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									            THE BUSINESS LAWYER
      Section of Business Law ! American Bar Association
              University of Maryland School of Law

                              ARTICLES
    Function Over Form: A Reassessment of Standards of Review
                    in Delaware Corporation Law
         William T. Allen, Jack B. Jacobs and Leo E. Strine, Jr.
      Second-Generation Shareholder Bylaws: Post-Quickturn
                              Alternatives
                 John C. Coates IV and Bradley C. Faris
     The Fiduciary Duties of Institutional Investors in Securities
                               Litigation
                Craig C. Martin and Matthew H. Metcalf
   Trying to Hear the Whistle Blowing: The Widely Misunderstood
       “Illegal Act” Reporting Requirements of Exchange Act
                              Section 10A
                         Thomas L. Riesenberg
     On-Line Broker-JDealers: Conducting Compliance Reviews
                             in Cyberspace
                Joseph M. Furey and Beth D. Kiesewetter
               Extrajurisdictional Practice by Lawyers
                            William T. Barker
                               REPORTS
                   Corporate Director’s Guidebook
                     Committee on Corporate Laws
     Changes in the Model Business Corporation Act--Proposed
      Amendments Relating to Domestications and Conversions
                     Committee on Corporate Laws
   PEB Report: Article 9 Perfection Choice of Law Analysis Where
    Revised Article 9 Is Not in Effect in All States by July 1, 2001
Permanent Editorial Board for the Uniform Commercial Code, The American Law
 Institute, and the National Conference of Commissioners on Uniform State Laws
                               SURVEY
        The Uniform Commercial Code Survey: Introduction
       Robyn L. Meadows, Carl S. Bjerre, and Stephen L. Sepinuck
                                  Sales
John D. Wladis, Larry T. Garvin, Martin A. Kotler, and Robyn L. Meadows
                                                   continued on back cover

                  August 2001 ! Volume 56 ! Number 4
                                  Leases
  Lawrence F. Flick, II, Edwin E. Huddleson, III, and Stephen T. Whelan
                                Payments
         Stephen C. Veltri, Marina I. Adams, and Paul S. Turner
                      Letters of Credit: 2000 Cases
                  James G. Barnes and James E. Byrne
          Article 7: Documents of Title – 2000 Developments
                             Drew L. Kershen
                          Recent Article 8 Cases
                           Howard Darmstadter
      U.C.C. Article 9: Personal Property Secured Transactions
                             Steven O. Weise
                                Litigation
                 Jeffrey J. Wong and Steven W. Sanford
  Survey of International Commercial Law Developments: 1999-2000
                  Sandra M. Rocks and B. Shea Owens



THE BUSINESS LAWYER                                UNIVERSITY OF MARYLAND
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The Fiduciary Duties of Institutional Investors in Securities Litigation


By Craig C. Martin and Matthew H. Metcalf*


INTRODUCTION

         “I have the greatest practice in the world because I have no clients. I bring the case. I hire
the plaintiff. I do not have some client telling me what to do. I decide what to do”1 These are the
words of a famous plaintiffs’ securities lawyer, known to the legal community and Congress as the
“King of Strike Suits.”2 His statement epitomizes the wide-spread perception that securities fraud
class actions have become “lawyer-driven” and are typically initiated and controlled by plaintiffs’
counsel.3 As a result of this perception, Congress enacted the Private Securities Litigation Reform
Act (PSLRA) in 1995.4 This Article will discuss briefly the history of the PSLRA and the
mechanisms by which an institutional investor, such as a pension plan, may take the lead role in
securities fraud class action lawsuits under this Act. This Article will discuss some of the benefits
that an institutional investor might gain from being active in these cases, as well as some of the
unique concerns institutional investors must consider when contemplating such activity, in light of
their fiduciary obligations under the Employee Retirement Income Security Act (ERISA).5 Finally,
this Article will look to the future of institutional investor involvement in securities class actions
under the PSLRA.

HISTORY OF THE PSLRA

        The major impetus behind the PSLRA was the widespread perception that securities fraud
class action lawsuits had become little more than a mechanism used by plaintiffs’ lawyers to build
their own wealth.6 The legislative history of the Act describes Congress’ review of “significant
evidence of abuse in private securities lawsuits,” including “the manipulation by class action lawyers



       1
         See In re Network Assocs. Inc., Sec. Litig., 76 F. Supp. 2d 1017, 1032 (N.D. Cal. 1999)
(quoting Milberg, Weiss, Bershad, Hynes & Lerach LLP partner William Lerach), amended, class
cert. denied, request granted, No. C 99-01729 WHA Class Action, 1999 U.S. Dist. LEXIS 21484
(N.D. Cal. Nov. 22, 1999).
       2
        Id.
       3
        Id. at 1020.
       4
        See Private Securities Litigation Reform Act (PSLRA) of 1995, 15 U.S.C. §§ 77z-1, 78u-4
(Supp. V 1999). For the sake of simplicity, citations hereinafter will refer to 15 U.S.C. § 77a-1
exclusively.
       5
        29 U.S.C. § 1104 (1994).
       6
        See, e.g., Tim Oliver Brandi, The Strike Suit: A Common Problem of the Derivative Suite
and the Shareholder Class Action, 93 DICK. L. REV. 355 (1994).
of the clients whom they purportedly represent.”7 Congress further expressed its concern about the
proliferation of “professional plaintiffs” who owned nominal numbers of shares but allowed lawyers
to file abusive class actions on their behalf.8 Additionally, Congress found that the existing system
encouraged such class actions regardless of their legal merit; plaintiffs inevitably profited, regardless
of the defendant’s culpability, because most defendants and their insurers would rather settle than
incur the legal fees and expenses required for motion practice, discovery, preparation, and trial.9

