The District Court for the Southern District of New York recently addressed whether the “next best” or “reasonable approximation” standard should apply when the court evaluates proposed cy pres designations in class action settlements. Observing that the Second Circuit had not definitively resolved this issue to date, the district court engaged in a thorough evaluation of the origins, justifications, and policy implications of the two standards. In the end, the court concluded that the reasonable approximation standard was superior and consistent with the court’s mandate throughout the settlement approval process: to approve a fair, reasonable, and adequate settlement; not the best possible one.

The issue arose in the final stages of the consolidated securities fraud class actions brought by Citigroup shareholders seeking to recover the losses they suffered when Citigroup shares declined in value during the Great Recession. See generally In re Citigroup Inc. Sec. Litig., 753 F. Supp. 2d 206 (S.D. N.Y. 2010). After years of litigation, the parties settled with Citigroup agreeing to create a $590 million fund to compensate the class and pay legal fees and costs. The settlement agreement contained a clause that authorized lead class counsel to donate any unclaimed funds to charitable organizations once redistribution of such funds was no longer feasible – commonly referred to as a cy pres designation. The district court approved the settlement in 2013.

The claims administrator distributed 99.9 percent of the fund over the course of the next three years leaving only $374,820 remaining as of February 2016. Lead counsel then declared that it was no longer feasible to make further distributions and designated three non-profits to receive the remainder. The district court initially approved these cy pres designations but then granted an objecting class member’s motion to reconsider filed three days later. The objector did not contest that further distributions were unfeasible; rather, his sole argument was that the cy pres designees did not have a sufficiently close nexus to the class and the purpose of the litigation. Specifically, the objector argued that cy pres designees must be the “next best” recipients apart from the class members themselves and not recipients – like those lead counsel had designated – whose interests merely “reasonably approximate” the interests being pursued by class.

The district court began its analysis by observing that the cy pres doctrine originated in Roman and English trust law in which courts could take trust funds previously designated for a purpose now defunct and reallocate the money to some other purpose consistent with the settlor’s original goals in creating the trust. The court commented that because cy pres in trust law is designed to honor the original purpose of the trust as much as possible, the nexus between the cy pres designee and the trust’s original beneficiary should be “very snug.” Modern courts have borrowed from such time-honored trust law and approved class action cy pres designations only when two elements are met: (1) further distributions to class members are not feasible; and (2) the cy pres designee bears some relationship to the original class.

The extent of the “relationship” necessary to satisfy the second element is the source of scholarly debate and has given rise to the two different standards. Advocates for the “next best” standard, including the Ninth Circuit, find support in the trust law origins of the cy pres doctrine, including that the name itself derives from the Norman French expression meaning, “as near as possible.” Advocates for the “reasonably approximate” standard, including several district courts in the Second Circuit, find support in §3.07(c) of the American Law Institute’s publication, Principles of the Law of Aggregate Litigation, which states that before a court approves a cy pres designation, it “should require the parties to identify a recipient whose interests reasonably approximate those being pursued by the class.”

With this foundation, the district court evaluated the following factors to help inform its decision on the appropriate cy pres standard: (a) the relative purposes of trust and class action cy pres designations; (b) the effectiveness of each standard in protecting the interests of class members; and (c) the potential that each standard would have for promoting judicial efficiency.

First, the court found that the purposes of trust and class action cy pres were sufficiently different to make the court wary of importing the trust concept wholesale into the context of class action settlements. For example, the court noted that the trust law goal of preserving the grantor’s original purpose carried less force in class action settlements because the ultimate goal – compensating the class members – had almost already been achieved at the point when further distributions to class members are not feasible.

Next, the court determined that neither standard was effective in maximizing class members’ recovery from a settlement fund. The court reasoned that the best way to protect the interests of the class is to focus on when cy pres awards are deployed – not to limit to whom they may be deployed – by insisting that such designations occur only when it is no longer feasible to distribute funds to the class. Moreover, the court observed that by the time cy pres designations are made at the tail end of the litigation, the risk that class counsel might harm the class by acting on hypothetical conflicts of interest in selecting designees was too low to justify adoption of the more stringent “next best” standard. The court commented that at the end of the litigation, “class counsel has presumably already proved worthy of the court’s trust” and “is entitled to a certain amount of leeway.”

Finally, the court concluded that the next best standard would tax judicial resources and expose the court to the appearance of impropriety by embroiling the court in policy disputes judging the comparative worth of our nation’s public interest organizations about which courts have no knowledge.

Based on the foregoing, the court adopted the “reasonable approximate” standard because it best preserves the court’s broad supervisory powers regarding the administration and allocation of settlement funds and provides the court with needed flexibility to review cy pres designations by class counsel. The court then proceeded to reevaluate each of the designees proposed by lead counsel to determine whether they reasonably approximated the interests of the class, approved all three of them, and authorized lead counsel to make the distributions from the remaining settlement funds.

In Re Citigroup, Inc. Securities Litigation, No. 07-cv-9901 (S.D. N.Y. August 9, 2016)