The Good The Bad and The Ugly: Legal & Ethical Issues in Class Action Settlements and Opt outs

EMERGING ETHICAL TRAPS IN PROSECUTING, SETTLING AND OPTING OUT OF CLASS ACTIONS

Breton Leone-Quick, Esq. Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. Boston, MA

INTRODUCTION It’s been nearly five years since the indictments of members of a prominent firm involved in securities class actions. As a result, have federal courts become increasingly interested in policing the ethical conduct of attorneys that appear before them in class actions? This article begins by examining some recent high-profile decisions by the Ninth and Seventh Circuits involving allegations of unethical conduct, and then compares and contrasts these decisions with other decisions dealing with similar issues in order to assess the current state of scrutiny on the ethical behavior of counsel in class actions. Unfortunately, it does not appear as if any broad conclusions can be drawn; rather, courts across (and even sometimes within) jurisdictions seem to be inconsistent with respect to the treatment of and consequences for potentially unethical conduct. This is, of course, both unfortunate for the integrity of the profession, and it leaves practitioners open to wildly inconsistent sanctions depending largely on the whim of the individual court.

Given that there is a lack of consensus across jurisdictions on how to handle various ethical issues that can arise in the course of a class action, this article seeks to provide an introduction to and discussion of some of these issues so that practitioners can approach them with the requisite wariness and diligence that is prudent whenever proceeding in an unsettled area of the law. I.

HOW CLOSELY ARE FEDERAL COURTS POLICING ETHICAL CONDUCT IN CLASS ACTIONS?

History has demonstrated that – in extreme cases – the consequences for unethical behavior in class actions can include a criminal indictment. These types of extreme cases, however, offer little guidance with respect to how courts may be policing less egregious alleged violations of ethical duties, and leave practitioners without clear guidance on the types of consequences that may flow from more minor violations of ethical rules. The area of ethical conduct that generally receives the most scrutiny in the class action context is the reasonableness of class counsel’s fee given that – besides the ethical obligation to only charge a reasonable fee – Federal Rule of Civil Procedure 23 requires courts to also make this assessment. A couple of recent decisions by the Ninth Circuit suggest that it may be trending towards greater scrutiny on class counsel’s fee. Another area where potential ethical missteps can be used against counsel is when the court is considering a motion for class certification. A recent decision by the Seventh Circuit examines whether a counsel’s alleged unethical conduct should lead to denial of certification of the class because that counsel will be unable to “fairly and adequately” represent the class.

A. How to Lose a Fee: The Latest on Incentive Fee Arrangements and Unreasonable Fees. In Rodriguez v. Feldman, 688 F.3d 645 (9th Cir. 2012), the Ninth Circuit affirmed the district court’s decision to entirely deny attorneys’ fees to class counsel. The appeal arose from a settlement of a class action that involved an antitrust suit brought against West Publishing Corporation. Near the beginning of the litigation, a plaintiffs’ firm (which later merged into another firm) entered into incentive payment agreements with five plaintiffs. Id. at 649. The agreements provided that the firm would seek incentive fees for the plaintiffs from the court in an amount based upon the settlement amount with defendants.1/ Specifically, the agreement provided that if the settlement amount was greater than $500,000, counsel would seek a $10,000 incentive award for the plaintiffs; if the settlement amount was more than $1.5 million, counsel would seek a $25,000 award; if the settlement was more than $5 million, counsel would seek a $50,000 award; and if the settlement was $10 million or more, counsel would seek a $75,000 award. Id. at 649-50. The case ultimately settled for $49 million, and class counsel sought $325,000 in incentive fee awards for the plaintiffs who had entered the incentive fee agreements. Id. at 650. Several other groups of class members, who had obtained their own counsel, objected to the application for the fee incentives, and the district court agreed, ruling that the incentive fee agreements violated the ethical rule against fee-sharing and created a conflict of interest between the named plaintiffs and the class. Id. at 650-51. The district court approved the class settlement, and approved payment of fees to class counsel, but declined to approve the payment of incentive fees to the class plaintiffs who had entered the incentive payment agreement. Id. Several objectors appealed the approval of the settlement, and the Ninth Circuit issued a decision in Rodriguez v. W. Publi’g Corp., 563 F.3d 948 (9th Cir. 2009). The court affirmed the approval of the settlement, although it expressed disapproval of the incentive fee agreements. 688 F.3d at 651. It found that the incentive fee agreements “created an unacceptable disconnect between the interests of the contracting representatives and class counsel, on the one hand, and members of the class on the other.” Id. (quoting 563 F.3d at 960). This was because the named plaintiffs who entered the incentive fee agreements had a disincentive to proceed to trial or settle the case for anything more 1/

In securities class actions, PSLRA allows a plaintiff to apply to the court for reasonable costs and expenses (including lost wages) in representing the class. See 15 U.S.C. § 78u-4(a)(2)(A)(vi).

than $10 million. Id. But the Ninth Circuit held that this issue was not enough to deny approval of the settlement because there were two other class representatives who did not have incentive fee agreements. Id. The Ninth Circuit did remand the issue of what impact, if any, the incentive fee agreements should have on the award of attorneys’ fees to class counsel. In remanding this issue, the court noted that “simultaneous representation of clients with conflicting interests (and without informed written consent) is an automatic ethics violation in California and grounds for disqualification and that an attorney cannot recover fees for such conflicting representation.” Id. (quoting 563 F.3d at 967-68). On remand, the district court found that class counsel was not entitled to any fees as a result of its conflicted representation. Id. at 652. Class counsel appealed the decision. On appeal, the Ninth Circuit began by noting how absent a contractual or statutory basis for fees, federal courts have the discretion to award fees to attorneys who recover money for a common fund benefiting persons other than themselves. Id. at 653. The court noted that this doctrine – the common fund doctrine – was an equitable doctrine under federal common law that requires attorneys’ fees to be reasonable under the circumstances. Id. In affirming the district court’s decision to deny all fees to class counsel, the Ninth Circuit discussed several relevant legal issues impacting the analysis of whether the denial of the fee was warranted. An initial issue that the court resolved was the role that state law played in its analysis of the ethical violation and fee award. As set forth above, the court made it clear that the fee award was governed by federal common law, and provided a discussion of federal caselaw involving denial of fees by other federal circuit courts of appeals (including the Eighth, D.C., and Third Circuits). Id. at 654. The court, however, did carve out a role for state law by describing how it would look to state law for guidance on the issue of whether an ethical violation affects an attorneys’ entitlement to a fee, id., and that pursuant to the district court’s local rules, state law controls the question of whether an ethical violation occurred. Id. at 656. The court then re-affirmed its conclusion from the earlier Rodriguez appeal that class counsel had committed an ethical violation under California law by representing clients with conflicting interests. The court then proceeded to assess whether the district court abused its discretion in denying all fees to class counsel for its violation. In finding that the district court did not abuse its discretion, the court focused on a couple of facts: 

The conflict of interest arose at the outset of the representation as a result of knowing and willful creation of the conflict through entering the incentive fee agreements. Id. at 657.



Class counsel took no steps to disclose this conflict of interest to the court. Id. at 658.

The other potentially significant aspect of the Rodriguez decision was that the court found that the district court committed “clear error” in determining that counsel for the objectors who first raised the incentive fee agreement issue to the court were not entitled to reasonable attorneys’ fees. Id. at 659. The court therefore confirmed – in a relatively high profile case – the principle that that when counsel for objectors confer a benefit to the class, they should be entitled to fees. While this high-profile reminder that objectors should be entitled to fees upon adding value to the class may not increase the number or depth of objectors, it certainly solidifies the incentives for objectors to come forward. In a separate blow to class counsel, the Ninth Circuit vacated a class action settlement because, in part, the “$2 million award of attorneys’ fees is unreasonable.” Dennis v. Kellog Co., Nos. 11-55674, 11-55706 (9th Cir. July 13, 2012). But in September 2012, the Ninth Circuit retracted this decision, replaced it with a decision that still vacated the settlement but did not address the attorneys’ fee issue, and stated that the prior opinion could no longer be depended on for precedent. Dennis v. Kellog Co., 697 F.3d 858 (9th Cir. 2012). Nevertheless, the Ninth Circuit’s analysis on fees – even though withdrawn – provides a potentially interesting glimpse into how the court may very well view fee analyses in the future. The Dennis case involved a class action settlement of a case involving allegedly misleading advertisements by a children’s cereal maker.

The settlement was structured as follows:  Defendant would establish a $2.75 million fund for distribution to class members.  Pursuant to the Cy Pres doctrine, defendant agreed to distribute $5.5 million to charities that feed the indigent.  Defendant agreed to refrain from making certain claims in its advertisements; and  Defendant agreed to pay class counsel’s fees up to $2 million. Dennis, Nos. 11-55674, 11-55706, slip op. at 8115-8116 (9th Cir. July 13, 2012). Plaintiffs and defendant maintained that the total value of the settlement (including notice and administrative costs) was worth approximately $10.6 million. Id. at 8117. In the first part of its decision, the court first struck down the settlement because the Cy Pres distribution was not sufficiently related to the class members and their claims. Id. at 8119-8124. The court then noted that even had it not struck down the settlement because of the Cy Pres distributions, it would still have vacated the settlement because the $2 million in attorneys’ fees was not reasonable. The court first critiqued that the district court relied solely on a percentage analysis to determine the reasonableness of the fees. Id. at 8125. It also noted that the objectors had not requested that the court review the fees under a lodestar method, but that it would nevertheless use that method as a test on the reasonableness of the fees. Id. at 8125-26. In finding that the district court had erred in determining that the fees were reasonable, the court focused on: 

The fact that the parties moved for settlement only three months after filing the amended complaint.



The settlement “results in vaporous benefit to the class members and is flawed at its core”; and



Class counsel’s financing of the litigation and investment of time was limited. Id. at 8126-27.

