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THE DAY AHEAD: Between the lines of Cisco&#039&#039s class-action suit

COMMENTARY--Cisco Systems has been demoted to class-action lawsuit status. The crime? Cisco shares have tanked. The outcome? Some settlement that'll make lawyers money.

Nevermind that Cisco (Nasdaq: CSCO) was one of the biggest Wall Street darlings in the 1990s. Nevermind that the networking giant has made a lot of folks rich. In lawyerland, it's what have you done for me lately. Nothing? Here's the class-action lawsuit.

Milberg Weiss, a law firm that surfaces with a lawsuit whenever a stock falls, issued a press release last week telling the masses that they can join a class-action suit to squeeze some cash out of Cisco. Any investor that bought Cisco shares between Aug. 10, 1999 and Feb. 6, 2001 is eligible. You can even join the lawsuit online (chances are it'll go through a Cisco router to get there).

Let's read between the lines.

Milberg Weiss wrote: The complaint alleges that by the beginning of the Class Period in 8/99, Internet Service Providers and competitive local telephone companies had technology to deploy but little capital, and Cisco used this as an opportunity to increase its sales by providing capital financing to such companies but making such financing conditional upon the purchase of large amounts of Cisco product.

Between the lines: Cisco should have been noble and turned down the free money that Wall Street excess brought. CEO John Chambers should have spurned the easy sales and allowed companies like Lucent Technologies take the business. Can you imagine where Cisco shares would be if they didn't play the game?

Milberg Weiss: Through this alleged manipulation and the shipment of defective or incomplete products, as well as Cisco's failure to adequately accrue for excess and overvalued inventory and uncollectible finance receivables, Cisco was able to report "record" earnings each quarter during the Class Period. Defendants thus made positive but false statements about Cisco's products, financial results and business during the Class Period. As a result, Cisco's stock traded as high as $82.

Where were these lawyers when the shares were peaking? Oh yeah, they were trading Cisco stock. And those Cisco's products couldn't have been that bad--the saying that no IT manager gets fired for buying Cisco gear still stands. Also if there was true manipulation, the Securities and Exchange Commission would have been on the case way before the lawyers.

Milberg Weiss: The inflation in Cisco's stock price was essential to its main corporate strategy, that of growth through acquisition, which Cisco accomplished through the exchange of inflated Cisco shares. In addition, each of the defendants had the motive and the opportunity to perpetrate the fraudulent scheme and course of business described herein in order to sell $595 million worth of their own Cisco shares at prices as high as $80.24 per share, or 84% higher than the price to which Cisco shares dropped after the end of the Class Period, as the true state of Cisco's business and prospects began to reach the market.

Fraudulent scheme? C'mon. Cisco was up front about its growth-through-acquisition strategy and nearly everyone realized that the company needed its high stock price. And Cisco isn't alone. Because of the bear market, merger and acquisition activity has slowed to a standstill. Few companies have the currency to do a deal. As for insider selling, the sales are often on autopilot so execs can diversity. This is Wall Street not "The X-Files."

Milberg Weiss: After completing more than 20 major acquisitions between 9/99 and 2/01…Cisco announced extremely disappointing 2ndQ F01 results, including EPS of only $0.18. This disclosure shocked the market, causing Cisco's stock to decline to less than $30 per share before closing at $31-1/16 per share on 2/7/01, on record volume of more than 279 million shares, inflicting billions of dollars of damage on plaintiff and the Class. Cisco later admitted that 3rdQ F01 sales would be less than $4.8 billion, or lower than any quarter since the 2ndQ F00. Defendants' misconduct has wiped out over $400 billion in market capitalization as Cisco stock has fallen 84% from its Class Period high of $82 per share as the truth about Cisco, its operations and prospects began to reach the market. On 4/16/01, Cisco announced a $2.5 billion write-down of inventory (or 90% of its inventory as of 1/31/01) of components in its service business. This was one of the largest inventory write-downs in U.S. history. Cisco stock has dropped to as low as $13-3/16.

Finally, some agreement. Cisco's inventory write-off was a whopper. As for the profit warnings, the list of companies hit by the economic slowdown is a tech who's who list. Cisco executives were just as shocked as the market about the economy. Maybe Federal Reserve Chairman Alan Greenspan will get sued too. As for the valuation argument, most investors at least had an inkling that Cisco was overvalued at $400 billion in market cap. When you invest, the right price for a stock (valuation) is a notable thing to watch.

Milberg Weiss: Plaintiff seeks to recover damages on behalf of all purchasers of Cisco common stock during the Class Period (the "Class").

And Milberg rakes a nice chunk of any settlement. The fees are rolling in, especially since all these well-heeled tech bellwethers are struggling. Gotta love this bear market.

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