The class certification decision in In Diamond Foods, Inc. Sec. Litig., 2013 WL 1891382 (N.D. Cal. May 6, 2013) contains a number of interesting holdings.
(1) Market efficiency is an issue for the finder of fact - A rebuttable presumption of reliance based on the fraud-on-the-market theory is only available to plaintiffs if the company's stock traded on an efficient market. Market efficiency means that the company's stock price reflected all publicly available information, which is typically tested by examining a number of empirical factors. In Diamond Foods, the court noted that the Supreme Court and the Ninth Circuit have never addressed "whether market efficiency is an issue for the jury to determine in trial (or, where appropriate, summary judgment), or is a matter reserved for the judge." The court concluded, however, that the majority of courts correctly "treat efficiency as an issue for the finder of fact."
(2) Comcast decision inapplicable to securities class actions - In the Supreme Court's recent Comcast decision, it held that class certification should be denied if damages are incapable of measurement on a classwide basis. The Diamond Foods court found that the Comcast holding was inapplicable to securities class actions, where it is widely accepted that an event study can be "used to identify the economic loss caused by alleged fraud." Indeed, the defendant failed "to identify any specific complications that would make such a calculation impossible or ill-advised in this case."
(3) Pay-to-play allegations insufficient to find proposed class representative inadequate - The lead counsel had made political contributions to Mississippi Attorney General Jim Hood, who controlled the lead plaintiff's selection of counsel. The court found that none of the contributions, however, were made "after counsel were approved by the Court in June 2012." While lead counsel also had made contributions to the Democratic Attorneys General Assocation in 2012, there did not appear be any "communication between the law firms and Attorney General Hood, or his office, regarding any expectation that the law firms contribute to DAGA or that such contributions would eventually make their way to Attorney General Hood." Accordingly, the court held that "[d]efendant has not advanced a record adequate to torpedo this action based on a pay-to-play theory."
Holding: Motion for class certification granted.
In a securities class action brought against Central European Distribution Corp., the court received applications for lead plaintiff from Harry Nelis (an individual investor) and the Prosperity Subsidiary Group (a grouping of four institutional investors). Nelis was represented by Pomerantz Haudek, while the Prosperity Subsidiary Group was represented by Robbins Geller. Apparently recognizing that the Prosperity Subsidiary Group's application was problematic, however, Robbins Geller also submitted a "response" to the court on behalf of another investor, a Puerto Rico public pension fund, in which the fund expressed an interest in being named lead plaintiff if the Prosperity Subsidiary Group was not selected.
In Grodko v. Central European Distribution Corp., 2012 WL 6595931 (D.N.J. Dec. 17, 2012), the court addressed this unusual lineup. The court found that the Prosperity Subsidiary Group had the largest alleged losses, but faced a unique defense based on loss causation. All of the investors in the group had sold their shares well before the disclosures that allegedly revealed the defendants' fraud. Accordingly, the court denied the Prosperity Subsidiary Group's application. While the Puerto Rico fund had the next largest alleged losses, Nelis argued that it should not be selected because (a) the Puerto Rico fund had failed to file a timely application for lead plaintiff, and (b) Robbins Geller was engaging in "unethical gamesmanship" based on its representation of multiple plaintiffs.
The court rejected Nelis' arguments. First, the Puerto Rico fund had filed a complaint in the action. Under the language of the PSLRA, the court held that the filing of an initial complaint is sufficient to entitle the party to consideration as lead plaintiff. Second, the court noted that "Nelis has not cited any legal authority supporting his contention that counsel in a securities class action are necessarily behaving unethically when they represent multiple plaintiffs." Indeed, Pomerantz Hudek also represented both Nelis and a different investor who had filed one of the initial complaints. Nor was there any apparent conflict of interest between Robbins Geller's various clients.
Holding: Appointing the Puerto Rico fund as lead plaintiff and Robbins Geller as lead counsel.
Two items on the relationship between investors and their counsel.
(1) The battle over the attorneys' fees award in the Tyco securities litigation continues. At the heart of the dispute is whether lead counsel was bound by its contractual fee arrangement with the lead plaintiff, which provided for a much lower fee award, or could seek whatever level of fees the court would approve. Forbes has a column on the latest filings in the case.
(2) Judge Jed Rakoff is no stranger to securities litigation and is not known for holding back on his opinions. In City of Pontiac General Employees' Retirement System v. Lockheed Martin Corp., 2012 WL 546475 (S.D.N.Y. Feb. 21, 2012), the judge took on the common practice of plaintiffs' firms entering into "monitoring" agreements with institutional investors. Under these agreements, the plaintiffs' firm (without charge) monitors the investments made by the institution to see if any securities class actions should be brought. If the plaintiffs' firm recommends that a case be brought and the institution agrees, the plaintiffs' firm will be the institution's presumptive choice as counsel. Judge Rakoff noted that the practice "creates a clear incentive for the monitoring firm to discover 'fraud' in the investments it monitors," which would appear to undermine the PSLRA's goal of discouraging lawyer-driven litigation. Nevertheless, the court approved the proposed lead plaintiff and lead counsel, finding that it appeared that the institution had "the ability to properly exercise [its] role as lead plaintiff" and had affirmed at a hearing on the matter that it would play an active part in the litigation going forward.
In a strange story, a court in the S.D.N.Y. has dismissed the lead plaintiff from a securities class action brought against Smith Barney Fund Management and Citigroup Global Markets because, after six years of litigation, it was revealed that the entity had not actually purchased the securities at issue. The lawsuit, originally filed in 2005, alleges various misrepresentations by an investment advisor for certain Smith Barney mutual funds, which later were acquired by Citigroup. According to counsel for the plaintiffs, the relevant brokerage documentation erroneously showed that the Operating Local 639 Annuity Trust Fund had invested in one of the relevant mutual funds (when, in reality, its investment was in a similarly named fund).
The court, in an apparently scathing decision, cited "epic failures" by the attorneys on both sides of the case in not investigating the issue earlier. For its part, "[h]ad Smith Barney simply checked its records, it would have avoided six years of sparring with a phantom opponent." Bloomberg and the WSJ Law Blog have articles on the decision.
(1) Given that the PSLRA has been in effect since 1995, federal courts of appeals have been spending a surprising amount of time lately addressing writs of mandamus on how to interpret the statute's lead plaintiff provisions. Just last month, a Ninth Circuit panel held that a district court cannot reject the lead plaintiff's proposed lead counsel and substitute lead counsel of the court's own choosing. In In re Bard Associates, Inc., 2009 WL 4350780, (10th Cir. Dec. 2, 2009), the Tenth Circuit was asked to consider whether an investment advisor who applied to act as lead plaintiff, but did not obtain assignments of its clients' claims until after its motion was filed, made a valid application. The panel found that the district court did not abuse its discretion when it rejected the investment advisor's application on the grounds that the investment advisor had failed to establish its standing to sue as of the lead plaintiff application deadline.
(2) Settling a securities class action for $40 million is not that unusual. Settling a securities class action for $40 million after obtaining the dismissal of the case (and before any appellate ruling) is quite unusual. The D&O Diary and The American Lawyer have full coverage of Dell's interesting settlement announced last week. It certainly seems hard to argue with lead counsel's conclusion that it was "a very, very good result for the class . . . [p]articularly given the procedural posture of the case."
There is nothing unusual about a court reducing the requested attorneys' fees as part of its approval of a securities class action settlement. That said, it is rarely accompanied by the written fireworks found in the recent opinion in the UnitedHealth Group options backdating case.
The case settled last year for $895 million (later increased by payments from individual defendants to a combined class fund of $925.5 million). In In re UnitedHealth Group PSLRA Litig., 2009 WL 2482029 (D. Minn. Aug. 11, 2009), Judge James Rosenbaum granted final approval to the settlement, but reduced the requested attorneys' fees from $110 million (11.92% of common fund) to $64.785 million (7% of common fund).
The court was sharply critical of lead counsel's reliance on the fee agreement with its client, which (a) had been entered into after the denial of the motion to dismiss, (b) was not the product of competitive bidding, and (c) had an escalating schedule that increased the percentage paid in attorneys' fees as the recovery increased. The court found that it was not bound by the agreement and "any risk that declining percentages will force class action counsel to settle 'too early and too cheaply' is overstated."
