Class Action Countermeasures : Class Action Lawyers & Attorneys : McGuireWoods Law Firm : Complex Litigation, Mass Torts

Two years ago, I wrote about the difficulties defendants face when securities plaintiffs invoke confidential witnesses in their complaints. The case that prompted that discussion, City of Livonia Employee Retirement System v. Boeing Corp., now has a sequel. As it turns out, both parties appealed the opinion below: the plaintiffs because the court below had dismissed their case with prejudice, and the defendants because the court had not imposed sanctions consistent with the PSLRA.

Judge Posner wrote the opinion for the three-judge panel. He began with a brief (and very informative) summary of the relevant provisions of the PSLRA. In relaying the background of the case, Judge Posner specifically addressed the credibility of confidential witnesses head-on:

Allegations concerning--in the first amended complaint merely implying--unnamed confidential sources of damaging information require a heavy discount. The sources may be ill-informed, may be acting from spite rather than knowledge, may be misrepresented, may even be nonexistent--a gimmick for obtaining discovery costly to the defendants and maybe forcing settlement or inducing more favorable settlement terms.

(Emphasis added.)  In this case, since the plaintiffs acknowledged at oral argument that they would not be relying on their formerly confidential witness, he quickly affirmed the dismissal with prejudice.

Then he moved on to sanctions, where he had some more severe things to say about the various amended complaints:

The plaintiffs' lawyers had made confident assurances in their complaints about a confidential source--their only barrier to dismissal of their suit--even though none of the lawyers had spoken to the source and their investigator had acknowledged that she couldn't verify what (according to her) he had told her. She had qualms: the names the source had given her of persons to whom he reported in the Boeing chain of command were inconsistent with what she was able to learn about the chain. This should have been a red flag to the plaintiffs' lawyers. Their failure to inquire further puts one in mind of ostrich tactics--of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing. Representations in a filing in a federal district court that are not grounded in an "inquiry reasonable under the circumstances" or that are unlikely to "have evidentiary support after a reasonable opportunity for further investigation or discovery" violate Rules 11(b) and 11(b)(3).

(Italics in original; bold added.) So the opinion affirmed the dismissal, and remanded the case the district court for a finding of whether sanctions were appropriate in this case, and, if so, how much.

There are two key takeaways here for defense lawyers. The first, as I wrote the last time I discussed Livonia, is that it is always worth probing deeply into the pleadings, especially in securities cases where there are heightened pleading standards. The second is a more general lesson for all lawyers: once you've been caught cutting corners, don't push your luck with an appeal.

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Back in January, NERA Economic Consulting published yet another interesting paper, entitled Dynamic Litigation Analysis: Predicting Securities Class Action Settlements as a Case Evolves, by Dr. Ronald Miller.

Using the data NERA has collected on securities class actions over 20 years, Dr. Miller comes to some interesting conclusions about motions practice in securities cases. Most notably:

• Few securities class actions are resolved at the summary judgment stage.
• The filing of a motion to dismiss has little effect on settlement value of securities cases, but the granting of dismissal can reduce the value of a settlement by up to 40%. (Why not 100%? Presumably because class actions that settle after a successful motion to dismiss involved multiple lawsuits, or some other threat of recurrent litigation.)
• The resolution of a motion for class certification (either pro or con) does not have a statistically significant effect on settlement value, but the mere filing of the certification motion drives up settlement value by about 33%.

These findings reinforce an intuition (backed by experience) that many securities class action lawyers share: unlike in other class actions where certification is the real battle, in securities class actions, the real fight is the motion to dismiss.

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Blue Coat Systems, Inc. was a web security firm that, in 2008, tried to break into the growing field of wide-area network optimization by acquiring a company called Packeteer, Inc. The move was supposed to secure long-term growth, but arguably had the opposite effect.

On May 27, 2010, Blue Coat issued some financial results and held a conference call with industry analysts. While Blue Coat had met its its previous financial projections, its forward- looking guidance was not as optimistic as in previous calls. The analysts (and their readers) apparently worried, because the next day Blue Coat shares lost a quarter of their value after unusually heavy trading. (In other words, investors stampeded to sell the stock.)

And, as sure as the elimination of redundant data transfers follows deduplication, that drop in value was followed by a class action complaint. The problem, in this case, was that Blue Coat had hit its financial projections; it had just reported a less-rosy future than it had described before.

The plaintiffs responded to that dilemma by contending that:

an inference can be drawn that Blue Coat had intentionally misled the market by making unduly positive statements about its business and prospects, with knowledge that actual conditions were less favorable.

The defendants moved to dismiss, posing the question: can you bring a securities class action based only on forward-looking statements? According to the Northern District of California in Scandlon v. Blue Coat Sys., Inc., No. C-11-4293, 2013 U.S. Dist. LEXIS 10433 (N.D. Cal. Jan. 25, 2013), the answer seems to be "no."

The court specifically held that the plaintiffs had not pled sufficient factual allegations to meet the heightened standards of the PSLRA. But, as a quick look at the three deficiencies the court identified shows, most attempts to sue only on forward-looking statements would founder on the same problems:

Falsity - The court found it difficult to determine exactly what statements the plaintiffs claimed were misrepresentations. This was complicated by the facts that a number of the statements the plaintiffs pointed to were non-actionable "puffery," and that

Businesses are entitled, however, to synthesize and analyze the available information, and to reach judgments as to how "rosy" things are or are not. Not every detail that informs the overall opinions expressed must be disclosed to avoid committing fraud, even if some of the judgments subsequently turn out to have been wrong.

Scienter - The PSLRA requires a specific allegation that the defendants had the state of mind to commit fraud. Here, the court noted that the plaintiffs had pled themselves into a corner. To justify their focus on forward-looking statements, the plaintiffs had stressed the theme that management had made a bad decision by buying Packeteer. But alleging that management might not be competent businessmen was inconsistent with an inference of scienter:

In essence, plaintiff is alleging that Blue Coat made bad business judgments and poorly executed its changes in strategy after the Packeteer acquisition. While plaintiff is trying to argue that Blue Coat management had become aware of such shortcomings by the time it was making the generally positive public statements in issue, an equally plausible inference is that to the extent any statements were unduly positive, that was merely another aspect of management's failure to understand and respond well to business conditions. 

Loss causation - As the court succinctly pointed out, if the plaintiffs could not allege that any of Blue Coat's statements were false, there was no way they could demonstrate that a false statement caused their financial loss.

So what is the takeaway here? The most effective motions to dismiss are the ones that really test whether the plaintiffs' allegations hang together as a whole. If a court can't reconcile the plaintiffs' theory of the case, it's not going to go forward, especially when it has to meet a heightened standard of pleading like Rule 9(b) or the PSLRA.

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The Supreme Court has handed down its first class-action related opinion of the 2012-13 Term, Amgen Inc. v. Connecticut Retirement Plans & Trust Funds. And while that opinion represents a loss for the defendants in the specific case, it's not as big a problem for securities defendants in general.

Amgen involved an alleged securities fraud committed by Amgen Inc., a biotechnology company. As the Ninth Circuit's opinion lays out the alleged misstatements:

First, Amgen supposedly downplayed the FDA's safety concerns about its products in advance of an FDA meeting with a group of oncologists. Second, Amgen allegedly concealed details about a clinical trial that was canceled over concerns that Amgen's product exacerbated tumor growth in a small number of patients. Third, Amgen purportedly exaggerated the onlabel (that is, for FDA-approved uses) safety of its products. And fourth, Amgen allegedly misrepresented its marketing practices, claiming that it promoted its products solely for onlabel uses when it in fact promoted significant off-label usage, in violation of federal drug branding statutes.

Amgen moved to dismiss the case, but lost that motion. The plaintiffs then moved for certification, relying on the fraud-on-the-market theory to demonstrate classwide reliance. Amgen opposed, arguing in part that the plaintiffs had not shown that the alleged misstatements were material (a requirement the Supreme Court appeared to impose in Basic, Inc. v. Levinson). The problem was, materiality was both a "prerequisite" for fraud-on-the-market and an essential element of a 10b-5 claim. So the question the litigants (and the Court at argument) struggled with was: when do you have to prove materiality? At class certification, or on the merits?

Justice Ginsburg's opinion is remarkably clear, from the beginning:

Contrary to Amgen’s argument, the key question in this case is not whether materiality is an essential predicate of the fraud-on-the-market theory; indisputably it is. Instead, the pivotal inquiry is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will “predominate over any questions affecting only individual members” as the litigation progresses. Fed. Rule Civ. Proc. 23(b)(3). For two reasons, the answer to this question is clearly “no.”

(Emphases added.)  The first reason the Court cited was that materiality must meet an objective "reasonable investor" standard, which will not vary from class member to class member. The second reason, however, is the one that shows why the Amgen opinion should not cause securities defendants too much heartburn:

there is no risk whatever that a failure of proof on the common question of materiality will result in individual questions predominating. Because materiality is an essential element of a Rule 10b–5 claim, see Matrixx Initiatives, 563 U. S., at ___ (slip op., at 9), Connecticut Retirement’s failure to present sufficient evidence of materiality to defeat a summary-judgment motion or to prevail at trial would not cause individual reliance questions to overwhelm the questions common to the class.

(Emphasis added.) In other words, because of the "reasonable investor" standard for materiality, there was never a hope of showing variations there to begin with. The defendant's hope was always in just showing that materiality did not exist. And, if the defendant can do that, it can win the case outright.
In other words, what the Supreme Court did here was to remove one option for the defendant to challenge materiality. Before Amgen, the defendant could challenge materiality at four points during the litigation:

• during a motion to dismiss (decided on a 12(b)(6) standard, but with some assistance from the PSLRA, which requires plaintiffs to plead specific facts supporting loss causation);
• during a motion for summary judgment (decided on a "no contested material facts" standard);
• during class certification (decided on a standard that ranged between "burden of persuasion" and "preponderance of the evidence" depending on the jurisdiction); or
• during trial (decided on a "preponderance of the evidence" standard).

Now, the class certification challenge is gone, but the others remain. There are sound strategic reasons to want a challenge at the certification stage, but nothing prevents the defendant from filing a summary judgment motion before certification if it believes it can win the materiality issue cleanly.
So while, at first blush it appears the Court has taken away a certification argument for the defense, what it has really done is to remind the defendant that when it has a strong merits argument to make, it should do so.

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For many, the start of a new year is not just a time to look ahead, but also a nice landmark for looking back. So it is with class-action litigators. In the past month, there have been at least four different "Year End Reviews" of class actions. (I'm not counting my own, which are more top ten lists than anything else.)

So how do these various reviews stack up? Pretty well, actually.

Baker Hostetler's 2012 Class Action Year End Review
Where to find it: Here.
What's to like: It's a comprehensive look at class actions in 2012; and one of the authors is Paul Karlsgodt, the guy who brings you the Class Action Blawg.  It also has a very useful breakdown of recent class actions by topic and by specific industry.
What's to complain about:  Not much.  It gets the law largely right.  The most I might quibble with would be some of the editorial choices, but those are small potatoes indeed.
Most interesting finding: Watch out for privacy and LIBOR-related class actions.

"The continued proliferation of privacy class action litigation is widely expected in 2013, as the courts continue to grapple with the interpretation of both new and old privacy laws to rapidly changing technologies. Another potential trend to keep an eye on is the development of class action litigation relating to the LIBOR rate-fixing scandal, which has the potential to impact trillions of dollars of financial transactions worldwide and could be a catalyst to the accelerated expansion of class and collective action procedures in other parts of the world."

Skadden's Insights/Global Litigation
Where to find it: Here.
What's to like: A brief, incisive review of class action practice by defense guru John Beisner and his partner Jessica Miller. (Also, a products liability summary by former class action blogger Russell Jackson.)
What's to complain about: It's pretty brief; less than 2.5 pages. But it does pack a lot into them.
Most interesting finding: Watch out for single-state class actions.

"While nationwide classes based on state law are still moribund, a number of traditionally conservative courts around the country have embraced smaller, single-state consumer fraud and employment discrimination class actions, suggesting that 2013 may bring more class actions."

Seyfarth Shaw's Ninth Annual Workplace Class Actions
Where to find it: Here. 
What's to like: Comprehensive, detailed, data-driven analysis of awards and settlements in workplace class actions.
What's to complain about: Doctrinally, it's a little vague on occasion. And you have to order it, rather than just being able to download it. (I received only the first two chapters for review purposes.)
Most interesting finding: Dukes's big influence was in enabling a divide-and-conquer strategy for employment defendants.

"Wal-Mart influenced settlement strategies in workplace class actions in a profound way. Employers settled fewer employment discrimination class actions than at any time over the past decade and at a fraction of the levels as in 2006 to 2011. This reflected the impact of Wal-Mart, and the notion that difficulties in certifying nationwide, massive class actions impaired the ability of the plaintiffs’ bar to convert their case filings into blockbuster settlements. It also manifested the ability of defendants to dismantle large class cases, or to devalue them for settlement purposes. Simply stated, Wal-Mart aided employers to defeat, fracture, and/or devalue employment discrimination class actions, and resulted in fewer settlements at lower amounts."

(Internal footnote omitted.)

Cornerstone Research: Securities Class Action Filings 2012 Year in Review
Where to find it: Here. 
What's to like: Data, data, and more data. The class action media has already had a field day picking this apart, because there's just so much in it.
What's to complain about: Nothing, really. It does what it says on the tin, which is give data on filings, rather than settlements or decisions.
Most interesting finding: Merger class actions are declining.

"Compared with the past two years, federal filings associated with merger and acquisition (M&A) transactions have fallen sharply. Thirteen cases were filed in 2012 compared with 40 and 43 in 2010 and 2011, respectively. Evidence indicates these actions are now being pursued almost exclusively in state courts after the unusual jump in federal M&A filings in 2010 and 2011."

I understand how this probably looks: in the past month, I've complained that there's very little interesting going on in class action scholarship, and I've posted a "biting criticism" (as one correspondent put it) of the latest overview from two of the most respected names in class action academia. And then I turn around and praise three year end reviews by defense firms, and one by a consulting firm. But these are currently the facts on the ground. University academics--perhaps because they don't have much skin in the game except as "class action experts" in litigation--have shown in the past two years that they care mostly about Supreme Court cases and the "demise of the class action" that will result after the next wrong decision. Practicing lawyers, on the other hand, care about actually winning cases and serving clients. To do their jobs, they need good information; to get clients, they have to share that information. At this point, that apparently means that I'd rather be reading another firm's take on the last year than one by a law professor, no matter how distinguished.

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On Monday, the Supreme Court heard arguments in two different class actions, united by a common problem.

The first, Comcast Corp. v. Behrend, asked whether a trial court should hold plaintiffs to the Daubert standard for expert testimony at class certification, a question that has divided federal circuits for several years. Due in part to a difficult record below (Comcast had not actually registered a Daubert objection), the Justices argued back and forth about whether there was an issue to decide at all, and, if so, what it was. At one point, Justice Kagan remakes in frustration:

I am still in search of a legal question that anybody disagrees about here.

Taking a slightly different tack, Justice Kennedy questioned whether one can even impose a standard for the admissibility of evidence like Daubert on a trial judge who will simultaneously decide admissibility (which requires looking at evidence to determine its worth) and finding facts (judging the probity of the evidence):

the judge doesn't really have a gate -- what do you call it, a gatekeeper function here. There is no--there's no jury. And if the judge admits the evidence and if it turns out that that doesn't meet the standard of reliability, then he can exclude it.

I don't--I don't see why the judge has to say: All right, now first I'm going to do Daubert, and next I'm going to do whether this is reliable. This is just a magic words approach, it seems to me.

(Emphasis added.)  Meanwhile, Justice Scalia, like many lawyers, struggled with the threshold issue of how to pronounce "Daubert":

I never know how to say it. Is it [DAW-bert] or  [Doe-BEAR]?

While it's usually a fool's game to determine from the arguments which way the Court is leaning, it is remarkable that a number of Justices on both sides (including Kennedy, Scalia, Alito, Sotomayor, and Kagan) questioned whether a Daubert inquiry is necessary to a judge-conducted certification hearing.  In my limited experience, consensus like that at argument can imply consensus in chambers as well.

