US investors sue Cable & Wireless for failing to disclose tax threat

Cable & Wireless was dealt a further blow yesterday after a US law firm began legal action over the potential £1.5bn tax liability which came to light earlier this month.

The law firm Schiffrin & Barroway has launched a class action lawsuit accusing the troubled telecoms group of violating sections of the Securities Exchange Act by issuing "a series of materially false and misleading statements" to the market between 6 August 1999 and 6 December 2002.

In particular, it alleges that a press release issued by the telecoms company on 6 August 1999, detailing the sale of its 50 per cent stake in the mobile phone operator One2One to Deutsche Telekom, was misleading as it did not mention the potential £1.5bn liability.

Under the terms of the deal, C&W had agreed to protect Deutsche Telekom from any future tax liabilities and agreed that should its debt rating fall below "Baa" status, it would ringfence £1.5bn of cash or get a guarantee.

"According to the complaint, such statements were materially false and misleading because they failed to disclose that a critical term of the One2One deal was a £1.5bn tax indemnification clause agreed to by Cable & Wireless," Schiffrin & Barroway said.

The credit ratings agency Moody's downgraded C&W's debt to junk status on 6 December, triggering that agreement and forcing the company to flag the potential liability.

Shares in Cable & Wireless collapsed nearly 43 per cent to close at 47.75p on 9 December – the first day of trading after the announcements were made – while the American Depositary Receipts (ADRs), which trade in the US, lost 40 per cent to close at $2.33 on the same day. The UK shares were 44p yesterday, compared with a high of 1,562p in 2000.

Schiffrin & Barroway has filed the class action suit in the US District Court for the Eastern District of Virginia on behalf of all buyers of ADRs in the company between 6 August 1999 and 6 December 2002. It is looking to recover damages.

A spokesman for Cable & Wireless said yesterday the company "understands its obligations" to shareholders and would defend itself vigorously against the action. While the group has insisted that it believes the £1.5bn potential liability will never crystallise, it has so far refused to explain why.

The sum relates to the issue of whether capital gains tax was payable from the disposal. C&W says its legal and tax advisers insist there is no liability and that the sale of the One2One stake did not give rise to a taxable gain.

But the company will not know that it has escaped the tax payment for sure until the Inland Revenue closes its investigation into the matter which, analysts reckon, could be another 12 months away.

The revelation shocked and angered the investment community, which fears there are more financial skeletons in the company's closet, and also increased pressure on Graham Wallace, the company's chief executive, to quit.

Were he to leave, he would be entitled to a payout of at least £1.55m since he is on a two-year contract. The only other executive on the board on a two-year contract is Robert Lerwill, the deputy chief executive and former finance director, who was paid £400,000 in salary and fees last year.