As for the lodestar check, the court rejected lead counsel's calculation of its expended fees, finding that "the submissions reflect rates far beyond those charged in the Twin Cities market, as well as considerable time billed by staff which is properly counted as overhead." Based on the court's recalculation, the awarded fees resulted in a 6.5 multiplier. The court did graciously note in a footnote, however, that if lead plaintiff wished "to divide its aliquot portion of the recovery between itself and its lawyers as provided in their fee agreement, this Opinion should not be read to suggest any opposition."
Thanks to Securities Docket for the link to the opinion.
Quote of note: "[Lead counsel] supports its request with the expert report of Professor Charles Silver, who asks, 'Can judges do better than lead plaintiffs when it comes to setting fees?' He believes not, because '[j]udges have neither better information, better access to markets, nor better incentives.' His argument rests on Adam Smith's premise that the self-regulated market knows best, and 'prices are best set by buyers and sellers bargaining in a competitive environment.' Seldom have the groves of academe and the ivory towers sheltered within their leafy bowers seemed farther from reality. A lecture on the virtues of the unrestrained free market sounds a bit hollow in light of the parties', this Nation's, and indeed the world's, experiences with the beauties of self-regulated financial markets during a period remarkably coterminous with the existence of this case. The Court rejects the proffered expert's opinion."
Senior District Judge Milton Shadur has a colorful history when it comes to applying the PSLRA's lead plaintiff/lead counsel provisions. It just got a bit more colorful with his decision in Gorham v. General Growth Properties, Inc., 2009 WL 661303 (N.D. Ill. March 16, 2009).
In selecting a lead plaintiff in General Growth, the court was forced to choose between two individual investors, neither of whom had moved for lead plaintiff status within the requisite 60 days after publication of notice of the case. Investor A filed a complaint within the 60-day period, had a small loss, and entered into a high-cost fee arrangement with proposed lead counsel. Investor B only filed a complaint after the 60-day period, had a larger loss, and entered into a low-cost fee arrangment with proposed lead counsel. In pressing its application, Investor A argued that he was - in Judge Shadur's phrasing - "the only crap game in town" because Investor B had not even filed a complaint within the first 60 days.
Judge Shadur found, however, that "any presumption that [Investor A] is the 'most adequate plaintiff' has been fully rebutted by the inferiority of his chosen counsel's proposal for the fees to be charged to the class members out of any recovery." Accordingly, the court appointed Investor B as lead plaintiff and his chosen counsel as lead counsel.
Quote of note: "This Court flatly rejects the prospect of having such a tiny wisp of a tail-[Investor A] with his minimal investment in General Growth-wag the very large dog of the plaintiff class. What [Investor A] has to lose in terms of his in-pocket recovery, if the class is successful in the litigation and if his own counsel's formulation were to apply rather than the far more client-favorable formulation proffered by [Investor B's counsel], is in the range of a few hundred dollars, while what the class would stand to lose under the [Investor A]-sponsored formula would be measured in millions of dollars."
A few interesting lead plaintiff/lead counsel decisions from the end of last year (and one article).
(1) In In re Adelphia Comm. Corp. Sec. & Derivative Lit., 2008 WL 4128702 (Sept. 3, 2008) a law firm that did not act as lead counsel in the case moved for a third of the aggregate fee award. The law firm argued that it had provided "an independent and substantial benefit" for the class by initiating and preserving the Section 11 and Section 12 claims that ultimately were asserted against two of Adelphia's underwriters. The court found no evidence, however, "that the use of those statutes, or their use against [the two underwriters], represents ground-breaking legal or factual analysis." The law firm was awarded the amount that had been allocated by lead counsel - $155,610, or the time the law firm had invested in the case, at its normal hourly rates, up until the appointment of lead plaintiffs and counsel.
(2) A lead plaintiff cannot receive a disproportionate share of any settlement, but it can seek reimbursement for its costs and expenses. In In re Enron Corp. Sec., Derivative & "ERISA" Lit., 2008 WL 4178144 (Sept. 8, 2008), the court considered whether to reimburse the lead plaintiff for $600,000 in costs and expenses. The lead plaintiff argued that because one of its in-house counsel devoted an estimated 30% of his time to the case, it was forced to employ outside co-counsel on a number of matters. Accordingly, the lead plaintiff sought its costs for the in-house counsel's time. Despite an objection that the lead plaintiff had failed to identify any "specific costs it was required to pay" because of its in-house counsel's work on the litigation, the court granted the request.
(3) In Kuriakose v. Fed. Home Loan Mort. Co., 2008 WL 4974839 (Nov. 24, 2008), the Treasurer of the State of North Carolina moved on behalf of the North Carolina Retirement Systems to act as lead plaintiff in the case. Unfortunately for him, the North Carolina State Attorney General filed an opposition "on the ground that the Treasurer lacks authority under North Carolina law either to seek NCRS's appointment as lead plaintiff or to retain counsel to represent NCRS in this litigation." The court found that it would not "be in the class's interest to have a lead plaintiff likely to become bogged down in state court litigation concerning its participation."
Is there a better way to deal with the selection and compensation of lead plaintiff and lead counsel in securities class actions? The author of The 10b-5 Daily offered a few thoughts on the issue in a Class Action Watch article (Oct. 2008 edition).
Judge Vaughn Walker of the N.D. of Cal. has often expressed skepticism about attorneys' fees payments in securities class actions (click here and here). So the parties in the Chiron case may not have been surprised when he denied preliminary approval of their $30 million settlement agreement on the grounds that the attorneys' fees request was excessive. Milberg Weiss had asked for $7.5 million or 25% of the settlement, which Judge Walker found resulted in a lodestar of between 8 and 10. More noteworthy, however, is that the court's opinion reportedly also: (a) expressed concern over the pending criminal charges against Milberg Weiss; (b) questioned whether the lead plaintiff was an adequate class representative given its approval of the attorneys' fees request; and (c) suggested that defense counsel, which represents some individuals in connection with the Milberg Weiss-related criminal probes, may have had an incentive not to look too closely at the adequacy issue. The Recorder and Reuters have articles on the decision.
Two recent appellate decisions of interest:
(1) In Central Laborers' Pension Fund v. Integrated Electrical Services, Inc., 2007 WL 2367776 (5th Cir. August 21, 2007), the court addressed the pleading of scienter under the Supreme Court's recent Tellabs decision. Notably, the court found that (a) the confidential witness allegations lacked sufficient detail supporting their reliability (although the court stopped short of suggesting that the plaintiffs should provide the names of the witnesses), (b) the argument that the stock trading of one of the defendants was non-suspicious because he traded pursuant to a Rule 10b5-1 plan was "flawed" because the plan was put into effect during the class period, and (c) an inference of scienter cannot be drawn from a Sarbanes-Oxley certification unless the person signing the certification had reason to know or should have suspected that the financial statements contained misrepresentations. The court concluded that the "allegations read in toto do not permit a strong inference of scienter."
(2) In Employers-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Anchor Capital Advisors, 2007 WL 2325079 (9th Cir. August 16, 2007), the court considered whether a lead plaintiff decision can be appealed following the dismissal of the underlying case. A group of public pension funds had unsuccessfully moved to serve as lead plaintiff. The lower court subsequently granted the defendants' motion to dismiss the case. The appointed lead plaintiff declined to file an amended complaint and instead requested that the individual uncertified actions be dismissed with prejudice. The pension funds moved to appeal the earlier lead plaintiff decision, but the appellate court held that because the pension funds never filed their own complaint or intervened in the pending action, they were merely "potential class members in a potential class action suit" and had no standing to bring an appeal.
(1) Since 1999, international institutional investors have sought to serve as lead plaintiffs 182 times in 98 different cases.
(2) The international institutional investors that filed lead plaintiff motions were from 17 different countries. Germany, Canada, and Israel were the countries with the largest number of movants.
In the post-Dura world, in-and-out traders (i.e., investors who both bought and sold their shares during the class period) continue to have difficulties pursuing securities fraud claims. Hard on the heels of the lead plaintiff decision in the Comverse case comes an opinion from the D. of Mass. declining to appoint an in-and-out trader as a class representative.