The second case, Amgen Inc. v. Connecticut Retirement Plans & Trust Funds (previously), asked whether a securities class-action plaintiff must demonstrate that the defendant's misstatements were material at the class certification stage (because the fraud-on-the-market theory many plaintiffs rely on requires a demonstration of materiality) or only at trial (where materiality is an element of the claim).

This question--when materiality is itself material to a securities class action--frustrated the Court so much that Justice Scalia suggested the solution may be to overrule the original fraud-on-the-market case, Basic Inc. v. Levinson:

If you have the same question, then maybe we shouldn't have this fraud-on-the-market theory. Because the whole purpose of it is--is to--to assume that--that the whole class was--was damaged and relied--because you can rely on an efficient market. But you can only rely on an efficient market where there has been a material misrepresentation. So maybe we should overrule Basic because it was certainly based upon a theory that--that simply collapses once you remove the materiality element.

(Emphasis added.)  Despite Justice Scalia's bold proposal, I'd say it is unlikely the Court will use Amgen as grounds to overrule Basic. That said, the argument does not provide a lot of clues as to which way most of the Justices lean. Justice Scalia seemed concerned about postponing the materiality inquiry given its likely effect on settlement; Justices Kagan and Sotomayor appeared more interested in whether materiality really needs to be decided before the merits.

Despite the disparate subject matters, there is a common thread to these two cases. Each asks what facts really need to be decided before a class action may be decided. And that makes them well worth watching this Term. Taken individually, these are technical questions that each arise only in certain kinds of class actions. But taken together, the Court may well make an important statement about the role of factual inquiry for class certification. And as class-action lawyers know, that factual inquiry dictates a number of tactical issues, from the extent of discovery to settlement posture.
 

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In 1998, the class action plaintiffs' firm Milberg Weiss filed sued Computer Associates for violating the federal securities laws by lying about its revenues in order to increase its stock price. In a perfectly unremarkable development, it was appointed co-lead counsel of the consolidated class. (Various firms had filed a total of eleven complaints.) Over the next four years, the pressure on Computer Associates mounted. Thirteen more complaints were filed, and the US Attorney's office (EDNY) and SEC launched a joint investigation of the firm.

So Computer Associates decided to settle the case. After seven months of mediation with the plaintiffs, it announced a settlement where class members would receive 5.7 million shares of stock in the company, then valued at around $140 million. Counsel's fee was 1.4 million shares, valued at approximately $35 million. (One might ask whether a settlement like this either (1) counts as a coupon settlement, or (2) created problems by diluting current shares, but neither of those was raise by the parties, who were all interested in the settlement going through.) By the end of 2003, the court had approved the settlement; there were no objectors.

Four months later, several Computer Associates executives pled guilty to conspiracy to commit securities fraud and obstruction of justice; the firm admitted that its executives had engaged in a multi-billion dollar fraud and coverup, and it restated an additional $2.2 billion in earnings. In addition, the Wall Street Journal reported that Computer Associates had withheld 23 boxes of documents during class-action discovery.

At this point, several of the class-action plaintiffs asked Milberg Weiss to vacate the certification order under Rule 60(b), because they had been deprived of essential information in the 23 boxes. Milberg Weiss declined to do so. So the plaintiffs proceeded on their own. After three years of litigation and discovery, the court dismissed the Rule 60(b) motion, in part because it wished to protect the "finality which a settlement is intended to produce." (It also noted that these plaintiffs had not objected to the settlement at the time.)

At that point, the disgruntled class members filed a malpractice action against Milberg Weiss and others in New York state court, alleging legal malpractice and breach of fiduciary duty. The lawyer-defendants responded by asking the E.D.N.Y. for an injunction against the malpractice action under the All Writs Act and Anti-Injunction Act, defending the settlement approval and the dismissal of the 60(b) motion. The E.D.N.Y. issued the injunction, and the plaintiffs appealed.

Which brings us to this week's case, Wyly v. Milberg, in which the Second Circuit affirmed the injunction. For those interested in the minutiae of the All Writs Act and Anti-Injunction Act, the court held that it could not uphold the injunction under the "in aid of jurisdiction" prong of the All Writs Act, because the court lacked in personam jurisdiction, and the mere connection with a class action was not enough to invoke any of the known exceptions to that rule:

We have never held that a district court's involvement in complex litigation justifies, without more, issuance of an injunction "in aid of" the court's jurisdiction, and we decline to create such a rule here.

Instead, the Second Circuit turned to the "relitigation" exception to the Anti-Injunction Act, which required it to conduct a preclusion analysis of the malpractice case. After determining that res judicata (claim preclusion) did not apply, it reasoned that

Before applying the elements of issue preclusion to this case, we begin with a preliminary observation about the Appellees' argument. In the course of the federal class action litigation, the District Court did not "actually decide" whether the Appellees committed legal malpractice; that claim was not presented, and therefore the Court had no reason to address malpractice as such. The Appellees' issue-preclusion argument is focused not on whether the District Court previously adjudicated a malpractice claim, however, but on whether the Court resolved one of the elements of a malpractice claim--namely, counsel's deficient performance.

(Emphasis in original.)  And it found that the Settlement Order had in fact established that the attorneys had acted in a reasonable manner, precluding a finding that could establish malpractice.

The Settlement Order held, inter alia, that the global settlement of the 1998 and 2002 class actions was "fair, reasonable[,] and adequate," and that class counsel was entitled to an award of fees that the District Court found to be "fair and reasonable." Whether an award of "fair and reasonable" attorneys' fees necessarily decides the deficient-performance prong of a legal malpractice claim is an issue of first impression in this Circuit. We conclude that the deficient-performance prong of New York's legal malpractice rule is identical to the reasonable-performance issue that the District Court decided as a necessary component of the Settlement Order.

(Internal footnote omitted.)  Since the lower court had found counsel to be adequate, and had also found that its performance merited its requested fee, there was no way another court could find that counsel had committed malpractice.

It is possible that the circumstances that gave rise to this case may come up again sometime. But that's not the reason for defense lawyers to focus on it. (After all, here, the defense had pulled off a coup: settling the case for less than it might be worth after the conclusion of a criminal investigation.) Instead, here are four other reasons this case is important for defense lawyers:

1. The full record is fascinating reading, and offers a lot of between-the-lines looks at how a large securities plaintiff's firm operates.
2. The Second Circuit's "relitigation" reasoning may have application in other cases where plaintiffs seek a second bite at the apple in state court. Defendants are often interested in finality, and this is a case that offers some help in achieving that in litigation.
3. We often talk about how plaintiffs in class actions are only nominal, and it is the attorneys who really run the cases.  This case is a stark example of just what that divorce between plaintiff and attorney can mean in a class action.
4. The case is an important reminder that if you do not challenge adequacy of counsel or the level of attorneys' fees when they first arise, you may be precluded from doing so later, when it really matters.

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 It turns out that Elizabeth Chamblee Burch is not the only law professor currently worried about adequacy in securities class actions. Boston University law professor David H. Webber has an article in the Northwestern University Law Review on The Plight of the Individual Investor in Securities Class Actions.

While Professor Burch was concerned with whether or not institutional investors were adequate representatives on their own, Professor Weber is more concerned with whether they can ever represent individual investors. In particular, he sees three conflicts that may be insurmountable:

1. Derivatives trading. Institutional investors tend to engage in derivatives trading; individual investors less so. Derivatives trading may mean that institutional investors do not suffer the same losses as individual investors, or face the same risks. More importantly, it may subject them to unique defenses, such as a lack of reliance. (Basic, Inc. v. Levinson did not do away with the reliance requirement in securities fraud, it just allowed a court to presume reliance from stock price. If a derivatives trader has not relied on the stock price …)
2. Governance reforms. Webber notes that institutional investors are more likely to seek corporate governance reforms as part of their settlements. And, as he points out, if an investor accepts governance reform as part of a settlement package, it is usually in exchange for less overall money. Institutional investors who are repeat players may very well prefer the governance reform. Individual investors may prefer the cash.
3. Merger class actions. Finally, institutional investors are far more likely to be on both sides of a merger transaction, a situation that may well disqualify them from representing a class challenging the approval of a merger.

Professor Webber's proposed solution is to pair up individual investors with institutional investors. (Which is not too far off from Professor Burch's "plaintiff group" proposal.) But his critique, especially when coupled with Professor Burch's, and with the circularity problem in securities class actions, raises the question of whether securities fraud cases are appropriate for class treatment after all. Meanwhile, however, his specific discussions of the problems with institutional investors can provide defense lawyers with additional ammunition to fight certification in less meritorious cases.

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 Georgia Professor Elizabeth Chamblee Burch has an essay out for the University of Cincinnati's Corporate Law Symposium, in which she argues that institutional investors may have problems serving as adequate class representatives in securities class actions.

As she acknowledges, this is a counter-intuitive position, but that hardly makes it wrong. We have grown used to thinking of institutional investors as "good" class plaintiffs [] ever since the passage of the PSLRA, when Bill Lerach began to recruit them as named plaintiffs in securities class actions. But, as Professor Burch explains,

a divide often exists between institutional and individual investors such that the former, when acting alone, cannot adequately represent the latter. To briefly explain this divide, institutions are more likely than individuals to:
(1) trade in derivatives, which means that the institution may not rigorously pursue the litigation because even though it has a large voting stake in the defendant corporation, it lacks the risk of economic exposure;
(2) continue to own stock in the defendant corporation, which means the institution may exchange corporate-governance reforms for lower monetary settlements, whereas former shareholders would prefer to maximize their compensation;
(3) take litigation risks because less money is at risk vis-a-vis its overall wealth than would an individual who has lost her life savings (the so-called "peanuts effect"); and
(4) think that, because they own heavily diversified portfolios, fraud is just as likely to benefit them as it is to harm them over time and reason that it makes sense to avoid significant time investments and transaction costs in pursuing wrongdoing. 

(Emphases added)  Her solution (which she has advocated before): a lead plaintiff group.

Appointing a lead-plaintiff group solves the problem that Reynolds v. Sims paints starkly in political context: each citizen has a right to participate fully in state government and that right is "unconstitutionally impaired when its weight is in a substantial fashion diluted when compared with votes of citizens living in other parts of the State. . . ." Rule 23 assumes that a representative's self-interest overlaps with the interests of those she represents so that when she pursues her own interests, she benefits the class. Consequently, appointing a diverse, representative group with both individuals and institutions ensures equal access to voice opportunities, adequate representation, and due process in securities classes just as voting rights do in the political context.

As Professor Burch points out, this essay is not particularly new. She has written on these ideas before. But it is a quick, cogent take on one of the larger unaddressed problems in securities class actions. As such, it's well worth a read.

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Last week, NERA Economic Consulting released its latest mid-year report on trends in class-action securities filings. The trend most are mentioning is the decline in the pace of securities settlements, coupled with the fact that settlement amounts remain high. But there are a number of other interesting observations that are worth mentioning. Among them:

Of the cases that settled, 90% had a motion to dismiss filed and 42% had motion for class certification filed.

(Emphasis added.) This makes a degree of sense. A failed motion to dismiss would help the defendant to understand whether a legal theory has merit (or, at least, whether a court will allow a plaintiff to run with a theory others might not). Moeover, the motion to dismiss remains a critical filing in securities class action litigation.  While it would be interesting to know how many of those motions for class certification were granted, it is useful to know that slightly fewer than half of the settled cases at least got as far as seeing what plaintiffs' certification theory was. (Securities class actions, of course, often face fewer individualized issues than other class actions.)

The report also notes that merger objection class actions (which had long found homes in Delaware state court) are growing in federal court.

There continued to be a relatively large number of merger and acquisition objection cases (merger objection cases) in recent years. Merger objection cases first represented an important component of federal filings in 2010, when they amounted to 31% of filings..

And the report also observes that forum-shopping remains a common tactic in class-action filings:

"Filings remain concentrated in two circuits: the Second (encompassing New York, Connecticut, and Vermont), and the Ninth (including California, Washington, and certain other Western states and territories). However, in the first half of 2012 the balance between these two circuits was substantially different from that in previous years.

During the first half of this year, filings in the Second Circuit have been made at a higher pace than in any recent year except 2008. Filings in the Ninth Circuit, by contrast, have decreased substantially. At their current pace, there will be only 30 filings in the Ninth Circuit this year, which would be the lowest total since the passage of the PSLRA in 1995."

The decline in Ninth Circuit filings is probably due to a combination of the fallout from Wal-Mart Stores, Inc. v. Dukes, and the recent ruling in Mazza v. American Honda Co., which held that plaintiffs could not file nationwide class actions based solely on California law. While neither of these two holdings has a direct effect on securities class actions, it's been my unscientific impression that the various California district courts in particular have responded by clamping down on class actions in general; it would make sense that plaintiffs might decide to begin filing elsewhere under those circumstances. Nonetheless, it is clear that plaintiffs still far prefer to file in the Second and Ninth Circuits when possible. (Some of this might stem from the fact that the more favorable environment means that the plaintiffs' bar in these two areas is more developed.)

So what's the takeaway from these trends? Plaintiffs remain innovative, and class actions remain far from dead.

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 As most of you following class action-related news know by now, the Supreme Court has granted certiorari to review another class action decision: the Ninth Circuit's recent opinion in Connecticut Retirement Plans & Trust Funds v. Amgen, Inc.  (Hat tip to Paul Karlsgodt of the reliably great ClassActionBlawg for getting the scoop.) As usual, SCOTUSblog has all of the relevant documents.

The issue in this case, is whether a court must decide whether an allegedly fraudulent statement is material before it applies the fraud-on-the-market presumption from Basic, Inc. v. Levinson. As the certiorari petition puts it:

The courts of appeals are split, however, on the question whether plaintiffs must also prove, for class certification, an additional predicate to the fraud-on-the-market theory— that the alleged misrepresentation was material. The courts of appeals also are split on the related question whether a defendant may, at the class certification stage, present evidence rebutting the applicability of the fraud-on-the-market theory.

But I want to focus, briefly, on a few other things this certiorari petition does, because it's an excellent example of how to get an issue in front of the Court. After all, to get a certiorari petition heard, one has to (1) convince a Supreme Court clerk to pull the petition out of the cert pool (think "slush pile"), and (2) attract the votes of at least four of nine justices who have a lot of other issues to decide. And, much as I would love to think otherwise, most of the justices of the Supreme Court are probably not as fascinated by class action issues as Paul or myself. (This same logic applies to 23(f) petitions, which are themselves an attempt to convince a busy federal appellate court to review an issue it doesn't have to.) So what does this cert petition do right?

It establishes stakes for the Court. By linking the resolution of securities class actions to the settlement rate, the petition provides a concrete bad outcome if the issue is not heard--settlement of meritless claims. But it also contrasts the Ninth Circuit's handling of the issue to a recent Supreme Court opinion:

None of the reasons given by the Ninth Circuit for treating the materiality predicate differently from the efficient-market and public-statement predicates has merit. To the contrary, the Ninth Circuit’s reasoning contravenes this Court’s precedents, including Basic and Erica P. John Fund.

It explains why the circuit split matters. There's a nice reference to the percentages of securities class actions filed in various circuits, which shows that the vast majority are now filed in circuits with different interpretations of this rule.

This circuit split is entrenched and mature. Moreover, with the Ninth Circuit having entered the fray, the split now involves courts of appeals for circuits that account for a substantial majority of securities fraud litigation. In 2010 and 2011, 74% and 73% (respectively) of all securities fraud class actions were filed in the Second, Third, Fifth, Seventh, and Ninth Circuits.

The statistics are a nice touch. They hammer home just how chaotic it would be to have an inconsistent rule in a large sector of class action litigation.

It explains why certiorari is appropriate now. As the brief points out

Now that the Second, Third, Fifth, Seventh, and Ninth Circuits have resolved the questions presented for their respective circuits, the likelihood that the is- sues will be presented again in a discretionary Rule 23(f) appeal is necessarily low. Courts of appeals gen- erally grant permission for a Rule 23(f) appeal only when the district court’s class certification order presents an important question of class-action law that is unsettled within the circuit …

Remember that percentage of securities filings? That plays in here as well. Since the vast majority of securities filings are in courts that have already decided the issue, the petitioners argued that there would likely not be another chance for the Supreme Court to hear this issue.

What's the takeaway? It's a simple one, but extremely important and often forgotten: know your audience. Want to get the Supreme Court's attention? Show them why the opinion endangers one of their recent holdings, and why it won't get reviewed unless they take it now.