The court made it clear that the second factor primarily drove its analysis, even though it claimed it would have reached the same result even had the $5 million Cy Pres distributions been valid. The court explained that even including the vacated Cy Pres distributions, the benefit “yields little for the plaintiff class” given that the “paltry sum” class members would receive, the lack of reasonable certainty that any class members would benefit from the Cy Pres distribution, and the limited nature of the injunctive relief. Id. at 8127. The court then proceeded to conduct a lodestar analysis even assuming that the Cy Pres distribution should be included in the total value of the settlement. The court found that the lode star multiplier was 4.3, and that this was “quite high, particularly in a case that was not heavily litigated.” Id. After vacating the settlement on the basis of an improper Cy Pres distribution and unreasonable attorneys’ fees, the court remanded to the district court with the suggestion that “if and when the issue of fees is again before the district court, the court shall consider all of the circumstances of the case as they exist at the time, including time wasted in preparing a stillborn settlement, in finally determining a reasonable award of attorneys’ fees.” Id. at 8129. The Dennis court appeared to be primarily troubled by the fact that a majority of the purported settlement value – nearly $8 million of the total $10.6 million – was derived from the purported value of the temporary injunctive relief and a large Cy Pres distribution that would not benefit class members. And even though the portion of the opinion vacating the award of attorneys’ fees was later eliminated from a revised opinion of the court, that portion of the opinion still provides guidance to practitioners district courts on how to handle fee awards. As set forth above, the now-revoked opinion urged courts to provide a clear record of the consideration of factors impacting the reasonableness of the fee, not to exclusively rely on a percentage analysis, and to probe

with extra scrutiny fee awards in settlements with relatively high Cy Pres distributions or where the value derives from injunctive relief of potentially speculative value. Despite these two recent decisions in the Ninth Circuit, the caselaw is full of examples where courts have pretty much ignored much more egregious alleged conduct by class counsel in connection with the fee issue than the Ninth Circuit faced. One example, discussed here for illustrative purposes, occurred in Warnell v. Ford Motor Co., 205 F. Supp. 2d 956 (N.D. Ill. 2002), which involved a clear example of a fee that was unreasonable on its face (representing more than twice the value that class counsel was able to secure for the class), and a deceptive attempt at double-dipping. The Warnell case involved a settlement of a class action against Ford based on gender discrimination claims. The settlement provided for the establishment of a $9 million fund for the benefit of the class, and a $3 million fund for the payment of “all” attorneys’ fees. Id. at 958-59. Only approximately $5 million of the $9 million was actually distributed to class members, with the remaining amounts being used for a scholarship and job training program for members of the class who were still employed by Ford. Id. at 958. The court eventually approved attorneys’ fees to class counsel in the amount of $2.75 million. Id. In motion practice relating to the settlement, some of the named plaintiffs disclosed to the court that class counsel – in addition to collecting the $2.75 million in fees awarded by the court – had enforced separate contingent fee agreements with the plaintiffs and had collected $635,000 from the plaintiffs based on the amount the plaintiffs had recovered from the settlement fund. Id. Class counsel argued that its failure to disclose the existence of these separate incentive agreements and its intention to enforce them was not intended to deceive the court, but the court found otherwise. Id. The court pointed out how the approved settlement expressly provided that “all” attorneys’ fees were to be paid from the $3 million attorneys’ fee fund and that enforcement of the separate agreements violated this provision. Id. at 959. When faced with this argument, Class counsel amazingly tried to avoid the implications of the clear language of the settlement by arguing that the court’s only role was to determine if the total fees they collected were reasonable. Id. What made this argument particularly audacious is the fact that the $2.75 they had already received – by any conceivable metric – was already an unreasonable fee. This is because prior to settlement of the class action, the EEOC had already negotiated a fund that would have provided for $7.5 million to be distributed to class members. Id. at 962. So class counsel essentially collected a $2.75 million fee for increasing the settlement fund by only $1.5 million. (Amazingly, there were no objections to this fee award). Id. Ultimately, all the court did when faced with what it found to be deceptive double-dipping was to void the enforcement of contingent fee agreements, and allowed class counsel to keep the previously awarded $2.75 million.2/ There is no rational way of trying to reconcile Warnell (and many others like it) with the recent Ninth Circuit decisions. Perhaps the Ninth Circuit decisions represent an emerging trend towards greater scrutiny, but it is probably premature to reach this conclusion, especially with the Ninth Circuit deciding to revoke its fee decision in Dennis. Perhaps the Warnell case should be considered an outlier, but there are too many other examples of puzzling fee awards to support this conclusion. Ultimately, perhaps the only lesson to be drawn is that treatment of fee awards from jurisdiction to jurisdiction (and possibly even within jurisdictions) is wildly inconsistent. B. How to Have Class Certification Denied or be Disqualified as Class Counsel: Paying Potential Witnesses is Not a Good Idea. In addition to losing a fee, another possible consequence for unethical behavior is being disqualified as class counsel or the possible denial of the certification of a class based on the fact that class counsel that engages in unethical behavior cannot provide fair and adequate representation to the class. 2/

The court did send a copy of its opinion to the Illinois Attorney Registration and Disciplinary Committee and the New York State Bar Association’s Committee on Professional Discipline. At least one of the attorneys for the class was suspended from practicing for 30 days based on the concealment of the fee agreements from the court.

The Seventh Circuit examined this issue in its recent opinion in Reliable Money Order, Inc. v. McKnight Sales Co., Inc., 2013 U.S. App. LEXIS 501 (7th Cir. Jan. 9, 2013). The Reliable Money Order court found that counsel who had (a) obtained lists of putative class members under false pretenses and in violation of a protective order, (b) did not properly register solicitation letters it sent to putative class members and then destroyed the list of individuals the letters went to, and (c) paid a key witness $5,000 could still provide adequate representation to the class. The Reliable Money Order appeal arose from a series of separate class actions filed by recipients of junk faxes in violation of the Telephone Consumer Protection Act, which imposes $500 in statutory damages for faxing unsolicited advertisements. These statutory damages are tripled for a showing of willfulness, and each fax constitutes a separate violation. Id. at *2. In the course of investigating claims brought under the Act in four putative class actions, plaintiffs’ law firm (referred to as “class counsel” below) discovered a company, Business-to-Business Solutions (“B2B”) that contracted with businesses to send advertisements by fax. Id. at *3. The data that B2B had was crucial to the class actions as it contained lists of the recipients of the faxes that would allow class counsel to prove an identifiable class to be certified in each of its four putative class actions. Through the discovery process, class counsel managed to procure the fax lists from B2B, who had recovered them for its back-up disks. Id. at *4. Class counsel then realized that if it was able to obtain all of B2B’s fax listings, it would have a “treasure trove” of potential clients in order to file other similar class actions. Id. In order to get this data, class counsel sought production of all of B2B’s hard drives and back-up disks. Class counsel told B2B that it would only examine the data on the disks and hard-drives that related to the four pending cases, and that the production of the disks and hard drives would be subject to a protective order that prevented the disclosure of anything on the hard drive to any third-parties. Id. at *5. In communications with defense counsel, class counsel made it clear that the hard drives and disks were subject to the protective order. Id. at *6. Once class counsel received the data on B2B’s hard drives, it filed over one hundred other class action lawsuits using the data that was on them. Id. at *8. In connection with filing these actions, it sent solicitation letters to putative class members letting them know that they could be members of a class. Id. at *7. Class counsel did not register these letters with the Wisconsin Office of Lawyer Regulation, although it was required to do so. Id. Class counsel then destroyed the list identifying the putative plaintiffs that received the solicitations. Id. Then, later on in the course of the litigation, class counsel sent a $5,000 check payable to B2B to B2B’s attorney purportedly for “document retrieval,” despite the fact that B2B had already been fully paid for document retrieval, and the costs it had incurred for document retrieval were nowhere near $5,000. Id. at *8. B2B’s lawyer voided the check. Id. He believed it was intended as an improper payoff to his clients, id. at *33, who would be a key witness in the hundreds of pending class actions brought by class counsel. As a result of this conduct, defendants in the many class actions brought by class counsel began seeking denial of certification of their respective classes on the basis that class counsel could not provide fair and adequate representation to the class. As the district courts grappled with and decided these issues, the Seventh Circuit adopted a standard for deciding whether misconduct by counsel warrants denial of certification of the class in a separate case. Creative Montessori Learning Ctrs. v. Ashford Gear, LLC, 662 F.3d 913 (7th Cir. 2011). In light of this new standard, the Seventh Circuit accepted an appeal from one of the district court orders certifying the class in the cases brought by class counsel. In explaining the standard established in Ashford Gear, the Reliable Money Order court explained that “when ‘class counsel have demonstrated a lack of integrity’ through misconduct and unethical action, a ‘court can have no confidence that they will act as conscientious fiduciaries of the class.’” 2013 U.S. App. LEXIS 501, at *24. Therefore, “‘misconduct by class counsel that creates serious doubt that counsel will represent the class loyally requires denial of class certification.’” Id. at *15 (quoting 662 F.3d at 919). And “misconduct that prejudices the class or creates a direct conflict between counsel and the class requires” denial of certification. Id. at *24.

After examining class counsel’s procurement of the computer hard drives and back-up disks from B2B,3/ class counsel’s solicitation letters, and class counsel’s $5,000 payment to B2B, the court determined that class counsel’s conduct did not require denial of certification of the class. Id. at *28-34. There are two significant aspects of the Reliable Money Order case: (1) the high standard for a finding of misconduct that warrants denial of certification of the class, and (2) the forgiving analysis the court applied to class counsel’s conduct. 4/ The Reliable Money Order court, applying its prior holding from Ashford Gear, created a very high standard for the type of conduct that would warrant a finding that counsel could not fairly or adequately represent the class. The focus on loyalty to the class would seemingly forgive an incredibly wide range of potentially egregious and unethical and improper conduct so long as that conduct does not create a conflict with the interests of the class. But is it really in the interests of a class to have potentially unethical or dishonest counsel serving as its counsel just because the unethical conduct did not create an actual conflict with the class or directly prejudice the class in some way? This standard would seemingly allow counsel to engage in all kinds of unethical behavior without fear of being disqualified so long as they remained “loyal” to the class. Although the court did note that “serious” or “major” ethical violations – without any prejudice to the class – could be enough to deny class certification, it is hard to reconcile that comment with the majority of the opinion that focused so intensely on whether there was prejudice to the class or a conflict with the class. The other interesting aspect of the Reliable Money Order court’s decision was the relatively brief analysis the court provided with respect to whether class counsel’s alleged misconduct warranted denial of certification. The court first addressed that even if class counsel may have procured B2B’s hard drives and disks through misleading statements to B2B and in violation of the Illinois Rules of Professional Conduct 4.1 and 4.3, that conduct was not sufficient to deny certification of the class. Id. at *28-29. The court observed that this potentially misleading conduct did not prejudice the class because it was directed at third-parties. Id. at *28. In making this determination the court did not consider the fact that misleading conduct directed at third-parties could very well prejudice the class in at least three tangible ways: (1) it will likely make third-parties, including B2B who was a key witness in the action, less open or willing to provide assistance to class counsel or the class, (2) any instances of dishonesty in the course of litigation likely will have an adverse impact on the credibility of the attorney before the court, and (3) lack of credibility will make it more difficult to interact with opposing counsel, including on possible negotiation of a settlement. The court’s analysis of the $5,000 payment to B2B was also somewhat forgiving. The court began its analysis of this payment by noting how if the payment was “made to influence testimony or made payment of expenses contingent upon the outcome of the case, [class counsel] would have committed a serious breach of the ethical rules that would require denial of class certification.” Id. at *33. But in forgiving the payment that class counsel made to B2B, the court stated that there was no evidence that the payment to B2B came with these sorts of strings attached. Id. at *33-34. But in many cases there is seldom direct evidence of bribery (i.e., a memo from the payor to the payee stating that the payment is made in consideration of some sort of unlawful purpose), and payments are routinely found to be improper when there is an absence of any legitimate reason for the payments, and the circumstances under which the payments were made is suspicious – two circumstances that were present in the Reliable Money Order case. While the Reliable Money Order case seemingly lowers the expected standards of conduct for attorneys representing classes in courts in the Seventh Circuit, other jurisdictions have come down much more harshly on attorneys who have sent payments to potential witnesses. For example, a class action in Louisiana involving a $5,000 payment from one of plaintiffs’ attorneys to a witness resulted in the attorney being disqualified from the case and suspended from the practice of law for three years. In re: Joseph M, Bruno, 956 So. 2d 577 (La. 2007). 3/

The issue of whether discovery in one case can be used to find potential members of a class for another case does not appear to be an issue that has received much scrutiny from the federal courts. See also Jones v. YMCA of the USA, 2011 U.S. Dist. LEXIS 36087, at *11 (N.D. Ill. Mar. 31, 2011) (granting motion to compel names of defendant’s employees and managers over the argument that plaintiffs’ counsel was simply going to use the list to solicit new clients). 4/ It should be noted that none of the district courts that considered this issue before it made its way to the Seventh Circuit found the conduct of class counsel to be sufficiently egregious to warrant denial of class certification.