In In re Organogenesis Sec. Litig., 2007 WL 776425 (D. Mass. March 15, 2007), the court found that during the class period one of the proposed class representatives "sold almost six times as many shares as he purchased." Under the last-in, first out ("LIFO") methodology of assessing damages adopted by the court, these trades resulted in the investor making a profit on his trading during the class period and rendered him an unsuitable class representative. The court also rejected the other proposed class representative because the investor made his final stock purchase prior to the date one of the individual defendants joined the company and, therefore, lacked standing to proceed against that individual defendant. Finally, the court found that Milberg Weiss was not an adequate lead counsel based on: (a) the submission of erroneous stock certifications on behalf of one of the proposed class representatives; (b) the possible negative effects of the federal indictment against the firm; and (c) the firm's failure to clearly inform the court of the role of one of its indicted attorneys in the case.
Quote of note: "The court realizes that refusing to certify a class will make it more difficult to prosecute the fraud alleged in this case. But the allegation of fraud is not alone enough to merit class certification. The additional requirements exist for the important reason of ensuring that the named plaintiffs effectively represent the claims of the absent parties."
While the Dura decision by the Supreme Court suggests that in-and-out traders (i.e., investors who both bought and sold their shares during the class period) cannot establish the existence of loss causation, lower courts have not uniformly applied this principle. In the latest case to consider the issue, In re Comverse Technology, Inc. Securities Litigation, a court in the E.D.N.Y. has issued a decision vacating a magistrate judge's order appointing the Plumbers and Pipefitters National Pension Fund (P&P) as lead plaintiff in the case. The court concluded that the magistrate judge improperly overvalued P&P's financial interest in the action by including losses resulting from in-and-out trades.
Citing Dura, the court held that "any losses that P&P may have incurred before Comverse's misconduct was ever disclosed to the public are not recoverable, because those losses cannot be proximately linked to the misconduct at issue in this litigation." P&P actually realized a gain on the Comverse shares that it purchased during the class period and held until after the alleged corrective disclosures were made. As a result, the court appointed a different lead plaintiff and lead counsel. The New York Law Journal has an article on the case.
Quote of note (opinion): "While the Dura Court decided a motion to dismiss, and not a lead plaintiff motion, the logical outgrowth of that holding is that [in-and-out] losses must not be considered in the recoverable losses calculation that courts engage in when selecting a lead plaintiff."
There have been some new developments in a pair of old disputes.
(1) Newsday reports that after a long-running legal battle, a California state court has granted a motion brought by Texas billionaire Sam Wyly and "order[ed] three class action law firms to turn over years' worth of evidence they collected as part of their lawsuits alleging accounting fraud by former [Computer Associates] executives." Wyly, who was a class member in the suits, alleges that the litigation was improperly settled for a low amount just prior to Computer Associates' public disclosures of accounting fraud. (For earlier posts on this story - click here and here)
(2) The court presiding over the Halliburton securities class action has granted a motion by the Archdiocese of Milwaukee Supporting Fund, which is acting as lead plaintiff in the case, to remove Lerach Coughlin and Scott + Scott as lead counsel. Legal Pad has a post. (For an earlier post on this story - click here.)
Both the Federal Rules of Civil Procedure and the PSLRA provide that plaintiffs' counsel in a securities class action may be awarded a "reasonable" fee as determined by the court. Courts generally agree that it is appropriate to cross-check a proposed percentage fee award using the lodestar method (take the reasonable hours expended times a reasonable hourly rate and adjust with a multiplier), but there is no uniformity as to what are the appropriate hours, rates, and multiplier to use.
Bloomberg has an article on the approval of the settlement in the Nortel securities litigation. There are two items of note. First, the overall settlement value apparently has declined by over $1 billion since the settlement was first announced. Second, the court reduced the proposed attorneys' fees from 8.5% (approximately $96 million) to 3% (approximately $34 million) of the settlement value.
A review of the opinion, which is not yet available online, reveals that the court's main concern was that the proposed attorneys' fees award resulted in a lodestar multiplier of 5.8 (i.e., "fees totaling 5.8 times the number of hours actually worked"). The court viewed this as excessive, citing a number of prominent cases (including Bristol-Myers Squibb and Worldcom) where other S.D.N.Y. judges approved attorneys' fee awards that had lodestar multipliers of 3.5 or less. Based on a 3% award, the lodestar multiplier in Nortel is approximately 2.05.
The Halliburton securities litigation is back in the news, two years after the S.D. of Tex. rejected a proposed settlement of the case. Forbes has an article on a motion by the Archdiocese of Milwaukee Supporting Fund, which is acting as lead plaintiff in the case, to replace Lerach Coughlin and Scott + Scott as lead counsel.
Terayon Communications Systems, Inc. (Nasdaq: TERN), a Santa Clara-based provider of digital video networking applications, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Cal. The case originally was filed in 2000 and is based on allegedly misleading statements concerning the company's ability to obtain certification for its technology.
The settlement is for $15 million, with Terayon paying $2.3 million and the rest covered by insurance. Prior to this settlement, the case had been a lightening rod for criticism over the relationship between short sellers and the securities plaintiffs' bar. For posts from The 10b-5 Daily on the case, see here, here, and here.
Professor Michael Perino, author of the leading treatise on the PSLRA, has published an empirical study of attorneys' fees in securities class actions. The paper is entitled "Markets and Monitors: The Impact of Competition and Experience on Attorneys' Fees in Securities Class Actions." Perino finds that the participation of a public pension fund as a lead plaintiff is correlated with lower attorneys’ fees requests and awards. By contrast, there is no statistically significant correlation associated with the participation of a union pension fund, the other type of institutional investor examined by the study. Court auctions of the lead counsel role result in significantly lower attorneys' fees. In addition, the participation of repeat players (either courts that are more experienced handling securities class actions or institutional objectors) are correlated with lower attorneys' fees.
Quote of note: "These findings suggest four basic policy responses. First, because the fee arrangements that public pension funds negotiate appear to be the product of at least some competitive bargaining, courts should look to those arrangements as guidelines for awarding fees in cases without institutional investors. Second, to obtain the benefits of judicial experience in fee awards, courts with comparatively little experience in handling securities class actions should look to the fees that more experienced courts award, a process that will be facilitated by making award decisions (which are predominantly unreported) more widely available. Third, policy should continue to encourage institutions, most particularly public pension funds, to serve as lead plaintiffs and to encourage institutions to monitor fee requests and object to those that are excessive. Finally, courts should continue to experiment with auctioning the role of lead counsel in those cases in which the available lead plaintiffs do not appear to have used competition or otherwise to have engaged in arm’s length bargaining to select class counsel."
Under the PSLRA, the lead plaintiff in a securities class action is presumptively the party with the largest financial interest in the relief sought by the class (i.e., the movant who alleges the most potential damages). Although the statute expressly refers to the selection of a "person or group of persons" to fill the lead plaintiff role, some courts have expressed hostility to proposed lead plaintiff groups that are merely aggregations of unrelated investors.
In an unusual decision in In re Pfizer Inc. Sec. Litig., 2005 WL 2759850 (S.D.N.Y. Oct. 21, 2005), the court took this a step further. First, the court rejected the various proposed groups of investors, finding that they had been "artificially grouped by [their] attorneys." Second, the court declined to appoint the investor with the largest claimed losses because "inaccuracies in its damages calculations" called into question its reliability. Finally, the court selected as lead plaintiff an investor whose counsel had withdrawn its motion for appointment as lead plaintiff (at least conditionally) in favor of another movant.
Quote of note: "Several of the putative plaintiffs are aggregated into artificial 'groups.' Nothing before the Court indicates that this aggregation is anything other than an attempt to create the highest possible 'financial interest' figure under the PSLRA and I reject it."
As any law student quickly learns, a lot of interesting points can be found in the footnotes of judicial opinions. "Footnote 4" in the Molson Coors Brewing Company lead plaintiff decision, authored by Judge Kent Jordan (D. Del.), is already lighting up the blogosphere and citations are sure to follow.
In his decision - In re Molson Coors Brewing Co. Sec. Litig., 2005 WL 3271488 (D.Del. December 2, 2005) - Judge Jordan describes his task as deciding "which of the plaintiffs' law firms will win the money race." The judge's accompanying footnote states that he means "no disrespect" to the plaintiffs' firms competing to be named lead counsel, but that the "'pick me' urgency seems far more likely to come from the lawyers than the parties because, in the real world, people are not so eager to undertake work that someone else will do for them." He goes on to state that the proposed lead plaintiffs' natural inclination to let someone else "shoulder the burden of supervising the litigation" gets "overridden because securities lawyers are involved, lawyers who are vying for the chance to take the laboring oar in litigation and the monetary rewards that go with it." The judge concludes that PSLRA's lead plaintiff provisions may be ineffective because "lawyers are still very much in the driver's seat."