        The intellectual backdrop for the PSLRA came from a 1995 law review article by Elliot J.
Weiss and John S. Beckerman.10 Weiss and Beckerman studied the stake of institutional investors
in class actions and discovered that the fifty largest claimants in a sample of class actions accounted
for more than fifty-seven percent of the value of the claims filed.11 Weiss and Beckerman criticized
the then-existing class action procedures as deterring institutional investors from involvement in
suits and proposed changes favoring large investors.12 The authors argued for reforms that they felt
would spur activism and would allow institutional investors to take on a leadership role and
effectively act as a monitor against frivolous strike suits.13

         Congress embraced the rationale of Weiss and Beckerman when developing the PSLRA,
citing studies showing that institutional are America’s largest shareholders and have the most to gain
from meritorious litigation.14 Further, Congress expected that an increased role for institutional
investors would benefit both injured shareholders and the courts, and that institutional investors
would, consistent with their fiduciary obligation, be able to balance the interests of the class and the
long-term interests of the company.15

       The PSLRA encourages institutional investors and pension funds to participate in securities
fraud class action suits through provisions that provided them with enhanced opportunities to




        7
        See H.R. CONF. REP. No. 104-369, at 31 (1995), reprinted in 1995 U.S.C.C.A.N. 697, 730
[hereinafter House Conference Report].
        8
         See id. at 32, 1995 U.S.C.C.A.N. at 731.
        9
         Id. at 31, 1995 U.S.C.C.A.N. at 730.
        10
          See Elliot J. Weiss & John S. Beckerman, Let the Money Do the Monitoring: How
Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 YALE L.J. 2053
(1995).
        11
             See id. at 2056.
        12
             See id. at 2126.
        13
             See id. at 2105-09.
        14
        See S. REP. No. 104-98, at 11 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 690 [hereinafter
Senate Report].
        15
             See id.
undertake the role of class representative, or lead plaintiff.16 By favoring institutional investors,
Congress sought to “increase the likelihood that parties with significant holdings in issuers, whose
interests are more strongly aligned with the class of shareholders, will participate in the litigation
and exercise control over the selection and actions of plaintiff’s counsel.”17 With these incentives,
the PSLRA aims to “empower investors so that they, not their lawyers, control securities litigation”
by transferring “primary control of private securities litigation from lawyers to investors.”18

PSLRA PROCEDURAL MECHANISMS FAVORING INSTITUTIONAL
INVESTORS

        The PSLRA changed the procedural mechanisms applying to securities class action litigation
in an effort to procedurally advantage larger investors, such as institutional investors, seeking to
control such litigation. This section provides a brief overview of the mechanisms created by the
PSLRA and discusses how these mechanisms work to the advantage of institutional investors
seeking to take control of securities class action litigation. In addition, a few of the cases applying
these mechanisms will be discussed to give a view of how these PSLRA mechanisms have in fact
advantaged institutional investors in specific instances.

       PROCEDURAL OVERVIEW

         The heart of the PSLRA is the statutory procedures enacted to determine which party will
be allowed to control securities class action litigation as the “lead plaintiff.”19 The lead plaintiff
provisions of the PSLRA are the critical mechanisms by which Congress sought to implement the
goals of the act. These provisions are intended to encourage the most capable representative of the
potential class to act as lead plaintiff.20 The key PSLRA provisions serving this purpose are the
notice and certification requirements, the “most adequate plaintiff” presumption, and the specific
restrictions imposed on “professional plaintiffs.”21

       Notice and Certification Requirements

        The PSLRA’s notice and certification procedures allow investors to learn about a lawsuit and
then file to become lead plaintiff. The person filing an initial complaint under the PSLRA is
required to notify all class members that a claim has been filed to provide other potential lead
plaintiffs with an opportunity to step forward. To this end, the filing plaintiff must publish notice
to class members within twenty days stating that an action is pending, what claims are asserted, and



       16
            See House Conference Report, supra note 7, at 34, 1995 U.S.C.C.A.N. at 733.
       17
            See id. at 32.
       18
            See Senate Report, supra note 14, at 6, 1995 U.S.C.C.A.N. at 685.
       19
            See PSLRA, 15 U.S.C. § 77z-1(a)(3) (Supp. V 1999).
       20
            See id. § 77z-1(a)(3)(B)(i).
       21
            See id. § 77z-1(a)(2)-(3).
the length of the class period.22 The intent of this notice provision is to eliminate the “race to the
courthouse” problems under prior law, which rewarded speedy filing over diligent investigation.23
Under the PSLRA, first-filing plaintiffs must compete for “lead plaintiff” status with any member
of the purported class which chooses to file a motion to serve as lead plaintiff within sixty days after
the publication of the required notice.24

        Some courts and other institutions are taking advantage of the Internet to distribute PSLRA-
required information. For instance, the U.S. District Court for the Northern District of California
has issued local rules implementing the PSLRA which require, in part, that certain documents
including pleadings, briefs, and affidavits be posted to a designated Internet site.25 In addition,
California’s Stanford University runs a web-based securities class action clearinghouse which posts
notice of actions, pleadings, and other documents.26

         Under the PSLRA, the person filing the complaint must also file a certification which states
(i)that they have authorized filing of a complaint; (ii) that they did not purchase the security at
plaintiff counsel’s urging; (iii) that they are willing to serve as lead plaintiff; (iv) details of all their
transactions in the security at issue; (v) any other class action in which the person or entity was
involved; and (vi) that they will not accept payment for serving as lead plaintiff.27 Although the
statute states that “[e]ach plaintiff seeking to serve as a representative party on behalf of a class shall
provide a sworn certification”28 detailing these six requirements, at least one district has held that
institutional investors seeking to become lead plaintiffs after the filing of an initial complaint need
not comply with this certification requirement.29 In light of the important information provided by
this certification, including a statement of the potential lead plaintiff’s interest in the action, it would
seem prudent for the courts to require all plaintiffs, including institutional investors, to file such
certification.




