Blue Cross board sues its advisers Insurer complains it was misled by its consultants, lawyer

Blue Cross and Blue Shield of Maryland sued the New York consulting firm Booz Allen & Hamilton Inc. yesterday, claiming that the firm misled it on the status of the Blues' computer system and executive pay. The insurer also sued its former senior legal counsel, Fred M. Gloth Jr., for what it said was an illegally obtained $142,000 bonus.

At the same time, a committee of the board of directors announced that a six-month investigation by a Washington law firm had uncovered no evidence of gross negligence by the company's directors or former officers, as alleged in a lawsuit filed by subscribers in March.


As a result, the state's largest insurer will ask a Baltimore County judge this month to dismiss the subscriber lawsuit, which first accused Booz Allen, as well as the insurer's officers and directors, of gross negligence. Blue Cross said it would ask the court to substitute its own claim against Booz Allen and Mr. Gloth.

The lawsuit by five subscribers, filed in March, seeks $145 million in damages and accuses eight current directors and eight former managers of gross negligence. It is based on the findings of a U.S. Senate subcommittee more than a year ago that the Maryland Blues had been grossly mismanaged and its financial problems, including $120 million in losses, had been hidden from the public.


The Blues relied on exceptions to industry financial reporting rules to appear solvent beginning in 1989 until December. Meanwhile, it became involved in money-losing businesses and paid its executives some of the highest compensation in the industry.

After the Senate findings, the board members claimed they had been misled by senior company executives and its advisers, including Booz Allen. Booz Allen denied Blue Cross' allegations.

The legal action filed yesterday by the Blues against Booz Allen seeks the returned of unspecified fees and "consequential" damages. The insurer paid Booz Allen at least $2 million for its studies. The lawsuit accuses Booz Allen of failing to tell the board of a report it prepared that raised the cost to develop and fix the Blues' computer system to $56 million over the original $9 million estimate.

The suit also says that a $142,000 bonus to Mr. Gloth was not approved by the board.

Meanwhile, the special committee of Blues directors held a news conference yesterday to announce the results of its legal inquiry in the aftermath of the subscriber lawsuit.

Joseph A. Califano Jr., a Blues board member who headed the special committee, said that Mr. Gloth and former President Carl J. Sardegna committed "serious errors of judgment and demonstrated a profound lack of diligence and candor in their relations with the board."

The findings justify the Blues' decision this year not to pay more than $5 million in retirement benefits to the former executives, he said.

Neither Mr. Gloth nor Mr. Sardegna returned calls asking for their comment.


Mr. Califano also said there were "some instances of incompetence and mismanagement" on the part of some Blues officers, notably Mr. Sardegna. But the Washington law firm, Kirkpatrick & Lockhart, did not find that the two men deliberately misled the board or personally benefited -- standards for seeking monetary damages under Maryland law. The law protects officers and directors from liability for errors of judgment even when these result in large losses, except in instances of fraud or outrageous negligence.

Nor did the lawyers' probe find grounds to sue Blues directors who oversaw the company's finances at a time when the company was virtually insolvent. A review by a Columbia University accounting professor of the audit committee's work found its actions were "reasonably diligent."

Booz Allen said it would dispute the charges.

"Obviously we are surprised and very disappointed they decided to pursue the lawsuit," said Mary Duhon, director of communications for Booz Allen. She predicted that, once all information was considered, the company would be exonerated.

Blue Cross directors hired Kirkpatrick & Lockhart to investigate claims of subscribers in response to a request by state Attorney General Joseph J. Curran. The lawyers interviewed more than 50 people and examined 140,000 pages of documents in the probe, which so far has cost the company $700,000.

Mr. Curran said yesterday that two of his objectives have been accomplished. "They [the directors] responded to the $5 million [retirement payment] which we said was just not proper, and they apparently agreed to go forward with a claim against Booz Allen."


He said he would continue to evaluate what else should be done after reviewing of paperwork associated with the investigation.

A hearing on the motion to dismiss and counter motions or arguments from subscribers is scheduled for Nov. 30 in Baltimore Circuit Court.

A lawyer for the subscribers said yesterday that Blue Cross "is hiding behind a law that doesn't apply."

The lawyer, Jon W. Brassel of Annapolis, said he will argue that a company whose board is self-perpetuating and that is not subject to recall by shareholders doesn't enjoy immunity from making bad business judgments under the state's corporate liability law.

"Their posture that 'we did bad things but we are protected' doesn't fly, in my opinion," Mr. Brassel said. "The fortunate thing for 1.4 million subscribers is that it is not up to the Blues, it is up to the court."

The attorney general, Mr. Curran, said yesterday that the law was intended to protect volunteers who serve on boards of such entities as the Girl Scouts from lawsuits.