The Bruno case was a disciplinary action brought by the Office of Disciplinary Conduct against attorney Bruno who had served as a member of the Plaintiffs’ Legal Committee (“PLC”) in a class action arising from an explosion at a Shell Oil Company refinery. Near the beginning of the litigation, Bruno was introduced to a longtime Shell employee, Jack Zewe, who had information that defense counsel was destroying evidence and tampering with potential testimony. Id. at 577-78. Mr. Zewe made it clear that he was afraid of losing his job if his involvement were discovered, and so he expected compensation for his services in communicating with Bruno. Id. at 578. After Bruno began working with Mr. Zewer, he paid him $5,000 with the understanding that Mr. Zewe would keep track of his time and expenses and Bruno would apply to have his expenses covered as an expert witness upon settlement of the action. Id. Shell discovered Mr. Zewe’s involvement and moved to disqualify members of the PLC from representing the class. Id. In response, an attorney representing the PLC unknowingly argued that Mr. Zewe had not received any payments. Id. Attorney Bruno did not correct this misrepresentation. Id. Only 2.5 months after the hearing did Attorney Bruno disclose that he had paid Mr. Zewe money and promised additional sums at the conclusion of the litigation. Id. This disclosure prompted an investigation by the US Attorneys’ Office, and while Bruno was not indicted, he was banned from practicing law in the Eastern District of Louisiana for a year, id., and banned from practicing law in Louisiana state courts for three years. Id. at 583. The state disciplinary proceeding focused on the violation of Rule 3.4(b) (a lawyer shall not offer an inducement to a witness that is prohibited by law), and the failure to correct false statements co-counsel had unknowingly made about the payment. Id. at 579. II. The Ethical Traps Inherent in Communicating with Members of a Putative or Certified Class. Another area of the law that lacks consistency across jurisdictions, and therefore poses potential ethical traps for practitioners – especially as competition for representing potential class members as class counsel or opt-out counsel increases – is the ethical rules applicable to the scope and nature of contact that counsel can have with putative or actual class members. The following discussion provides an overview of the issues that arise in this area, but because (as will be shown below) the expectations on counsel can vary from jurisdiction to jurisdiction, it is important for practitioners to learn to fully understand the specific requirements in whichever jurisdiction they find themselves practicing. A. What Are the Applicable Ethical Obligations Concerning Contact with a Potential or Certified Class? As an initial matter, it is well-established that courts have a certain amount of freedom to regulate the extent and type of contact that attorneys can have with members of a putative class. But any such “order limiting communications between parties and potential class members should be based on a clear record and specific findings that reflect a weighing of the need for a limitation and the potential interference with the rights of the parties.” Bernard v. Gulf Oil Co., 425 U.S. 89, 101 (1981). Among these rights is the right to free speech under the First Amendment, although any restraints on speech in the context of a class action are generally viewed under “a relaxed standard of scrutiny better suited to the hardiness of commercial speech.” Kleiner v. The First Nat’l Bank of Atlanta, 751 F.2d 1193, 1205 (11th Cir. 1985). And, “[i]n general, an order limiting communications regarding ongoing litigation between a class and class opponents will satisfy first amendment concerns if it is grounded in good case and issued with a ‘heightened sensitivity.’” Id. The Kleiner case provides an interesting overview of this issue. The district court certified a class containing potentially 8600 members who were customers of a bank that allegedly charged them higher interest rates than it had originally promised to them. Id. at 1196. Counsel for the class sought a protective order preventing the bank from having any ex parte contact with class members arguing that such contact could cause bank customers to be deterred from participating in the class. The court entered a protective order preventing any contact between the bank or its counsel and the class members (save for five depositions), but said that it would consider revisiting its ruling if the bank submitted some authority suggesting that it should be able to have informal contact with the class members. Id.

In July, the bank devised a plan where it would contact members of the class to convince them to opt-out of the class in order to reduce the amount of its potential damages, id. at 1197, despite the fact that the protective order prohibited such contact. The bank gathered 175 loan officers to staff the telephones, and the calls purposefully occurred while the judge was on vacation. Id. The loan officers were told to call the class members that they knew best and to do the best “selling job they had ever done,” to get those persons to opt-out. Id. at 1198. The bank reached a total of 3000 customers and 2800 of them decided to opt-out. Id. Upon discovery of this scheme, the district court held a hearing and sanctioned the law firm, assessed attorney’s fees against the bank, disqualified counsel, and voided the opt-out requests. Id. at 1199. The Eleventh Circuit affirmed the district court’s rulings (although it differed a bit on the scope of the sanctions), id. at 1208-1211, and dismissed the bank’s arguments that the protective order impermissibly infringed on its first amendment rights. Id. at 1206-07. The interesting question raised by the Kleiner case is whether the court would have reached a similar result in the absence of the protective order. The district court based its decision on the grounds that the bank’s and its attorneys’ conduct not only violated its protective order, but also violated the ABA Rule of Professional Conduct 4.2, which prohibits attorneys from communicating about the subject of representation with a party known to be represented. Id. at 1198. As an initial matter, it would seem as if the Rule does not apply given that the contact was between the bank (and not their counsel) and the class members. The Eleventh Circuit did not address this issue, although it did make reference to the Rule in noting that the protective order in no way tread upon any legitimate speech by the bank’s counsel because the bank’s counsel had an “ethical duty to refrain from discussing the litigation with members of the class as of the date of the certification, if not sooner….” Id. at 1207. So the unanswered question raised by the Kleiner case, therefore, is what are an attorneys’ obligations with respect to contact with class members absent a court order on this issue? The interpretations of the ethical obligations that apply to such situations are still evolving and inconsistent and there is no clear or universal answer to this question. In general, fundamental notions of fairness dictate that solicitation of potential class members by plaintiffs’ counsel should be governed by ethical rules, including Rule 7.3, and that the courts should be wary of defense counsel using unilateral contact with potential class members to try and get them to drop out of the class. It appears that these were the motivating factors behind the ABA/BNA Manual on Professional Conduct 1301:101, Formal Opinion 07-445 (April 11, 2007), titled “Contact by Counsel with Putative Members of Class Prior to Class Certification.” This opinion, in relevant part, provides that: 



There are no ethical prohibitions on counsel for plaintiffs and defendants communicating with potential members of a class. These communications, however, are governed by Rule 4.3 (prohibition on providing legal advice to unrepresented persons with interests potentially adverse to the client), and Rule 7.3 (rule regulating attorney solicitations). o

The practical effect of emphasizing how Rule 4.3 is applicable to communications with potential members of the class is that defense counsel are likely prohibited from advising potential class members not to participate in the class as this type of communication could very well be seen as providing legal advice to an unrepresented person who may be adverse to the client.

o

According to this opinion, Plaintiffs’ counsel are free to contact putative class members. Any communications concerning possible representations must be designated as advertising materials, but contact merely to develop facts is not limited or otherwise regulated by any rules.

The Rule states that the attorney client relationship between class members and counsel for purposes of Rule 4.2 (communications with represented individuals) does not arise until the class has been certified and until the period for opt-outs has expired.

o

This interpretation is at odds with numerous court decisions that hold that the attorney client relationship, for purposes of Rule 4.2, between members of a class and class counsel begins upon certification, and not upon expiration of the opt out period. See, e.g., Kleiner, 751 F.2d at 1207; see also Gortat v. Capala Brothers, Inc., 2010 U.S. Dist. LEXIS 45549 (E.D.N.Y. May 10, 2010) (compiling decisions where Rule 4.2 applied as soon as the class was certified). This is significant because the ABA rule would allow attorneys to solicit members of a class to opt out even after certification, but such solicitations in other jurisdictions could be prohibited upon certification of the class.

It should be noted that this opinion is relatively recent, and comes against a backdrop of significant caselaw and ethical opinions by states that – as discussed above – may not always reach the same conclusions. In fact, there have been subsequent opinions by states that come out the opposite way. For example, an ethics opinion from Pennsylvania states that a “corporation’s lawyers defending a not-yet-certified class action brought in Pennsylvania by a nationwide group of corporate employees may not directly contact members of the putative class.” ABA/BNA Manual on Professional Conduct 1301:7501, Pennsylvania Ethics Opinions 2009-1 (April 2009). Given these possible divergences, counsel should still proceed with caution when contemplating contact with potential class members, and the following sections of this article are intended to highlight a couple of ethical areas where counsel should proceed with extra care. B. How should Counsel Go About Having or Limiting Communications with Members of a Potential Class? While the ABA Opinion seems to make it clear that defense counsel face no ethical prohibitions on contacting class members prior to expiration of the opt-out period (so long as those communications are consistent with Rule 4.3), courts have traditionally been wary of defense counsel having unfettered communications with potential class members. The safest way to proceed, therefore, would be to seek a court order allowing such communications. Of course this risks the possibility of having the request turned down, see Dondore v. NGK Metals Corp., 152 F. Supp. 2d 662 (E.D. Pa. 2001), and begs the age-old question of whether it is better to ask for permission or forgiveness. It is true that, prior to certification and in the absence of any protective order, courts consistently allow defendants to contact putative class members to try and procure declarations that will be helpful to defeat class certification so long as the communications are not coercive or misleading. See Munoz v. Giumarra Vineyards Corp., 2012 U.S. Dist. LEXIS 93003, at *19-23 (E.D. Ca. 2012) (examining cases where contact was coercive or misleading). But what happens when the court has issued a specific protective order limiting contact, or Rule 4.2 is in play? How does defense counsel seek contact with a member of the class? In such instances, one possibility would be for the member of the class seeks to be excluded from the definition of the class or decides to opt out of the class on her own (if it is not too late for that). The former scenario is exactly what occurred recently in Kirola v. The City of San Francisco, 2011 U.S. Dist. LEXIS 34114 (N.D. Cal. Mar. 17, 2011). That case involved a certified class of individuals who brought suit against the City of San Francisco for alleged violations of the ADA based on lack of physical access for handicapped individuals to various city facilities. Id. at *3. One of the class members was Joanna Fraguli, a handicapped employee of the city, who, in part, oversaw physical access issues at many of the City’s facilities. Id. The City sought permission to communicate with her, but was denied by the court. Id. at *3-4. Fortunately for the City, Ms. Fraguli obtained independent counsel and sought to modify the definition of the class so as to exclude herself because her interests conflicted with those of the class as she participated in some of the decisions that were being challenged by the class. Id. at *5-8. It is interesting to note that prior to Ms. Fraguli’s motion, the City had sought to have the class definition exclude City Officials from the definition of the class but was unsuccessful. Id. at *4. The lesson learned from this case is that if the court is reluctant to provide a defendant access to its own employee who may be a key witness, the defendant should refer that employee to independent counsel who can then advise the employee whether it is in his or her interests to seek exclusion from the definition of the class because a court is much more likely to enter such an order if it comes from the employee herself, and not from the defendant. Plaintiffs’ counsel – especially prior to certification of the class – also face issues of access with respect to communications with putative class members who are employees that are considered to be represented by company counsel for purposes of Rule 4.2. Such a prohibition on communications between counsel and these putative class