Under the PSLRA, the presumptive lead plaintiff in a securities class action is the party with the largest financial interest in the relief sought by the class. Courts have struggled, however, with how to apply this presumption when faced with proposed lead plaintiff groups. In In re Flight Safety Technologies, Inc. Sec. Litig., 2005 WL 2663033 (D. Conn. Oct. 19, 2005), two competing plaintiffs' groups joined forces and sought to have eight investors named as co-lead plaintiffs. The court found that "appointing eight unrelated and unfamiliar plaintiffs as co-lead plaintiffs, when no preexisting relationship is evident, would be counter to both the terms and the spirit of the PSLRA." Instead, the court appointed one individual investor (who had alleged the most potential damages) and one institutional investor (noting that Congress had expressed a preference for institutional investors).
Quote of note: "In the briefs submitted prior to the date on which the pending joint motion for appointment was filed, the Rogers Group and the Ozkam Group spent considerable time and effort criticizing the ability of the members of the other group to serve as lead plaintiffs in this action. As noted previously, those groups have since abandoned their concerns, however, and combined with those previously deemed inadequate in order to pursue their remedy. This gives new meaning to Lord Palmerston’s quotation: 'We have no eternal allies and we have no perpetual enemies. Our interests are eternal and perpetual, and these interests it is our duty to follow.'"
The Rocky Mountain News has an article on the $50 million settlement of the shareholder class action related to the merger of Qwest Communications and U.S. West. The Association of U.S. West Retirees challenged the proposed $15 million attorneys' fees award (30% of the settlement), arguing that the case and settlement stunk "like a three-day-old unrefrigerated dead fish." The district court judge, however, rejected the challenge. At the hearing, the court noted that there "weren't any other lawyers in the United States that took the gamble that these people did - not one other law firm anywhere."
The Wall Street Journal has extensive coverage (subscrip. req'd) this week of an unusual turn of events in the class action pending against KPMG in the D. of Ark. The case was filed by the law firm of Bernstein Litowitz and alleges fraud in connection with the sale of certain tax shelters. In a recent motion, Bernstein Litowitz claims that another plaintiffs' firm, Milberg Weiss, is "colluding" with KPMG to put together a new suit with a "pre-packaged settlement ... presumably on terms less favorable to the class."
The motion describes the situation as a "reverse auction," with KPMG attempting to negotiate a weak settlement that will preclude other settlements. Bernstein Litowitz is seeking to halt any settlement negotitations, be designated interim class counsel, and prevent Milberg Weiss from filing its own suit. In today's follow-up article, the paper reports that Bernstein Litowitz apparently has obtained confirmation that the talks between KPMG and Milberg Weiss are ongoing.
The PSLRA states that securities class action plaintiffs, within 20 days of filing a complaint, "shall cause to be published, in a widely circulated national business-oriented publication or wire service, a notice advising members of the purported plaintiff class." After the publication of this notice, it is not uncommon for other plaintiffs' firms (who have not filed complaints) to publish similar notices in the hopes of attracting a client who can be put forward as a lead plaintiff candidate. The initial plaintiffs' firms do not usually react to this practice in public, but that may be changing. In a recent case, the firms who filed the first complaint have issued a press release "cautioning investors" about these notices and stating that because they conducted an investigation prior to filing the complaint "they are in a superior position to answer questions about the claims alleged." A link to the press release can be found here.
The Star-Ledger (N.J.) ran an article this week on the named plaintiff in one of the securities class actions filed against Able Laboratories in the D. of N.J. According to the article, the small, individual investor was unaware of the exact problems at the company until he was cold-called by a plaintiffs' firm and asked to participate in the suit. Thanks to Securities Litigation Watch for the link.
Quote of note: "'The law firm called me,' said Lodish, 31, who bought the shares on the advice of an investment counselor. 'I know the stock went up and went down. For me to guess is speculative if it was the right thing for it to go up or the right thing for it to go down.'"
Fee objectors are becoming a more common feature in securities class action settlements and, in some cases, are getting results. The Elan securities litigation was settled last year for $75 million. Plaintiffs requested that their counsel be awarded attorneys' fees of 20% of the settlement or $15 million. There were fifteen objectors to the proposed award, with two of the objectors presenting substantive grounds for their opposition.
In its decision (In re Elan Sec. Litig., 2005 WL 911444 (S.D.N.Y. April 20, 2005)), the court reduced the fee award to 12% of the settlement or $9 million. Notably, the court agreed with the fee objectors that the plaintiffs faced only a modest risk of dismissal at the outset of the case and that the plaintiffs' attempt to use the hours worked by non-lead counsel to justify the size of the fee award should be rejected.
Quote of note: "Virtually all of Unappointed Counsel's hours fall into two categories: (1) 'Investigation, Initial Pleadings, Consolidated Complaint,' and (2) 'PSLRA Notice, Lead Plaintiff Motion.' But Unappointed Counsel failed to segregate the hours devoted to investigation and/or preparation of the Consolidated Complaint and do not establish why they should be compensated for, among other things, seeking but failing to be appointed lead counsel."
Both the Federal Rules of Civil Procedure and the PSLRA provide that plaintiffs' counsel in a securities class action may be awarded a "reasonable" fee as determined by the court. Courts generally agree that it is appropriate to cross-check a proposed percentage fee award using the lodestar method (take the reasonable hours expended times a reasonable hourly rate and enhance with a multiplier), but there is no uniformity as to what are the appropriate hours, rates, and multiplier to use.
In an interesting decision, Chief Judge Vaughn Walker of the N.D. of Cal. (who is no stranger to controversy on the subject of attorneys' fees) attempts to establish a more rigorous method of assessing the reasonableness of a proposed fee. The court's exhaustive lodestar analysis in In re HPL Technologies, Inc. Sec. Litig., 2005 WL 941586 (N.D. Cal. April 22, 2005) includes adjusting the value of the common stock portion of the settlement because of its illiquidity, lowering the hourly rates cited by the attorneys based on national standards, and creating hypothetical scenarios to establish a reasonable multiplier range. Although the court ultimately reduces the proposed percentage fee from 15% to 11% based on the lodestar crosscheck, it concedes that its "excursion has led it to take up legal issues that have not been briefed by counsel" and expressly grants leave for lead counsel to move for relief from the judgment. The 10b-5 Daily will keep an eye on further developments.
Quote of note: "The court can envision no defensible normative reason in this case--or indeed in common fund cases generally--that the amount of the fee ought to depend on the method used to compute it. Both methods should result in a 'reasonable' fee, and reasonableness cannot logically depend on whether the fee is expressed as a percentage of the recovery or the product of hours and rates."
In an interesting decision from earlier this month, the U.S. Court of Appeals for the Third Circuit has held that deference should be given to a lead plaintiff's decision not to compensate non-lead counsel. The case stems from the $3.2 billion settlement in the Cendant Corp. securities litigation. Lead counsel for the plaintiffs obtained $52 million in legal fees, which it shared with twelve other law firms that had been authorized to work on the case. An additional forty-five firms that represented individual plaintiffs, however, were frozen out of any fees. Three of these firms appealed the lower court's rejection of their fee applications.
In In re Cendant Corp. Sec. Litig., 2005 WL 820592 (3rd Cir. April 11, 2005), the Third Circuit held that the PSLRA "significantly restricts the ability of plaintiffs' attorneys to interpose themselves as representatives of a class and expect compensation for their work on behalf of that class." As a result, the lead plaintiff's "refusal to compensate non-lead counsel will generally be entitled to a presumption of correctness." The court did find that non-lead counsel can ask the court to compensate them for work done before the appointment of a lead plaintiff, but they must "demonstrate that their work actually benefited the class."
The Legal Intelligencer has an article (via law.com - free regist. req'd) on the decision.
Quote of note: "After the lead plaintiff is appointed, however, the PSLRA grants that lead plaintiff primary responsibility for selecting and supervising the attorneys who work on behalf of the class. We conclude that this mandate should be put into effect by granting a presumption of correctness to the lead plaintiff's decision not to compensate non-lead counsel for work done after the appointment of the lead plaintiff. Non-lead counsel may refute the presumption of correctness only by showing that lead plaintiff violated its fiduciary duties by refusing compensation, or by clearly demonstrating that counsel reasonably performed work that independently increased the recovery of the class."