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 So, unless you live under a rock, you've probably heard that JP Morgan lost some money last week. And, as one might expect, with a $2 billion loss, lots of people have opinions. One of those is Yale Law Professor Jonathan Macey, who wrote an op-ed in the Wall Street Journal (behind a paywall) worrying that, since both the SEC and the Department of Justice has launched an investigation into the loss, the Obama administration was turning losing money into a federal crime. (WSJ Law Blog summary here.) Professor Macey is a very smart man. But he also has never spent time as a litigator. (Go ahead, check; I'll wait.) And I think, in this case, that shows.

See, here's the thing. While Professor Macey is very worried, I'm not sure that JP Morgan's executives are complaining about either the SEC's or DOJ's investigations. I'm sure they're not celebrating them, but there's have good reason to welcome the investigations at this point.

Let's leave aside for a moment the fact that JP Morgan CEO Jamie Dimon already said he was expecting regulators to sniff around (because that was, in fact, their job). That might just be diplomacy.

But it's also a great way to reduce JP Morgan's eventual legal exposure from any lawsuits. JP Morgan's stock went down once the loss was announced. (To be expected.) And that meant securities lawsuits would soon follow.  In fact, Thompson/Reuters legal reporter Alison Frankel immediately asked what the over-under would be for filing the first class action. 

It wasn't long. As of this post, Robbins Geller Rudman & Dowd LLP and Bernstein Liebhard have both announced class actions against JP Morgan. (This once again calls into question the deterrence justification for these lawsuits; to say that JP Morgan needs more deterrence than a $2 billion loss to tighten its practices stretches credulity. If deterrence is the name of the game, these firms should be looking for the next JP Morgan, not suing this one.)

One of the best ways to inoculate against those class actions is to let the regulators in to give the firm a clean bill of health. If a clean bill of health is not possible (and it may not be, see Dealbook's analysis here), better to negotiate a settlement with the government than with lawyers who will take a 33% cut for themselves. If JP Morgan works with the government, it has an excellent rhetorical argument against fast-tracking a class action (why duplicate government effort?) and a good doctrinal argument against certifying the class (the class action would not be superior to the government investigations). That's not making it a crime to lose money, that's using the legitimacy of the DOJ to buttress the legitimacy of JP Morgan when it needs to defend civil lawsuits. If the DOJ and JPM's C-suite both contain smart people (and they clearly do), then they'll take advantage of this situation--the DOJ (and perhaps the SEC) to show that they're on the case when something is rotten on Wall Street, and JP Morgan to show that government action is enough.

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For fourteen years, from 1970 to 1984, more than 150,000 people bought stock in Petro-Lewis and its limited partnerships. Late in that period, the price of gas declined, and Petro-Lewis had to borrow money to to pay out distributions. In 1984, it announced that it was in severe financial straits, and cut its distributions by half, a move that resulted in a number of lawsuits, including Kirkpatrick v. JC Bradford & Co. 

In that class action, the plaintiffs alleged that JC Bradford had violated the securities laws by misleading investors in Petro-Lewis about its financial condition. At the class certification hearing, JC Bradford argued (1) that individualized issues predominated because the plaintiffs would have to prove reliance, and (2) that the named plaintiffs were not adequate. The trial court denied certification, relying on both of these grounds. The plaintiffs appealed.

The Eleventh Circuit held that denying certification based on predominance was error (mainly because of the same logic that motivated Basic Inc v Levinson).  

And then the court turned to adequacy. It conceded that

As the district court aptly noted, a potential class is entitled to more than "blind reliance upon even competent counsel by uninterested and inexperienced representatives."

(Emphasis added.)  And it observed that

Several district courts thus have properly denied class certification where the class representatives had so little knowledge of and involvement in the class action that they would be unable or unwilling to protect the interests of the class against the possibly competing interests of the attorneys.

(Emphases added.)  But it also argued that that the named plaintiffs did not have to demonstrate "to any particular degree" their vigor in pursuing class claims. Obviously, the court reasoned, a class would "be better served if the named plaintiffs fully participate in the litigation," but realistically class counsel is usually far more motivated to pursue claims than class members are. While it conceded that this created a "potential for abuse," it concluded, that

in securities cases such as these, where the class is represented by competent and zealous counsel, class certification should not be denied simply because of a perceived lack of subjective interest on the part of the named plaintiffs unless their participation is so minimal that they virtually have abdicated to their attorneys the conduct of the case.

Because the adequacy of the named plaintiffs was a mixed question of law and fact, the court did not reverse the trial court's adequacy finding. Instead it just remanded the case so that the trial court could make a finding according to the appropriate standard.

(Incidentally, there is one other feature of Kirkpatrick that is likely to become important. In footnote 6, the court also held that

The presence of arbitration agreements is relevant for another factor in determining the suitability of class treatment on the 10b-5 claims. ... Those purchasers whose 10b-5 claims are subject to arbitration thus could not be considered members of the class. In ruling on the motion for class certification, the district court did not determine whether the potential class members not subject to arbitration would be sufficient to satisfy the numerosity requirement of Rule 23(a)(2). The court should make this determination on remand.

Given the newfound emphasis on arbitration agreements, it is likely that, in a number of cases, classes where many members would be subject to arbitration clauses may lack numerosity.)

Kirkpatrick has a mixed legacy as a case. Defendants quite rightly cite it to demonstrate that one cannot completely abdicate a case to plaintiffs' counsel. And they also cite it to point out that one key feature to adequacy is the ability of the class representative to stand up to her lawyers when their interests diverge. The court did hold that one can largely look to the zeal and vigor of plaintiffs' counsel, instead of the plaintiff, but it specifically limited that holding to securities cases like the one before it.  And, as we know, particularly since the PSLRA was enacted, securities cases involve a much more searching inquiry into the adequacy of plaintiffs' counsel than other class actions.

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 Today's case, Katz v. Gerardi (10th Cir. 2011), involves a pair of securities class actions that were challenging a merger that had gone through (a currently burgeoning field for securities class action lawyers). The case involved a real estate investment trust (REIT), in which the two plaintiffs (Jack Katz and Infinity Clark Street Operating) were members. The REIT merged with another entity, and, as part of the merger, the two plaintiffs were bought out. Katz received cash for his shares; Infinity took shares in the new entity.

Then each of the plaintiffs sued, alleging that the merger's offer documents were false and misleading. Infinity filed a case in the District of Colorado, alleging breach of contract and fiduciary duty. (All of its claims were dismissed, except one that was stayed pending arbitration.) Katz filed his lawsuit in Illinois state court, claiming violation of securities laws. The defendants removed it to federal court (a story by itself), and the case was transferred to the District of Colorado. Once there, Katz amended his complaint and joined Infinity.

The defendants moved to dismiss, based on two theories. (1) Infinity could not assert federal securities-law claims because, since its previous lawsuit hadn't asserted them, it was splitting its claims; and (2) Katz could not assert federal securities claims because he was not a buyer of stock, but a seller. The district court dismissed the claims, and both plaintiffs appealed.  The Tenth Circuit affirmed.

Infinity had argued that it was not required to assert all of its claims in its first class action because the doctrine prohibiting claim-splitting (which derives from res judicata principles) required a final judgment. The Tenth Circuit disagreed.

Our precedent cannot be clearer: the test for claim splitting is not whether there is finality of judgment, but whether the first suit, assuming it were final, would preclude the second suit. This makes sense, given that the claim-splitting rule exists to allow district courts to manage their docket and dispense with duplicative litigation. If the party challenging a second suit on the basis of claim splitting had to wait until the first suit was final, the rule would be meaningless. The second, duplicative suit would forge ahead until the first suit became final, all the while wasting judicial resources.

(Emphases added.)  Katz's argument involved a more creative question, but one that goes to the heart of merger class actions. Was he a buyer or a seller of the stock? Katz had argued that he was a buyer, because the merger had effected a "fundamental change" in his shares, essentially forcing him to "buy" them before selling them. Judge Easterbrook of the Seventh Circuit (who heard the same argument in the fight over removal) had called this argument "word play designed to overcome the actual text of the securities laws." (Emphasis added.)  And the Tenth Circuit agreed.

The merger did not force him to purchase new securities, but only to sell his A-1 Units for cash or new units. Since Katz's 1933 Act claims only give standing to purchasers of securities, which Katz is not, his claims were properly dismissed.

So, what can defense lawyers use from this case? First and foremost, it provides an excellent definition of claim-splitting, one that applies not only to motions to dismiss, but also to arguments about adequacy and superiority when opposing certification.  And second, it offers a useful reminder that it's always best to argue that words mean what they seem to. If your argument requires claiming that black is white, you're not liable to win your case so much as get yourself killed at the next crosswalk.

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 This month's look at "classic" class action scholarship focuses on the article Nonpecuniary Class Action Settlements by Geoffrey Miller and Lori Singer. Like the name suggests, nonpecuniary settlements are settlements that don't require cash payments to the absent class members. According to Miller and Singer, they include:

• Coupon settlements.
• Monitoring settlements, "where the defendant endows a fund whichis used to identify and compensate for future harm allegedly arising from the defendant's product or conduct"
• Securities settlements, "where the defendant distributes stocks, puts, or warrants instead of cash to membersof a class as consideration for a release of claims for alleged wrongdoing"
• Reverter fund settlements, where the defendant may keep any unclaimed funds
• Fluid recovery settlements (also known as cy pres)

(It's interesting to note that Miller and Singer do not consider forms of injunctive relief like "corporate therapeutics," injunctions where the defendant agrees to change its offending behavior. This omission is likely due to the fact that these techniques were not yet in common use in 1997.) According to Miller and Singer, their

goal is to replace some of the recent hysteria about coupon and other nonpecuniary settlements with a more balanced account that identifies the benefits, as well as the costs, of such agreements.

Non-monetary settlements are attractive to defendants because they don't have to spend as much. (The benefit usually costs less--sometimes far less--than its cash equivalent.) They are attractive to plaintiffs because they allow them to place a dollar value on the settlement that is large enough to justify large attorneys' fees. (I don't have to point out that it is extremely rare for a class-action plaintiff to actually run a class action, do I?)

Miller and Singer identify the largest problem with nonpecuniary settlements as one of valuation. From their perspective, that means that both the defendant (who wants to pay less in total) and the plaintiffs' counsel (who wants the largest possible fee) have an incentive to manipulate the valuation of the nonpecuniary elements.

When nonpecuniary settlements are being negotiated instead of cash awards, there is an added level of complexity because the defendant and class counsel have an opportunity to manipulate the valuation of the settlement in order to serve their individual purposes. The problem of sacrificing class recovery for the attorneys' fee becomes exacerbated. Because the fee is typically in cash, the ratio of the fee to the class recovery can be manipulated by exaggerating the value of the nonpecuniary class settlement. Thus the fee may seem a smaller percentage of the class recovery than it is in fact.

These are not necessarily bad things. Defendants would argue--and economic analysis would back up--that a nonpecuniary benefit that costs them little but is worth a great deal to a class member creates wealth. (But let's be clear: not every coupon is going to be worth more to a class member than it cost the defendant.) Plaintiffs' counsel would argue--and some academics would support--that larger fees will deter bad conduct more efficiently than cash to the class. And Miller and Singer argue that when the defendant shares its savings with absent class members (say by providing them with coupons for free-of-charge and free-of-strings products), a nonpecuniary settlement can actually achieve the rarest of goals, creating value for all parties.

Miller and Singer's article came out eight years before the Class Action Fairness Act institutionalized some of the critiques of coupon settlements, making it more difficult to provide that form of nonpecuniary relief. But, as almost any class-action lawyer will admit, nonpecuniary relief remains in high demand among both plaintiffs and defendants. Sometimes it will create value, but often it still results in settlements that draw valid objections.

CATEGORY - Settlement
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 In the 1990s, a group of attorneys sued a number of securities broker-dealers nationwide. They alleged that the broker-dealers had executed a number of securities orders at the "National Best Bid and Offer" (NBBO) price--which would provide a customer with the lowest available ask or the highest available bid for a security--an industry-wide practice at the time. Broker-dealers operate under a "duty of best execution," which requires them to "use reasonable efforts to maximize the economic benefit to the client in each transaction." The plaintiffs accused the broker-dealers of violating that duty by executing orders at the NBBO price instead of the examining other feasible alternatives. Since broker-dealers had used NBBO on literally hundreds of millions of transactions, the proposed class action meant big money.

The broker-dealers had lost a motion to dismiss. However, when the plaintiffs moved for certification, the trial court denied it. The plaintiffs appealed pursuant to the newly-enacted Rule 23(f). The Third Circuit affirmed the trial court. The Third Circuit's opinion contains three notable discussions.

First, because Rule 23(f) had only just come into being, it discussed the standards for bringing an interlocutory appeal under the Rule.

If granting the appeal ... would permit us to address (1) the possible case-ending effect of an imprudent class certification decision (the decision is likely dispositive of the litigation); (2) an erroneous ruling; or (3) facilitate development of the law on class certification, then granting the motion would be appropriate. But these instances should not circumscribe our discretion; there may also be other valid reasons for the exercise of interlocutory review. Again, we emphasize that the courts of appeals have been afforded the authority to grant or deny these petitions “on the basis of any consideration that the court of appeals finds persuasive.

(Emphases added, internal quotation omitted.) These standards are largely similar to most other circuits'.

Second, the court addressed plaintiffs' argument that the district court had improperly engaged in a merits evaluation when it found that plaintiffs could not prove economic loss using classwide proof. In doing so, it articulated a standard that is now accepted by the majority of circuits:

As the Court concluded in Livesay, class certification may require courts to answer questions that are often enmeshed in the factual and legal issues comprising the plaintiff's cause of action. ... In reviewing a motion for class certification, a preliminary inquiry into the merits is sometimes necessary to determine whether the alleged claims can be properly resolved as a class action. This is such an instance. We must probe beyond the surface of plaintiffs' allegations in performing our review to assess whether plaintiffs' securities claims satisfy Fed.R.Civ.P. 23's requirements.

(Emphasis added, internal citations, quotations, and footnote omitted.)

The court also found that plaintiffs could not prove economic loss on a classwide basis. The plaintiffs had attempted to invoke Basic Inc. v. Levinson to argue that the court should presume classwide injury much as it presumes classwide reliance in securities cases. The court, however, disagreed:

"Because claims may take on several forms, proving economic loss on a common basis is a fact-specific inquiry. We find no support in the case law for presuming economic injury for purposes ofin Rule 10b-5 claims absent indication that each plaintiff has suffered an economic loss.
In assessing the question of economic loss, it is important to bear in mind how the facts here differ from those in a typical action. Unlike a "fraud-on-the-market" claim, this case does not involve a misrepresentation or omission that decreased the value of a security. Furthermore, unlike excessive over-pricing policy claims, this case does not involve a practice that necessarily harmed investors across the class.In this case, defendants allegedly executed trades solely at the NBBO price. Depending on the facts of each trade, the NBBO listed price may or may not have provided a class member with the best price. Therefore, economic loss to the plaintiffs cannot be presumed by the purchase or sale of a security at the NBBO price, and we will not presume it across the class.

(Emphasis added, internal citations omitted)

In sum, Newton provided guidance on three issues on which defendants still rely heavily: when an interlocutory appeal is appropriate, how much a court may look at the merits in evaluating class certification, and the extent to which a court may examine variations in "damages" to determine whether individual issues predominate. Any one of those might qualify it as a "classic case." The combination of all three ensures that this opinion will be cited for years to come.

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If not, I have a post up on the excellent OUPblog about it, pitched more toward the educated layperson.   

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 My colleague Samantha Thompson has written a post for McGuireWoods's government-investigations group blog Subject to Inquiry on Erica John Fund v. Halliburton.  It's a good summary, and worth a read.  

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It's June, which means the Supreme Court is issuing a spate of opinions to finish out its 2010-11 term. Yesterday, the Court announced its opinion for Erica John Fund v. Halliburton. It's a short opinion, and a unanimous one. (Chief Justice Roberts wrote the opinion for the 9-0 Court.)

As you may remember, this case concerns an alleged securities fraud. The plaintiffs had alleged that Halliburton understated its asbestos litigation liability and overstated the benefits of a proposed merger. Once the truth came out, the price of Halliburton's stock dropped. When the plaintiffs moved for class certification, Halliburton argued that they could not show that the misrepresentations actually caused the loss. The trial court denied certification, and the Fifth Circuit affirmed.