members is not necessarily consistent with the rationale underlying the class action process because it prohibits an attorney from discussing possible claims with a potential client, and given that these employees are likely the most knowledgeable members of a class, it is sometimes important for class counsel to have access to them (outside formal discovery) to develop the class’s claims. Despite this tension between the ethical rules and the principles behind class actions, courts have imposed severe sanctions on counsel who have violated Rule 4.2’s prohibition. Hammond v. City of Junction City, Kansas, 2002 U.S. Dist. LEXIS 4093 (D. Kan. 2002) (disqualifying counsel that contacted one of defendant’s managers, and requiring it to pay reasonable costs and attorneys’ fees incurred by defendant in connection with the motion for disqualification). In such a situation, however, class counsel should not abandon all hope of being able to communicate with a putative class member covered by Rule 4.2, but should rather seek permission from the court to do so. See Abdallah v. Coca-Cola Co., 186 F.R.D. 672 (N.D. Ga. 1999) (allowing communications between counsel and upper level employees of Coca-Cola so long as communications were limited to the issue of their claims and not about other matters concerning the litigation); see also Jones, 2011 U.S. Dist. LEXIS 48346 at *13 (if the parties have a disagreement over whether plaintiffs can communicate with managers who are members of a putative class, they should submit the dispute to the court if they cannot resolve it); Hammond (disqualified and sanctioned plaintiff’s firm should have sought a ruling from the court on contact with the manager prior to making contact). C. When Does the Privilege Attach to Communications Between Possible Members of a Class and Plaintiffs’ Counsel? Even though the attorney client relationship does not generally arise for purposes of Rule 4.2 until at least after the class is certified, pre-certification communications between counsel and potential class members can still be covered by the attorney client privilege given that the privilege generally covers pre-engagement communications in most jurisdictions. But plaintiffs’ counsel should not assume that this is always the case, and should carefully consider the privilege issues in connection with their communications with potential members of the class Barton v. United States District Court for the Central District of California, 410 F.3d 1104 (9th Cir. 2005) involved an appeal from a district court order finding that a pre-engagement communication between counsel and potential class members was not covered by the attorney-client privilege. The Barton case was a class action brought against SmithKline Beecham Corporation claiming injury from a drug that SmithKline manufactured. Id. at 1106. The named plaintiffs initiated contact with counsel by filling out a detailed questionnaire on counsel’s website. Id. The questionnaire asked for extensive information about use of the drug at issue. Id. at 1107. The questionnaire also included a disclaimer stating that submission of the form was not a request for legal advice and that submission of the form did not create an attorney client relationship. Id. The defendants in the case requested – through discovery – copies of the questionnaires that the named plaintiffs submitted. Id. at 1106. The district court granted the request over objections from the plaintiffs, but the Ninth Circuit reversed. The Ninth Circuit found that the plaintiffs filled out the questionnaire with the purpose of trying to secure legal advice. Id. at 1110. It then observed how communications are protected under California law “when a person consults a lawyer for the purposes of ‘retaining the lawyer,’ ‘securing legal service,’ or securing ‘advice.’” Id. at 1111. The court then found that while the disclaimer protected the law firm by making it clear that no attorney client relationship was being formed, it did not constitute a disclaimer by the plaintiffs that they were not seeking to secure legal services by submitting it. Id. Therefore, the disclaimer on the questionnaire did not affect the privilege. Id. But a subsequent federal case makes it clear just how important the precise wording of the questionnaire is with respect to attachment of the privilege. Schiller v. The City of New York, 245 F.R.D. 112 (S.D.N.Y. 2007). The Schiller case involved suits by individuals against the City of New York for the police response to protests over the GOP convention. Id. at 113. The NYCLU had distributed questionnaires via email and made the questionnaire available on its website seeking information about interactions that persons had with the police. The form was called “NYCLU Pier 57 Intake Form.” Id. at 114. In deciding that the form was not privileged, the court found that the NYCLU provided no evidence suggesting “that any person who completed a questionire believed at the time that he or she was seeking representation by the NYCLU,” and found that any such belief would have been unreasonable anyway because the form stated that it sought information to “effectively advocate for change,” and that it would be shared with “other legal organizations.” Id. at 116. The court also found that the questionnaire was not subject to the attorney client privilege because the NYCLU had not expressed an intention to file a class action suit, had not

filed any suits at all when it distributed the questionnaires, and did not provide any affidavits by persons who filled out the questionnaires that they considered themselves to be clients or potential clients. Id. at 117. D. Are Attorneys Free to Solicit Members of a Class to Opt-out of the Class? In jurisdictions that follow the ABA Formal Opinion 07-445, discussed above, on when the attorney client relationship arises between class members and their counsel for purposes of Rule 4.2, plaintiff’s counsel will generally face no prohibition on reaching out to class members to solicit them to opt out of the class. Of course in jurisdictions where representation is seen to begin upon certification, then only pre-certification solicitations would seem to be allowed, although counsel may be free to respond to communications directed to them by members of the class who are seeking representation. See In re Apple Inc.Sec. Litig., 2011 U.S. Dist. LEXIS 52685, at *16-17 n.6 (N.D. Cal. May 17, 2011) (finding that there was no violation of the California Rules of Professional Conduct when there was no direct evidence that counsel solicited a class member and that it appears as if the class member retained counsel in some other way). But, any such solicitations are still subject to the rule on client solicitations that generally require any solicitations not to be misleading. This prohibition raises several issues in the class action context given the complexity and the many considerations that go into whether a plaintiff is better off opting out. Conceivably, any solicitations to opt-out would be subject to second-guessing and hind-sight with respect to the type of facts and issues they would need to disclose in order to not be misleading. Possibly the most widespread solicitation of opt-outs occurred in a large asbestos case pending in the Eastern District of Pennsylvania. Georgine v. Amchem Products, Inc., et al., 160 F.R.D. 478 (E.D. Pa. 1995). In that case, the court found that tens of thousands of letters sent by numerous attorneys to members of the class soliciting opt-outs were misleading, and in many instances, contained outright false statements about the settlement. Id. at 489-99. The court found that compounding these misleading statements was the fact that the letters did not discuss any of the substantial benefits to remaining in the class. Id. at 496. As a remedy for all of these misleading solicitations, the court set aside the opt out requests and required that a new notice be sent to class members who had decided to opt out requiring them to make their decision again. Id. at 503. It seems clear that if solicitations of class members to opt-out is truly on the rise, then there will be more scrutiny on the solicitations that led to any opt-out decisions.

The Good, the Bad and The Ugly: Legal & Ethical Issues in Class Action Settlements and Opt Outs

Securities Opt-Out Litigation – The “New Normal” For Some Investors

Geoffrey C. Jarvis Grant & Eisenhofer P.A. Wilmington, DE

INTRODUCTION As recently as 15 years ago, institutional investors played little role in securities litigation, remaining passive class members content to stay in the background.1 Those times are gone. With the passage of the PSLRA, institutional investors are actively seeking lead plaintiff status. And when their losses are big enough and their claims strong enough, they are increasingly exercising their right to opt out of the class action and file their own lawsuits, in the jurisdictions of their choice and with their chosen counsel. Opting out of a securities class action, that is, foregoing any potential recovery an investor would otherwise receive as a class member in exchange for the ability to raise the same or similar claims in an individual action, is nothing new, but over the last decade such actions are increasing in number – and notoriety. Whether an institutional investor’s resources are best served by opting out of a pending class action involves a cost/benefit analysis of the 1

See, e.g., John C. Coffee, Jr., Accountability and Competition in Securities Class Actions: Why “Exit” Works Better than “Voice,” 30 Cardozo L. Rev. 407, 425 (2008).

particular facts at hand. It is a scrutiny that seems to be occurring more frequently in the board rooms of institutional investors across the country. The “benefits” fall into three major categories: 1) the potential to receive a significantly larger recovery; 2) the ability to control the litigation – and settlement; and 3) the power/perception of vigilance. The cons are largely twofold: 1) a higher cost and discovery burden; and 2) the -- albeit small -- risk of non-recovery. The Benefits Maximizing Recovery The primary reason an institutional investor would seek to file its own lawsuit is to maximize the recovery of its losses. It is no secret that recovery in a class action could be pennies to the dollar, a ratio not appealing to investors who have lost tens, or hundreds, of millions of dollars at the hands of corporations they previously had trusted. Compare that to the impressive and highly-touted successes of past opt-outs. For example, the $2.4 billion settlement of the AOL Time Warner class action yielded opt-out settlements to the University of California of $246 million (estimated to be 16 to 24 times better than it would have received in the class settlement)2, the Ohio State Pension Funds for $175 million ($135 million more than it would have received)3, CalPERS for $117.7 million (a 90% recovery rate, about 17 times more than it would have received)4, CalSTRS for $105 million ($90 million more than it would have received)5, and the State of Alaska for $50 million (50 times what it would have received).6 And then there is Qwest, which paid $400 million in a class settlement, and over $400 million to the opt-outs (collectively). One opt-out, Colorado Public Employees’ Retirement Association received a settlement of $15.5 million, instead of the $400,000 it was due to receive under the settlement (a 38 fold increase).7 CalSTRS settled for $46.5 million (30 times more than it would have received in the settlement).8 The Teacher Retirement System of Texas settled for $61.6 million, compared to the $1.4 million it would have received in the settlement.9 Alaska received $19 million for its funds’ losses, 45 times more than the $427,000 the class settlement would have provided.10 In 2005, Bristol Myers settled an opt-out case brought by 4 investors relating to allegations of “channel-stuffing” (the author represented the plaintiffs). That case, bringing state claims in state court, settled for approximately $90 million, while the federal class action based upon the same claims settled for only $300 million for all investors.11 The 4 opt-outs received more than 10 times what they would have obtained through the class action. The examples noted above are merely those that were publicly disclosed through press releases. In many more cases, the results are confidential, but it is believed that those confidential settlements mirror the types of results noted above. In fact, as opt-out cases become more frequent in the class action industry, the settlement details are becoming less public. For example, when CalPERS and its co-plaintiffs settled their highly publicized opt-out case against Countrywide (with Bank of America) in 2011, the settlement amount was not released.12