Under the PSLRA, the lead plaintiff in a securities class action is presumptively the party with the largest financial interest in the relief sought by the class (i.e., the movant who alleges the most potential damages). The presumption may be rebutted, however, by a showing that this party will not fairly and adequately protect the interests of the class or is subject to unique defenses not applicable to other class members. In creating this provision, Congress sought to encourage the participation of institutional investors as lead plaintiffs.
An open question is to what extent this legislative history, as opposed to the plain language of the "largest financial interest" presumption, should influence a court in its selection of a lead plaintiff. To put it another way, what happens when the mechanism created by Congress does not result in the preferred outcome? In two recent cases, courts appear to have been swayed heavily by Congressional intent.
In Malasky v. IAC/Interactive Corp., 2004 WL 2980085 (S.D.N.Y. Dec. 21, 2004), the court found that an individual investor had the largest financial stake in the case and was otherwise qualified to act as lead plaintiff. Nevertheless, the court held that because the individual investor was "not an institutional investor," he would be paired with an institutional investor as co-lead plaintiff.
Taking this analysis even a step further, in In re Cardinal Health, Inc. Sec. Litig., 2005 WL 238073 (S.D.Ohio Jan. 26, 2005), the court rejected an institutional investor, at least in part, because it was not a pension fund. Based on a statement in the House Conference Report on the PSLRA, the court found that the "PSLRA prefers pension funds."
There has already been one appellate decision, on a writ of mandamus, holding that "a straightforward application of the [PSLRA lead plaintiff] statutory scheme . . . provides no occasion for comparing plaintiffs with each other on any basis other than their financial stake in the case." See In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002). More appellate courts may be asked to take up this issue in the future.
In a three-way matchup that will have the securities litigation bar watching, the Recorder reports (free regist. req'd) that the recently split law firms of Milberg Weiss and Lerach Coughlin are battling it out for the lead plaintiff/lead counsel position in the securities class actions filed against Chiron, a flu vaccine manufacturer, in the N.D. of Cal. Who will preside over this battle? None other than Chief Judge Vaughn Walker.
Judge Walker recently got into a highly-publicized disagreement with Milberg Weiss (when the two firms were still together) over the lead plaintiff contest in the Copper Mountain litigation. After the proposed lead plaintiff represented by Milberg Weiss decided not to fill that role (despite having won a 9th Circuit appeal on the issue), Judge Walker compared him to a "heroic prince" who turned into a "frog." Stay tuned.
A court in the W.D. of Wash. has dramatically cut the requested attorneys' fees in the InfoSpace securities class action settlement. The case settled prior to a decision on the motion to dismiss for $34,300,000. Plaintiffs' counsel sought attorneys' fees of 25% of the settlement fund (i.e., approximately $8.5 million). Interestingly, objections to the fee request were filed by three public pension funds.
In its decision (In re InfoSpace, Inc. Sec. Litig., 2004 WL 1879013 (W.D. Wash. Aug. 5, 2004)), the court noted that the Ninth Circuit has established 25% of a settlement fund as a "benchmark" award for attorneys' fees in common fund cases. Nevertheless, the court found that a "25 percent benchmark does not promote the objectives of the PSLRA."
In the InfoSpace case, there was "a modest risk to recovery" and if the requested fees were awarded the damaged investors would only receive about 14 cents per share. Under these circumstances, the court decided to apply a lodestar method (take the reasonable hours expended times a reasonable hourly rate and enhance with a multiplier) to determine the fee award. After various rate adjustments, and applying a multiplier of 3.5, the court awarded attorneys' fees of approximately $4 million.
Quote of note: "In contrast to the 14 cents per share (or 0.10 percent recovery) to the class member investors, the 25 percent fee requested by plaintiffs' counsel, $8,456,353, results in an almost seven-fold increase for plaintiffs' counsel based on the number of hours spent on this case and the very high billable hourly rates reported by the attorneys. Such a result is unfair and does not provide a sound basis for an award of attorneys' fees in this case. Such an award would also constitute a substantial windfall to the attorneys to the detriment of the class members who would only recover pennies on the dollar. The Court concludes that the lodestar method provides a more accurate basis for fees to be awarded in this case."
Matria Healthcare has announced the dismissal of the securities class action pending against the company in the N.D. of Ga. The court's opinion addresses the issue of whether in-and-out traders (i.e., investors who both bought and sold their shares during the class period) can be effective lead plaintiffs.
Only one person filed suit against Matria on a class action basis and he was subsequently named lead plaintiff. The proposed class period extended from October 24, 2000 to June 25, 2002, when the company disclosed problems with its information technology capabilities, but the lead plaintiff had sold all of his Matria shares on February 6, 2002.
In its opinion (Barr v. Matria Healthcare, Inc., 2004 WL 1551566 (N.D. Ga. July 7, 2004)), the court found that it was "undisputed that the Plaintiff sold his stock in response to an adverse market reaction to the Defendants' January 30, 2002 press release." The January 30 press release, however, made no mention of Matria's information technology problems. As a result, the court found that the lead plaintiff could not demonstrate loss causation because the relevant misrepresentations "were not disclosed until well after the Plaintiff had sold his stock at the still artificially inflated price."
Holding: Motion to dismiss granted with prejudice (also on other grounds).
The Wall Street Journal has an article (subscrip. req'd) on the lead plaintiff hearing held last week in the mutual fund trading practices cases. (The 10b-5 Daily has posted about the cases frequently, most recently on speculation that the settlements could total $1 billion.)
Quote of note: "'Nobody should expect to get rich off this case,' said U.S. District Judge J. Frederick Motz in early April. 'If there is any recovery, the great bulk of the recovery should go to those who were injured, not to their lawyers, particularly in light of the fact that so much of the underlying investigative work has already been done by public authorities,' he added. 'Any of you who have expressed an interest as being appointed as plaintiffs' counsel are forewarned that we mean what we say. You may wish to reconsider your request for appointment in light of this observation.' The admonishment did little good. Six dozen lawyers showed up at last week's hearing to angle for a lead counsel spot."
Quote of note II: "Legislation passed by Congress in 1995 and affirmed in court rulings dictate that plaintiffs with the largest financial stake in a case should get lead-plaintiff status, which usually makes their lawyers lead counsel. But it isn't always clear which investor suffered most, especially when there are different ways of showing harm. In the mutual-fund cases, lawyers presented myriad formulas to make their clients look like the biggest losers."
A few years ago, Senior Judge Milton Shadur of the N.D. of Ill. issued a lead plaintiff decision in the Comdisco securities litigation. See In re Comdisco Sec. Litig., 150 F. Supp. 2d 943 (N.D. Ill. 2001). The decision disqualified the Pennsylvania State Employees' Retirement Systems ("PASERS") from serving as lead plaintiff despite the fact that PASERS had the most claimed losses of any of the movants. The court reasoned:
It turns out that when the Class Period of January 25 through October 3, 2000 (which is the proper referent) is focused upon, PASERS' claim that it suffered some $2.4 million in losses in connection with its investment in Comdisco common stock is only a mirage created by PASERS' adoption of a FIFO (first-in-first-out) approach to its dealings in the stock. In fact PASERS was an active trader during the Class Period, with 15 separate sales that more than matched its purchases during that time frame: Its Class Period purchases of Comdisco common stock aggregated 213,800 shares, while its sales during the same period totaled 218,400 shares. And when those transactions are properly matched, rather than by the impermissible application of a FIFO methodology (which by definition brings into play PASERS' pre-Class-Period holdings as the purported measure of its claimed loss), PASERS' Class Period sales at inflated prices caused it to derive unwitting benefits rather than true losses from the alleged securities fraud--so much so that [another movant] demonstrates that PACERS derived a net gain of almost $300,000 (rather than any net loss at all) from its purchases and sales during the Class Period.
In essence, the court applied a "last-in, first out" (LIFO) methodology in examining PASERS' trades and determined that PASERS did not have any cognizable losses based on the alleged fraud.
