahr to represent Rite Aid and Grass, who was at the time the
only senior officer of Rite Aid named in the litigation. Gerson had known
Davis since 1984, when both practiced law at the Philadelphia firm of
Wolf, Block, Schorr & Solis-Cohen. We credit Gerson's testimony that,
after conferring with Grass and Bergonzi, he concluded that all
defendants in the putative class action had an identity of interest
because the allegations were, in Gerson's view, without merit, and thus
one firm could represent all defendants.
Davis memorialized the representation in a March 24, 1999 engagement
letter which began by thanking Gerson "for engaging this firm to
represent the interests of Rite Aid Corporation and Martin L. Grass in
the defense of the putative class actions that have been filed against
Rite Aid and Mr. Grass following the Company's March 12, 1999 earnings
announcement," Ex. A, Mem. of Rite Aid Corp. in Opp'n to Mot. to
Disqualify Counsel (Decl. of Alan Davis, Esq.) (hereinafter "Decl. of
Alan Davis") at Ex. 1. Of great pertinence to the pending motion, on page
2 of his March 24 engagement letter, Davis advised Gerson that:
It is undisputed that at the time Gerson retained Davis to represent
Rite Aid and Grass, Gerson had also retained the Washington, D.C. firm of
Wilmer Cutler & Pickering to represent Grass personally. Gerson had
engaged Wilmer Cutler for Grass after the Wall Street Journal had in
January of 1999 published an exposé regarding related-party
transactions involving Rite Aid that allegedly benefitted Grass and the
Grass family. The Wilmer Cutler partners who represented Grass were
William McLucas and Harry Weiss, Esqs.
In his testimony before us, Grass testified that he could not recall
ever seeing an engagement letter either from Wilmer Cutler or Ballard
Spahr. Grass also acknowledged in his testimony that he looked to Gerson
to help him retain outside counsel in such matters.
Shortly after Davis sent Gerson the March 24, 1999 engagement letter,
additional putative class action complaints were filed. The first
derivative action was filed on May 14, 1999. These new suits also named
Frank Bergonzi, the former Chief Financial Officer, and Timothy Noonan,
then Rite Aid's President and Chief Operating Officer. Gerson requested
that Ballard Spahr represent these new defendants on the same terms as
the original representation of the corporation and Grass. Thus, on March
26, 1999, Ballard Spahr entered its appearance for Rite Aid and Messrs.
Grass, Bergonzi and Noonan.
After we held a motions hearing on June 2, 1999, the plaintiffs on July
14 filed what they styled a "Corrected Consolidated Amended Class Action
Complaint". Pursuant to our Order, Ballard Spahr filed a motion to
dismiss that complaint on behalf of all defendants on September 1, 1999.
Events at Rite Aid took a sudden turn the following month. On October
11, 1999, Rite Aid announced that its 1997, 1998 and 1999 financial
statements would have to be restated, resulting later that month in a
$500 million reduction of Rite Aid's previously represented pre-tax
earnings. On October 15, 1999, at a particularly dramatic meeting of the
Rite Aid Finance Committee at the New York City office of Skadden, Arps,
Martin Grass silently resigned his position as Chairman and Chief
Executive Officer of Rite Aid, an event that was publicly announced on
October 19, 1999. This resignation was sufficiently unpleasant that Grass
was given no compensation or retirement benefits upon his resignation and
none have been paid to him since.*fn4 By contrast, when Bergonzi was
earlier forced to step down as Chief Financial Officer, he received the
lavish severance agreement that we received as Exhibit R-6 which
provided, inter alia, for compensation of $525,000 per year through 2002.
As a result of these developments, the Audit Committee of Rite Aid's
Board of Directors began an internal investigation and obtained its own
outside law counsel and other professionals, including, most notably, the
Ten Eyck forensic accounting firm. This Committee has, since that time,
worked cooperatively with the Securities and Exchange Commission which is
investigating possible violations of the federal securities laws, and
with the United States Attorney's Office for the Middle
District of Pennsylvania, which apparently is investigating possible
Although Davis had followed these dramatic developments in the public
press, it was not until October 29, 1999 that he had a meeting at his firm
with Gerson and Mr. Ten Eyck, the forensic accountant the Audit Committee
had retained. Davis then for the first time learned of facts suggesting
that Messrs. Grass and Bergonzi had engaged in conduct which appeared to
constitute serious breaches of their fiduciary duties to Rite Aid, both
before and after commencement of the shareholder litigation, but had
concealed those breaches from Rite Aid and Ballard Spahr. ...