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?
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.