A member of the plaintiffs' bar subsequently wrote an analysis of the case entitled Fee-Fi-Fo-Fum: Why The Rejection Of FIFO Is . . . Not Smart, 2 Class Action Litig. Report (BNA) 786 (2001). The article concluded that Judge Shadur's decision to use LIFO to determine PASERS' losses had the effect of improperly comparing green apples (pre-class-period shares) with red apples (class-period shares) because it brought "into play the sale of pre-class-period holdings." In the author's view, "it is only the inflated purchases that are relevant, because only those shares relate to the fraud."
Apparently, plaintiffs' counsel in the Comdisco case (which is still pending) recently brought the article to Judge Shadur's attention. The judge was not amused. In an unusual memorandum opinion issued this week, Judge Shadur decided to clarify his earlier statements on the topic. See In re Comdisco Sec. Litig., 2004 U.S. Dist. LEXIS 7230 (N.D. Ill. April 26, 2004). The court noted that "one possible consequence of working with apples may be the production of applesauce -- as Webster's Third New Int'l Dictionary (unabridged) 104 defines that product: 'an insincere expression of opinion: an assertion that is patently absurd and usu. phrased in exaggerated terms: BUNK, BALONEY (I know applesauce when I hear it -- Ring Lardner).'" The court found that this was the case here, because any real-world analysis of losses required the use of LIFO.
"Simply put, the article's attempted criticism of the use of LIFO in determining the identity of the 'most adequate plaintiff' under the [PSLRA] impermissibly ignores the obvious fact that with every securities class action having to identify a class period, the focal point of the inquiry must begin (for standing purposes and otherwise) with purchases or sales -- or both -- during that class period. And in turn that focus calls for a primary concentration on class period transactions, with is consistent with LIFO rather than FIFO treatment. Regrettably the cited article, like the source from which it drew its Fee-Fi-Fo-Fum title, is no better than a fairy tale."
Astute readers will note that this debate is closely related to the larger debate over what is necessary to adequately plead loss causation in securities class actions. (See this post for an overview.)
Addition: Both decisions referenced in this post can be found at this website under case number 1 01-CV-2110.
The 10b-5 Daily has previously posted about the remarkable lead plaintiff/lead counsel order in the Terayon Communications securities class action pending in the N.D. of Cal.
In Judge Patel's order, she removed Capital Partners and one of its employees as lead plaintiffs and wondered "whether counsel for plaintiffs actively participated in or provided advice to plaintiffs regarding their scheme to cause a fall in Terayon’s stock price." The court found "it is probable that there is a conflict not only between lead plaintiffs and the class but also between lead counsel and the remainder of the class." Lead counsel was asked to provide a written response to a number of questions and defendants were given leave to take further discovery on the issue.
The written response has been submitted in a March 24 filing by lead counsel. According to an article (via law.com - free regist. req'd) in The Recorder, lead counsel argued "that some of the contentions advanced by defendants are manifestly wrong, and led the court to express concern that this action might be the product of improper conduct, when in fact there was no improper conduct." Lead counsel also provided the court with information about its communications with Cardinal and denied that it had extended the class period to hide Cardinal's short position in Terayon's stock.
Quote of note: "The firm also asked to have another hearing before Patel to further defend its actions in [the case]. Patel has yet to decide if she'll schedule another hearing."
Addition: The lead counsel's filing can be found here.
Two interesting lead plaintiff/lead counsel decisions from last week.
(1) There are usually a number of initial complaints filed in a securities class action, with later filers often copying, in whole or in substantial part, the allegations in the first-filed complaint. Some courts have questioned whether this practice meets the requirements of Federal Rule of Civil Procedure 11, but it usually does not become an issue in the lead plaintiff/lead counsel contest.
In Taubenfeld v. Career Education Corp., 2004 WL 554810 (N.D. Ill. March 19, 2004), however, one of the candidates for lead plaintiff argued that another candidate should be rejected because it had "selected counsel that has not independently investigated this case but instead simply copied the work product" of other counsel. The court declined to comment "on the appropriateness of copying another plaintiff's complaint verbatim" and held that the issue did not affect the candidate's adequacy to serve as lead plaintiff. The court also noted that there was evidence, in the form of an affidavit, that the proposed lead counsel had conducted an independent investigation of the claims (but apparently declined to include any additional allegations in its complaint "because it would have given the defendants more time to prepare defenses to such information").
(2) Sometimes even an unopposed motion for appointment as lead plaintiff can be rejected. In Huang v. Acterna Corp., 2004 WL 536951 (D. Md. March 18, 2004), the court found that the class notice published by the plaintiffs was insufficient because: (a) it did not provide enough information for potential lead plaintiffs; and (b) it was published in The New York Times, which might not meet the PSLRA's requirement that notice appear in a "widely-circulated national business-oriented publication or wire service."
The court instructed the plaintiffs to send a more informative notice directly to the largest financial and institutional investors in the company, which "can be easily identified by defendants and submitted to plaintiffs." No word on the propriety of requiring the defendants to help find a better lead plaintiff to prosecute the case against them. Ouch. (Securities Litigation Watch also has a post on this decision.)
Federal Rule of Civil Procedure 23 ("Class Actions") recently was amended to require a court to consider certain factors in appointing class counsel, including the "work counsel has done in identifying or investigating potential claims" and its overall expertise. As part of this process, the court can direct potential class counsel "to propose terms for attorney fees and nontaxable costs." If there is more than one adequate applicant for class counsel, the court must appoint "the applicant best able to represent the interests of the class." See FRCP 23(g).
Under the PLSRA, the lead plaintiff generally must satisfy "the requirements of Rule 23." The statute also states, however, that the lead plaintiff "shall, subject to approval of the court, select and retain counsel to represent the class." Many courts have interpreted this provision as granting them relatively little discretion over the appointment of lead counsel. Is that still true following the implementation of the Rule 23 amendments?
To date, only two courts have discussed the interaction between new Rule 23(g) and the PSLRA. In In re Cree, Inc. Sec. Litig., 219 F.R.D. 369 (M.D.N.C. 2003),* the court noted that it had an "obligation to assure that lead plaintiff's choice of representation best suits the need of the class" and it was "guided in the exercise of its discretion by the provisions of the new Rule 23(g)." The court previously had requested that the potential lead counsel submit information concerning its experience, resources, and proposed fees. After reviewing this information, the court found that it was satisfied with the proposed lead counsel, but warned that it "will take its obligation seriously to see that any fees sought by counsel are just and reasonable under the circumstances."
In In re Copper Mountain Sec. Litig., 2004 WL 369859 (N.D. Cal. Feb. 10, 2004) (discussed at length in this recent post), the court addressed the 9th Circuit's decision in In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002) on remand. In reversing the lower court's earlier lead plaintiff/lead counsel decision, the Cavanugh panel had held that information about fee arrangements "is relevant only to determine whether the presumptive lead plaintiff's choice of counsel is so irrational, or so tainted by self-dealing or conflict of interest, as to cast genuine or serious doubt on that plaintiff's willingness or ability to perform the functions of lead plaintiff." After stating that "Cavanaugh would seem to establish that the largest stakeholder's selection of counsel must be approved unless that selection is either mad or crooked," the lower court noted that "the continuing vitality of the Cavanaugh test may be questioned in light of recent amendments to FRCP 23."
It seems likely that these cases are the tip of the iceberg on this issue. Stay tuned.
*Disclosure: The author of The 10b-5 Daily represents the defendants in the Cree securities litigation.
Close on the heels of the Copper Mountain decision (the "fairy tale" case) comes another remarkable lead plaintiff/lead counsel order. In the Terayon securities class action, Judge Marilyn Hall Patel of the N.D. of Cal. has both disqualified two of the lead plaintiffs and found it "probable" that lead counsel must also be removed.
Terayon Communication Systems, Inc. is a Santa Clara-based maker of cable modem equipment. The securities class action against the company, initially filed in April 2000, is based on allegedly misleading statements concerning the company's ability to obtain certification for its technology.
Judge Patel originally appointed Cardinal Investment Co. and Marshall Payne (an employee of Cardinal) as two of the lead plaintiffs in the case. It came out in discovery, however, that Cardinal and Payne were significant short sellers of Terayon stock (hundreds of thousands of shares) and in early 2000 had begun a campaign to flood the market with negative information about the company. The campaign included phone calls to the certification entity, starting Internet chat room rumors, letters to the SEC, and contacts with financial reporters.