I noted when the Court granted certiorari that the Fifth Circuit's opinon had drawn fire from academics for requiring an early merits inquiry. The Court did not address that criticism directly. Instead, it focused on defining loss causation.

The question presented in this case is whether securities fraud plaintiffs must also prove loss causation in order to obtain class certification. We hold that they need not.

The Court discusses how its opinion in Basic, Inc. v. Levinson (which allows a court to presume reliance where an efficient securities market exists) establishes the standard for determining causation at the class certification stage.

It is undisputed that securities fraud plaintiffs must prove certain things in order to invoke ’s rebuttable presumption of reliance. It is common ground, for example, that plaintiffs must demonstrate that the alleged misrepresentations were publicly known (else how would the market take them into account?), that the stock traded in an efficient market, and that the relevant transaction took place “between the time the misrepresentations were made and the time the truth was revealed.”

However, according to the Court,

The Court of Appeals’ requirement is not justified by Basic or its logic. To begin, we have never before mentioned loss causation as a precondition for invoking Basic’s rebuttable presumption of reliance. The term “loss causation” does not even appear in our Basic opinion. And for good reason: Loss causation addresses a matter different from whether an investor relied on a misrepresentation, presumptively or otherwise, when buying or selling a stock.

(Emphasis added.) The Court calls the kind of causation represented by reliance "transaction causation." In other words, did the misrepresentation cause the buyer to buy?

Loss causation, by contrast, requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss. As we made clear in Dura Pharmaceuticals, the fact that a stock’s “price on the date of purchase was inflated because of [a] misrepresentation” does not necessarily mean that the misstatement is the cause of a later decline in value. We observed that the drop could instead be the result of other intervening causes, such as “changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events.” If one of those factors were responsible for the loss or part of it, a plaintiff would not be able to prove loss causation to that extent. This is true even if the investor purchased the stock at a distorted price, and thereby presumptively relied on the misrepresentation reflected in that price.

In other words:

Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory.

What's the likely effect of this opinion? For most circuits, which did not observe the loss causation requirement, not much. The opinion largely reaffirms the status quo. In the Fifth Circuit, we're likely to see an uptick in class action filings, and certifications of securities class actions.

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The caper was a simple one: the money was just sitting there unclaimed, so Kevin Waltzer would claim it.

In this case, the unclaimed money was sitting in common funds for three securities class-action settlements--In re Nasdaq Market-Makers Antitrust Litigation, In re Cendant Corporation Litigation, and In re BankAmerica Corporation Securities Litigation. To claim it, Waltzer posed as a financier who had traded the stocks at issue in each case. With the help of several accomplices (including one at the accounting firm that made the disbursements for the settlement) Waltzer cleared more than $40 million before he was caught by the IRS, and turned on the rest of his crew.

Today's case, United States v. Negroni, details the fallout from the scheme. The legal issue revolves around whether the trial court had justifiably departed downwards from the Federal Sentencing Guidelines when sentencing several of the defendants. The Third Circuit said it did not, and remanded the case for resentencing. Its primary reason for doing so was oddly similar to some class action appeals -- the trial court had not adequately explained its reasons for the downward departure.

But what's more relevant to class-action practice is the nature of the scheme. The defendants here were fraudulently claiming proceeds from securities class-action settlements. And, like with most criminal activity, it's hard to imagine that the crooks who got caught were the only ones committing the crime.  

Negroni shows that there is good reason to build verification mechanisms into a class settlement. Plaintiffs' lawyers often argue that these mechanisms serve only to depress claims. But Negroni shows exactly how individuals can make false claims; and the richer the proposed settlement, the more likely it is that it will attract con men like the defendants here.

Less important from a practical perspective, but more interesting from a theoretical one, this decision undermines the more extreme versions of deterrence that some academics use to justify increasing attorneys' fees in class actions. If class actions were only about deterring bad conduct and it didn't matter where the money went, there'd be no reason to punish these defendants. In class actions, there is rarely a high claims rate against the common fund.  So, from a "pure deterrence" perspective, the fact that this money went to con men instead of deserving shareholders should not matter. But, of course, it does matter. And why is that? Because courts recognize that class actions--like other civil lawsuits--are devices for making wronged victims whole, as opposed to simply deterring alleged bad actors. Even if current practice occasionally renders that goal a legal fiction, it's an essential legal fiction. Shattering our suspension of disbelief by allowing con men to walk away with the proceeds, whether they be posing as class members, lawyers, or experts, does extraordinary damage to a delicately balanced system.

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 As a class action lawyer (and one who defends class actions, no less), I often face the problem of explaining to friends and family exactly what I do all day. The cases themselves are often interesting, but the way we lawyers go about defending them--by mastering the arcana of one of the Federal Rules of Civil Procedure--can seem hopelessly dry. And that is why, at times, I have comforted myself with the (hollow, I admit) consolation that at least I'm not an ERISA lawyer.

Except, of course, that ERISA can spawn class-action lawsuits as well. Some simply challenge a plan administrator's decisions in administering employees' retirement benefits. But, more and more frequently, plaintiffs' lawyers are filing ERISA "stock-drop" cases, which go after the same alleged frauds challenged in securities class actions, but use ERISA plan beneficiaries as plaintiffs instead of individual or institutional investors.

The combination of Rule 23 and ERISA is enough to send many experienced lawyers into fits of anxiety or ennui, but Vanderbilt law student Lauren Fromme has bravely stepped in to explain the workings of the ERISA stock-drop suit in her comment "Unreliable Securities for Retirement Income Security: Certifying the ERISA Stock-Drop Class."

Let me say first, Fromme has written an outstanding student note, not so much for its final prescription (which I'll admit is intriguing), but for its careful exploration of a burgeoning trend in securities class actions. Fromme begins by identifying the key differences between a securities case and an ERISA stock-drop suit, namely:

First, most 10b-5 lawsuits are governed by the Private Securities Litigation Reform Act of 1995 ("PSLRA"), which provides for an automatic discovery stay and heightened pleading requirements. Mirroring Federal Rule of Civil Procedure 9(b), the PSLRA requires that 10b-5 claimants plead "loss causation" and "state with particularity" facts creating a "cogent and compelling inference" that the defendants acted with intent to deceive. ERISA claims, however, are not covered by PSLRA, and Federal Rule of Civil Procedure 26 is the sole guidance for discovery. Without the additional requirements of PLSRA and Rule 9(b), ERISA plaintiffs need only plead facts creating a "plausible" inference of causal connection under Federal Rule of Civil Procedure Rule 8(a), making it easier to survive a motion to dismiss. Second, Rule 10b-5 plaintiffs must show that the defendants acted with scienter, which is a wrongful state of mind requiring at least a showing of recklessness, while ERISA requires only a showing of negligence. Third, Rule 10b-5 only allows for the recovery of damages as defined by the loss resulting from the defendant's misstatements. Remedies under ERISA, however, may exceed the plaintiffs' damages, including lost profits and other equitable relief restoring the benefit plan for losses. Finally, Rule 10b-5 defendants are defined broadly by their relationship to any fraudulent misstatements, while ERISA defendants must be plan fiduciaries.

(Emphases added, internal footnotes omitted)

As Fromme points out, the largest obstacle to certifying an ERISA stock-drop class is the treatment of the investors' reliance on the alleged misrepresentations. Reliance matters in ERISA suits (which seek restitution to a firm's retirement plan) because most plans are defined-contribution plans, rather than defined benefit plans. As a result, participants choose their own investments, and bear the risk of those investments working out or not. (Courts certify ERISA suits under all three subsections of Rule 23(b), but Fromme argues causation matters even in Rule 23(b)(1) or (b)(2) suits to the extent defendants can demonstrate that a representative plaintiff is atypical of the class because she relied on a misrepresentation no one else did.) ERISA suits are not suits under 10b-5, so it is unclear that the Basic rule that allows plaintiffs to presume reliance is in effect.

Fromme's proposal to fix this apparent contradiction is to require "some reliance":

the plan participants collectively in an ERISA section 502(a)(2) claim can be likened to a single plaintiff asserting a claim under Rule 10b-5. All of the plan participants might not rely on the fiduciary's misstatements, but as long as some participants rely there will be actual causation. This is similar to a single 10b-5 plaintiff, for example, who detrimentally relies in part on the corporate officer's misstatements, in part on her own intuition, and in part on the recommendations of a friend. As long as the plaintiff in this 10b-5 case can demonstrate the detrimental reliance on the material misstatements, her reliance on the other aspects of the security should not matter. Therefore, to establish liability in an ERISA section 502(a)(2) claim, all that the plaintiffs must show is that some of the plan participants relied on the material misstatements. Only some reliance will be enough to cause harm to the plan as a whole.

Fromme's proposal is interesting, although it raises some questions about how it would play out in practice. Does a plan participant who did not rely on a misstatement have standing to offer evidence of others' reliance? Will this create a greater focus on cherry-picking class representatives, which may raise adequacy problems? Nonetheless, this is an outstanding piece of student scholarship, and well worth a read by anyone who defends securities class actions.

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I've talked before about the problem of circularity in securities class actions. Briefly put:

[A] securities class action takes money from the firm, and pays it to the shareholders, minus costs and attorneys' fees. The hitch is that the firm is owned by the shareholders, which means that the attorneys have just taken money from the shareholders' property and handed it to them directly, while taking a one-third cut for themselves.

At the time, I pointed out that while the circularity critique may suggest that securities class-acton plaintiffs are inadequate the moment they bring a lawsuit, courts were unlikely to give that argument much credit. Villanova professor Richard Booth, however, has authored a working paper that refines the argument, and shows why securities class actions may actually cause adequacy problems in language most courts will understand. Booth notes that there are two kinds of investors: diversified investors that actively manage their portfolios in some way, and more passive "buy-and-hold" investors. diversified investors are far less likely to buy and hold investments. Instead, they tend to be "actively managed," trading investments based on a number of factors in an attempt to beat the returns the market offers. Most importantly, even a diversified investor with a stable strategy will buy and sell individual stocks as it rebalances its portfolio. As a result, a diversified investor--and many, if not most, investors are diversified--is just as likely to gain from a securities fraud (selling the stock when its value is still inflated) as it is to lose. Under those circumstances, as Booth describes it, securities class actions operate as a redundant insurance policy.

Moreover, because the diversified investor has shielded itself from any large individual loss that comes from a buy-and-hold strategy, they are more likely to prefer derivative lawsuits to class actions. Why? Because in a derivative class action, the vast majority of the money recovered goes back into the corporation, rather than out to the original buyers of the stock. Booth also points out that attorney fees tend to be lower in derivative actions, effectively reducing the "lawyer tax" on any recovery. Or, as Booth himself puts it:

Undiversified investors are likely to favor class actions. Diversified investors are likely to oppose class actions and favor derivative actions. Although undiversified investors would not object to a derivative action in principle, they might object because the derivative recovery would reduce the class recovery. In other words, each group opposes what the other favors. Investors who stand to gain more from a class action will want their representative plaintiff (and lawyer) to maximize their claim by downplaying or indeed ignoring any evidence of derivative claims. The remainder of investors will want a zealous derivative plaintiff (and lawyer) to maximize derivative claims.

(Emphasis added)  Booth's working paper suggests three strategies for the lawyer defending a securities class action:

• Aim discovery at the plaintiff's investment strategy. If the plaintiff in a securities class action actively manages its assets, then it is far less likely to have suffered a significant loss. If it pursued a buy-and-hold strategy for the stock, it may not be an adequate or typical representative of those investors who more actively manage their assets. (Many defense lawyers already ask about investment strategy as a matter of course, but a reminder never hurts.)
• Argue derivative actions are superior to class actions. I've discussed superiority in securities class actions before, but Booth's analysis reinforces the point: a securities class action may not be the best way of recovering investment losses. In fact, a derivative lawsuit--because it generates less in fees and puts the money back into the corporation itself--offers natural advantages over a class action.
• Argue adequacy. One of the strongest strands of adequacy doctrine is the discussion of intra-class conflict. If the defendant can generate evidence that shows that the named plaintiff does not actually represent the investment strategies of a significant percentage of the class--and in fact may be actively undermining others' investment strategies--that is strong evidence that an irreconcilable class conflict exists.

These tactics are hardly radical; in fact, they're based on common sense about how people actually invest. Unfortunately, as the circularity critique highlights, common sense is not always so common in the realm of securities class actions.

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A few weeks ago, I mentioned that the Supreme Court had begun to hand down its class-action cases for the term. I was wrong. It actually delivered another opinion a month ago that, despite sitting on my desktop, I had forgotten. And that's something I ought to correct.

The case, Matrixx Initiatives, Inc. v. Siracusano, arose out of an alleged securities fraud. According to the plaintiffs, Matrixx Initiatives, Inc. (in the person of three of its executives) withheld reports of a possible link between its cold remedy Zicam and a condition known as anosmia, or loss of the sense of smell. Specifically, the plaintiffs alleged that, starting in 1999, Matrixx had received calls from doctors who had reported "clusters" of patients who used Zicam and suffered anosmia. (Even under more rigorous conditions than self-reporting, cluster samples tend to lack the precision required for statistical significance.)

Matrixx convinced the district court to dismiss the complaint by arguing that clusters are not significant enough to reach the standard of materiality under § 10 of the Securities Exchange Act, and that the plaintiffs had not pled that the defendants had scienter under the PSLRA. The Second Circuit reversed, and Matrixx appealed to the Supreme Court.

The Court faced two questions, both of which arise primarily in securities class actions. First, does an omission of data that is not statistically significant count as material? Second, is recklessness enough to fulfill the PSLRA's scienter requirement?

It didn't struggle with either question. Justice Sotomayor wrote for a unanimous court. First, the Court held that data does not have to be statistically significant to be material.

As Matrixx itself concedes, medical experts rely on other evidence to establish an inference of causation. We note that courts frequently permit expert testimony on causation based on evidence other than statistical significance. We need not consider whether the expert testimony was properly admitted in those cases, and we do not attempt to define here what constitutes reliable evidence of causation. It suffices to note that, as these courts have recognized, "medical professionals and researchers do not limit the data they consider to the results of randomized clinical trials or to statistically significant evidence."

(Internal citations omitted.) Justice Sotomayor concluded that since

medical professionals and regulators act on the basis of evidence of causation that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well.

The Court did try to set some limit on the materiality of any adverse events. It noted that adverse event reports are "daily events" for pharmaceutical manufacturers. So the real question was not whether there had been an adverse event report, but how a reasonable investor would treat the "total mix" of information at that time.

The Court also briefly discussed scienter. Given plaintiffs' allegations that Matrixx had hired a consultant and convened a "panel of physicians and scientists" to help it respond to the reports of anosmia,

[t]he inference that Matrixx acted recklessly (or intentionally, for that matter) is at least as compelling, if not more compelling, than the inference that it simply thought the reports did not indicate anything meaningful about adverse reactions.

So what does this ruling mean for defense lawyers? First, it should guarantee continued business. Efforts to limit its reach aside, the Court's ruling provides an opening for enterprising plaintiffs' counsel to file securities-fraud cases based on isolated events, so long as they argue that the events changed the total mix of information available to an investor. The ruling also means that lawyers will have to pay extra attention to how their clients conduct investor relations. The more aggressive the investor-relations strategies, the more likely plaintiffs will be able to paint a picture that the company thought a given event indicated something meaningful, leading to an inference of scienter.

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The confidential witness is the bane of the securities defendant's existence. While there may be some legitimate reasons to keep a witness confidential, the words "Confidential Witness #1" can also hide problems with the plaintiffs' case, like sloppy research or outright misrepresentation.

How do we know this is the case? Well, many defendants have "Confidential" horror stories, but more importantly, these problems are sometimes revealed in the case proper. Case in point:City of Livonia Employees' Retirement System v. Boeing Co.  As the Northern District of Illinois puts it in its opinion, the case reads like an airport thriller.

At the center of this drama is the purported confidential source, who had a series of fateful conversations with plaintiffs' investigators and months later with defense counsel. The confidential source did not meet plaintiffs' counsel until he was recently deposed, months after plaintiffs' counsel used information purportedly provided by the confidential source to survive dismissal of this lawsuit. The confidential source now denies the information attributed to him in plaintiffs' pleadings and in their representations to the court. Plaintiffs assert their confidential source is presently lying, while the confidential source claims it is plaintiffs' investigators who are the liars.