        22
             See id. § 77z-1(a)(3)(A)(i).
        23
         See, e.g. John F. Olson, et al., Pleading Reform, Plaintiff Qualification and Discovery Stays
under the Reform Act, 51 BUS. LAW. 1101, 1104, (1996).
        24
             See 15 U.S.C. § 77z-1(a)(3)(A)(i), (B)(i).
        25
             See U.S.D.C. N.D. CAL. CIVIL L.R. 23-2 (1995).
        26
          See Stanford Securities Class Action Clearinghouse (visited June 23, 2001 available at
<http.://securities.stanford.edu.
        27
             See 15 U.S.C. § 77z-1(a)(2).
        28
             Id.
        29
        See Blaich v. Employee Solutions, Inc. [Supp. 1998 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 90, 403, at 90, 146 (D. Ariz. Nov. 21, 1997) (holding that institutional investor need not
comply with certification requirements).
        The “Most Adequate Plaintiff” Presumption

       The PSLRA creates a rebuttable presumption that the most adequate plaintiff is the “person
or group of persons” with the largest financial interest in the relief sought by the class—a
presumption which clearly favors an institutional investor’s appointment as lead plaintiff.30 There
are, however, a number of statutory procedures, discussed herein, which must be observed before
the court can designate a lead plaintiff.

        Within sixty days after publication of the required notice, any member of the purported class
may move to serve as lead plaintiff.31 Within ninety days after publication of the notice, the court
shall appoint as lead plaintiff the class member “most capable of adequately representing the
interests of class members.”32 The court is guided in this “most adequate plaintiff” determination
by a rebuttable statutory presumption in favor of the person or group of persons that: (i) has either
filed the complaint or made a motion to serve as lead plaintiff; (ii) has the largest financial interest
in the relief sought by the class; and (iii) otherwise satisfies the requirements of Rule 23 of the
Federal Rules of Civil Procedures.33

        Establishing the Presumption

       The key factor in determining the “most adequate plaintiff” presumption is whether the
movant has the largest financial interest in the relief sought by the class.34 The difficulty in this
determination is the language of the statute which allows a “person or group of persons” to be
considered for the position of lead plaintiff.35 This has led plaintiffs’ class action lawyers to attempt
to aggregate large groups of small investors, and then argue that this otherwise unrelated “group”
holds the largest financial interest.36 Some courts have taken the position that allowing the
aggregation of unrelated plaintiffs eviscerates the PSLRA’s intent to have one large, sophisticated
investor with a major financial interest lead the class.37 Other courts have relied on the statutory
language that refers to the lead plaintiff as a “person or group of persons” to hold that congress


        30
             See 15 U.S.C. § 77z-1(a)(3)(B)(iii).
        31
             See id. 77z-1(a)(3)(i)(II).
        32
             See id. 77z-1(a)(3)(B)(i).
        33
             See id. 77z-1(a)(3)(B)(iii)(bb).
        34
             See id. 77z-1(a)(3)(B)(ii)(I)(bb).
        35
             See id. 77z-1(a)(3)(B)(iii)(I).
        36
         See, e.g., Bowman v. Legato Sys., Inc. [2000 Transfer Binder] Fed. Sec. L. Rep. (CCH)
¶ 91,049, at 94,887-88 (N.C. Cal. July 28, 2000) (rejecting motion of 1,000 aggregated shareholders
for appointment as lead plaintiff).
        37
        See In Re Network Assoc., Inc. Sec. Litig., 76 F. Supp. 2d 1017, 1023 (N.D. Cal. 1999)
amended, class cert. denied, request granted, No. C 99-01729 WHA Class Action, 1999 U.S. Dist.
LEXIS 21484 (N.C. Cal. Nov. 22, 1999); see also In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156,
157 (S.D.N.Y. 1997); Gluck v. Cellstar Corp., 976 F. Supp. 542, 549 (N.D. Tex. 1997).
envisioned an aggregate group of lead plaintiffs.38 This debate over the proper interpretation of the
“group of persons” language is one of the most significant open questions relating to the PSLRA’s
lead plaintiff provisions.

        Once a court makes a determination as to which “person or groups of persons” will be
allowed to compete for the lead plaintiff position, a relatively straightforward four-factor test is often
used to determine which group has the largest financial interest: (i) number of shares purchases;
(ii) number of net shares purchased; (iii) total net funds expended by the plaintiffs during the class
period; and (iv) approximate losses suffered by the plaintiffs.39

        The other major factor in establishing the most adequate plaintiff presumption is the
prospective lead plaintiff’s satisfaction of the requirements of Rule 23 of the Federal Rules of Civil
Procedure.40 The most important Rule 23 requirements with regard to a lead plaintiff are, first, that
the class representative’s claim be typical of the class and, second, that the class representative fairly
and adequately protects the interests of the class.41 As discussed in the next subsection, parties
opposing institutional investors as lead plaintiffs have argued that such investors fail to meet
typicality or adequacy requirements for a variety of reasons. In light of the PSLRA’s clear intent
to increase the role of institutional investors in securities class action litigation, most courts have
rejected such challenges.

