The United States District Court for the Northern District of California has rejected a proposed settlement in a securities fraud class action, issuing an opinion that reflects overarching concerns for weaknesses in the class action mechanism and carries potentially wider implications for other lawsuits. In re Chiron Corp. Sec. Litig., No. C-04-4293 (N.D. Cal. Nov. 30, 2007).
The court addressed four issues suggesting that the settlement was "negotiated under questionable circumstances" and that class members were not adequately represented: (1) excessive class counsel fees, (2) failure to disclose in the class notice the number of opt-out shares that would trigger defendants' right to terminate the settlement, (3) inadequacy of the lead plaintiff based on its role as lead plaintiff in many lawsuits, and (4) perceived conflicts arising from criminal charges pending against class counsel (Milberg Weiss) and the relationships between the lead plaintiff, class counsel, and defendants' counsel. After raising and addressing these issues sua sponte, the court concluded that it could not make a finding that the proposed settlement was fair and reasonable.
The court first addressed the proposed class counsel fees of $7.5 million, which comprised 25 percent of the proposed $30 million settlement fund. Noting the lack of incentive for a class action defendant to contest the amount allocated to attorney fees, the court made a lengthy analysis of the fee award, multiplying the hours worked on the case by the respective billing rates of class counsel (commonly known as a "lodestar cross-check"). The court criticized the proposed breakdown of fees that class counsel submitted, objecting to the inclusion of support staff costs as attorney fees rather than reimbursable expenses. The court also disagreed with class counsel's proposed billing rates, instead using an attorney fees matrix prepared by the U.S. Attorney's Office for the District of Columbia. Notably, under this matrix, the hourly rate for class counsel's most experienced lawyer was valued at approximately $460, rather than $920, as proposed by class counsel. The proposed class counsel fee award was eight to 10 times greater than the fee resulting from the court's lodestar analysis; hence, the court found, class counsel's proposed fee implied a multiplier of eight to 10. The court contrasted this figure with other common fund securities class action awards, which, according to the court's own experience and a recent study of similar awards, ordinarily involve a multiplier of only two to four. The court acknowledged that some multiplier was appropriate, as the case was prosecuted on a contingency basis. However, the court found that the proposed multiplier of eight to 10 was "patently unreasonable."
The court next addressed a supplemental agreement showing the number of shares that, if held by class members opting out of the settlement, would trigger the defendants' right to terminate the settlement. Counsel for both sides asked that this number be concealed from class members, arguing that revealing it would encourage shareholders to opt out and frustrate settlement. The court rejected this argument, stating that the agreement and "the merits of the settlement agreement are not so easily distinguished because class counsel represents the class, or at any rate, are supposed to do so." The court further explained that it was "hard-pressed to discern why [a] shareholder should not be told that he has the leverage to scuttle the settlement." The court also found that counsel's argument "hint[ed] at something darker still," acknowledging the possibility of collusion between defendants' counsel and class counsel.
The court also considered "the questionable adequacy of [the] lead plaintiff and purported representative." The court pointed out that the lead plaintiff, a union local, apparently made no effort to lower class counsel fees and maximize class recovery. The court also found a lack of "sufficient assurances of [the lead plaintiff's] independence from class counsel," explaining that the lead plaintiff had served as lead plaintiff or as a plaintiff in several other shareholder class actions with the same class counsel. The court found that class counsel's "use of 'serial plaintiffs' rais[ed] the specter of credibility problems and conflicts of interest." The court also expressed concern over the fact that lead plaintiff had been selected without open competition. The court concluded that approving settlement would be "inconsistent with the interests of absent class members and the class action process itself," as "[t]hat process presupposes that a single representative can stand in for, and monitor the litigation on behalf of, numerous others."
Finally, the court addressed concerns that class counsel effectively had made itself the class representative and had serious conflicts of interest with class members. The court discussed criminal investigations of Milberg Weiss and Lerach Coughlin Stoia Geller Rudman & Robbins, LLP (since renamed Coughlin Stoia), which also represented certain class plaintiffs. Lead counsel and attorneys from both firms had been accused of making illegal kickback payments to class action plaintiffs; lead counsel and some of the individual attorneys had pleaded not guilty, while at least two of the lawyers involved in the case had pleaded guilty. These allegations, the court explained, "go to the very heart of the fiduciary duties owed to absent class members by a lead plaintiff and lead counsel in a class action." The criminal charges heightened the court's fairness concerns, as "the kickback arrangements alleged criminally are that lead counsel gave the paid plaintiffs a greater interest in maximizing the amount of attorney fees awarded to lead counsel than in maximizing the net recovery to absent class members."
The court pointed out that Lerach Coughlin had been represented during the pendency of the class action by Skadden Arps Slate Meagher and Flom, which also represented defendants in the class action. The court explained that two other plaintiffs originally had sought appointment as lead plaintiff with Lerach Coughlin as lead counsel but had later withdrawn the motion, leaving the decision as to lead plaintiff and class counsel uncontested. The court wrote that it was "troubled whether Skadden Arps is able to probe the adequacy of lead plaintiff and/or lead counsel lest a rigorous challenge uncover problems that might be traced back to Lerach Coughlin." The court surmised that "class counsel, lead plaintiff, lead counsel's former attorneys now in Lerach Coughlin . . . , defendants and defendants' counsel—but not the class—had an interest in avoiding discovery into the adequacy of lead plaintiff." The court further warned that "[w]hen class counsel are not effectively monitored by the class representative, the result is indistinguishable from the situation in which an attorney serves as both class counsel and class representative" and found that the facts suggested that "lead counsel has effectively made itself the class representative and has assumed control of this action." The court maintained that it did not express an opinion on the merits of the pending criminal charges, but concluded that "given the temporal proximity of this settlement and the criminal proceedings against lead counsel, whether the charges bear on this case is a determination best left to the class following full disclosure."