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A landmark settlement last month that had 10 former WorldCom directors agreeing to pay $18 million from their own pockets to investors who lost money in the company’s failure was scuttled yesterday.

A landmark settlement last month that had 10 former WorldCom directors agreeing to pay $18 million from their own pockets to investors who lost money in the company’s failure was scuttled yesterday.

The settlement fell apart after the judge overseeing the case ruled that one aspect of the deal was illegal because it would have limited the directors’ potential liability and exposed the investment banks that are also defendants in the case to greater damages. The lead plaintiff in the case said it could not proceed with the settlement with that provision removed.

When the settlement was announced, it was hailed as a rare case where an investor held directors responsible for problems occurring on their watch. Because yesterday’s ruling turned on one technical aspect of the settlement with the former WorldCom directors, it is not expected to deter restive shareholders from trying to make corporate board members accountable.

The ruling by Judge Denise Cote of Federal District Court in Manhattan – who is presiding over the shareholder suit against directors and executives from WorldCom, its investment banks and Arthur Andersen, its auditor – sided with lawyers for the banks, who objected to the deal almost immediately after it was announced.

The judge’s ruling means that the 10 directors will remain as defendants in the case. As such, they face the possibility of paying significantly more than they had agreed to in the settlement if they are found liable by a jury for investor losses.

Federal law states that in cases involving the sale of securities, as this one does, defendants found liable for losses by a jury are responsible for the entire amount of the damages. But in 1995, the Private Securities Litigation Reform Act provided that directors involved in such a case are responsible only for their part of the fault, as determined by the jury. This law was intended to protect directors from staggering damages in such cases.

The settlement with the former WorldCom directors was unfair to the investment bank defendants, their lawyers argued, because with the board members no longer named as defendants in the case, the banks could not reduce their own liability in a verdict by the amount of the investors’ losses that the jury concluded was the responsibility of the company’s former directors.

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