The case was a traditional securities fraud case. The plaintiffs accused Boeing of lying to is investors about the delivery schedule for the 787 Dreamliner, a much-hyped and heavily-anticipated commercial jet model. In doing so, they relied heavily on information from "confidential witnesses."

The trial court had dismissed plaintiffs' amended complaint without prejudice, holding that there were not enough facts present to support a "strong inference" of scienter. In particular, it noted that

Plaintiffs' generalized reliance on confidential source information was insufficient to establish Boeing's scienter. Allegations by confidential sources are discounted, "usually steeply," because information from anonymous sources is not regarded as compelling or supportive of plausible inferences.

[Emphasis added.]  Nonetheless, the court offered the plaintiffs the chance to replead naming no more than one confidential source for their information about what Boeing knew and when it knew it. Plaintiffs' second amended complaint contained four paragraphs (139-42) that relied on confidential witness testimony. Boeing moved to dismiss this complaint as well, but the court denied its motion, relying heavily on the four new paragraphs.

So Boeing served discovery asking for the identity of the confidential witness. Then they interviewed him and took his deposition. And what they uncovered was--at least to the court--surprising:

[Former confidential witness] Singh has consistently denied that he was the source of the information attributed to him in the second amended complaint. Indeed, he denies he was employed by Boeing. Rather, he attests he worked for an outside contractor at Boeing starting in late August 2009, months after the events at issue in this suit; he denies personal knowledge of the 787-8 testing documents or their circulation to Boeing executives in April and May 2009; he claims he never met plaintiffs' counsel until his deposition on November 17, 2010; nor was he ever shown the allegations attributed to him in the second amended complaint until he met with defense counsel on November 2, 2010.

Deposition transcript in hand, Boeing filed for reconsideration on the grounds that plaintiffs had committed a fraud on the court. The plaintiffs opposed, arguing that their confidential witness was the liar, not their investigators. At this point, the trial court threw up its hands:

It matters not whether, as plaintiffs argue, Singh told their investigators the truth, but he is lying now for ulterior motives. The reality is that the informational basis for paragraphs 139-42 is at best unreliable and at worst fraudulent, whether it is Singh or plaintiffs' investigators who are lying.

Since the key four paragraphs weren't reliable, the court dismissed the second amended complaint, this time with prejudice.

So what can we learn from this case? First, always chase down the "confidential sources" on which the plaintiffs rely. Once the complaint has been filed, there is no reason for sources in a civil lawsuit to be confidential. Second, take the confidential witness's deposition. The confidential witness is a way for plaintiffs' counsel to sidestep the tighter restrictions of the PSLRA without having to do their actual homework. Deposing the witness keeps them accountable.

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 It's been a busy week, so please accept another set of links to class-related news in lieu of a full-fledged post.  Regular posting will resume next week.  

• Dukes discussion - On Tuesday, the Washington Legal Foundation hosted a panel on the upcoming Wal-Mart v. Dukes argument.  Panelists included Mike Murphy, Rachael Weinfeld, and yours truly.  It was an interesting discussion, especially Mike's take on how the Supreme Court would rule, and Rachael's discussion of the importance of the Daubert inquiry to class certification.  
• Dukes discussion II - Today, the American Constitution Society is hosting a panel on the same topic.  It's moderated by Michael Selmi, and panelists will include Marcia Greenberger, Adam Klein, Suzette Malveaux, and me.  It should also be a very interesting discussion.
• Lessons from Google Books - On Tuesday afternoon, the Southern District of New York refused to approve the Google Books settlement.  Glenn Lammi of the WLF has taken the opportunity to--like Judge Alsup--draw some lessons about what its opinion means for best settlement practices.
• More on circularity - Remember the circularity problem?  Securities class actions take money from a shareholder-owned corporation and return it to shareholders, minus attorneys' fees.  Why doesn't this critique apply to company-to-company litigation?  Amanda Rose and Richard Squire have a theory.  
• One shameless self-plug: recent searches that have led to this site include  "adequacy of counsel" "collective vs. class action conflict," "environmental class action," "motion to strike class allegations," "class acton interrogatories," "named plaintiff deposition," and "All Writs Act."  As well as on this blog, you can information about those subjects in the Class Action Playbook by me and Brian Anderson.  (Sections 2.8, 3.1.2, 3.1.6, 4.2.5, 4.5.4.1, 4.5.4.4, and 9.1.3 respectively.)

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Last year, a jury in New York City decided one of the few securities class actions ever to go to trial. Lest anyone think that a jury verdict is ever the end of a piece of complex litigation, the Southern District of New York released a post-trial opinion last week. The opinion is worth reading for several reasons--one of the best being that it contains one of the few accounts of how a securities class trial actually gets conducted. But, in addition, it also provides a look into how international securities class actions will be treated going forward.

Back in 2003, the defendants had moved to dismiss the original Vivendi complaint because--they argued--the federal court lacked subject-matter jurisdiction over "foreign-cubed" class actions. The trial court denied the motion to dismiss, citing the Second Circuit's well-settled "conduct and effects" test.

So the case proceeded through certification to trial, where the jury rendered a verdict against Vivendi.  Once the trial was conducted, the defendants moved for reconsideration of both the foreign plaintiffs' claims and the claims of various American buyers in light of the Supreme Court's decision in Morrison v. Australia National Bank, which prohibits "foreign-cubed" class actions. The plaintiffs opposed, arguing that due to some technicalities of SEC registration, all of Vivendi's shares had been "listed" on the New York Stock Exchange, even though many of those shares had not traded there. While the trial court sympathized with plaintiffs' position (it discussed in depth how the Supreme Court's opinion was not as clear as it could be), it found a "technical flaw" with their argument:

It is true that the registration of any shares under Section 12 of the Exchange Act extends registration to the entire class of securities. And when a foreign company registers ADRs with the SEC, it must also register the underlying ordinary shares, necessarily resulting in the registration with the SEC of all ordinary shares. But registration with the SEC is not the same as listing (registering) on an exchange. The sample NYSE listing application provided to the Court at argument indicates that only a discrete number of ordinary shares are listed; this being the number of ordinary shares needed to back-up the ADRs being listed. Thus while all ordinary shares of a foreign issuer are deemed to be registered with the SEC, a lesser fixed amount of shares are actually listed with the Exchange. And ordinary shares that are not listed on an exchange (for any purpose) would fall outside plaintiffs' literalist reading of the Morrison bright-line test as well as the underlying language of Section 10(b).

(Emphasis added.)  The court also found that

Though the Supreme Court in Morrison did not explicitly define the phrase "domestic transactions," there can be little doubt that the phrase was intended to be a reference to the location of the transaction, not to the location of the purchaser and that the Supreme Court clearly sought to bar claims based on purchases and sales of foreign securities on foreign exchanges, even though the purchasers were American.

(Emphasis in original.) As a result, it dismissed the claims of all class members--foreign or American--who bought ordinary shares. So what can we learn from this ruling?

* Plaintiffs will not take adverse Supreme Court rulings lying down.
* In a class trial, it is always worth preserving all issues, no matter how often one loses them.

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NERA Economic Consulting has released its annual study on Canadian securities class actions. It headlines the fact that there were a record number of active class actions (28). But some of the other trends it notes are as -- if not more -- interesting for class-action defense lawyers:

2010 was not substantially different from prior years.

In our 2009 update, we noted that Canadian securities class actions were continuing to mature. That year witnessed the certification of three class actions and the granting of leave to proceed under Part XXIII.1 of the Ontario Securities Act (OSA) in IMAX—rulings that we noted may ultimately prove to be an inflection point for this type of litigation. Although those judicial decisions may still prove to be a turning point, 2010 did not reveal any substantial upturn in filings or other trends as a result.

Canadian securities cases continue to focus on misrepresentations in accounting and operations.

Operational misrepresentations and accounting misrepresentations are historically the most common claims alleged by plaintiffs in Canadian securities class actions. This was also true for the cases filed in 2010, most of which involve allegations of operational misrepresentations, and two of which include allegations of accounting misrepresentations.

Canadian plaintiffs are getting faster at filing class actions.

Approximately one-third of the cases in our database of Canadian securities class actions were filed within two months of the end of the proposed class period, and almost two-thirds of all cases were filed within six months.

Cross-border class actions make up a significant portion of Canadian class actions.

As of 31 December 2010, there were a record 28 active Canadian securities class actions, representing approximately $15.9 billion in outstanding claims (including claims for punitive damages). Six of these are cross- border cases representing more than $11.6 billion in claims—about 73% of total claims. Excluding the $10 billion claim against CIBC, there is approximately $5.9 billion in outstanding claims, $1.6 billion (or 27%) of which are in cases with parallel US class actions.

NERA is not the only source to notice the cross-border trend (nor is it limited to securities cases), but it has done the best job of quantifying it. It also notes that in the wake of the US Supreme Court's ruling in Morrison v. Australian National Bank, this trend may actually decline.

All in all, the report makes interesting reading. So go, read.

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Plaintiffs in securities class actions often use "confidential witnesses" in their complaints to substantiate various allegations. The practice makes some sense at the complaint stage: it allows the plaintiff to plead fraud and loss causation with the specificity required by the PSLRA, without exposing potential witnesses to backlash from their employer should the case never proceed past the motion-to-dismiss stage. But once the motion to dismiss has been decided, is there any need for a plaintiff to keep confidential witnesses confidential?

In In re Netbank Securities Litigation, 259 F.R.D. 656 (N.D. Ga. 2009), the plaintiff alleged that Netbank had deceived some of its shareholders. The plaintiff survived a motion to dismiss, and the court certified a securities-fraud class. (It held that there was an efficient market in the securities traded, so the class was entitled to a presumption of reliance on the alleged misrepresentations.) But the really interesting part of this opinion is in its discussion of the motion to compel. The plaintiff had relied heavily on seven "confidential witnesses" in his complaint. So, in discovery, the defendants served interrogatories asking for their identities. And the plaintiff refused to reveal them. Once the defendants moved to compel, the court held that plaintiff had to provide the identities:

Mr. Brown first responds to Defendants' Motion to Compel by arguing it is without merit, as the list of 130 individuals he provided contains the confidential witnesses whose identification Defendants now seek. However, this argument is not persuasive. It is clearly established that Defendants may discover the facts upon which Plaintiffs base their allegations and such facts include names of witnesses from whom counsel obtained their information. The Reform Act, 15 U.S.C. § 78u-4(b)(1), dictates that in securities fraud cases, plaintiffs shoulder "the burden of identifying the sources for allegations pled on information and belief." Id. (citing 15 U.S.C. § 78u-4(b)(1)). That Mr. Brown has provided Defendants with a list of 130 individuals, arguing that Defendants can "conduct their own investigation[]" to determine the identities of the seven confidential witnesses among them, smacks of a needle-in-haystack search: time-consuming, wasteful and expensive.

(Emphasis added, internal citations and quotations omitted.) Nor did the court cotton to plaintiff's argument that public policy required shielding the identities of the confidential witnesses. As it pointed out, the discovery rules are liberal, and the plaintiff's argument that he had provided the identities among 123 other names undermined his argument against specifying further.

So what can defense lawyers learn from this case? In securities class actions with confidential witnesses, it is worth spending an interrogatory to learn their identities.

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Last Friday, the Supreme Court granted certiorari in Archdiocese of Milwaukee Supporting Fund, Inc. v Halliburton Co. This is the fourth certiorari grant this term for a class action.

So what's the issue in this case? Loss causation. In securities cases, plaintiffs are often allowed to rely on a theory called "fraud on the market," which requires the court to presume that shareholders relied on any false information that was introduced to an efficient securities market. The "fraud on the market" theory is a powerful tool for class action plaintiffs. When applied, it makes certification of a class much easier than otherwise.

Since certification changes the litigation (making it far more likely that a defendant will settle a meritless claim), the Fifth Circuit has held that a plaintiff must prove "loss causation" (that the alleged falsehoods, once revealed, actually caused the stock price to fall) by a preponderance of the evidence before a court may certify a class. (The Fifth Circuit has not gone rogue on this issue: the Supreme Court has issued several opinions on loss causation over the last five years.) On its face, it's a reasonable doctrine. Loss causation forms the basis of many strong securities class actions. (Indeed, former plaintiffs' lawyer Bill Lerach had boiled the theory down to a chart he would pull out in settlement discussions.)

In Archdiocese of Milwaukee Supporting Fund, Inc., the Fifth Circuit was faced with a securities case against energy conglomerate Halliburton. The plaintiffs had alleged that a number of misrepresentations -- including an understatement of asbestos litigation liability and an overstatement of the benefits of a merger -- had artificially inflated the price of Halliburton's stock; once they were revealed, the plaintiff shareholders lost money.

In the district court, Halliburton had opposed certification (and won) by arguing that the plaintiffs had not met their burden of proving loss causation, because Halliburton had disclosed a number of negative news items at the same time as it revealed that it had misrepresented the information the plaintiffs had pointed to. As a result, the plaintiffs could not prove that the misrepresentations had caused the stock to drop.

The plaintiffs appealed, arguing that they should not have to prove fraud at certification, but the Fifth Circuit affirmed the trial court.

Plaintiff argues that the district court misapplied our precedent, how ever, because it incorrectly required Plaintiff to prove actual fraud at the class certification stage. Plaintiff asserts that this requirement runs afoul of our recent decision in Flowserve. We do not agree with the Plaintiff's reading of Flowserve or its characterization of the district court's opinion.

...

Even if it were possible to say that the prior statements were more than erroneous expectations, both the October 4, 1999 announcement and the analyst reports contained multiple pieces of negative news. This required Plaintiff to "demonstrate that there is a reasonable likelihood that the cause of the decline in price is due to the revelation of the truth and not the release of the unrelated negative information." This showing of loss causation is a "rigorous process" and requires both expert testimony and analytical research or an event study that demonstrates a linkage between the culpable disclosure and the stock-price movement." That's what plaintiffs didn't do.

(Internal footnotes omitted.)  

At this stage, before the parties have briefed the issues, predicting what the Court will do is next to impossible. But it's worth noting that the "loss causation" doctrine has drawn fire from a number of academics as requiring a decision on the merits at certification. And the degree to which a court may inquire into the merits of a class action at certification has proven controversial over the last decade. Given the Court's interest in this issue, however it chooses to clarify the standard, it will have a large effect on securities class actions. Stay tuned.

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Florida State law professor Elizabeth Chamblee Burch is the latest to weigh in on the problem of how to make sure class actions are adequately governed.  In an forthcoming article from the Vanderbilt Law Review, she asks what makes an optimal lead plaintiff in a securities class action.

Burch focuses on the the difficulties raised by what she refers to as plaintiffs' law firms "courting process," particularly the use of "pay to play" practices and investment monitoring agreements.  Her discussion of these issues is worth quoting at length:

After the PSLRA, plaintiffs’ law firms sought to maintain their competitive advantage by courting large institutions, developing repeat relationships with them, and encouraging them to serve as lead plaintiff. Law firms’ courting process may involve “pay-to-play” practices where plaintiffs’ law firms contribute to the political campaigns of those selecting counsel for public or labor pension funds and lobbying the officials who control public pension funds. Lobbyists encourage pension funds to serve as lead plaintiff and to then select the lobbyist’s law-firm employer as lead counsel. These practices forge repeat relationships and inhibit competition in ways that lack merit and transparency. And because other eligible institutions like banks, mutual funds, and insurance companies maintain commercial relationships with the defendants or defendants’ customers, public and union pension funds are the institutions that typically take on the lead-plaintiff role.