2

Time-Warner to Settle UC Lawsuit for $246 Million, 93106: U.C. SANTA BARBARA, Vol. 17, No. 13, March 19, 2007. Time Warner Settles Lawsuit for $144 Million, L.A. TIMES, Mar. 8, 2007, at C6. The settlement included a payment of $144 million and another $31 million for legal fees and expenses. 4 Gilbert Chan, CalPERS' Time Strategy Pays Off: The state pension fund gets $117.7 million after opting out of class action against media giant, SACRAMENTO BEE, March 15, 2007. 5 Id. 6 Josh Gerstein, Time Warner Case Finds a Surprise, N.Y. SUN, Dec. 7, 2006, at 1. 7 Press Release, Colorado PERA, Colorado PERA Reaches $15.5 Million Settlement With Qwest, Nov. 21, 2007. 8 Juliet Williams, Qwest, Calif. Teachers Reach Settlement, WASHINGTON POST, Feb. 1, 2007. 9 Teacher Retirement System of Texas reaches settlement with Qwest Communications, WEATHERFORD DEMOCRAT, Dec. 13, 2007. 10 Press Release, Alaska Department of Law, Department of Law Announces $19 Million Settlement in Securities Fraud Claims Against Qwest Communications, Nov. 21, 2007. 11 Press Release, Bristol-Myers Squibb Co., Bristol-Myers Squibb Announces Settlement With Opt-Out Plaintiffs From Securities Class Action Litigation, June 1, 2005. 12 Edvard Pettersson, Bank of America Settles Countrywide Fraud Claims By Calpers, BLOOMBERG.COM, Nov. 22, 2011. 3

One reason a greater recovery is possible is that opt-outs can pursue broader legal theories and remedies. Class actions are limited to federal claims under Section 10(b) of the Securities Exchange Act of 193413 or federal claims that do not require reliance. This is due to the fact that where a claim requires each plaintiff to establish reliance, courts have determined that the issues regarding whether class members relied upon the allegedly misleading statements predominate and thus reliance-based claims are not suitable for class certification.14 Thus, class actions generally are limited to federal claims under Section 10(b) (where reliance can be presumed if the market for the security at issue is shown to be “efficient”)15 or federal claims that do not require reliance.16 Even non-fraud based state law claims cannot be pursued in a class action because of the restrictions imposed by SLUSA, a federal statute that limits class actions involving securities to federal claims (with certain exceptions dealing with fiduciary duty claims).17 Federal claims are further limited in that it is impossible to pursue most third parties. The courts have held that there is no aiding and abetting liability under the federal securities laws, so entities that did not make a false statement (unless they “control” a false statement making entity), cannot be sued.18 Contrary to class cases, opt-outs need not worry about what can be established with common evidence, and can pursue claims that require a showing of reliance on the part of the investor. Not thwarted by SLUSA, opt-outs can sue in state or federal court, and can seek state law claims such as common law fraud or negligent misrepresentation or can sue under state laws relating to securities (so-called “Blue Sky Laws”). Opt-outs can more easily include claims against secondary actor defendants for aiding and abetting liability, thereby extending the range of defendants (and insurance coverage). Opt-out cases also benefit from the lesser scale of damages than the massive class action, wherein defendants often argue that the billion dollar award plaintiffs are seeking would cripple, or even bankrupt them. 19 Opt-out cases, even those seeking significant amounts of damages, do not usually present the same problem, thereby removing one arrow from the defendant’s arsenal. Heightened Control As a class member, investors receive the benefit of any class recovery, with the only required action being to send in a claim form. Securities litigation is complex, and this arrangement is favorable in many instances. When greater control over the lawsuit is preferred, opting out can be the solution. Institutional investors who choose to file their own claims can do so with the counsel of their choice, in their preferred jurisdiction (perhaps with a more sympathetic home jury) and against the defendants they select. And of course, with their counsel’s guidance, they control which claims are included in the lawsuit. Because the class action litigation usually has been proceeding for a number of years prior to the time of opting out, opt-outs often have the added advantage of already knowing the defendant’s position, having seen their documents, deposition testimony, and court filings. Settlement of an opt-out claim stands in marked contrast to the settlement of a class action, where the notice, approval and claims adjudication can take years to come to fruition. An opt-out settlement, on the other hand, can be private, with funds distributed almost immediately. Further, as noted above, such settlements can often provide the opt-out plaintiff with a recovery many times greater than what such a plaintiff would have received in the class action. Opt-outs also control the decision regarding when to opt out. Investors often choose to opt out after a settlement is reached (but prior to court approval), but increasingly are opting out earlier.20 Investors thus can attempt to negotiate 13

15 U.S.C. §78j. See, e.g., Gariety v. Grant Thorton, LLP, 368 F.3d 356, 362 (4th Cir. 2004) (“Because proof of reliance is generally individualized to each plaintiff allegedly defrauded, fraud and negligent misrepresentation claims are not readily susceptible to class action treatment, precluding certification of such actions as a class action.”). 15 Basic Inc. v. Levinson, 485 U.S. 224 (1988). 16 Claims under Section 11 of the Securities Act of 1933,15 U.S.C. § 77k, are prototypical of claims that do not require reliance. 17 The Securities Litigation Uniform Standards Act, which precludes plaintiffs from filing a class action in state court if the case consists of more than fifty prospective members and asserts state law claims alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” 15 U.S.C. § 78bb(f)(1)(A). 18 Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994) (the Court held that "private civil liability under Rule 10b-5 does not extend to those who do not engage in a manipulative or deceptive practice but who aid and abet such a violation of 10(b)"). 19 Coffee, supra, at 431. 14

20

Recently, several large investors opted out of a securities lawsuit against Pfizer arising out of claims that the company misled investors about the safety of its pain relievers. The Pfizer opt-outs occurred after class certification and after many years of litigation in the class case. See, e.g., Julie Triedman, Heavy-Hitters Hit Pfizer with New Securities Suit, Highlighting Opt-Out

a settlement prior to officially opting out and filing a complaint, and then make the later choice of opting out or staying in if a settlement is not reached. The Power/Perception of Vigilance Another potential benefit is the positive public relations an institutional investor could receive from taking the less traveled, but more profitable, road. For example, when Oregon opted out of the $624 million Countrywide settlement and filed its own lawsuit, the state treasurer and attorney general issued a press release in which the Attorney General proudly stated: “Oregon will not accept pennies on the dollar when Wall Street defrauds Oregonians,” with the Treasurer adding in “[i]t is time to foreclose on Countrywide’s effort to pay so little for costing Oregonians so much.”21 When the Colorado Public Employees' Retirement Association reached its settlement with Qwest, it stated that "Colorado's public employees should take comfort in the fact that PERA continues to be vigilant in protecting their retirement and securing their financial future” and that "being involved in cases such as the separate proceeding against Qwest demonstrates our ongoing commitment to protecting the benefits of our current and future retirees."22 The examples are numerous. The Cons The Financial and Discovery Burdens There are downsides to opt-out litigation that should not be ignored. In theory, an opt-out case could take as much time and effort to litigate as the class action itself, and depending on the length and depth of the out-opt proceedings, the costs could be substantial. Thus, investors with smaller claims may not be well-suited for opting out, and may fare better as class members. A certain amount of number crunching is necessary to determine the size of the claim warranting an opt-out proceeding. Also serving as a deterrent is the real possibility of being subjected to extensive discovery, including both document requests and deposition testimony. Investment strategy, financial decisions, and other private matters could be fair game for discovery. Who knew what and when, with respect to the securities at issue, could be closely scrutinized by the defendant, bringing to light significant details of the institutional investor’s internal processes. Risks There is always the possibility that an investor could fail to resolve its claims and then lose at trial. For example, wellknown investor Kirk Kerkorian opted out of a class action against Daimler related to its merger with Chrysler. When the class action settled for $300 million, Mr. Kerkorian, who held nearly 14 percent of Chrysler’s shares, decided to take his opt-out case to trial – foregoing a class action recovery that certainly would have exceeded $30 million. After a two-week bench trial, the Court found for the defendants and Mr. Kerkorian received nothing.23 This type of negative result, however, is very rare, and the very large majority of opt-outs result in a recovery for plaintiff that exceeds the recovery that would have been obtained in the class action.

Trend, AM. LAW. LITIG. DAILY, Nov. 15, 2012. There are, however, potential limitations on the time where a plaintiff can opt out that differ from the opt-out deadline that may exist in the class case. While it has been presumed for many years that the statutes of limitation applicable to all federal claims that are asserted in a class action are tolled while that action is pending (or at least through class certification if it is denied), see American Pipe Construction Co. v. Utah, 414 U.S. 538 (1974), certain recent cases have suggested that a portion of the federal statute of limitations sometimes called the statute of repose (usually 3 or 5 years from the purchase of the security as to which a claim is asserted) cannot be tolled. See In re IndyMac MortgageBacked Securities Litigation, 793 F. Supp. 2d 637, 642-43 (S.D.N.Y. 2011); Footbridge Ltd. Trust et al. v. Countrywide Financial Corp., et al., 770 F. Supp. 2d 618, 623-24 (S.D.N.Y. 2011). This issue is currently before the United States Court of Appeals for the Second Circuit, and if the Circuit Court agrees with these lower courts, the ability to opt out later in securities litigation will be materially constrained. 21

Press Release, Oregon Department of Justice, Oregon Files Securities Lawsuit Against Countrywide for Misleading Filings that Caused $14 Million in Losses to State, Jan. 26, 2011. 22 Press Release, Colorado PERA, Colorado PERA Reaches $15.5 Million Settlement With Qwest, Nov. 21, 2007. 23 Rita K. Farrell, Kerkorian Appeals Ruling Backing Daimler-Chrysler Merger, N. Y. TIMES, Sept. 26, 2006.

Conclusion As one industry expert stated, "It's been nearly eight years since we started to see institutional investors opt out of WorldCom in 2005. …It's becoming the new normal."24 As caselaw develops to make it more difficult to certify large and broad securities class actions,25 it is likely that we will see even more opt-out litigation. Whether it is right for an aggrieved institutional investor must be carefully considered in each instance. If successfully pursued, it could give the investor a powerful seat at the bargaining table, and in some cases, a seat they cannot afford to turn down.26

24

Julie Triedman, Heavy-Hitters Hit Pfizer with New Securities Suit, Highlighting Opt-Out Trend, AM. LAW. LITIG. DAILY, Nov. 15, 2012 (quoting Adam Savett, CEO of TXT Capital, LLC). 25 Much of the securities bar is anxiously awaiting the Supreme Court’s decision in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, Supreme Court docket number 11-1085, which will impose even higher burdens on 10b-5 plaintiffs seeking to certify a class based on the fraud-on-the-market theory. 26 This article does not endeavor to determine whether the failure to file an opt-out claim could be a violation of ERISA's “exclusive benefit” standard, under which the fiduciary of an “employee benefit plan” must “discharge his duties with respect to a plan solely in the interests of the participants and beneficiaries and (A) for the exclusive purpose of: (1) providing benefits to participants and their beneficiaries; and (2) defraying reasonable expenses of administering the plan.” Employee Retirement Income Security Act of 1974 § 404(a), 29 U.S.C. 1104(a) (2000). 

The Good, the Bad and the Ugly: Legal & Ethical Issues in Class Action Settlements and Opt Outs

Will Upcoming Decisions Regarding the Application of Statutes of Repose and Limitations Fundamentally Change the Securities Class Action Landscape?