Moreover, Cardinal was apparently working closely with plaintiffs' counsel (later lead counsel for the class) during this period. Starting in February 2000, Internet website postings encouraged parties to contact plaintiffs' counsel about a proposed lawsuit against Terayon. According to Judge Patel, "the class period in the original complaint, i.e. the first day on which plaintiffs claim they were damaged, was February 9, 2000 the same day these Internet postings appeared. Defendants assert that these web postings were part of plaintiffs’ alleged scheme to drive the price of the stock down."
On April 11, 2000, the same day as a Terayon earnings conference call during which the company's executives were sharply criticized by short sellers using phony names, an investor plaintiff signed a sworn statement authorizing the filing of a complaint that closely tracked the language of Cardinal’s letters to the SEC. It was not until the next day, however, that the price of Terayon's stock dropped significantly. The complaint was filed on April 13.
Following the revelation of these facts, defendants moved to have Cardinal and Payne removed as lead plaintiffs. (See this earlier post in The 10b-5 Daily about press coverage of the hearing held last September.) Judge Patel has agreed and more.
The court found "[w]hile some short sales may not, in and of themselves render a lead plaintiff’s claims atypical, a pattern of affirmatively engaging in campaigns devised to lower the price of the stock in question certainly contains within it the seeds of discord between lead plaintiffs and the remaining plaintiffs." Accordingly, the court removed Cardinal and Payne as lead plaintiffs (and also noted that they "appear to have participated, if not perpetrated, a fraud of their own on the market" and could be subject to claims by their fellow shareholders).
As for lead counsel, the court expressed concern over lead counsel's pre-suit involvement with Cardinal and its apparent efforts "to mislead the court as to the scope and nature of lead plaintiffs’ holdings in Terayon stock" as part of the lead plaintiff selection process. Based on this course of events, the court wondered "whether counsel for plaintiffs actively participated in or provided advice to plaintiffs regarding their scheme to cause a fall in Terayon’s stock price" and invited a motion on whether lead counsel had waived privilege. In any event, the court found "it is probable that there is a conflict not only between lead plaintiffs and the class but also between lead counsel and the remainder of the class." Lead counsel was asked to provide a written response to a number of questions and defendants were given leave to take further discovery on the issue.
If the judge ain't happy, ain't nobody happy. Proving that axiom correct, Judge Vaughn Walker of the N.D. of Cal. issued a fairly amazing order last week in the Copper Mountain securities litigation, expressing displeasure with both plaintiffs and the 9th Circuit over the lead plaintiff/lead counsel selection process in that case.
The PSLRA provides that the "presumptively most adequate lead plaintiff" in a securities class action is the movant who "has the largest financial interest in the relief sought by the class" and "otherwise satisfies the requirements of Rule 23 of the Federal Rules of Civil Procedure." To summarize the process, the judge's task is to determine which plaintiff has the largest financial interest, evaluate whether that plaintiff meets the adequacy and typicality tests of Rule 23(a), and, if that plaintiff meets the requirements, declare that plaintiff the presumptive lead plaintiff (a presumption that may then be rebutted by other plaintiffs). The court must also approve the lead plaintiff's choice of counsel.
Three years ago, Judge Walker determined that he would not name the lead plaintiff movant in the Copper Mountain case with the largest financial interest as lead plaintiff because that candidate, known as the CMI Group, failed to demonstrate that it was an adequate lead plaintiff. Judge Walker based his decision on the CMI Group's failure to negotiate a "competitive" fee arrangement with proposed lead counsel and named a different movant as lead plaintiff. See In re Quintus Sec. Litig., 201 F.R.D. 475 (N.D. Cal. 2001) and In re Quintus Sec. Litig., 148 F. Supp. 2d 967 (N.D. Cal. 2001).
The CMI Group petitioned the Ninth Circuit for a writ of mandamus. In In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002), the court overruled Judge Walker's decision. The panel, in an opinion written by Judge Alex Kozinski, found that the lower court had failed to follow the statutory language of the PSLRA in appointing the lead plaintiff. In particular, the court found that "a straightforward application of the statutory scheme . . . provides no occasion for comparing plaintiffs with each other on any basis other than their financial stake in the case." Moreover, the lead plaintiff process "is not a beauty contest" and information about fee arrangements "is relevant only to determine whether the presumptive lead plaintiff's choice of counsel is so irrational, or so tainted by self-dealing or conflict of interest, as to cast genuine or serious doubt on that plaintiff's willingness or ability to perform the functions of lead plaintiff." Accordingly, the Ninth Circuit vacated the lower court's order and instructed the lower court to proceed with the CMI Group as the presumptive lead plaintiff.
On remand, however, the CMI Group apparently decided to no longer seek lead plaintiff status (or, as Judge Walker puts it, "vanished - fled the scene - gone south - maybe vaporized"). In his order, Judge Walker compares the situation to a "heroic prince" turning into a "frog" and is incredulous over the course of events:
"By vindicating their 'right' to be the presumptive lead plaintiffs through the extraordinary remedy of mandamus (and establishing circuit precedent of no little value to their lawyers), the CMI group might seem to possess a tenacity and determination seldom seen on the battlegrounds of federal litigation. But what might seem apparently is not. Could there have been some motivation other than vindicating the interests of defrauded investors behind the mandamus proceedings? Could it be that the Ninth Circuit panel, perceiving the black letter of the PSLRA, was actually reading a fairy tale?"
Also not surprisingly, Judge Walker appears to believe that the CMI Group's decision vindicates his earlier order. Noting that "Cavanaugh would seem to establish that the largest stakeholder's selection of counsel must be approved unless that selection is either mad or crooked," the court finds that the opinion converts the PSLRA into "a straightjacket against judicial measures to ensure that [securities class actions] genuinely benefit investors, not lawyers." In the absence of the CMI Group, Judge Walker ends up simply reappointing the earlier lead plaintiff to the position. "The moral of the story," the court concludes, "will be left to you, dear readers."
The Recorder has an article (via law.com - free regist. req'd) on the case in today's edition. Judge Walker's order is not yet available online.
Addition: The opinion is now on Westlaw - In re Copper Mountain Sec. Litig., 2004 WL 369859 (N.D. Cal. Feb. 10, 2004).
PricewaterhouseCoopers has released a study on the role of public pension funds in securities class actions. Notable results:
(1) The number of cases with public pension funds as lead plaintiff has steadily increased since the passage of the PSLRA in 1995 - from 4 cases filed in 1996 to 56 cases filed in 2002.
(2) Of the more than 100 active cases where a public pension fund is acting as lead plaintiff, 80% allege accounting issues.
(3) In 2003, 15 settlements averaging over $120 million were reached in cases where a public pension fund served as lead plaintiff -- sixteen times the average value of the remaining 85 cases settled last year.
There are a lot of conclusions that could be drawn from this data, but it is certainly clear that public pension funds are taking the lead in large accounting fraud cases.
The New York Law Journal has an article (via law.com - free registration req.) on Judge Cote's opinion & order in the WorldCom solicitation dispute. (The 10b-5 Daily has previously posted about the court's decision and the underlying dispute.)
As previously reported in The 10b-5 Daily, Milberg Weiss and Bernstein Litowitz are in the midst of a dispute over the recruitment of individual bondholders to bring securities fraud claims against WorldCom and related parties. Bernstein Litowitz, who represents the lead plaintiff in the main investor action against WorldCom, has complained in a series of submissions to the court that Milberg Weiss provided "misleading solicitations'' to WorldCom bondholders suggesting that they would not obtain a fair share of any settlement obtained in the main investor action and should bring their own individual actions.
Yesterday, District Judge Cote issued an opinion & order concerning this matter. The court found that Milberg Weiss has engaged in an "active campaign" to encourage pension funds to file individual actions and is running the individual actions as "a de facto class action." Moreover, the firm's communications have resulted in "some confusion and misunderstanding of the options available to putative class members."
The court ordered that a separate notice (in addition to the normal class certification notice) be sent to each plaintiff who has filed an individual action, with the initial draft to be written by Bernstein Litowitz. The requests for relief made by Bernstein Litowitz in its November 4 submission to the court were denied, but leave was granted for the firm to bring a formal motion on the subject.
The San Franciso Chronicle has a fascinating article on the Terayon Communication Systems, Inc. (Nasdaq: TERN) securities class action pending in the N.D. of Cal. Terayon is a Santa Clara-based maker of cable modem equipment. The case, originally filed in April 2000, is based on allegedly misleading statements made by the company in connection with its ability to obtain certification for its technology.