Law firms’ courting process also involves “portfolio monitoring,” where the law firm keeps abreast of the institution’s holdings and notifies it whenever it suffers a significant enough loss that it could serve as the lead plaintiff in a related class action. Portfolio monitoring is a preexisting contractual relationship between the lead plaintiff and class counsel. Preexisting relationships typically give courts pause, particularly when counsel has no relationship with other class members and no subclassing exists. But most courts find free portfolio monitoring in exchange for retaining the law firm unproblematic; they look for something more, like long-term friendships or familial relationships.Although courts have been slow to recognize it, portfolio monitoring is both widespread and troubling. The few courts who agree reason that the practice “creates a clear incentive for [the law firm] to discover ‘fraud’ in the investments it monitors” and thereby “fosters the very tendencies toward lawyer-driver litigation that the PSLRA was designed to curtail.” Plus, regularly depending on the same law firm makes it unlikely that institutions will bargain for lower attorneys’ fees or monitor trusted counsel. To be fair, some pension funds, such as MissPERS, use plaintiffs’ firms for free investment monitoring, but rely on multiple law firms and guarantee none that it will be selected as lead counsel. On one hand, portfolio monitoring is commendable—it encourages institutional investors to get involved, enforces substantive rights, and may uncover and deter fraud. But on the other, ongoing business relationships between the lead plaintiff and counsel appear improper, may cause counsel to maximize the institutional lead plaintiff’s return to the class’s detriment, and may encourage counsel to litigate in ways that establish favorable precedent for the institution.

(Emphases added.)  Burch has several suggestions for addressing these issues. Her most interesting is to recommend that securities class actions should be headed by plaintiff groups rather than lone plaintiffs, so long as the group reflects the diversity of the class.

Ideally, group members represent the class’s diverse interests such that when each member pursues her own self-interest, the group resembles a microcosm of the whole class.

Burch is not blind to the problems that plaintiffs' groups can pose. Nor is she a lone voice advocating for diversity. That said, she tends to be optimistic about how diverse stakeholders may interact in overseeing a class action. 

Put simply, class counsel should consult and take direction from the lead-plaintiff group on matters that implicate members’ values and litigation objectives or affect the case’s merits in much the same way that an attorney consults with her client in individual litigation. In short, if lead plaintiffs are to adequately represent class members’ interests, monitor the lawyers, and minimize agency costs, then, consistent with the PSLRA’s goal of increasing client control, they should have more decision-making authority.

While it would be helpful to know whether Burch is advocating a doctrinal or legislative reform (in other words, should courts just start enforcing this proposal, or does Congress need to amend the PSLRA?), the policy arguments she raises can prove useful for securities defense lawyers. At the very least, they exemplify a trend of continued concern about the adequacy of securities lead plaintiffs, and provide several examples of why one should not assume that institutional investors are always adequate lead plaintiffs.

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 In welcome news for content-starved class-action bloggers, NERA Economic Consulting (source of the perennially popular report on Italian class actions) has released its annual report on trends in securities class actions.

The report contains some of its usual data, always interesting but mostly just confirming existing trends. Among those:

• Overall, securities class-action filings are up again.
• The average settlement is $42 million; the median settlement is $11.1 million.
• Securities plaintiffs' lawyers earned $1.353 billion in aggregate fees.

The report also contains some other interesting facts with greater strategic implications. Among these:

• The Ninth Circuit is no longer tied with the Second Circuit, it is now the single greatest source of securities class-action filings.
• The predicted effect of the Supreme Court's ruling in Morrison v. Australia National Bank (fewer international securities cases) was muted by increased filings against Chinese companies.
• The time to file securities class actions continues to get shorter. Now the average time to file is 185 days from an announcement of adverse news. The median time to file is 30 days, which means more than half of all class actions are filed within a month. (If I had to guess, I'd say this is likely the result of plaintiffs' lawyers' increased focus on investment monitoring.)
• Cases based on product defects (including "defective" financial products) are up, so are breach-of-fiduciary-duty cases.

NERA's reports always reward careful study.  The news about the Ninth Circuit is intriguing; it may suggest that plaintiffs' counsel have decided that the Ninth Circuit is simply more hospitable to class actions.  And the increase in international class actions, coupled with the decrease in time to file, suggest that global business and pervasive media continue to affect the way in which plaintiffs build cases against corporate defendants.  That, in turn, suggests that defense firms will not go without work in 2011.

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 In Basic, Inc. v. Levinson, the Supreme Court recognized a rebuttable presumption of fraud on the market for securities-fraud cases. That presumption allowed for certification of a number of securities class actions. Plaintiffs since have taken that presumption and tried to apply it to various other sets of facts, most notably tobacco (although that attempt was ultimately unsuccessful) and drug marketing (also unsuccessfully). But the fact that class-action plaintiffs keep arguing for this presumption means that it's important for defense counsel to understand the theory underlying it.

So let's look at the actual Basic case. Basic, Inc. made chemical refractories for the steel industry. It became the subject of a merger bid. During the time it was talking with its merger partner, it made several statements denying that it was in merger talks. (Why do this? Announcing a merger would have put the company into play, wreaking havoc with its stock price, and jeopardizing the impending merger.) Once Basic publicly announced the merger, some of its shareholders filed a class action, claiming they had been harmed because they had sold shares after its denials depressed the stock price, and before it suspended trading in anticipation of the merger.

The trial court certified a class (presuming that the plaintiffs relied on Basic's public statements), but then granted summary judgment to Basic. The Sixth Circuit reversed the summary judgment, but affirmed the certification of the class. At that point, Basic filed a petition of certiorari to the Supreme Court.

The Court took on the case, in part to

determine whether a person who traded a corporation's shares on a securities exchange after the issuance of a materially misleading statement by the corporation may invoke a rebuttable presumption that, in trading, he relied on the integrity of the price set by the market.

In doing so, the Court set out its statement of the fraud-on-the-market theory. As abridged:

The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business.... Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.... The causal connection between the defendants' fraud and the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations ...

The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face transactions contemplated by early fraud cases, and our understanding of Rule 10b-5's reliance requirement must encompass these differences ...

In drafting that Act, Congress expressly relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an investor's reliance on the integrity of those markets ... Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations. ...

Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.

(Internal footnotes and quotation omitted.)

As one might expect, allowing a presumption of reliance under any circumstances is hardly a defense-oriented ruling. However, in the limited circumstances of the Basic case (a freely-traded market for securities, where public information rapidly translated into changes in stock price), the holding makes economic sense. More importantly, Basic's actual holding provides defense lawyers with several avenues of opposing class certification.

First, it limits "fraud on the market" to securities markets, where information is freely disseminated. That means that markets for consumer goods, for example, are not subject to fraud on the market theories, and plaintiffs will still have to prove individual reliance in cases like these. In fact, few markets have the characteristics that allow for a Basic presumption.

Second, it provides a way to argue against even securities fraud cases. The Court held that the Basic presumption is rebuttable. That means that if the defendant can show why it is that the alleged misrepresentation did not cause (or could not have caused) the harm, the plaintiff is not entitled to the presumption.

Fraud class actions are not going away any time soon. As a result, it is fair to expect that plaintiffs will try to avoid the problems of proving reliance on fraudulent statements any way they can. If for no other reason than that, the Basic presumption will remain an important piece of legal doctrine for class-action lawyers for some time to come.

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 Over the last ten days, Judge Baer issued a followup order in the Gildan Activewear case and gave an interview to the New York Law Journal discussing his reasoning. The order--which found both plaintiffs' firms to be adequate, and stressed that it was not criticizing their hiring practices--was pretty much a non-event. But Judge Baer's interview--in which he reaffirmed his belief that he has both the power and the responsibility to review a firm's diversity in discharging his Rule 23(f) function, has led to additional blog commentary. My own opinion on whether he can do so (probably yes) and whether he should (depends entirely on your conceptions of the proper role of government and preferences for disadvantaged minorities) hasn't changed. But the more I read about the reactions from both self-identified conservatives and liberals to Judge Baer's order, the more I become convinced that it may be a foreseeable, if unintended, consequence of using "public case" arguments to justify filing and certifying class actions.

The federal government does employ--with strict limts--some minority preferences in federal contracting. And, if one makes the argument (as academics like Brian Fitzpatrick and Myriam Gilles and plaintiffs' lawyers like Elizabeth Cabreser and Steve Berman do) that a class action is really a case on behalf of the public at large for deterring corporate misconduct, it's not a great stretch to see a securities class action as a contract from the federal judiciary (or public pension fund) to prosecute a case for the public good. (That may be why one tactic for recruiting institutional named plaintiffs--"pay to play"--bears the same name as a major concern for government regulation.)

Am I saying that class-action lawyers should be subject to minority-contracting rules? Most emphatically not. What I am saying is that rhetoric can have real-world consequences. In this case, if plaintiffs' lawyers successfully convince judges that they are quasi-public servants, they may find themselves being regulated much like public servants.

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One of the larger points of contention in class-action settlements is the size of the attorneys' fees. Indeed, with a few exceptions, no one defends the size of attorneys fees, and the most heated criticisms decry the size of the fees compared to the recovery the class actually receives. Which is what makes a recent case from the Ninth Circuit, In re Mercury Interactive Corp. Securities Litigation, so surprising: it turns out that Rule 23 already has one simple, often-ignored measure for limiting the amount of fees class counsel can charge.

The Mercury case arose after public disclosures that Mercury's then-CEO, CFO, and General Counsel had participated in a scheme to backdate stock options. (Backdating, for those who remember the bull market, is a practice of revising the date that individuals were granted stock options to allow for the largest possible profit on the stock. In other words, someone who was backdating options would revise the grant date to reflect the lowest possible stock price. When the grantee exercised the option, he'd pay a lower price for valuable stock.)

Like with many (but not all) securities class actions, this one settled quickly. As part of the settlement approval process, the district court held a fairness hearing, and provided a deadline for objections. However, the court set the deadline for objections before the plaintiffs' counsel's fee application deadline. That, as one might guess, presented a problem for the objectors: without seeing the details of plaintiffs' fee proposal, it was extremely difficult for them to evaluate whether it was properly justified.

One of the objectors, the New York State Teachers' Retirement System, nonetheless tried to challenge plaintiffs' fees, submitting a generalized objection to the anticipated 25% contingency fee. The district court approved the fee anyway, stating in part that:

[The objectors] do not object to any line item of work that was done, but rather they simply believe that the amount of the contingency fee should be 18 percent rather than 25 percent.

Teachers appealed, arguing that, in approving plaintiffs' fees, the district court had violated Rule 23(h). Rule 23(h), which governs awards of fees and taxable costs, provides that:

In a certified class action, the court may award reasonable attorney's fees and nontaxable costs that are authorized by law or by the parties' agreement. The following procedures apply:

(1) A claim for an award must be made by motion under Rule 54(d)(2), subject to the provisions of this subdivision (h), at a time the court sets. Notice of the motion must be served on all parties and, for motions by class counsel, directed to class members in a reasonable manner.
(2) A class member, or a party from whom payment is sought, may object to the motion.
(3) The court may hold a hearing and must find the facts and state its legal conclusions under Rule 52(a).
(4) The court may refer issues related to the amount of the award to a special master or a magistrate judge, as provided in Rule 54(d)(2)(D).

The Ninth Circuit reversed, holding that the district court had abused its discretion by violating Rule 23(h). In fact, it went even further, stating that

the practice borders on a denial of due process because it deprives objecting class members of a full and fair opportunity to contest class counsel's fee motion.

Why would this rise to the level of a due process violation?  As the Ninth Circuit pointed out

During the fee-setting stage of common fund class action suits such as this one, plaintiffs' counsel, otherwise a fiduciary for the class, becomes a claimant against the fund created for the benefit of the class. This shift puts plaintiffs' counsel's understandable interest in getting paid the most for its work representing the class at odds with the class' interest in securing the largest possible recovery for its members.

(Internal quotations omitted.) As a result, by requiring plaintiffs to submit a fee request before objections are due, Rule 23(h) provides an important check on plaintiffs' counsel at exactly the moment their interests diverge from those of the class.

Allowing class members an opportunity thoroughly to examine counsel's fee motion, inquire into the bases for various charges and ensure that they are adequately documented and supported is essential for the protection of the rights of class members. It also ensures that the district court, acting as a fiduciary for the class, is presented with adequate, and adequately-tested, information to evaluate the reasonableness of a proposed fee.

This may seem like an obvious point, one that hardly requires an entire blog post. But a number of trained lawyers have missed it over the years, and not just the lawyers and courts that have made submitting objections before fee requests "a common practice." When Professor Brian Fitzpatrick defended "quick-pay" provisions--and when I critiqued that defense--neither of us took into account the obvious problem; quick-pay provisions (which pay plaintiffs' counsel before the settlement has been approved) clearly violate the procedure dictated by Rule 23(h).

So what's the takeaway for this case? Always read the rules. Rule 23 exists to enable class actions, but also to ensure that, at all times, absent class members are adequately protected. And those protections often exist to rein in the excesses of plaintiffs' counsel.

EDITED AT 11:30 AM TO ADD:

Ted Frank, of the Center for Class Action Fairness, has commented to point out that the majority of quick-pay provisions allow payment after approval, but before appeals have been exhausted, which means that they would not facially violate Rule 23(h).  And I should note that Professor Fitzpatrick accurately described the timing of payment in his article.  The takeaway from this?  Bloggers should reread old posts if they're going to revisit them later; especially if it turns out they were right the first time.

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 With the exception of Supreme Court rulings or groundbreaking appellate opinions, there is little that counts as "breaking news" in the class-action world. But a lead-counsel appointment in the Southern District of New York has drawn so much coverage in the last twenty-four hours that it seems worth at least a brief discussion on a Friday morning.

The case is In re Gildan Activewear Inc. Securities Litigation. Judge Baer's order appoints class counsel, and imposes a diversity requirement on the plaintiffs' firms (Robbins Geller and Labaton Sucharow). The relevant language:

"WHEREAS this proposed class includes thousands of participants, both male and female, arguably from diverse backgrounds, and it is therefore important to all concerned that there is evidence of diversity, in terms of race and gender, in the class counsel I appoint, see In re J.P. Morgan Chase Cash Balance Litigation, 242 FRD 265, 277 (S.D.N.Y. 2007); it is hereby"

"ORDERED that Co-Lead Counsel, Robbins Geller Rudman & Dowd LLP and Labaton Sucharow LLP, shall make every effort to assign to this matter at least one minority lawyer and one woman lawyer with requisite experience; and it is further ..."

"ORDERED that the parties shall appear for a preliminary approval hearing on October 7, 2010, at 12:30 p.m., at which point Plaintiffs' compliance with the diversity requirement, as well as the other requirements listed here, will be evaluated ..."

(Emphasis added.)  This is not the first time Judge Baer has imposed this requirement. (And I'm not sure why this order has drawn more attention than the last one.) Nonetheless, it's clear that the discussion around this particular order raises at least three questions:

Can Judge Baer do this? Yes. Leaving aside the fact that he's a judge, he's got discretion to do something exactly like this according to Rule 23(g), which regulates the appointment of class counsel.  That rule, in full:

(g) Class Counsel.
(1) Appointing Class Counsel.
Unless a statute provides otherwise, a court that certifies a class must appoint class counsel. In appointing class counsel, the court:
(A) must consider:
(i) the work counsel has done in identifying or investigating potential claims in the action;
(ii) counsel's experience in handling class actions, other complex litigation, and the types of claims asserted in the action;
(iii) counsel's knowledge of the applicable law; and
(iv) the resources that counsel will commit to representing the class;
(B) may consider any other matter pertinent to counsel's ability to fairly and adequately represent the interests of the class;
(C) may order potential class counsel to provide information on any subject pertinent to the appointment and to propose terms for attorney's fees and nontaxable costs;
(D) may include in the appointing order provisions about the award of attorney's fees or nontaxable costs under Rule 23(h); and
(E) may make further orders in connection with the appointment.

Most lawyers focus on 23(g)(1)(A), which gives the factors they must meet, and there's nothing about racial or gender diversity there. But, 23(g)(1)(B) mentions that the Court "may consider any other matter pertinent to counsel's ability to fairly and adequately represent the interests of the class." This is the justification Judge Baer used back in 2007 in In re JP Morgan ("The proposed class includes thousands of Plan participants, both male and female, arguably from diverse racial and ethnic backgrounds. Therefore, I believe it is important to all concerned that there is evidence of diversity, in terms of race and gender, of any class counsel I appoint.") Class counsel are aware, at least on a visceral level, that this requirement can include almost anything.  So it would appear that Judge Baer has the discretion to do so.