Peter M. Saparoff, Esq. Alec J. Zadek, Esq. Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. Boston, MA

INTRODUCTION In the upcoming year, the Second and Ninth Circuit are poised to determine significant issues pertaining to the application of the Supreme Court decision, American Pipe and Construction Co. v. Utah, 414 U.S. 538 (1974) (“American Pipe”), to putative class member’ claims. Specifically, pending before both courts are appeals regarding whether or not: (1) American Pipe applies to toll statutes of repose; and (2) the statute of limitation or repose for purported claims included within class allegations are tolled by American Pipe even where the named plaintiff lacks standing to assert those claims. Overview of Statutes of Repose and Limitations

A statute of repose demarcates a fixed period of time within which a plaintiff can file a complaint. See Arivella v. Lucent Techs., Inc., 623 F. Supp. 2d 164, 172 (D. Mass. 2009). In short, a statute of repose is the outermost time for filing suit. Statutes of repose are designed to provide finality and certainty to defendants. In contrast, a statute of limitations is a period within which a plaintiff must file suit after he or she becomes aware of the injury suffered. Id. The purpose of a statute of limitations is to ensure that defendants are provided with notice of the claims against them within a certain period of time. The significance between the two periods is that a statute of repose may run before a plaintiff is aware that he or she has suffered an injury. It follows that a statute of repose may bar a potential plaintiff’s claim before the plaintiff is even aware of the injury. Application of American Pipe to Statutes of Limitations For potential class members, the application of statutes of limitations and statutes of repose is of paramount importance. Often, putative class actions proceed for a year or more without a decision on class certification. By the time there is a decision on class certification, the periods set forth in the applicable statutes of limitations and repose may have expired. In 1974, the Supreme Court, in American Pipe, provided guidance on this issue by holding that the commencement of a class action tolled the statute of limitations for potential plaintiffs until the court issued a decision on class certification. Specifically, the Court held that “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.” American Pipe, 414 U.S. at 554. In reaching its decision the Court noted that to deny tolling for potential class members “is simply inconsistent with Rule 23 . . . .” Id. at 550. According to the Court, a contrary conclusion, would frustrate the purpose of Rule 23 “because then the sole means by which members of the class could assure their participation in the judgment if notice of the class suit did not reach them until after the running of the limitation period would be to file earlier individual motions to join or intervene as parties.” Id. at 551. That scenario would obviate the purpose of Rule 23 altogether. Subsequently, the Court extended the holding in American Pipe to toll the statute of limitations for claims by potential class members who decided to opt-out of the underlying litigation after class certification was denied. Crown, Cork & Seal Co. v. Parker, 462 U.S. 345, 350 (1983). Neither American Pipe nor Crown, Cork & Seal reached the issue of whether the commencement of a class action tolled the statute of repose until the determination of class certification. As discussed below, there is growing uncertainty regarding the application of American Pipe to statutes of repose by district courts. This uncertainty could increase during 2013, when the Second and Ninth Circuits likely will rule on this issue, potentially expanding the divide between courts. Uncertainty Regarding the Application of American Pipe to Statutes of Repose As a general matter, a statute of limitations may be tolled for equitable reasons. This type of tolling is referred to as “equitable tolling.” Equitable tolling is a judicially created doctrine that stops the statute of limitations from running in certain instances involving unfairness or excusable neglect. For example, a statute of limitations will be tolled where a plaintiff filed defective pleading during the statutory period or where the plaintiff was induced or tricked by the defendant’s misconduct into allowing the filing deadline to pass. See Joseph v. Wiles, 223 F.3d 1155, 1166 (10th Cir. 2000). Equitable tolling does not similarly apply to toll statutes of repose. In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991), the Supreme Court, addressing claims under § 10(b) of the 1934 Act for fraudulent concealment, held that the applicable statute of repose was “inconsistent with tolling” and that “[b]ecause the purpose of the [statute of repose] is clearly to serve as a cutoff, we hold that tolling principles do not apply to that period.” Id. at 363. The decision in Lampf left open the possibility that a statute of repose could be tolled by another type of tolling, referred to as “legal tolling.” Legal tolling has been described as “the tolling that occurs any time an action is commenced and class certification is pending,” (Joseph, 223 F.3d at 1166), and as a species of tolling that is “derived from a statutory source.” Arivella, 623 F. Supp. 2d at 176. A majority of courts have distinguished the holdings in Lampf and Ameican Pipe by finding that the tolling described in American Pipe constitutes “legal tolling.” See Joseph, 223 F.3d at 1166-1168; Arivella, 623 F. Supp. 2d at 176;

see also Maine State Retirement Sys., 722 F. Supp. 2d at 1166 (holding that American Pipe applied to statutes of repose); In re Morgan Stanley Mortgage Pass-Through Certificates Litig., 2011 WL 4089580 (S.D.N.Y. Sept. 15, 2011) (same); Int’l Fund Mgmt. v. Citigroup, Inc., 2011 WL 4529640 (S.D.N.Y. Sept. 30, 2011) (same). More recently, the minority view, that American Pipe does not toll statutes of repose, has gained traction, particularly in the Southern District of New York. Footbridge Ltd. Trust v. Countrywide Financial Corp., 770 F. Supp. 2d 618 (S.D.N.Y. 2011); In re Lehman Bros. Sec. & ERISA Litig., 800 F. Supp. 2d 477 (S.D.N.Y. 2011); In re Indymac Mortgage-Backed Sec. Litig., 793 F. Supp. 2d 637 (S.D.N.Y. 2011); Albano v. Shea Homes Ltd. P’ship., 227 Ariz. 121 (2011). At this time, the Tenth Circuit, in Joseph v. Wiles, is the only Circuit Court to address the application of American Pipe. This likely will change during the course of the next year as the application of American Pipe to statutes of repose is pending before both the Second Circuit and Ninth Circuit. A Recent Appeal to the Ninth Circuit Questions the Applicability of American Pipe to Statutes of Repose and to Putative Class Members When the Lead Plaintiff Lacks Standing to Assert Their Claims The Ninth Circuit, in Stichting Pensioenfonds ABP v. Countrywide Fin. Corp., No. 11-56642 and 11-57135, is poised to decide the application of American Pipe tolling to putative class members’ claims when, subsequent to the commencement of the class action, it is determined that the named plaintiffs lack standing to assert claims on their behalf. The application of American Pipe to statutes of repose is also at issue in Stichting Pensioenfonds. Prior to the Stichting Pensioenfonds litigation, in 2007 and 2008, two class actions were filed against Countrywide Financial Corporation (“Countrywide”) and other defendants, alleging securities violations arising out of the sale of residential mortgage-backed securities between 2004 and 2007. The class actions, Luther v. Countrywide Home Loans Servicing LP, No. BC 380698 (Cal. Super. Ct.), and Washington State Plumbing and Pipefitting Pension Trust v. Countrywide Financial Corp., No. BC 392571 (Cal. Sup. Ct.), were later consolidated (together “Luther”). In 2010, Luther was dismissed for lack of subject matter jurisdiction. In the aftermath of the dismissal, several plaintiffs filed their own actions against Countrywide asserting allegations that were nearly identical to those alleged in Luther. Stichting Pensioenfonds concerns two such securities actions filed in 2010 and 2011. As with the other plaintiffs asserting claims against Countrywide, the Stichting Pensioenfunds plaintiffs relied on Luther to toll the statutes of limitation and repose with respect to their claims. One issue with this strategy was that the putative class in Luther included tranches of residential mortgage-backed securities that were not purchased by any of the named plaintiffs. This issue first arose in a similar action, captioned Maine State, where the district court held that American Pipe tolling only applied to those claims for which the Luther plaintiffs had standing. Maine State Retirement Sys. v. Countrywide Fin. Corp., 722 F. Supp. 2d 1157, 1166-1167 (C.D. Cal. 2010). Notably, the court held that to the extent claims were tolled by Luther, the holding in American Pipe applied to toll both the statute of limitations and the statute of repose. See id. at 1166. In Stichting Pensioenfonds, the court relied on its earlier decision in Maine State, to hold that the Luther complaints only tolled claims for securities which the named plaintiffs in Luther actually purchased. The plaintiffs appealed this decision. The Ninth Circuit’s decision in Stichting Pensioenfonds will determine whether or not American Pipe tolling applies to the purported putative class or only to those potential class members whose purchased the same securities as those purchased by the named plaintiff. In deciding this case, the Ninth Circuit will have the opportunity to rule on whether or not American Pipe tolling also applies to statutes of repose.

The Second Circuit Is Also Poised to Decide the Application of American Pipe in Its Jurisdiction Currently, there is discord in the Second Circuit regarding the application of American Pipe to statutes of repose. Compare In re Morgan Stanley Mortgage Pass-Through Certificates Litig., 2011 WL 4089580 (holding that American Pipe applies to toll statutes of repose during the period between the commencement of a class action and the decision on class certification); Int’l Fund Mgmt. v. Citigroup, Inc., 2011 WL 4529640 with Footbridge Ltd. Trust v. Countrywide Financial Corp., 770 F. Supp. 2d 618 (holding that American Pipe does not extend to toll statutes of repose); In re Lehman Bros. Sec. & ERISA Litig., 800 F. Supp. 2d 477. The Second Circuit, in Police and Fire

Retirement System of Detroit v. Indymac MBS, Inc., 11-2998 (2d Cir.), will have the opportunity to resolve this dispute. Police and Fire Retirement System consists of a consolidated appeal from the decision, in In re IndyMac., 793 F. Supp. 2d 637. The underlying litigation and issues on appeal in Police and Fire Retirement System are nearly identical to Stichting Pensioenfonds. Specifically, the underlying litigation, filed in 2009, consists of a consolidated putative class action asserting that securities violations arising out of the defendants’ offering of mortgage-backed securities. Id. at 641. In 2010, the court partially granted defendants’ motions to dismiss, holding, among other things, that the named plaintiff lacked standing to assert claims related to the offering of securities except for those securities which it had purchased. Id. In order to cure this deficiency and others in the putative class’ complaint, several potential plaintiffs moved to intervene in the litigation. In ruling on the motions to intervene, the district court held that that American Pipe does not extend to toll statutes of repose; therefore, those claims for which the statute of repose already expired were barred. In re IndyMac, 793 F. Supp. 2d. at 642-643. The court went on to address whether the rule announced in American Pipe applied to those intervenor’s claims for which the named plaintiff lacked standing. Noting absence of Second Circuit or Supreme Court precedence on this issue, the court held that American Pipe applied to toll the statute of limitations for those intervenors whose claims could not be asserted by the named plaintiff. Id. at 646. The district court’s decision is now pending on appeal. The Second Circuit’s opinion will resolve the split amongst the district courts within its jurisdiction, but it may create a more significant split amongst the Circuit Courts. Conclusion The decisions by the Second Circuit and Ninth Circuit have the potential to alter the landscape for class action litigation in the United States. For defendants, if American Pipe tolls the statute of repose and statute of limitations for all claims alleged by the named plaintiffs, then their exposure to liability would be extended far beyond any statute of repose. This uncertainty may lead to financial instability. On the other hand, if American Pipe does not toll the statute of repose and extends only to those claims for which the named plaintiff actually has standing, putative plaintiffs will have to decide between filing their own action or assuming the risk that they will lose the ability to pursue their claim if the named plaintiff lacks standing to assert it. As a result of this uncertainty for putative plaintiffs, institutional investors, such as pension funds, who are not covered by the named plaintiff’s claims, may assert their own claims or become class plaintiffs. Due to their significance and complexity, the issues underlying the application of American Pipe likely will not be fully resolved prior to a decision by the Supreme Court.

