In re Cendant Corp. Litigation

Brief Fact Summary.

A $3.2 billion settlement was approved by the district court of a securities fraud class action brought against Cendant Corp. (Defendants) and its auditors, Ernst & Young, and $262 million was awarded in fees to counsel for the plaintiff class. The selection of the CalPERS Group (Plaintiff) by the court as lead plaintiff and its utilization of an auction to choose lead counsel were confronted.

Synopsis of Rule of Law.

(1) A court is not guilty of discretion abuse where it appoints a group of plaintiffs with the most financial interest in the relief sought by the class as lead counsel, that is sophisticated, that is able to select competent class counsel, operate efficiently, that is capable of representing the class interestsufficiently and fairlyand that is not subject to unique defenses that cause it to be unable to sufficiently represent the class in a case governed by the Private Securities Litigation Reform Act (PSLRA).
(2) A court may not use an auction to select lead counsel as a matter of first resort, in a case governed by the Private Securities Litigation Reform Act (PSLRA).

Facts.

A $3.2 billion settlement of a securities fraud class action was approved by the district court and brought against Cendant Corp. and its auditors, Ernst & Young, and the plaintiff class was awarded $262 million in fees to counsel. A group comprised of three pension funds (the CalPERS Group) was selected by the court as lead plaintiff.  As instructed by the Private Securities Litigation Reform Act (PSLRA), the court identified that Group as being the movant with the largest financial interest in the relief sought by the class. The court concluded that the CalPERS Group was the presumptive lead plaintiff, once they found the CalPERS Group as satisfying the adequacy and typicality requirements. Without a rebuttal to this statutory presumption, the lead plaintiff was appointed as CalPERS Group by the court. Then the CalPERS Grouprequested that the court appoint as lead counsel two firms it had elected. The court originally refused, opting to select lead counsel through an auction, however, the court permitted  the CalPERS Group’s chosen counsel the choice to match what the court decided to be thelowest qualified bid. That option was exercised by the firms and they were appointed as lead counsel. The petition of lead counsel of $262 million in fees was at least $76 million higher than that listed under its retainer agreement with the CalPERS Group. The court’s use of an auction to choose lead counsel and its selection of CalPERS as lead plaintiff were challenged, and the court of appeals granted review.

Issue.

(1) Is a court guilty of discretion abuse where it appoints a group of plaintiffs with the most financial interest in the relief sought by the class as lead counsel, that is sophisticated, that is able to select competent class counsel, operate efficiently, that is capable of representing the class interest sufficiently and fairly and that is not subject to unique defenses that cause it to be unable to sufficiently represent the class in a case governed by the Private Securities Litigation Reform Act (PSLRA)? (2) May a court use an auction to select lead counsel as a matter of first resort, in a case governed by the Private Securities Litigation Reform Act (PSLRA)?

Held.