        Rebutting the Presumption

       A plaintiff that satisfies the three statutory factors listed above is presumed to be “the most
adequate plaintiff.”42 If a prospective lead plaintiff successfully establishes this presumption, it may
be rebutted “only upon proof by a member of the purported plaintiff class that the presumptively
most adequate plaintiff:”



        38
          See In re Party City Sec. Litig. 189 F.R.D. 91, 112-13 (D.N.J 1999); ss also D’Hondt v.
Digi Int’l, Inc. Nos., CIV. 97-5 JRT RLE, CIV. 97-295 JRT RLE, CIV. 97-156 JRT RLE, CIV. 97-
538 JRT RLE, CIV. 97-351 JRT RLE, CIV. 97-440 JRT RLE, 1997 WL 405668 at *4 (D. Minn.
April 3, 1997); see also In re Oxford Health Plans, Inc., Sec. Litig., 182 F.R.D. 42, 47 (S.D.N.Y.
1998).
        39
         See, e.g., In re Party City Sec. Litig., 189 F.R.D. 91, 105 (D.N.J. 1999); Lax v. First
Merchants Acceptance Corp., No. 97 C 2715, 97 C 2716, 97 C 2737, 97 C 2791, 97 C 3767, 97 C
4237, 97 C 4013, 97 C 4236, 1997 WL 461036, at *5 (N.D. Ill. Aug. 11, 1997); In re Olsten Corp.
Sec. Litig., 3 F. Supp 2d 286, 295 (E.D. N.Y. 1998).
        40
             See 15 U.S.C. § 77z-1(a)(3)(B)(iii)(I)(cc).
        41
         See FED. R. CIV. P. 23(a) (“One or more members of a class may sue or be sued as
representative parties on behalf of all only if (1) the class is so numerous that joinder of all members
is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or
defenses of the representative parties are typical of the claims or defenses of the class, and (4) the
representative parties will fairly and adequately protect the interests of the class.”).
        42
             15 U.S.C. § 77a-1(a)(3)(B)(iii)(I).
         (i)        will not fairly and adequately protect the interests of the class; or
         (ii)       is subject to unique defenses which render it incapable of adequately representing the
                    class.43

Both of these types of “rebuttal” evidence relate back to the typicality and adequacy requirements
of Rule 23 of the Federal Rules of Civil Procedure. Thus, in most cases, these kinds of rebuttal
arguments will be addressed when the court determines who the “presumptively most adequate
plaintiff” is in the first instance.

        The PSLRA’s legislative history indicates that the purpose of the rebuttal provision is to
placate fears that large investors might conspire with the management of the defendant company and
to provide potential lead plaintiffs with a mechanism to argue this issue.44 Parties challenging the
appointment of institutional investors as lead plaintiffs have raised a host of other “typically” and
“adequacy” arguments:

         •          Some plaintiffs argue that an investor who retains an interest in the defendant
                    company while pursuing a securities fraud claim against that company cannot fairly
                    or adequately represent a class of plaintiffs who no longer have shares in the
                    defendant company.45
         •          Other plaintiffs have argued that an institutional investor’s claim is not typical of the
                    claims of the class at large because institutional investors are more sophisticated in
                    making investment decisions and, therefore, might not be justified in relying on
                    certain misrepresentations or omissions.46
         •          Additionally, institutional investors have been opposed as potential lead plaintiffs on
                    the basis that their independent fiduciary obligations make institutional investors
                    unable to fairly and adequately represent the interest of the class.47

Each of these challenges has been addressed and generally rejected by various courts. Courts have
most often been persuaded that the underlying intent of the PSLRA to increase the role of
institutional investors is fundamentally inconsistent with arguments that such investors are, for




         43
              See id. § 77z-1(a)(3)(B)(iii)(II).
         44
              See House Conference Report, supra note 7, at 34, 1995 U.S.C.C.A.N. at 733.
         45
        See, e.g., Gluck v. Cellstar Corp., 976 F. Supp. 542, 548 (N.D. Tex. 1997) (rejecting
argument that institutional investor cannot adequately protect the claims of the class because it had
an ongoing interest in the defendant corporation).
         46
         See e.g., Chan v. Orthologic Corp., No. CIV 96-1514 PHX RCV, 1996 WL 108212, at *5
(D. Ariz. Dec. 17, 1996) (holding that sophistication argument is contrary to Congress’ intent to
encourage institutional investors to act as lead plaintiffs).
         47
              See, e.g., In re Oxford Health Plans, Inc., Sec. Litig., 182 F.R.D. 42, 46-47 (S.D.N.Y.
1998).
structural reasons, inadequate or atypical class representatives.48 These issues of typicality and
adequacy of institutional investors are discussed in further detail herein.