7399689v.2

The Good, the Bad and the Ugly: Legal & Ethical Issues in Class Action Settlements and Opt Outs

Why Institutional Investors Would Opt Out of Securities Class Actions:

Peter M. Saparoff, Esq. Alec J. Zadek, Esq. Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. Boston, MA

INTRODUCTION In the upcoming year, the Second and Ninth Circuit are poised to determine significant issues pertaining to the application of the Supreme Court decision, American Pipe and Construction Co. v. Utah, 414 U.S. 538 (1974) (“American Pipe”), to putative class member’ claims. Specifically, pending before both courts are appeals regarding whether or not: (1) American Pipe applies to toll statutes of repose; and (2) the statute of limitation or repose for purported claims included within class allegations are tolled by American Pipe even where the named plaintiff lacks standing to assert those claims. Overview of Statutes of Repose and Limitations A statute of repose demarcates a fixed period of time within which a plaintiff can file a complaint. See Arivella v. Lucent Techs., Inc., 623 F. Supp. 2d 164, 172 (D. Mass. 2009). In short, a statute of repose is the outermost time for filing suit. Statutes of repose are designed to provide finality and certainty to defendants. In contrast, a statute of limitations is a period within which a plaintiff must file suit after he or she becomes aware of the injury suffered. Id.

The purpose of a statute of limitations is to ensure that defendants are provided with notice of the claims against them within a certain period of time. The significance between the two periods is that a statute of repose may run before a plaintiff is aware that he or she has suffered an injury. It follows that a statute of repose may bar a potential plaintiff’s claim before the plaintiff is even aware of the injury. Application of American Pipe to Statutes of Limitations For potential class members, the application of statutes of limitations and statutes of repose is of paramount importance. Often, putative class actions proceed for a year or more without a decision on class certification. By the time there is a decision on class certification, the periods set forth in the applicable statutes of limitations and repose may have expired. In 1974, the Supreme Court, in American Pipe, provided guidance on this issue by holding that the commencement of a class action tolled the statute of limitations for potential plaintiffs until the court issued a decision on class certification. Specifically, the Court held that “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.” American Pipe, 414 U.S. at 554. In reaching its decision the Court noted that to deny tolling for potential class members “is simply inconsistent with Rule 23 . . . .” Id. at 550. According to the Court, a contrary conclusion, would frustrate the purpose of Rule 23 “because then the sole means by which members of the class could assure their participation in the judgment if notice of the class suit did not reach them until after the running of the limitation period would be to file earlier individual motions to join or intervene as parties.” Id. at 551. That scenario would obviate the purpose of Rule 23 altogether. Subsequently, the Court extended the holding in American Pipe to toll the statute of limitations for claims by potential class members who decided to opt-out of the underlying litigation after class certification was denied. Crown, Cork & Seal Co. v. Parker, 462 U.S. 345, 350 (1983). Neither American Pipe nor Crown, Cork & Seal reached the issue of whether the commencement of a class action tolled the statute of repose until the determination of class certification. As discussed below, there is growing uncertainty regarding the application of American Pipe to statutes of repose by district courts. This uncertainty could increase during 2013, when the Second and Ninth Circuits likely will rule on this issue, potentially expanding the divide between courts. Uncertainty Regarding the Application of American Pipe to Statutes of Repose As a general matter, a statute of limitations may be tolled for equitable reasons. This type of tolling is referred to as “equitable tolling.” Equitable tolling is a judicially created doctrine that stops the statute of limitations from running in certain instances involving unfairness or excusable neglect. For example, a statute of limitations will be tolled where a plaintiff filed defective pleading during the statutory period or where the plaintiff was induced or tricked by the defendant’s misconduct into allowing the filing deadline to pass. See Joseph v. Wiles, 223 F.3d 1155, 1166 (10th Cir. 2000). Equitable tolling does not similarly apply to toll statutes of repose. In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991), the Supreme Court, addressing claims under § 10(b) of the 1934 Act for fraudulent concealment, held that the applicable statute of repose was “inconsistent with tolling” and that “[b]ecause the purpose of the [statute of repose] is clearly to serve as a cutoff, we hold that tolling principles do not apply to that period.” Id. at 363. The decision in Lampf left open the possibility that a statute of repose could be tolled by another type of tolling, referred to as “legal tolling.” Legal tolling has been described as “the tolling that occurs any time an action is commenced and class certification is pending,” (Joseph, 223 F.3d at 1166), and as a species of tolling that is “derived from a statutory source.” Arivella, 623 F. Supp. 2d at 176. A majority of courts have distinguished the holdings in Lampf and Ameican Pipe by finding that the tolling described in American Pipe constitutes “legal tolling.” See Joseph, 223 F.3d at 1166-1168; Arivella, 623 F. Supp. 2d at 176; see also Maine State Retirement Sys., 722 F. Supp. 2d at 1166 (holding that American Pipe applied to statutes of repose); In re Morgan Stanley Mortgage Pass-Through Certificates Litig., 2011 WL 4089580 (S.D.N.Y. Sept. 15, 2011) (same); Int’l Fund Mgmt. v. Citigroup, Inc., 2011 WL 4529640 (S.D.N.Y. Sept. 30, 2011) (same).

More recently, the minority view, that American Pipe does not toll statutes of repose, has gained traction, particularly in the Southern District of New York. Footbridge Ltd. Trust v. Countrywide Financial Corp., 770 F. Supp. 2d 618 (S.D.N.Y. 2011); In re Lehman Bros. Sec. & ERISA Litig., 800 F. Supp. 2d 477 (S.D.N.Y. 2011); In re Indymac Mortgage-Backed Sec. Litig., 793 F. Supp. 2d 637 (S.D.N.Y. 2011); Albano v. Shea Homes Ltd. P’ship., 227 Ariz. 121 (2011). At this time, the Tenth Circuit, in Joseph v. Wiles, is the only Circuit Court to address the application of American Pipe. This likely will change during the course of the next year as the application of American Pipe to statutes of repose is pending before both the Second Circuit and Ninth Circuit. A Recent Appeal to the Ninth Circuit Questions the Applicability of American Pipe to Statutes of Repose and to Putative Class Members When the Lead Plaintiff Lacks Standing to Assert Their Claims The Ninth Circuit, in Stichting Pensioenfonds ABP v. Countrywide Fin. Corp., No. 11-56642 and 11-57135, is poised to decide the application of American Pipe tolling to putative class members’ claims when, subsequent to the commencement of the class action, it is determined that the named plaintiffs lack standing to assert claims on their behalf. The application of American Pipe to statutes of repose is also at issue in Stichting Pensioenfonds. Prior to the Stichting Pensioenfonds litigation, in 2007 and 2008, two class actions were filed against Countrywide Financial Corporation (“Countrywide”) and other defendants, alleging securities violations arising out of the sale of residential mortgage-backed securities between 2004 and 2007. The class actions, Luther v. Countrywide Home Loans Servicing LP, No. BC 380698 (Cal. Super. Ct.), and Washington State Plumbing and Pipefitting Pension Trust v. Countrywide Financial Corp., No. BC 392571 (Cal. Sup. Ct.), were later consolidated (together “Luther”). In 2010, Luther was dismissed for lack of subject matter jurisdiction. In the aftermath of the dismissal, several plaintiffs filed their own actions against Countrywide asserting allegations that were nearly identical to those alleged in Luther. Stichting Pensioenfonds concerns two such securities actions filed in 2010 and 2011. As with the other plaintiffs asserting claims against Countrywide, the Stichting Pensioenfunds plaintiffs relied on Luther to toll the statutes of limitation and repose with respect to their claims. One issue with this strategy was that the putative class in Luther included tranches of residential mortgage-backed securities that were not purchased by any of the named plaintiffs. This issue first arose in a similar action, captioned Maine State, where the district court held that American Pipe tolling only applied to those claims for which the Luther plaintiffs had standing. Maine State Retirement Sys. v. Countrywide Fin. Corp., 722 F. Supp. 2d 1157, 1166-1167 (C.D. Cal. 2010). Notably, the court held that to the extent claims were tolled by Luther, the holding in American Pipe applied to toll both the statute of limitations and the statute of repose. See id. at 1166. In Stichting Pensioenfonds, the court relied on its earlier decision in Maine State, to hold that the Luther complaints only tolled claims for securities which the named plaintiffs in Luther actually purchased. The plaintiffs appealed this decision. The Ninth Circuit’s decision in Stichting Pensioenfonds will determine whether or not American Pipe tolling applies to the purported putative class or only to those potential class members whose purchased the same securities as those purchased by the named plaintiff. In deciding this case, the Ninth Circuit will have the opportunity to rule on whether or not American Pipe tolling also applies to statutes of repose.

The Second Circuit Is Also Poised to Decide the Application of American Pipe in Its Jurisdiction Currently, there is discord in the Second Circuit regarding the application of American Pipe to statutes of repose. Compare In re Morgan Stanley Mortgage Pass-Through Certificates Litig., 2011 WL 4089580 (holding that American Pipe applies to toll statutes of repose during the period between the commencement of a class action and the decision on class certification); Int’l Fund Mgmt. v. Citigroup, Inc., 2011 WL 4529640 with Footbridge Ltd. Trust v. Countrywide Financial Corp., 770 F. Supp. 2d 618 (holding that American Pipe does not extend to toll statutes of repose); In re Lehman Bros. Sec. & ERISA Litig., 800 F. Supp. 2d 477. The Second Circuit, in Police and Fire Retirement System of Detroit v. Indymac MBS, Inc., 11-2998 (2d Cir.), will have the opportunity to resolve this dispute.

Police and Fire Retirement System consists of a consolidated appeal from the decision, in In re IndyMac., 793 F. Supp. 2d 637. The underlying litigation and issues on appeal in Police and Fire Retirement System are nearly identical to Stichting Pensioenfonds. Specifically, the underlying litigation, filed in 2009, consists of a consolidated putative class action asserting that securities violations arising out of the defendants’ offering of mortgage-backed securities. Id. at 641. In 2010, the court partially granted defendants’ motions to dismiss, holding, among other things, that the named plaintiff lacked standing to assert claims related to the offering of securities except for those securities which it had purchased. Id. In order to cure this deficiency and others in the putative class’ complaint, several potential plaintiffs moved to intervene in the litigation. In ruling on the motions to intervene, the district court held that that American Pipe does not extend to toll statutes of repose; therefore, those claims for which the statute of repose already expired were barred. In re IndyMac, 793 F. Supp. 2d. at 642-643. The court went on to address whether the rule announced in American Pipe applied to those intervenor’s claims for which the named plaintiff lacked standing. Noting absence of Second Circuit or Supreme Court precedence on this issue, the court held that American Pipe applied to toll the statute of limitations for those intervenors whose claims could not be asserted by the named plaintiff. Id. at 646. The district court’s decision is now pending on appeal. The Second Circuit’s opinion will resolve the split amongst the district courts within its jurisdiction, but it may create a more significant split amongst the Circuit Courts. Conclusion The decisions by the Second Circuit and Ninth Circuit have the potential to alter the landscape for class action litigation in the United States. For defendants, if American Pipe tolls the statute of repose and statute of limitations for all claims alleged by the named plaintiffs, then their exposure to liability would be extended far beyond any statute of repose. This uncertainty may lead to financial instability. On the other hand, if American Pipe does not toll the statute of repose and extends only to those claims for which the named plaintiff actually has standing, putative plaintiffs will have to decide between filing their own action or assuming the risk that they will lose the ability to pursue their claim if the named plaintiff lacks standing to assert it. As a result of this uncertainty for putative plaintiffs, institutional investors, such as pension funds, who are not covered by the named plaintiff’s claims, may assert their own claims or become class plaintiffs. Due to their significance and complexity, the issues underlying the application of American Pipe likely will not be fully resolved prior to a decision by the Supreme Court.

