Telos wins another round in Baltimore City Circuit Court

Defense contractor Telos Corp. was jubilant this spring, when it defeated a $79 million lawsuit challenging the actions of its board and management. It didn't have long to celebrate, though.

One day after the April 15 ruling in Baltimore City Circuit Court, its outside auditing firm withdrew -- a potentially devastating turn of events for the publicly traded company, and one it blamed on a threat of litigation by the same two directors who helped bring the $79 million lawsuit.

Now, things are once again looking up for the firm. A judge in Baltimore has ordered the dissatisfied directors to have no contact with the firm's outside auditors, at least until the company is able to file its annual 10K financial statement with the Securities and Exchange Commission.

"We're in a very difficult spot without those audited financial statements; you've got to have that to go out into the marketplace," said Telos' attorney, Ava E. Lias-Booker of McGuire Woods LLP in Baltimore. "Ultimately it will impact the ability to get government contracts to do business."

Judge Albert J. Matricciani Jr. ruled against the two directors, Seth W. Hamot and Andrew R. Siegel.

"Telos is likely to show that Hamot and Siegel used potentially misleading communications and threats of litigation in an effort to dictate the accounting treatment" the auditor should adopt, in violation of the Sarbanes-Oxley act and an SEC rule implementing it, the judge ruled.

He also found that Telos was likely to prevail on its claim that the men breached their fiduciary duty to the Ashburton, Va.-based company, which is incorporated in Maryland.

It "is in the public interest to protect the operational status quo of an ongoing viable business, which employs over 500 people and provides essential services to the United States military," the judge noted.

Matricciani is also weighing the fate of Telos' related claims for tortious interference with contract, tortious interference with prospective business relations, and breach of fiduciary duty against the directors.

He heard arguments on Hamot's and Siegel's motion to dismiss those claims on Monday but, despite the favorable language he used in granting the injunction, has not yet issued his decision.

"We're waiting for the judge's ruling; we'll take it from there," said Hamot's and Siegel's attorney, Harry Levy of Shumaker Williams PC in Towson.

Hedge-fund investors

According to SEC filings, Hamot and Siegel are the powers behind Costa Brava Partnership III LP, a Boston-based hedge fund that owns about 12 percent of a class of Telos' shares known as exchangeable redeemable preferred stock, or ERPS.

The ERPS shares trade at a discount because, due to lingering debt from a leveraged buyout, the company is unable to declare a dividend.

In the action decided in April, Costa Brava sought to force the company to declare a dividend or redeem the ERPS.

Hamot and Siegel, however, have their own lawsuit against Telos.

They sit on Telos' board as the representative of the ERPS shareholders, but in the current litigation, they claim the company has shut them out of management decisions and is withholding information to which they are entitled.

Telos, though, contends that they are trying to force the company into receivership through litigation.

In addition to the shareholder suit and the right-to-inspection case, Hamot and Siegel sued Telos' former auditor, Goodman and Co. LLP, in Virginia over its classification of ERPS as a long-term obligation for Telos' 2004 and 2005 financial statements.

That lawsuit, which resulted in Goodman withdrawing as Telos' outside auditor, resulted in an ambiguous verdict. The jury found Goodman had "aided and abetted a breach of fiduciary duty," but awarded no damages.

Based on that verdict, Hamot and Siegel wrote to Goodman on March 28 and demanded it reclassify the ERPS as a current obligation for Telos' 2006 financial statements or face additional litigation.

The letter was blind-copied to Telos' then-current outside auditor, the Reznick Group.

That was "the straw that broke the camel's back," Lias-Booker said. Reznick withdrew from the contract on April 16.

Hamot and Siegel did, in fact, file another suit against Goodman in Virginia in May.

"Being our auditor means you sign up to be sued by Hamot and Siegel," Lias-Booker said.

And, while the company cannot agree to defend such suits -- that would negate the auditor's independence -- Lias-Booker hopes the preliminary injunction will have a similar effect.

"The preliminary injunction is critical," she said. "That will go a long way, I hope, to soothing the discomfort of Reznick -- or others, if Reznick concludes it cannot re-engage -- that they will be protected."

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