       Discovery Relating to the Most Adequate Plaintiff

         The PSLRA limits the ability of other plaintiff challengers to receive discovery regarding
a prospective lead plaintiff. A challenger can discover information relating to the presumptively
“most adequate plaintiff” only if it can first demonstrate, prior to such discovery, a “reasonable basis
for a finding that the presumptively most adequate plaintiff is incapable of adequately representing
the class.”49 District courts have generally rejected a defendant’s attempts to use this PSLRA
provision to conduct discovery regarding the presumptive lead plaintiff, unless another plaintiff class
member has established a reasonable basis for finding that the potential lead plaintiff is inadequate.50

       Restrictions on “Professional Plaintiffs” and Their Counsel

        In addition to the lead plaintiff mechanisms described above, the PSLRA incorporates further
mechanisms to limit the ability of class action lawyers to drive the litigation through nominally
interested plaintiffs with small stakes in the security at issue. One such mechanism is specifically
intended to restrict “professional plaintiffs,” by declaring that a person may serve as a lead plaintiff
in no more than five securities class actions within any three-year period.51 Although the House
Conference Report specifically states that this “professional plaintiff” restriction is not intended to
apply to institutional investors, courts are split on the issue,52 Although some district courts have
held that this requirement does not apply to institutional investors,53 other courts have reached the
opposite conclusion.54



       48
           See, e.g., Gluck v. Cellstar Corp., 975 F. Supp. 542, 547-48 (N.D. Tex. 1997) (reasoning
that institutional investors cannot be challenged as lead plaintiffs based on characteristics common
to all institutional investors, such as sophistication).
       49
            See PSLRA, 15 U.S.C. § 77z-1(a)(3)(B)(iv)(Supp. V. 1999).
       50
         See Gluck, 976 F. Supp. at 546 (refusing discovery about Rule 23 unless another class
member demonstrated a reasonable basis for finding plaintiff inadequate or incapable of representing
the class); see also Greebel v. FTP Software, 939 F. Supp. 57, 61 (D. Mass. 1996) (stating that
defendants have standing to object to noncompliance with certification requirements but not over
who should be lead plaintiff).
       51
            See 15 U.S.C. § 77z-1(a)(3)(B)(vi).
       52
         See House Conference Report, supra note 7, at 35, 1995 U.S.C.C.A.N. at 734 (“Institutional
investors seeking to serve as lead plaintiff may need to exceed this limitation and do not represent
the type of professional plaintiff this legislation seeks to restrict.”)
       53
        See, e.g., Blaich v. Employee Solutions, Inc., [Supp. 1998 Transfer Binder] Fed. Sec. L.
Rep. (CCH) ¶ 90,109, at 90,146 (D. Ariz. Nov.21, 1997); see also Gluck, 976 F. Supp. at 548.
       54
        See, e.g., In re Telxon Corp. Sec. Litig., 67 F. Supp. 2d 803, 822 (N.D. Ohio 1999);
Aronson v. McKesson HBOC, Inc., 79 F. Supp. 2d 803, 822 (N.D. Ohio 1999).
         Another statutory mechanism intended to restrict the role of plaintiffs’ lawyers is a provision
requiring the lead counsel, subject to court approval.55 Through this provision, Congress expressed
a preference for the class representative to choose its own counsel, but retained the court’s discretion
to disapprove the lead plaintiff’s choice.56 The pre-PSLRA trend was to auction off lead counsel in
class actions by choosing the law firm that agreed to represent the class at the lowest rate.57
Concerns about attorneys’ fees, the rights of class members, and the statute apparently placing the
responsibility of choosing counsel on the lead plaintiff, have caused some courts to continue to
implement the modified auction approach.58 The U.S. District Court for the District of New Jersey,
for example, ordered that an auction be held and that plaintiff’s choice of counsel would be approved
if it could meet the lowest bid in the auction; otherwise, the position went to the lowest bidder.59
The U.S. District Court for the Northern District of Texas, on the other hand, simply approved the
lead plaintiff’s choice without much discussion.60 Although a lead plaintiff can find its own lawyer
under the PSLRA, a court might not necessarily agree with its choice, particularly if the courts use
this modified auction approach.

        COURTS HAVE SPECIFICALLY FAVORDD INSITUTIONAL INVESTORS
        UNDER PSLRA

        In deference to Congress’ clear preference for institutional investors to play a lead role in
securities fraud class actions, courts interpreting the language of the PSLRA have consistently
favored institutional investors, even “bending the rules” by appointing an institutional investor as
lead plaintiff even where the technical requirements of the PSLRA’s lead plaintiff, provisions may
not have been clearly satisfied. The examples discussed below show how courts have favored the
appointment of institutional investors as lead plaintiffs under the PSLRA.

        Switzenbaum v. Orbital Sciences Corporation61

        The PSLRA states that the class member with the largest financial interest in the outcome
is presumptively the “most adequate” lead plaintiff.62 The plaintiff with the largest financial interest,
however, is not always the institutional investor. The U.S. District Court for the Eastern District of
Virginia in Switzenbaum v. Orbital Sciences Corporation, decided that the New York City Pension


        55
             See 15 U.S.C. § 77z-1(a)(c)(B)(v).
        56
             See House Conference Report, supra note 7, at 35, 1995 U.S.C.C.A.N. at 734.
        57
             See In re Cendant Corp. Litig., 182 F.R.D. 144, 148-49 (D.N.J. 1998).
        58
             See id.
        59
             See id. at 151.
        60
        See Gluck v. Cellstar Corp., 976 F. Supp. 542, 550 (N. D. Tex. 1997); see also In re Oxford
Health Plans, Inc. Sec. Litig., 182 F.R.D. 42, 50 (S.D.N.Y. 1998).
        61
             187 F.R.D. 246 (D. Va. 1999).
        62
             See PSLRA of 1995, 15 U.S.C. § 77z-1(a)(3)(B)(iii)(I)(bb) (Supp. V. 1999).
Funds (NYCPF) was the best lead plaintiff even though it did not have the largest investment of the
class in the defendant company.63

