(Bloomberg) — Even within the brazen world of short-sellers, the allegations are eyebrow-raising.
Two investment firms filed a class action suit against a telecom company, claiming investors were short-changed during its $3.1 billion sale. Then, the telecom company claims, they used the lawsuit as a kind of Trojan horse to gain access to confidential information, which helped them execute millions of dollars in short sales and other trades.
The accusation has stalled what ought to have been a run-of-the-mill class-action case in which the two firms, JDS1 and The Arbitrage Fund (TAF), applied to act as lead plaintiffs to represent the best interests of a larger group of investors. Both firms have denied wrongdoing, but the resulting nest of interlocking claims and counter-claims has already dragged through the courts for five years.
It prompted the Delaware judge overseeing the case to raise serious doubts about who makes a suitable shareholder representative.
“I must say, this is a new front of litigation to me,” Vice Chancellor Sam Glasscock III, who has over a decade of experience on the bench, said during a March 18 hearing. Typically the process of appointing a lead plaintiff “at least in my experience, has not been much of a problem,” he added.
It also comes at a time when short selling is under increased scrutiny from prosecutors and the SEC, who are mapping out how investors find and use information they trade on.
Family Ties
IDT Corp. is the telecom company at the center of the dispute, along with its spin-off Straight Path Communications Inc. Both were founded by serial entrepreneur Howard Jonas. Straight Path was run by Jonas’s son Davidi prior to its sale to Verizon Communications Inc. in 2018.
A Bronx native, Jonas got his start selling hot dogs outside a methadone clinic in high school, later describing the experience in a book titled “On A Roll.” After attending Harvard, he made a fortune in telecom and became a low-key supporter of conservative causes in the U.S. and Israel.
Now a 65-year-old grandfather of 27, Jonas operates out of a Newark, New Jersey office tower acquired from another prominent business clan, the Kushners, whose patriarch, Charles, is a Jonas confidant as well as the father of Jared Kushner, Donald Trump’s son-in-law.
Howard Jonas’s current legal problems go back to a swath of telecom bandwidth he bought in 2001 out of the ashes of the dot-com-bust. In 2013 he pulled the spectrum out of IDT, folding it into the new, separately listed Straight Path. A tug of war followed, between bulls who bet the FCC would allot Straight Path’s spectrum to 5G service, and short-sellers who pooh-poohed its prospects.
In July 2016, the FCC allocated Straight Path’s spectrum for 5G, proving the doubters wrong. The following January the FCC struck a consent decree with the firm over allegations that it had violated agency regulations by squatting on that spectrum rather than putting it into use as its licenses required. Rather than terminating many of Straight Path’s licenses, however, the FCC gave the company 12 months to sell them and stipulated that the agency would receive 20% of the proceeds.
In the bidding war that followed, Verizon trumped AT&T with a $3.1 billion offer for Straight Path. Two months later Jonas, his son and IDT were hit with class-action claims. They allege the payment due to the FCC — more than $600 million — had been improperly forced onto Straight Path’s tab to the detriment of investors.
That suit was led by Julian D. Singer, owner of JDS1, a New Jersey-based investment firm that has been active in telecom stocks. It was later consolidated with a second suit filed by TAF, a small mutual fund managed by Water Island Capital.
Singer’s father, Gary, is a felon who was banned for life from acting as an officer or director of a public company after a fraud scheme in the nineties. Gary Singer testified during a deposition that he was an unpaid adviser to JDS1. A company lawyer said he is not restricted from assisting his son with investments.
“Gary Singer’s fingerprints are all over JDS1,” defense counsel said in court. At the time Gary was banned in 1997, the SEC warned he might try to circumvent the order by doing business through his family.
Counter Claims
As lawyers representing JDS1 and TAF gathered pre-trial evidence, Jonas’s side was doing the same. During a November hearing, Jonas’s team turned the tables, presenting evidence suggesting that TAF’s affiliates and JDS1 itself had collectively shorted at least 424,500 shares of IDT worth $6 million, and that TAF and its affiliates had also traded Straight Path shares.
That allegedly included shorting IDT’s stock beginning in July 2017, as JDS1 and TAF were filing their complaints against IDT, and continuing in the months that followed as lawyers in the case were receiving confidential information. (TAF itself is not alleged to have shorted IDT but its sister funds are, potentially making its status more difficult than JDS1’s for the court to untangle.)
Jonas’s side argued that using confidential information obtained in the litigation to trade undermines the class-action process, citing a 2012 Delaware court case in which billionaire Michael Steinhardt was found to have traded improperly. Steinhardt’s case bore similarities: He admitted trading the stock of a company while receiving written and oral updates about a class action suit he’d filed.
While Glasscock indicated that the alleged conduct in the case before him “does not approach the same level as in Steinhardt,” he said last month that he was likely to reject JDS1’s role “given the allegations of trading in the stock.”
Taking the hint, the three plaintiff firms in the case — Bernstein Litowitz Berger & Grossmann, Entwistle & Cappucci, and Labaton Sucharow — withdrew JDS1’s request two days later while asserting that their client would make an “adequate” class representative. “JDS1 was neither accused of nor found to have violated any inside trading laws,’’ JDS1’s attorney, Edward Timlin of Bernstein Litowitz, said in a written statement. “By stepping back, JDS1 is making it easier for the Court to focus on the merits of this case.” Singer declined to comment.
An official with Water Island declined to comment. In an April 11 letter to the court, an attorney for JDS1 and TAF denied that confidential information was shared with TAF or TAF affiliates. Vincent Cappucci, an attorney for TAF, also said his client has done nothing wrong. “TAF is confident the Court will approve it as a class representative as no credible issue has been raised to support a contrary finding,” he said in an email message.
Judge Glasscock sounded less sure. “The number and timing of trades in Straight Path alleged to have been undertaken by TAF and TAF affiliates since the initiation of this litigation are, frankly, troubling in light of TAF’s position as a volunteer fiduciary,” he wrote in a February memorandum opinion. He scheduled an evidentiary hearing into trading by TAF and its affiliates.
Plaintiff Dispute
To class action lawyers, representing a lead plaintiff often means receiving a large share of legal fees awarded as part of a settlement. With the IDT case at risk of falling apart for lack of a lead plaintiff, Cappucci offered up a technical argument that would allow TAF to keep the role without burdening the court with an evidentiary hearing. “Smart lawyers understand exactly what this is, your honor,” Cappucci said.
The defense pushed back. “The Arbitrage Fund will put on glasses, a fake nose, and a fake mustache and call themselves the lead plaintiff, and all of a sudden they can avoid an evidentiary hearing,” said IDT attorney Rudolf Koch.
Glasscock wasn’t buying that argument either. “I know, Mr. Cappucci, it’s your position we’re all smart lawyers here. I guess that excludes me,’’ he said. “I just don’t get it.”
He postponed the trial until late August, saying the evidentiary hearing into the trading allegations needs to take place first. The case is already one of the oldest on his docket.
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