7399689v.2

WHY INSTITUTIONAL INVESTORS WOULD OPT OUT OF SECURITIES CLASS ACTIONS PROS & CONS AND ISSUES FACED IN OPT OUT LITIGATION

Presented at ABA Annual Conference Chicago, IL April 25, 2013

Sherrie R. Savett Chair, Securities Litigation Department Berger & Montague, P.C. 1622 Locust Street Philadelphia, PA 19103 215-875-3071 [email protected]

2

Changing the Traditional Approach Will Increase Asset Recovery for Shareholders • Traditionally, if a securities fraud arose, institutional investors would take a passive approach and file a proof of claim in the settled class action, collecting its proportionate share • Large institutional investors are now frequently filing individual actions and opting out of class actions because the results obtained for opt out shareholders are often many times greater than what can be obtained by just filing a proof of claim in a settled class action

3

Snapshot: Pros and Cons of Opt Out Litigation Pros: • Increased Asset Recovery ▫ Opt-out cases often result in greatly increased recoveries over passive class participation • Greater Control Over Outcome ▫ The opt out investor can control its own litigation strategy and settlement, including insistence on corporate governance reforms • Claims Are Easier to Litigate ▫ No class certification issues; may have additional state law claims; increased leverage; greater flexibility; faster distribution of settlement funds • Shareholder Protection/Good Business Practice ▫ Individual litigation can satisfy fiduciary duties owed to an institutional investor’s stakeholders

4

Snapshot: Pros and Cons of Opt Out Litigation (cont.) Cons: • More time and effort compared to being an absent class member ▫ Overall supervision of the litigation process ▫ Cost of actually litigating; out-of-pocket costs can be significant, e.g. experts ▫ Review and approval of pleadings, briefs, etc. ▫ Document productions ▫ Deposition/trial testimony • There’s no guarantee the opt out recovery will be greater than what the recovery would have been as an absent class member

5

Increased Asset Recovery Often Results From Opt Out Litigation • Recent history has shown how institutions can achieve a much greater recovery by opting out of the class to pursue direct individual claims • Examples: ▫ ▫ ▫ ▫ ▫ ▫ ▫

Worldcom AOL Time Warner Qwest Tyco Merrill Lynch Bank of America Lehman

6

Increased Asset Recovery (cont.) • Worldcom (2005) ▫ $6.2 billion class settlement ▫ 65 large institutional investors, including California and New York pension funds, opted out of class, settling for a claimed 3 times greater recovery than they would have received under the class settlement

7

Increased Asset Recovery (cont.) • AOL/Time Warner (2006)

▫ $2.4 Billion class settlement ▫ More than 100 institutional opt outs

 Pennsylvania pension funds (represented by Berger & Montague) – $23 million settlement  Ohio pension funds – $175 million settlement – over 4 times class recovery  CalPERS – $117.7 million settlement – 17 times class recovery  State of Alaska – $50 million settlement – 50 times class recovery  Janus Capital Group – Owned 10% of Time Warner and 3% of AOL prior to merger

8

Increased Asset Recovery (cont.) • Qwest (2005-2007) ▫ $400 million class settlement ▫ $411 million in reported opt-out settlements  New Jersey Division of Investment (represented by Berger & Montague) – $45 million settlement many times greater than class settlement  Texas, California, and Alaska pension funds all reported settlements in excess of 30 times their respective recoveries under the class settlement

9

Increased Asset Recovery (cont.) • Lehman (2011-present) ▫ $90 million class settlement with D&Os ▫ $23 million in opt-out settlements with D&Os to date ▫ More than 30 opt out cases filed

10

Increased Asset Recovery (cont.) $80 $70 $60 $50

Opt-out Recovery Estimated InClass Recovery

$40 $30 $20 $10 $0 Alaska Funds AOL/Time Warner

Alaska Funds Qwest

Texas Teachers Qwest

Colorado Pub. Empl. Ret. Assoc. Qwest

CalSTRS Qwest

New Jersey Tyco

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Increased Asset Recovery (cont.) Fund & Case

Opt-Out Settlement (Millions)

Estimated Class Recovery (Millions)

Opt-Out Recovery Multiple

Alaska Funds AOL/Time Warner

$50

$1

50

U.C. Regents AOL/Time Warner

$246

$14.5

16-24

CalPERS AOL/Time Warner

$117.7

$6

17

Ohio Funds AOL/Time Warner

$144

$9

16

CalSTRS AOL/Time Warner

$105

$15

7

Alaska Funds Qwest

$19.0

$0.4

44.5

Texas Teachers Qwest

$61.6

$1.4

44.0

Colorado Pub. Empl. Ret. Assoc. Qwest

$15.5

$0.4

38.8

CalSTRS Qwest

$46.5

$1.6

30

New Jersey Tyco

$73.25

$4.2

17

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Increased Asset Recovery (cont.) • Many prominent institutional investors, including mutual fund companies, have opted out to pursue direct individual actions: ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫

AUSA Life Insurance Company Blackrock Federated Investors Franklin Mutual Advisors Fred Alger & Company Janus Capital Group Munder Capital Nuveen Investments Oaktree Capital Management PIMCO Russell Investments Stark Investments Stichting Pensionenfunds ABP The Vanguard Group (Enron bond litigation)

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Greater Control Over Outcome • Ability to select and direct own legal counsel ▫ Passive class participants have no choice of counsel, litigation strategy, or settlement approval • Ability to negotiate attorneys’ fees ▫ Passive class participants have no say in attorneys’ fees unless they choose to object • Absolute settlement authority ▫ Opt outs are not subject to the class settlement calculus or court approval process

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Claims Are Easier to Litigate • No class certification issues ▫ Individual claims are not subject to increasingly strict standards for granting class certification, including proving presumed reliance and class-wide damages • Individual action may allow the pursuit of additional claims ▫ An individual action can be brought in state court, where the investor may be able to pursue additional and more expansive liability and damages claims, including against aiders and abettors and for punitive damages, while avoiding heightened federal pleading requirements under the PSLRA and FRCP 9(b ▫ Claims may also be brought for securities (such as preferred stock, bonds, or options) not covered by the class action ▫ Claims may be brought against additional defendants not named in the class action

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Claims Are Easier to Litigate (cont.) • Increased Leverage ▫ Large institutional investors (particularly indexed investors) are often long-term shareholders that the defendant company knows must be dealt with, by way of both cash settlement and corporate governance reforms ▫ Institutional investor also has leverage when it comes to settlement, which can lead to enhanced recovery  Defendants are unlikely to settle class case without resolving at the same time a large individual case that is outstanding

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Claims Are Easier to Litigate (cont.) • Faster distribution of settlement funds ▫ No need for court approval or claims forms; individual settlements usually call for payment within 30 to 45 days ▫ Class process, by contrast, takes a minimum of 120 days after settlement is reached and often much longer, sometimes years, because of objections, appeals, and the distribution process, which usually takes one year or more.

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Shareholder Protection/Good Business Practice • Funds owe fiduciary duty to shareholders to seek to recover when fraud has been committed ▫ This is likely a bigger concern for public institutional investors (pension funds) than private ones (hedge funds)

• Increasing recovery through individual action serves both shareholders and the funds, and is good business practice ▫ Shareholders obtain enhanced recovery over class settlement ▫ Increasing assets in the funds is good business practice

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Cons of Opt Out Litigation • Much more time and effort compared to being an absent class member ▫ Opt out plaintiffs supervise the overall litigation process, review and approve pleadings and briefs, participate in discovery, control settlement negotiations, etc. ▫ Opt out plaintiffs are usually in frequent contact with their counsel ▫ Document production efforts can be significant, encompassing thousands or more pages of documents and burdensome searches for electronic and hardcopy documents ▫ Defendants will try to get a broad-based range of documents which involve trading strategies. Battles ensue over scope of documents sought.

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Cons of Opt Out Litigation (cont.) 

Deposition or trial testimony may be required from multiple employees which is distracting and time consuming. Third party money managers deposed which, with a big pension fund, can be many witnesses who sometimes produce inconsistent testimony which defendants use against the institution.

• The opt out plaintiff’s investment strategies or other inner workings could be made public ▫ This is likely a bigger drawback for hedge funds than pension funds

• There is no guarantee the recovery will be greater than as an absent class member

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Timing of the Opt Out Decision • Opt out decision can be made at any time up to opt out deadline • Alternatives: ▫ Upon notice of investor’s claims or commencement of class case ▫ Upon notice of class certification ▫ Upon notice of class settlement

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Timing of the Opt Out Decision (cont.) Considerations: ▫ Strategically it may be better to file an opt out case early to make the presence known to defendants ▫ Knowing that a large individual case exists affects the defendant’s allocation of settlement resources  The defendant will likely hold back amounts from the class case to resolve opt out cases  Mediation is often a vehicle for settlement – having a separate case on file grants a seat at the negotiating table

22

Timing of the Opt Out Decision (cont.) ▫ Opt outs could take a wait-and-see approach regarding success of the class claims  Await motion to dismiss ruling to gage strength of class claims  Await class settlement to gage need for better recovery

▫ Conversely, waiting too long could prejudice the opt out  Statute of limitations issues  Lost opportunity to coordinate discovery with the class and/or other opt outs  Fading memories of witnesses as time passes

23

Relationship Between Opt Outs and The Class Action • Coordinated pretrial proceedings are usually ordered via the MDL Panel or otherwise ▫ Efficiencies are gained from coordinating discovery and dispositive motions (motions to dismiss, summary judgment) ▫ The class may be ordered to brief dispositive motions before opt outs. This can allow opt outs to shape their arguments and strategies with the benefit of hindsight. Conversely, it can hurt opt outs if the judge’s rulings are adverse to the class and create a preclusive effect.

• Class counsel generally drives the train regarding settlement negotiations, discovery protocols, etc.

24

Considerations in the Decision to Bring an Individual Securities Action • Size of loss and estimated damages ▫ General threshold of $10 million minimum to pursue individual action

• Solvency of the Defendants to satisfy a reasonable settlement or judgment • Procedural status of the class action, including any favorable/unfavorable rulings by the Court

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Considerations in the Decision to Bring an Individual Securities Action (cont.) • Strength of case ▫ Look for strong cases that contain some of the following elements:  Restatement of earnings  Governmental action or critical reports (e.g., SEC or DOJ investigation, FDA denial of drug approval)  Insider selling  Sharp stock drop contrary to market trend  Restructuring/Resignations of key officials  Internal investigations  Recall of product

▫ Avoid cases where stock drop appears to be based on missed earnings projections