        In Switzenbaum, the Orbital Sciences Corporation allegedly exaggerated Orbital’s business
successes for the first quarter of its 1998 fiscal year, thus inflating its stock price. A group of seven
individual investors who purchased Orbital securities at the inflated price filed suit and, calling
themselves the “Orbital Plaintiff Group,” moved to be appointed lead plaintiff. A group of several
New York City retirement funds, NYCPF, however, also filed a motion to be appointed lead
plaintiff. Although the seven members of the Orbital Plaintiff Group had together suffered greater
losses than NYCPF, the court was skeptical because the Orbital group did not provided information
about the identity of its members other than their names.64 The court also noted that the Orbital
Plaintiff Group could not agree on who the members of the group were, and the court decided that
this put their adequacy as representative in doubt.65

        NYCPF had the next largest loss and it had established mechanisms to make collective
decisions and to monitor their chose lead counsel. Consequently, NYCPF was chosen to be lead
plaintiff.66 The district court could have requested the Orbital Plaintiff Group to investigate further
to determine exactly what investors were in its class and strictly adhere to the “largest financial
interest” requirement. Instead, it chose an institutional investor, presuming that it was better able
to manage a class action securities fraud case.

        Blaich v. Employee Solutions, Inc.67

        The notice and certification requirements in the PSLRA state that a prospective lead plaintiff
or those filing a complaint must file a certification verifying that: (i) they have authorized the filing
of a complaint; (ii) they did not purchase the security at plaintiff counsel’s urging; (iii) details
regarding all transactions in the security at issue; (iv) class actions in which the person or group of
persons were previously involved; and (v) that the prospective lead plaintiff will not accept payment
for serving as lead plaintiff.68 The details that need to be stated in the certification imply that
Congress intended to impose strict disclosure requirements on individuals or entities filing a
certification to be a lead plaintiff. The U.S. District Court for the District of Arizona, however,
decided that these certification requirements could be overlooked when the institutional investor is
not the plaintiff who filed the complaint.




        63
             Switzenbaum, 187 F.R.D. at 251.
        64
             Id.. at 250.
        65
             Id. at 251.
        66
             Id.
        67
         [Supp. 1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,109, at 90,145 (D. Ariz.
Nov. 21, 1997).
        68
             See PSLRA, 15 U.S.C. § 77z-1(a)(2) (Supp. V 1999).
        In Blaich v. Employee Solutions, Inc., plaintiffs filed a securities fraud suit claiming that
officers of Employee Solutions, Inc. (ESI) artificially inflated the price of their stock through
misrepresentations and omissions in public filings, statements, and press releases. One group, the
Sucher plaintiffs (Sucher), sought to discover information about the City of Philadelphia so that they
could rebut the PSLRA presumption that Philadelphia was the most adequate plaintiff. Sucher
claimed that Philadelphia did not fulfill PSLRA requirements because it failed to file a timely
certification, the certification that Philadelphia did file was insufficient, and that Philadelphia
misstated its losses. The court rejected the discovery request and additionally found that Sucher was
not an adequate class representative.69

        The court also ruled that institutional investors did not have to comply with certification
procedures.70 It reasoned that the certification requirement applied only to those filing a complaint,
and that this PSLRA restriction applied to “professional plaintiffs”—not institutional investors.71
In addition, the court decided that because Philadelphia had the most losses, it was presumptively
the best lead plaintiff.72

         Neither the PSLRA nor its legislative history state that an institutional investor does not have
to comply with the certification procedures unless it is the plaintiff that filed the actual complaint.
The district court, however, waived these strict disclosure requirements to Philadelphia. Its
interpretation of the PSLRA was that “Congress mandated that a certification be filed with the
complaint but did not expressly require that a certification be filed with a motion to be appointed
lead plaintiff.”73 While the purpose of the certification would support a certification requirement
for all parties moving to act as lead plaintiff, regardless of whether that person or entity had filed
the complaint, this district court was willing to overlook this rationale in favor of an institutional
investor wishing to serve as lead plaintiff.74

          COURTS HAVE REJECTED CHALLENGES TO THE TYPICALITY OF
          INSTITUTIONAL INVESTORS AS LEAD PLAINTIFFS UNDER FEDERAL
          RULE 23

        As discussed above, in order to get the benefit of the PSLRA presumption, the prospective
lead plaintiff must satisfy the requirements of Rule 23 of the Federal Rules of Civil Procedure.75



          69
               See Blaich, [Supp. 1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 90,147.
          70
               Id. at 90,146.
          71
               Id.
          72
               Id. at 90,147.
          73
               See id. at 90,146 [quoting Greebel v. FTP Software, Inc., 939 F. Supp. 57, 61 (D. Mass.
1996)).
          74
               Id. at 90,146.
          75
               See PSLRA, 15 U.S.C. § 77z-1(a)(3)(B)(iii)(I)(cc) (Supp. V 1999).
Rule 23 requires that the claims or defenses of the parties be typical of the class.76 Many courts have
considered the question of whether an investor’s level of sophistication is relevant to proving
securities fraud; if it is, an institutional investor with more sophistication in investing could be
subject to a unique defense.

        In cases involving sophisticated investors, the argument is often made that because of their
sophistication, it is unlikely that they would be misled by misrepresentations and would know not
to rely on certain types of information.77 Before enactment of the PSLRA, several courts denied
class certification based on the sophisticated investor argument.78 Most courts, however, currently
reject this argument based on the PSLRA’s lead plaintiff provisions.

         For example, in Chan v. Orthologic Corp.,79 the U.S. District Court for the District of
Arizona dismissed a claim that the City of Philadelphia was too sophisticated to be the lead
plaintiff.80 The court noted that the PSLRA itself is evidence that Congress did not find that
institutional investors were improper plaintiffs even though they usually have greater market
expertise than small, individual investors.81 Similarly, in Gluch v. Cellstar Corp.,82 the U.S. District
Court for the Northern District of Texas rejected an argument that the State of Wisconsin Investment
Board (SWIB) was subject to a unique defense as a sophisticated investor and appointed the pension
fund as lead plaintiff.83 These cases indicate that courts interpreting the PSLRA will find that an
institutional investor’s sophistication, without more, does not violate the Rule 23 typicality
requirement.