(Becker, C.J.) No. A court is not guilty of discretion abuse where it appoints a group of plaintiffs with the most financial interest in the relief sought by the class as lead counsel, that is sophisticated, that is able to select competent class counsel, operate efficiently, that is capable of representing the class interest sufficiently and fairly and that is not subject to unique defenses that cause it to be unable to sufficiently represent the class in a case governed by the Private Securities Litigation Reform Act (PSLRA). With regard to a securities class action, there is the possibility for economic conflict betwixt the interests of lead counsel and the class.Counsel looks to maximize their net fee, whereas the client hopes to maximize net recovery, as a result of this possible conflict, courts needed to oversee the relationship betwixt the class and its lawyers. Oftentimes the lead plaintiff was an unsophisticated investor who may not have led a significant counsel selection process so they tried different ways of choosing lead counsel, one of which is by auction, where the court asks for law firm bids and chooses the lowest bidder that the court feels will satisfactorily represent the class. The court not weighing quality v. cost as an actual client would and bids in huge, possibly high-recovery cases are probably quite complex and may be hard for a court to accurately assess relative costs to the class, are two of the issues with this method. Legal scholars have argued that institutional investors are very capable to select, retain and monitor lead counsel in securities class actions and Congress created a two-step process for appointing a lead plaintiff specified in the PSLRA. The first step is for the court to find the presumptive lead plaintiff (by finding the movant with the “the largest financial interest in the relief sought by the class”) and then decides if anyone from the putative class has rebutted this presumption. In close cases, the factors to consider are; number of shares the movant bought throughout the class period, total net funds expended throughout that timeframe, losses endured by plaintiffs, and if the possible lead plaintiff is willing and able to choose competent class counsel and negotiate a rational retainer arrangement with them.  If a group is a possible lead plaintiff the court may consider if the group can satisfactorily and fairly defend the interests of the class, for the PSLRA has no condition mandating that members of a proper group be “related†in some way – only that any group “fairly  and  adequately  protect the interests of the class.”  The movant group must not be too large to properly represent the class, the court will determine this via a rule of reason. As soon as the presumptive lead plaintiff has been chosen, the presumption is up for rebuttal by a class member only through evidence that this chosen one will not fairly and adequately defend the interests of the class or is exposed to special defenses that make plaintiff powerless to suitably represent the class. The district court properly identified the CalPERS Group as the presumptively most acceptable plaintiff, as per application of the standards in this case. Provided their legal sophistication and ability to select well-qualified counsel, a no rebuttal of the presumption that this group of the three largest pension funds in the U.S. could adequately protect the class’s interests was lacking. There was no reason to believe this group was artificially created or too large to operate competently on the class’ behalf, nor was the group’s retainer agreement unreasonable. Attempts to rebut the presumption that the CalPERS Group should be lead plaintiff was not successful when it determined that claims that the CalPERS Group hired counsel due to political contributions counsel had made (pay­ to-play) were not backed up with adequate evidence, was decided correctly by the district court.

(2) No. In PSLRA governed cases, a court is not to utilize an auction to choose lead counsel as a first resort. Supported by the structure of the statute (which explicitly permits the lead plaintiff the power to “select and retain” lead counsel), the PSLRA makes it known that initially power rests with the lead plaintiff, not with the court. This was passed in hopes of encouraging large, sophisticated investors to become lead counsel for Congress felt they would do a good job choosing competent lead counsel. The PSLRA’s legislative history also supports this conclusion, solidifying Congress’ intention for lead plaintiff to choose lead counsel. The court may disqualify a lead plaintiff if that individual will not adequately and fairly represent the class interests by insisting on a more expensive counsel and appoint another who could serve in the proper capacity, however, this would not force the court to appoint the movant whose lawyer stated they would work for much less. A presumptive lead plaintiff that denies the counsel of fee terms decided through an auction is not reason to believe that it will not adequately represent the class interests. Congress asserts that institutional investors may choose proper class counsel more intelligently than the courts so just because they choose different lawyers from the ones chosen by the court does not mean that their abilities to represent the class should be questioned and so the courts query is restricted to if the lead plaintiff’s choice and agreement with counsel are, on their own terms, reasonable. An auction could be appropriate in certain situations but application of these principles here did not justify the district court in conducting an auction. The argument that the court’s willingness to allow counsel selected by CalPers Group to match the district court’s determination of the lowest qualified bid completely shielded the CalPERS Group’s right to “select and retain†lead counsel was rejected. This is due to the court’s order providing the matching power to the CalPERS Group’s choice of counsel, not the Group, which failed to conserve the Group’s capability to “select†lead counsel and because the court’s order meant that the choice of the Group would only be recognized if it were made pursuant to fee terms put in place by the district court. The court’s approach damaged the CalPERS Group’s capacity to “retain†counsel as well. The explanations provided by the court for arranging an auction (to keep down costs, to squash doubt regarding pay-to-play claims and the understanding between counsel and institutional investors that have potential to lessen arms-length bargaining) are not sufficient as they stand to warrant an auction. The district court exploited its discretion by arranging an auction as evidenced by the reasons above. Because the counsel selected were the same as those the lead plaintiff wanted appointed initially, this mistake was harmless.

Discussion.

Even though the court here came to the conclusion that only a class member is permitted to challenge the presumptive lead counsel’s appointment, there have been rulings by other courts that there is nothing in the PSLRA that impedes or limits defendants the right to challenge a motion to appoint lead plaintiff or class counsel but usually do not allow interlocutory appeals to those appointments