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April 17, 2001


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.

Factual Background*fn3

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 criminal wrongdoing.

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. ...

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