       76
            See FED. R. CIV. P. 23(a).
       77
         See Jonathon R. Macy & Geoffrey P. Miller, The Plaintiffs’ Attorney’s Role in Class Action
and Derivative Litigation: Economic Analysis and Recommendation for Reform, 58 U. CHI. L. REV.
1, 72 (1991).
       78
          See J.H. Cohn & Co. v. American Appraisal Assocs., 628 F.2d 994, 998-99 (7th Cir. 1980)
(denying mutual fund’s request to act as lead plaintiff because the fund was familiar with financial
statements and may not have been justified in relying on misrepresentations or omissions or material
facts unlike other purchasers); See also Hanon v. Dataproducts Corp., 976 F.2d 497, 508-09 (9th Cir.
1992) (establishing similar argument against a “professional plaintiff”).
       79
            No. CIV 96-1514 PHX RCV, 1996 WL 1082812 (D. Ariz. Dec. 19, 1996).
       80
            See id. at *5.
       81
            Id.
       82
            976 F. Supp. 542 (N.D. Tex. 1997).
       83
            Id. at 547-48.
        INSTITUTIONAL INVESTORS AS LEAD PLAINTIFF: AN OPPORTUNITY,
        NOT A DUTY

        When Congress enacted the PSLRA, it gave large institutional investors, such as pension
plans, the opportunity to take control of securities fraud class actions. The PSLRA, however, itself
imposes no affirmative duty to serve as lead plaintiff.84 The PSLRA’s legislative history explicitly
states that Congress did not intend to impose any new fiduciary duty on institutional investors:

                   Although the most adequate plaintiff provision does not confer any new fiduciary
                   duty on institutional investors—and the courts should not impose such a duty—the
                   Conference Committee nevertheless intends that the lead plaintiff provision will
                   encourage institutional investors to take a more active role in securities class action
                   lawsuits.85

Although Congress expressed hope that institutional investors such as pension funds, consistent with
their duties to their beneficiaries, would provide fair and reasonable class representatives, the
PSLRA itself clearly does not require an institutional investor to litigate. But by heeding Congress’
call and acting as lead plaintiff in a securities fraud class action, an institutional investor utilizes its
enormous power to ensure a fair result and helps eliminate lawyer-driven securities litigation. In
this way, institutional investor involvement in securities litigation will serve the goals of Congress
in passing the PSLRA. In addition, the involvement of institutional investors in securities litigation
as lead plaintiffs may carry more tangible benefit to the investors themselves, as discussed in the
next section.

THE BENEFITS OF AN INSTITUTIONAL INVESTOR ACTING AS LEAD
PLAINTIFF

         The PSLRA does not require institutional investors to play an active role in securities fraud
claims. Accordingly, an institutional investor, like any other investor, must decide whether it is
worthwhile to serve as lead plaintiff, probably by engaging in an ordinary cost/benefit analysis.
Many institutional investors, however, may not yet realize the enormous benefits, both systemic and
direct, that increased participation in securities litigation may bring, and thus current perceptions
regarding the value of such participation need to be reexamined.

        Joseph A. Grundfest and Michael A. Perino suggest in a recent law review article that an
investor should consider three important issues when determining whether to seek appointment as
lead plaintiff under the PSLRA.86 First, an investor must consider whether involvement will result
in some gain above which would otherwise be recovered if the investor took a passive role.87

        84
             See PSLRA, 15 U.S.C. § 77z-1(a)(2)(A)(iii) (Supp. V 1999).
        85
             See House Conference Report, supra note 7, at 34, 1995 U.S.C.C.A.N. at 733.
        86
         See Joseph A. Grundfest & Michael A. Perino, The Pentium Papers: A Case Study of
Collective Institutional Investor Activism in Litigation, 38 ARIZ. L. REV. 559, 573-74 (1996)
[hereinafter The Pentium Papers].
        87
             Id. at 574.
Second, the prospective lead plaintiff should consider what the costs of the litigation might be.88
Third, the investor must consider what is at stake, including not only the amount of loss to be
recovered but also ancillary benefits to successful litigation, such as deterring future securities fraud
in the future.89

       Absent other factors, institutional investors should become involved in an action only if their
involvement yields some benefit beyond what would be gained by passivity and that gain would not
be subsumed by added costs of litigation.90 Passivity shields a pension plan from risk and from
disclosure of information it might like to keep confidential—but also limits the plan’s ability to
influence the outcome. As one district court judge noted, “as in other areas of economics,
minimization or risk leads to minimization of reward.”91

        There are substantial benefits that institutional investors provide to their beneficiaries,
shareholders, and other class members through participation in litigation as a lead plaintiff. These
potential benefits, properly considered, may spur institutional investors to shed their traditional
passive role in securities litigation and seek out opportunities to act as lead plaintiffs in appropriate
cases. This section discusses the potential systemic and direct benefits that institutional investors
should consider when deciding whether to seek appointments as lead plaintiffs under the PSLRA,
and further analyzes the positive role these investors can exert through increased involvement in
securities class action cases.