The lead plaintiff (or one of them) in the case is Cardinal Investment Co. According to the article, court records reveal that Cardinal was a massive short seller of Terayon stock (hundreds of thousands of shares) and in early 2000 began a campaign to flood the market with negative information about the company. The campaign included phone calls to the certification entity, starting Internet chat room rumours, letters to the SEC, and contacts with financial reporters. At the same time, Cardinal apparently hedged its short position by purchasing 6000 shares of Terayon stock.
On April 11, 2000, the same day as a Terayon earnings conference call during which the company's executives were sharply criticized by short sellers using phony names, an investor plaintiff signed a sworn statement authorizing the filing of a complaint that "repeated almost verbatim the accusations contained in Cardinal's letters to the SEC." It was not until the next day, however, that the price of Terayon's stock dropped significantly. The highly detailed complaint was filed on April 13. Cardinal also brought a suit and later successfully moved to act as a lead plaintiff in the case based on the losses in its hedge position.
The motion to dismiss in the case was denied by District Judge Patel in early 2002. Discovery, however, has apparently revealed Cardinal's role in the company's downfall. Terayon has asked Judge Patel to remove Cardinal as a lead plaintiff.
Quote of note: "On Sept. 8, during a hearing on Terayon's request, Patel sounded receptive to the company's arguments, noting that Cardinal's partners 'were doing just about everything they could to make sure the (stock) price went down.' But her sharpest comments concerned the puzzling events that led to Cardinal's lawsuit. 'I think it's utterly amazing,' she told the opposing attorneys, 'that we have this lengthy complaint, and with all of these excruciating details, and the stock just drops the day before.' It 'raises some very serious questions.'"
Two prominent plaintiffs' firms, Milberg Weiss and Bernstein Litowitz, are in the midst of a dispute over the recruitment of individual bondholders to bring securities fraud claims against WorldCom and related parties. Bernstein Litowitz represents the lead plaintiff in the main investor action against WorldCom, which has been brought on behalf of both common shareholders and bondholders in the S.D.N.Y.
In an October 29 letter to the court, Bernstein Litowitz complains that Milberg Weiss provided "misleading solicitations'' to WorldCom bondholders suggesting that they would not obtain a fair share of any settlement obtained in the main investor action and should bring their own individual actions. According to a Reuters article, Milberg Weiss "strongly denied the accusations, which will be aired at a hearing [today] in New York before U.S. District Judge Denise Cote." (As posted in The 10b-5 Daily, class certification was recently granted in the WorldCom case.)
Under the PSLRA, the lead plaintiff in a securities class action is presumptively the party with the largest financial interest in the relief sought by the class. The presumption may be rebutted, however, by a showing that this party will not fairly and adequately protect the interests of the class or is subject to unique defenses not applicable to other class members. Not only does the lead plaintiff get to run the case, it also has virtually free reign to appoint its attorney as lead counsel for the class. Given that the lead counsel can obtain significant fees from a successful securities class action, the battle over the lead plaintiff position is often intense.
The State of New Jersey has been an active participant in securities class actions over the past few years, often applying for the lead plaintiff role. (The 10b-5 Daily previously posted about this development.) In In re Motorola Securities Litigation, 2003 WL 21673928 (N.D. Ill. July 16, 2003), New Jersey was far and away the lead plaintiff candidate with the most alleged losses. Its candidacy came under fierce attack, however, from another group of investors, led by Commerzbank, who were also seeking the lead plaintiff position.
First, Commerzbank argued that New Jersey would be subject to a unique defense because state officials have publicly criticized the state's Department of Investment, blaming it for the relevant losses. The court rejected this argument, noting that "if New Jersey's investment strategy during the early part of the decade was less than ideal, this actually may make the State more typical of those who have lost money in the stock market rather than less."
Second, Commerzbank argued that newspaper reports in New Jersey suggested the existence of a "pay-to-play" scheme, in which Governor McGreevey would consider hiring law firms to represent the state in securities litigation if they made political contributions. The newspaper article in question, however, made no mention of the Motorola litigation or the two firms representing the state in the case (who both submitted declarations denying they had been awarded the representation in return for political contributions).
Holding: New Jersey appointed lead plaintiff.
The decision can be found here by putting in the case number (No. 03 CV 287).
The Bristol Herald Courier has an article today on the lead plaintiff contest in the King Pharmaceuticals securities class action in the E.D. of Tenn. (Thanks to the SW Virginia Law Blog for the link.) The case is based on allegedly misleading financial statements made by the company.
At least two groups of pensions funds, as well as some individual investors who were shareholders in a company King Pharmaceuticals acquired, have moved for lead plaintiff status. U.S. Magistrate Judge Dennis Inman presided over the hearing.
Quote of note: "Inman said federal law favors the appointment of the stockholder who lost the most money. 'I'd like to know who is the biggest hog at the trough,' Inman said. That question prompted a lively debate among the dozen-plus lawyers, all of whom had a reason that their client should get the nod."
The May 2003 edition of the Fordham Law Review contains a transcript of an interesting, if slightly dated, panel discussion on the selection of lead plaintiff/lead counsel in securities class actions. See 71 Fordham L. Rev. 2363 (panel discussion took place on Feb. 5, 2002). The panel participants included Judge Edward Becker (3rd Cir.), Judge Milton Shadur (N.D. Ill.), Jill Fisch (Professor - Fordham), Gregory Joseph (private attorney), and Mel Weiss (private attorney).
Quote of note (Judge Becker): "Congress originally thought that institutions in this new client-driven, as opposed to lawyer-driven, regime that it was creating would be the lead plaintiffs, but it really has not turned out that way. The only institutions that have agreed to be lead plaintiffs are public pension funds and a few union-related institutions. By and large, the mutual funds was the group that I think Congress had in mind--because they've got more stock than anybody in any of these corporations that go sour--but the mutual funds won't touch it. Doing a cost/benefit analysis, they think that it just ain't worth it for them to get involved. So the mutual funds have not come forth as lead plaintiffs. The private pension funds have not."
A few weeks ago The 10b-5 Daily speculated that Oscar Wyatt, Jr., who was both helping to finance the attempt to oust the current board of El Paso Corp. and acting as the lead plaintiff in a shareholder class action against the company, would be in an interesting position if the dissident slate of directors won. Would his interests be sufficiently aligned with the the interests of the rest of the class if El Paso was controlled by individuals he had helped elect? We'll never know. The Houston Chronicle reported last week that the incumbent board of directors was reelected in a close vote.
Quote of note: "Wyatt, who founded a company, Coastal Corp., that was later sold to El Paso, is the lead plaintiff in a shareholder lawsuit accusing El Paso of federal securities violations. Kuehn [El Paso's CEO] recognized Wyatt to speak [at the shareholders' meeting]. 'Mr. Kuehn, you don't really need to recognize me. I'm recognized by a lot of people, which is something you are not.'"
Quote of note: "Several dozen shareholders cast their ballots at the meeting, including those who were undecided heading in. Among them was Jacqueline Goettsche of Katy who said she bought shares of El Paso four months ago just so she could attend the meeting. 'It's more exciting than going to the opera,' Goettsche said."
There was an interesting Associated Press story on Friday about the ongoing proxy battle and securities class action involving El Paso Corp., a Houston-based provider of natural gas services. Oscar Wyatt, Jr. is the founder of Coastal Energy, which was sold to El Paso in 2001. As a result of the sale, Wyatt owns 5 million shares of El Paso. Currently, Wyatt is both helping to finance the attempt to oust the current board and acting as the lead plaintiff in a shareholder class action accusing "the company of hiding debt, reporting revenue from so-called 'wash' energy trades and defrauding investors." If the dissident slate of directors wins, however, can Wyatt continue as the lead plaintiff in the class action (even if he will not be a board member)? A court might find that Wyatt's interests are no longer sufficiently aligned with the interests of the rest of the class.
Addition: The Associated Press has a follow-up story about a full-page ad criticizing El Paso's management that Wyatt ran in the Sunday edition of the Houston Chronicle.
Addition: The June 9 edition of Fortune has a lengthy profile of Wyatt and El Paso. The story states: "People familiar with the matter say that even if Wyatt wins [the proxy battle], he'll continue to push forward with the lawsuit."