Should he do this? That really depends on one's political outlook. I'm a practicing class action lawyer; I'm more interested in strategy than policy. But, it appears that the strongest arguments on each side are probably:

• "Public lawyers" ought to be diverse. Governments everywhere have minority contracting requirements or opportunities. Why should courts be any different when they appoint class counsel? Many class-action lawyers already claim to be "public lawyers." [http://www.classactioncountermeasures.com/2010/06/articles/certification-1/are-class-actions-public-or-private-cases/] If so, there's no reason not to impose some of the same conditions we impose on government contractors.
• Diversity doesn't have much to do with securities law. In re JP Morgan (which was an age discrimination and ERISA case) the link between the diversity of counsel and the diversity of the class was at least marginally stronger. (Although Judge Baer did not require the firms to provide any aged lawyers.) It's harder to say why one's gender or racial background would affect their understanding of the securities laws, particularly when their clients are institutional investors, as opposed to individuals. And my guess is that, to the extent that either firm opposes the order, this is the line of argument they follow.

What does it mean that he did this? First, Judge Baer's order may tip the balance to Robbins Geller being lead counsel. A (very) quick trawl through both Robbins Geller's and Labaton Sucharow's websites shows that Robbins Geller has the requisite levels of diversity. Labaton, however, does not appear to have any female partners or senior partners. (It does have two female "Of Counsel.") If Judge Baer decides that partnership is the "requisite level of experience" (no guarantee), Labaton may have difficulty meeting that criterion.

Second, given how competitive plaintiffs' counsel already are in seeking lead counsel appointments, Judge Baer's order changes the game, at least for firms in the class-action-rich Southern District of New York. Expect to see a number of plaintiffs' firms reevaluating their hiring and attorney-development policies. And I would also guess we may see some firms use their diverse teams as a selling point in lead-counsel battles.

Finally, Judge Baer's order suggests a possible adequacy-of-counsel argument for defendants. Given the personal and political volatility of diversity debates, it's an argument that counsel should deploy carefully. But, if a firm finds itself defending a Title VII class action in the Southern District of New York, it may well be worth it to bring plaintiffs' counsel's lack of diversity to the court's attention.

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 Adequacy can be a difficult concept to get one's head around. And, as a result, courts and parties have found a number of different ways to frame the question of whether a named plaintiff is an adequate class representative. They can look at whether the named plaintiff knows enough about the case to oversee her counsel (although some courts are sometimes reluctant to disqualify a plaintiff on these grounds). Courts can also ask whether the plaintiff has enough independence from counsel to oversee them when their interests may diverge from the class's.   And sometimes courts can just look at the personal character of the named plaintiff. 
Another way of framing the issue is to look at whether the named plaintiff is committed to protecting the interests of the class. What do I mean by "committed"? Take the case of Buettgen v. Harless, 263 F.R.D. 378 (N.D. Tex. 2009). Buettgen was a securities case, involving allegations that the defendants had, through various misrepresentations, artificially inflated the stock price of phone directory company Idearc, Inc. A number of different plaintiffs filed class actions against Idearc and its officers, including a group of individual investors calling themselves the "Buettgen Group," another group of individual investors calling themselves the "Lyman Group," and two institutional funds, one Swiss and one American.

Each of these four plaintiffs filed a motion to be considered as lead plaintiff for the consolidated class actions, a position that carries with it control of the litigation, and a larger share of fees for plaintiffs' counsel. The court, in deciding the motions, pointed out that the Private Securities Litigation Reform Act (PSLRA):

"requires a court to presume that the most adequate plaintiff is the person or group of persons that:
(1) filed the complaint or a motion in response to a notice;
(2) has the largest financial interest in the relief sought by the class; and
(3) otherwise satisfies the requirements of Rule 23 of the Federal Rules of Civil Procedure.
Id. § 78u-4(a)(3)(B)(iii)(I).

This presumption can be rebutted only by proof offered by a class member that the presumptively most adequate plaintiff:
(aa) will not fairly and adequately protect the interests of the class; or
(bb) is subject to unique defenses that render such plaintiff incapable of adequately representing the class.
Id. § 78u-4(a)(3)(B)(iii)(II)."

In this case, all four plaintiffs had filed the appropriate motions. The court ranked the plaintiffs by the size of their losses (the Buettgen Group had sustained the largest loss, followed by the Swiss fund, the Lyman Group, and the American fund). But when the court looked at each plaintiff's adequacy, the analysis got more difficult. The Swiss fund was vulnerable to unique defenses, and therefore not adequate. But the Court also expressed reservations about the two investor groups, because neither was cohesive enough to represent the class. (Why would cohesiveness matter? Because if a group is not cohesive, then it is likely that it was put together by plaintiffs' counsel to meet the "largest financial interest" prong of the PSLRA, implying that the counsel controlled the plaintiffs.) As the court observed:

"[T]he Buettgen Group fails to present evidence that the members of the group have ever communicated in a meaningful way. For example, instead of explaining how they are prepared to work together to manage this litigation on behalf of the proposed class, the Buettgen Group submitted essentially boilerplate certifications discussing their stock purchases and alleged losses. ... Additionally, the Buettgen Group's motion is undermined by the group's invitation to the Court to hand-pick one of its constituents to serve as lead plaintiff if the Court deems the Buettgen Group inappropriate. Buettgen Group Such a willingness to abandon the group only suggests how loosely it was put together. ...
Likewise, the Lyman Group suffers from the same grouping issues that apply to the Buettgen Group. The Lyman Group consists of two individuals that provided similar boilerplate certifications as the Buettgen Group. Also, the Lyman Group states, "if the Court is inclined to appoint only one Lead Plaintiff, each of the Movants moves in the alternative for appointment individually as Lead Plaintiff." As stated above, when a group shows willingness to abandon the group the Court is lead to believe the group was only loosely put together. "

(Internal quotations and citations omitted, emphasis added.)

What does this ruling mean for defendants? It provides another way of looking at adequacy of named plaintiffs. If the named plaintiffs are not sufficiently committed to the litigation to talk to each other, then it is unlikely that they can oversee their counsel independently. And that is a good reason to find them to be inadequate class representatives.

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 Obviously, securities fraud is bad for firms. But, once a fraud has been discovered (driving down the stock price), does a securities class action add injury to injury? A number of commentators have suggested so, using the following logic: a securities class action takes money from the firm, and pays it to the shareholders, minus costs and attorneys' fees. The hitch is that the firm is owned by the shareholders, which means that the attorneys have just taken money from the shareholders' property and handed it to them directly, while taking a one-third cut for themselves. (This is sometimes known as the "circularity" critique, because the money just moves in a circle--except for the part that moves into the lawyers' pockets.)

If securities class actions really just represent a 33% "lawyer tax," then why haven't firms challenged these lawsuits as being, on their face, evidence of inadequate counsel? One big reason is that doing so is dangerous from a rhetorical point of view. If a firm has been accused of defrauding its shareholders, it may lack the ethos to argue that the real fraud is the lawsuit itself.

And yet the circularity problem remains. However, a new article from the University of Pennsylvania Law Review, Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms, by Lynn Bai, James D. Cox, and Randall S. Thomas (158 U. Pa. L. Rev. 1877), suggests a possible legal argument for countering this kind of lawsuit.

The authors looked at a number of firms in different industries that had been accused of securities-related frauds (usually accounting frauds designed to artificially inflate the price of the stock), in order to determine whether the resulting class actions harmed the firms' performance in the long term. They examined a number of different measurements of performance, including stock price, sales, and liquidity.

The basic conclusion? Filing a securities class action has an immediate negative effect on stock price, but the firm gradually rebounds, even as the litigation progresses. However, both stock price and operational efficiency tend to remain low for a long time afterwards. Why? Because, in settling a class action, the firm winds up using most of its cash to pay the shareholders and lawyers, forcing a liquidity crisis that impairs its short-term performance. Once a firm lacks sufficient cash to operate day-to-day, it can't do what it needs to regain legitimate competitiveness, resulting in a continually depressed stock price.

Now, one possible reason for a continued low stock price is that the firm's performance was never that great to begin with. However, the authors also compared the firm's performance to the amount they paid in settlement, and found a strong relationship. In the authors' own words:

"defendants were more likely to experience lower liquidity levels than their peers in the post-settlement years than in the Pre-class Period. Moreover, this probability increased with the settlement amount ... These numbers are consistent with the theory that insurance provided less than full coverage of the settlement amounts and that the defendants paid the discrepancy out of their current assets. The settlement payment exacerbated liquidity constraints, making the defendants more vulnerable to liquidity crunches and prone to bankruptcy."

So, does this suggest that a securities defendant could accuse a plaintiff of being inadequate simply for filing the lawsuit in the first place? Not really. But it does suggest that in many cases, a securities class action may not be superior to other methods of resolving the lawsuit. If a class-action settlement (or by extension, damages award) harms the firm by reducing liquidity when the firm needs it most, then it is harming many of the same shareholders it is supposed to help. By contrast, SEC fines aimed at the officers who profited from a fraud, or SEC consent orders aimed at reforming the company's bad practices, can reform bad practices without crippling a firm's ability to rebound from actions of bad managers.

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Last Thursday, in Morrison v. National Australia Bank (slip op.), the Supreme Court held 8-0 (Sotomayor, J. not participating) that “foreign-cubed” class actions (where the plaintiff, the defendant, and the sale of the security are all located outside the US) did not have sufficient ties to the United States to justify invoking US securities laws. The bulk of Justice Scalia’s majority opinion focused on the question of when one could presume that a law would apply outside the US. (The “presumption of extraterritoriality.”) As a statement of how the US will treat cases that may have international application, this is an important opinion. But, for most class-action practitioners, I think it will prove more just a footnote.

The thing is, Morrison seems to be a comparatively easy case. True “foreign-cubed” class actions—with no discernable connection to the US—are comparatively rare in US courts. In its opinion, the Court of Appeals for the Second Circuit noted that “[t]his is the first so-called ‘foreign-cubed’ securities class action to reach this Circuit,” and the Second Circuit is no stranger to securities class actions.  Even Morrison wasn’t a pure foreign-cubed case at first; it started as a hybrid involving both domestic and foreign-based classes. (The domestic plaintiff’s claims were dismissed under Rule 12(b)(6).) For most plaintiffs’ lawyers, filing a proposed class action involving a foreign plaintiff, a foreign defendant, and foreign conduct would be a long shot from the beginning: assuming the case were tried on the facts, there’s no strong hook to convince an American factfinder to care about the result. Or, as Justice Scalia put it:

Nothing suggests that this national public interest pertains to transactions conducted on foreign exchanges and markets.

So, is there any strategic advice defense lawyers can glean from this case? The case does provide some additional rhetorical cover for defendants. As we know, many class-action plaintiffs’ lawyers advertise themselves as private attorneys-general, whom the courts can rely on when the publicly-appointed cops are too busy or too ignorant to stop corporate wrongdoing. In this case, the Solicitor General (arguing on behalf of the petitioner) made that argument, claiming that unless its securities laws were given extraterritorial application, the US would become like the Barbary Coast, a home base for fearsome pirates. Justice Scalia dismissed this geographic metaphor with one of his own:

While there is no reason to believe that the United States has become the Barbary Coast for those perpetrating frauds on the foreign securities markets, some fear it has become the Shangri-La of class-action litigation for lawyers representing those allegedly cheated in foreign securities markets.

The geographic metaphor gets a little tortured, so to put it in classic movie terms: when a plaintiff invokes the cinematic image of the lone sheriff on a lawless frontier, it’s still worth asking whether he’ll be played by Gary Cooper or Orson Welles.

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One aspect of grand strategy in litigation is making preparations for the possibility of getting sued. Preparing to get sued does not mean that a company has done something wrong. While some lawsuits are valid, others are not. And, given the pressures that entrepreneurial class-action lawyers face, it is inevitable that some will file lawsuits regardless of merit. In an atmosphere like this, preparing for lawsuits in advance is a necessary caution. 

Corporations really do make these preparations. In their working paper “Litigation Risks and Corporate Cash Holdings,” professors Matteo Arena and Brandon Julio found that the concentration of securities class actions in a particular industry "is a strong predictor of actual litigation events." (In other words, the more lawsuits already filed in a particular industry, the more lawsuits likely will be filed in the immediate future.) They also found (as one might expect) a strong correlation between that concentration and the amount of cash companies in that industry stockpiled. Companies stockpiled additional cash whether or not they were actually sued. (The authors subjected their hypothesis to a mathematical technique known as “simultaneous equations” to confirm that the companies weren’t just being sued because they had extra cash on hand.)

The authors made several other observations as well. Among them, increased litigation risk makes it harder to find auditors, depresses stock price, and increases managerial turnover. What lessons can we draw from all of this?

• Start talking to clients before they're sued if they're in a high-risk industry that's just been hit. They may be putting aside money in anticipation of a case anyway, and learning about how they conduct business can be very helpful for hitting the ground running once they are actually served with a complaint.
• Be specific with clients about the consequences of litigation risk. Even in the best of companies, the incentives may not align for preventing litigation. Minimizing risk (which can be hard to quantify) may take a backseat to increasing revenue, or ensuring that the current stock price is as high as possible. (It’s not like we lawyers are immune to these pressures.) The consequences of increased litigation risk are concrete things that will matter to firm management. Stock price affects their compensation. Managerial turnover means their jobs are at risk.

No one can predict exactly when a given company will be sued. But knowing generally what risks a company may face (even just by virtue of the industry it competes in) can enable defense lawyers to get a head start on some of the preparations for complex litigation.

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Securities class actions have often drawn criticisms from both defense counsel and their ideological allies. One of the more interesting criticisms has been that securities class actions may be nothing more than shell games moving money around in such a way that the only parties to benefit are the lawyers. The theory goes like this: when a plaintiff files a securities class action, she seeks compensation for a drop in the value of her shares. The firm, faced with a bet-the-company lawsuit, settles (with a payout to the plaintiffs’ lawyers). The settlement, on a prorated basis, goes to the plaintiff. And then the value of her stock in the company drops because the company has paid her a settlement and her (and its) attorneys a large fee.
It’s a tidy story, presenting a logic that’s difficult to argue against. But is it true? Law professors Lynn Bai, James Cox, and Randall Thomas set out to test this story. Their study, “Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms” reached a number of conclusions, two of which are important to this discussion.

• Defendant firms tend to perform worse than their counterparts after they’re sued. Or, as the authors put it, their regression analysis “confirm[s] the deterioration in sample defendants’ operational efficiency in the early years following the commencement of the lawsuit. For the post-settlement periods, defendant firms with high settlement amounts had a higher probability of under-performing their peer groups than companies facing lower settlement amounts.”
• Class-action settlements often come out of a firm’s operating capital. “These numbers are consistent with the theory that insurance provided less than a full coverage of the settlement amounts and the discrepancy was paid out of the defendants’ current assets. The settlement payment exacerbated liquidity constraints on the part of the defendants, making them more vulnerable to liquidity crunches and prone to bankruptcy.”

In this case, the bottom line for defendants is that securities class actions affect the bottom line of defendants. One hardly needs an academic study to prove that. But this is one of the first studies to outline the ways in which a securities class action can directly affect the financial health of a firm. Ironically, the securities class action winds up sapping the very assets that a firm needs to stay healthy, and provide an adequate return on investment for the same shareholders the lawsuit is supposed to protect. From a strictly doctrinal standpoint, this study suggests that a securities class action may not be superior to other methods of resolving any controversy arising out of a stock drop. It’s an argument that defense counsel will surely pursue further.
 

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Over the last week, I provided a brief review of the new biography of disgraced (but largely successful) class-action plaintiff’s lawyer William Lerach, and a discussion of some of his psychological quirks that one might encounter in some other plaintiffs’ lawyers. Today, I’m closing out my discussion of Circle of Greed by looking at some of the strategies that class-action plaintiffs’ lawyers employ that may not make it into reported cases. As with the “psychology” post, I’ve included page references to the book for those following along at home.

• Smaller settled cases fund larger, riskier cases. One business strategy that plaintiffs’ firms employ is to take on a number of smaller cases that may settle more easily (say, because they involve straightforward issues or technical statutory violations). These settlements provide a steady income stream that can fund larger, riskier cases (like Lerach’s pursuit of Enron). (165)
• Smaller settlements with minor defendants can fund pursuit of larger targets. This same tactic applies within a larger case. In a case with multiple defendants, if some defendants are willing to settle early, the plaintiffs may be able to leverage larger settlements from later settlors. (380)
• Publicity is a major tool for plaintiffs’ lawyers. Lerach viewed leaking information to the media as a valid tactic for putting pressure on defendants. (177) And often, a sustained publicity campaign would also help him win battles to be appointed lead counsel. (330)
• Making the fight personal can be an effective tool. Lerach’s teams would sometimes file fraud claims against directors so that they could not invoke their D&O insurance policies, putting their personal finances on the line. (162) He would also seek to make trial as embarrassing as possible for the defendants, in order to increase the leverage in settlement discussions. (116) In one case, he went so far as to retain a fellow trial counsel whom he viewed as particularly obnoxious in depositions, specifically so that he would get under the defendants’ skin, provoking them into making errors in their testimony. (120)
• The strongest plaintiffs’ cases are often the simplest. Lerach was notorious within his own firm for “the chart”: a simple presentation that contrasted a defendant’s stock price with the allegedly dishonest statements its executives made. (116) It was a compelling trial exhibit, settlement tool, and organizing principle for Milberg’s (and later, Lerach Coughlin’s) stock-drop cases. And the primary reason it was compelling is that it laid out a simple, hard-to-contradict story.

None of these strategies were unique to Lerach. And while some may seem like “dirty pool” to some defendants, it’s important to keep in mind that they serve larger purposes – some are part of the business model, some are part of the competition among plaintiffs’ lawyers, and some are aimed more at settlement than winning an immediate tactical battle. The better a class-action defendant understands the strategies the other side employs, the better it will be able to counter them. And while it may not have been their primary goal, Patrick Dillon and Carl M. Cannon have given defendants a good resource for deepening that understanding.

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On Tuesday, I provided a brief review of the Lerach biography Circle of Greed. Today, I want to focus on what some of the stories about Lerach can reveal about the psychology of the class-action plaintiffs’ lawyer.

I freely concede that this is about as unscientific an inquiry as one can make. For better or for worse, William Lerach was an extreme case. (He was extremely successful plaintiffs’ lawyers, but the extremes he went to also landed him in jail for two years.) So, many plaintiffs’ lawyers may have some of these characteristics, but likely not to the same degree as Lerach did. Nonetheless, the insight into Lerach’s psychology provides a few insights into what may make one kind of successful plaintiffs’ lawyer (page cites are from the book):

• Plaintiffs’ lawyers are competitive, even with each other. Lerach’s “firm so dominated the field of class action securities lawsuits that ‘if other firms did not come to us with California cases, they very much risked being excluded altogether from these cases.’” (89)
• You don’t have to be paranoid to be a plaintiff’s lawyer, but it helps. “Lerach's mind was conditioned to think of the possible grift first, the innocent explanation second.” (79)
• Plaintiffs’ lawyers are not above making the fight personal. After Lerach had clashed with defense expert Daniel Fischel of Lexecon, he authorized “opposition research” to build a dossier on Fischel, worrying even his partner, Mel Weiss. (Disclosure: Daniel Fischel was my Corporations professor in law school.) (160)
• Sometimes, very personal. In a case against the Washington Public Power Supply System, Weiss and Fischel crossed paths. Fischel held out his hand and introduced himself. “‘I know who you are,’ Weiss sneered, ‘And I will destroy you.’” (164)

Why bother to look at how two plaintiffs’ lawyers (Lerach and Weiss) looked at the world? Because some of what we learn may apply more broadly. Milberg Weiss was not the only plaintiffs’ firm that played hardball with other plaintiffs’ firms. Nor is Lerach likely to be the only plaintiffs’ lawyer who winds up viewing all corporations with suspicion. (Much as many defense lawyers are eventually conditioned to view plaintiffs’ lawyers with suspicion.) Understanding what drives one’s adversary allows one to better respond to their strategies, whether in the courtroom or across a settlement table.

Next Tuesday, I’ll take one last look at this book, and pull out some of the more common tactics class-action plaintiffs (including Lerach) have used.
 

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I’ve written before about how – the odd beauty contest aside – the plaintiffs’ bar often seems as opaque as the Cold War Kremlin to defense lawyers. Journalists Patrick Dillon and Carl M. Cannon have done their part for class-action glasnost, however, with their new biography of William Lerach, Circle of Greed: The Spectactular Rise and Fall of the Lawyer Who Brought Corporate America to Its Knees. 

Bill Lerach (pronounced LEER-ach) – who was to become one of the most feared lawyers in the class-action plaintiffs’ bar – was born in Pittsburgh, and graduated from the University of Pittsburgh Law School. (While he was there, he wrote a law-review comment critical of class-action settlements.) He started his career at Reed Smith, before joining forces with Mel Weiss of Milberg Weiss, and moving to San Diego to open Milberg’s west coast office.  (That office later split to form Lerach Coughlin, now Coughlin Stoia.)

From that point, Lerach’s career took off. He was at the forefront of a number of big moments in class-action litigation. He perfected the pre-PLSRA securities suit. He helped develop the “fraud-on-the-market” theory that allows plaintiffs to presume reliance in certain kinds of securities class actions. He was a pioneer in developing “scheme liability.  And he took on a number of large corporations, including NuCorp, Worldcom, and Enron. He was poised to sue contracting giant Halliburton when he finally pled guilty to criminal conspiracy.

Ultimately, Lerach was undone by his own excesses. In his race to the courthouse to be the first to file, he had kickback agreements with several named plaintiffs. He paid one of his experts on contingency (a practice discouraged by most ethics rules). His early strategies gave rise to the Private Securities Litigation Reform Act (sometimes known colloquially as the “Get Lerach” Act). And his lawsuit against Lexecon consultant (and University of Chicago law professor) Daniel Fischel ultimately backfired and cost him and his firm more than $50 million in cash.

The authors tell the story well. They’re prone to easy moralizing in places (both against Lerach and the corporate defendants he sued), but for the most part they confine themselves to the facts they have unearthed. And they do provide an informative portrait of the development of much of today’s securities class-action practice.

The book’s biggest draw for class-action practitioners, however, is that it offers an invaluable, up-close portrait of one of the leading plaintiffs’ lawyers, and even an occasional look into plaintiffs’ tactics and strategies.

What lessons can we learn from this biography? Come back on Thursday to find out.

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For the defendant, lead-plaintiff motions in class actions can often seem like a small sideshow to the real litigation. (Indeed, in many kinds of class actions, where only a single firm or consortium has brought a lawsuit, the lead-plaintiff motion may only be pro forma.) For plaintiffs however – particularly securities plaintiffs – lead-plaintiff motions lie somewhere between corporate merger and bloodsport. The consequences to winning or losing these motions can have effects for years, and the efforts to win have landed more than one attorney in ethical trouble, and sometimes prison.

But how important is the lead-plaintiff motion really? NYU Professor Stephen Choi offers one look (based on a survey of lead-plaintiff motions between 2003 and 2005) in a working paper entitled Motions for Lead Plaintiff in Securities Class Actions. His conclusion? Getting appointed lead plaintiff is still critically important to plaintiffs’ attorneys, primarily because it allows them to command higher fees.

Professor Choi also found that plaintiffs’ counsel – particularly experienced attorneys with lots of repeat interactions with co-counsel – will enter into side deals to determine who will be lead plaintiff, and with it, lead plaintiffs’ counsel. As a result, the plaintiffs with the largest losses are not always appointed lead plaintiff, and their attorneys are often able to command higher fees for fewer hours worked.

What use is Professor Choi’s study to the securities class-action defendant? The paper does provide valuable intelligence on how plaintiffs' counsel operate, something that defendants always need more of.  But, more importantly, Professor Choi’s data suggests a possible argument at class certification. His data on fees and hours worked can operate as a rough proxy for client supervision. If there is evidence that plaintiffs’ counsel cut a side deal to determine who would be lead plaintiff (for example, if an investor with larger losses stepped aside to allow another investor represented by a larger firm to be lead plaintiff), that may indicate that the lead plaintiff does not have the independence to adequately oversee its attorneys. In that case, the defendant may argue that the named plaintiff is not an adequate representative of the class.

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Last month, when the Florida SBA held its “beauty contest,” a number of plaintiffs’ firms put their internal workings on display in the hopes of securing its business. At the time, I noted that many of these firms offered investment monitoring services to their clients. In return for this free “investment monitoring,” the investor presumably would make the plaintiff’s firm its counsel in any securities-fraud suits it ended up filing.

Described that way, the monitoring agreement sounds like a win-win. The institutional investor gets a watchdog, and the plaintiff’s firm gets a potential lead plaintiff. The Southern District of New York (no stranger to securities class actions) saw it differently.

In Iron Workers Local No. 25 Pension Fund v. Credit-Based Asset Servicing & Securitization, LLC, plaintiffs represented by two different firms – Bernstein Litowitz and Coughlin Stoia – competed to be named lead plaintiffs for a securities class action. During the course of determining which fund should be lead plaintiff,

the Court was made aware of an arrangement between the Iron Workers Fund and its counsel, Coughlin Stoia Geller Rudman & Robbins LLP ("Coughlin Stoia"), that cast in doubt the adequacy of the Fund to serve as lead plaintiff in any event. … As Dennis Kramer, the Fund's administrator, testified:

Q. [by the Court] ... what you've chosen to enter into, as I understand it, is a contract where the monitoring counsel will also be the counsel who represents you if a lawsuit is brought, is that right?
A. [by Mr. Kramer] Yes, that's true.
Q. And the only way they get paid is if they bring such a lawsuit and recover, is that right?
A. Correct.

Going far beyond any traditional contingency arrangement of which the Court is aware, this practice, on its face, creates a clear incentive for Coughlin Stoia to discover "fraud" in the investments it monitors and to recommend to the Fund's non-lawyer administrator (and, through him, to the trustees) that the Fund, at no cost to itself, bring a class action lawsuit. In other words, the practice fosters the very tendencies toward lawyer-driver litigation that the PSLRA was designed to curtail.

(Internal citation omitted, emphasis added.) The court invited further briefing on adequacy, as well as on the ethical implications of the agreement. While the briefing cited several cases in which courts had commented favorably on the monitoring agreements (and an affidavit condoning the practice by ethics guru Geoffrey Hazard), the court remained unconvinced, and awarded lead plaintiff status to Bernstein Litowitz’s client. (The court noted that Bernstein Litowitz also offered investment monitoring, but did so without the same explicit quid pro quo.)

Investment monitoring agreements are still common. And most plaintiffs’ firms prize their reputations for integrity as critical for winning lead counsel slots, so they’re likely to try to avoid the appearance of conflict. But, that said, the S.D.N.Y.’s unease suggests that defense counsel may find ammunition for opposing class certification if they probe further into the nature of the monitoring agreement in each case.

 

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Last week, I wrote that in class actions, divining the motives of plaintiffs’ firms can feel like Kremlinology; this week it seems more like missology. The Florida State Board of Administration (which oversees Florida’s retirement funds) has conducted a “beauty contest” for its next securities counsel, and done so with what various observers have called unparalleled transparency. The result is a trove of publicly-available data on the securities plaintiffs’ bar’s practices and priorities.

The American Lawyer’s Litigation Daily managed to obtain the various submissions from the securities firms that bid for the SBA’s business. And the submissions – from noted plaintiffs' firms Coughlin Stoia, Lieff Cabraser, Barrack Rodos & Racine, Berman DeValerio, Bernstein Liebhard, Bernstein Litowitz, Entwistle & Capucci, Granet & Eisenhoffer, Kaplan Fox, Labaton Sucharow, and Pomerantz Haudek – reveal a number of interesting facts about the competing firms. Among them:

• A number of plaintiffs’ firms have their own proprietary software systems for monitoring their clients’ investments. When an investment loses value, and the firm can correlate it to some fraud or other mismanagement, they recommend filing a lawsuit.
• In addition to monitoring investments, a number of these firms employ teams of in-house forensic accountants. At least one (Lieff Cabraser) also employs a former FBI agent for “identifying and conducting interviews with witnesses and performing other investigative tasks.”
• In response to the SBA’s question about litigation financing, most firms answered that they were sufficiently capitalized to handle motions practice, discovery, and the retention of experts.
• The SBA is very concerned with dismissal rates of lawsuits.
• Despite the fact that they weren’t asked, a number of firms discussed the number of times that they had been appointed Lead Counsel or – more interesting – the number of times they had won Lead Counsel motions.

There are a number of inferences defense firms can draw from the information in these submissions. Among them:

• Intelligence is very important to plaintiffs’ firms. Each of these firms invests a lot of money in monitoring stock prices and performing preliminary research
• For plaintiffs, the Motion to Dismiss is the critical motion. Because class-action defense firms want to rid themselves of a case early and completely, they often structure their defense around each of the dispositive motions that occur in a class action, starting with the motion to dismiss, but including the certification motion and summary judgment. Securities plaintiffs and their lawyers really emphasize the 12(b)(6) motion.
• Plaintiffs’ counsel are subject to intense competition. The other motion that the various firms tout is the Motion for Lead Counsel, which indicates that this is another landmark. (The intense investment in pre-lawsuit research also suggests intense competition to be “first to file.”)
• Reputation is paramount. Firms that compete regularly to represent public pension funds must work extremely hard to avoid the appearance of impropriety. (This beauty contest offers two examples. One firm was anonymously accused of various shady practices – including diverting cy pres settlement funds to a partner’s synagogue – into which the SBA is looking. In addition, Coughlin Stoia’s response to questions on restructuring and ethics issues labors to avoid mentioning founding partner William Lerach’s legal difficulties.)
• These firms’ business models are built around settlement. When touting their “wins” each of these firms promoted settlements that had resulted in large payments, as opposed to trial wins. This is no surprise (very few securities class actions go to trial), but it is helpful to remember that securities class-action practice is less about trial victory than it is about leveraging a successful settlement.

These aren’t universal observations. These are the firms at the top of the food chain, so their practices will not be the same as other plaintiffs’ firms. Also, these were submissions for beauty contests, which – as defense lawyers know – require a firm to put its best face forward. Still, knowing the structural differences between plaintiff and defense firms can be instructive in figuring out how best to respond to plaintiffs.

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 Despite the amount of time defense counsel spend handling class actions, one aspect often continues to frustrate analysis – plaintiffs’ counsel. Studying how plaintiffs’ counsel operate in class actions (which is, of course, essential to opposing them in individual litigation) can sometimes feel like Kremlinology, or reading tea leaves. Since plaintiffs’ counsel have a strong interest in presenting their best possible face to the world – and defendants often feel strong distrust of plaintiffs’ PR – defense counsel risk predicting the moves of a caricature, rather than a fully-fleshed opponent.

Fortunately, a number of academics have begun to examine the ways in which plaintiffs’ counsel interact, find clients, and build their cases. One of the more prolific scholars of class-action practice, Stephen Choi, has teamed with longtime co-author A.C. Pritchard and judicial clerk Drew T. Johnson-Skinner to perform an analysis of “pay to play” practices among plaintiffs’ counsel and state pension funds. 

As Choi and company describe it, since the passage of the Private Securities Litigation Reform Act (which heavily favors institutional investors over individual investors as class representatives, on the theory that they are more likely to be independent of class counsel):

Most of the institutional investors that have agreed to serve as lead plaintiffs have been government-sponsored pension funds. Many of these funds are managed directly by politicians, such as state comptrollers, who must campaign to retain their current positions, or may have designs on higher offices. Alternatively, these funds are managed by political appointees, who typically owe their position to the state’s governor. The presence of political influence over these funds naturally raises the question of whether law firms are making political contributions to the politicians who wield that influence in order to enhance their chances of being selected to represent the pension funds. Simply put, are law firms buying lead counsel status with campaign contributions, i.e., do class action lawyers pay to play?

(Emphasis added.) Their conclusion? Yes. Class-action lawyers do. And firms that appear to win their work as a result of “pay to play” practices generally receive higher attorneys’ fees than those that don’t.

So what are the strategic implications of this finding? For defendants, Choi and company’s analysis implies that it's worth serving discovery exploring the various relationships plaintiffs’ counsel may have had, even with larger institutional investors. Commentators (and courts) had previously presumed that institutional investors would be more adequate than smaller clients because they had the incentive to oversee counsel (because they had a larger stake in the litigation), and the investing knowledge required to do it effectively. However, Choi and company's analysis implies that pension funds that accept “pay to play” contributions may lack the financial independence to oversee class counsel. If they lack that independence, they may not be adequate fiduciaries of the interests of the class. And that's a powerful argument against certifying a class.

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