         SYSTEM BENEFITS FROM INCREASED INSTITUTIONAL INVESTOR
         PARTICIPATION

         Institutional investors’ participation provides a system benefit where such investors control
litigation, pursue meritorious claims, and limit shortsighted, opportunistic behavior by plaintiffs’
lawyers and “professional plaintiffs.” These are some of the benefits Congress envisioned when
passing the PSLRA. Some argue, however, that the benefits of institutional investor participation
may be realized even without formal participation as “lead plaintiff” in securities litigation.92 This
section will examine the system benefits of increased institutional investor participation, both formal
and informal.

         Formal Participation as Lead Plaintiff

        As lead plaintiff, institutional investors can influence, direct, and control the litigation and
utilize substantial resources to work toward a more favorable outcome. At the point when a
securities fraud claim is filed against a defendant corporation, institutional investors are more likely


         88
              Id.
         89
              Id.
         90
              See id.
         91
              See In re Horizon/CMS Healthcare Corp. Sec. Litig., 3 F. Supp. 2d 1208, 1214 (D.N.M.
1998).
         92
              See The Pentium Papers, supra note 86, at 561.
to retain an interest in the defendant company throughout the litigation. Therefore, through
involvement as a lead plaintiff, the institutional investor will inevitably consider the defendant
company—a result which is more economically beneficial in the long-run. Further, institutional
investors have more financial knowledge and legal expertise than small individual investors and are
more skilled at determining whether a securities fraud claim is meritorious or if it is just an attempt
to foster an easy settlement by plaintiffs’ counsel.

        In Gluck v. Cellstar Corp.,93 the U.S. District Court for the Northern District of Texas
appointed the State of Wisconsin Investment Board (SWIB) as lead plaintiff. The court rejected
opposing class members’ arguments that SWIB could not be an adequate class representative
because it would consider Cellstar’s long-term interests when litigating the case because of its
contemporaneous stock ownership.94 In this case, Sidney Gluck and three individuals filed suit on
behalf of themselves and others against Cellstar claiming violations of securities laws. Gluck, acting
in accordance with the PSLRA, published notice over Business Wire. Within sixty days of notice,
SWIB sought appointment as lead plaintiff. The district court determined that SWIB had the largest
financial interest in the relief sought by the class because it held more than 1.6 million of the
7.5 million shares held by outsiders, with a loss of over $10 million.95 Also, the court determined
that SWIB met the typicality and adequacy requirements imposed by Rule 23.96

        Gluck and the other investors argued that SWIB would not be an adequate representative,
maintaining that because SWIB retained a current interest in the defendant company, it would
consider Cellstar’s interests, which would be detrimental to the plaintiff class.97 The court, however,
found that balancing Cellstar’s interests with the class’ interests was a positive aspect of SWIB’s
involvement and that Congress intended institutional investors serving as lead plaintiff to consider
such issues.98 In fact, the court quoted the PSLRA’s legislative history, which stated that: “the
Committee believes that an institutional investor acting as lead plaintiff can, consistent with its
fiduciary obligations, balance the interests of the class with the long-term interests of the company
and its public investors.”99 Gluck then argued that the court should appoint SWIB and his group as
co-lead plaintiffs. The district court refused to do so, noting that “[i]ncreasing the number of Lead
Plaintiffs would detract from the Reform Act’s fundamental goal of client control, as it would
inevitably delegate more control and responsibility to the lawyers for the class and make the class
representatives more reliant on the lawyers.100



       93
            976 F. Supp. 542 (N.D. Tex. 1997).
       94
            See id. at 548.
       95
            Id. at 546.
       96
            Id.
       97
            Id. at 548.
       98
            Id.
       99
            Id. (quoting Senate Report, supra note 14, at 11, 1995 U.S.C.C.A.N. at 690).
       100
             Id. at 549.
         The district court emphasized that the institutional investor’s litigation strategy would
inevitably be one that is most economically sound. It noted that “[t]he best relief for the plaintiff
class is not always the relief which would be sought by a ‘professional plaintiff’ or a plaintiff with
a very small share in the defendant company.”101 Regardless of the merits of a securities fraud
claim, lawyers for “professional plaintiffs,” the court explained, seek the maximum damage award
without regard to future company performance or share appreciation.102 In the long-run, however,
the return to the plaintiff class might be greater through a “less-than-maximum” damage payment
immediately which could result in subsequent economic growth of the defendant company.103 The
court held that SWIB would be the optimal lead plaintiff because it would contemplate the long-term
effect of the litigation on the defendant and, as a result, pursue a solution that encourages future
corporate growth while protecting the cumulative interests of its beneficiaries and other small
investors in the class.104 This holding shows the court’s awareness of the inherent systemic benefits
institutional investors provide when acting as a lead plaintiff under the PSLRA.

       Informal Participation of Institutional Investors

        Some authors have argued that the systemic benefits of increased institutional investor
participation may be realized even absent formal participation as “lead plaintiff” under the
PSLRA.105 Stanford Law School professors Joseph A. Grundfest and Michael A. Perino found one
example of beneficial informal investor involvement in the “Pentium Chip Litigation,” where the
informal intervention of institutional investors in a securities fraud action arguably prevented the
prosecution of a frivolous claim.106 Grundfest and Perino’s thesis is that institutional investors may
be able to wield their influence through informal means to influence securities litigation in much the
same manner that institutional investors have influenced issues of internal corporate governance as
substantial shareholders.107

        In 1994, Intel, which actively markets its Pentium processor to the engineering and scientific
community, discovered a flaw in computer processor chips it had been manufacturing since 1993.
Intel determined that it would not notify purchasers of the law, because it was unlikely to affect

       101
             Id. at 548.
       102
             Id.
       103
             Id.
       104
             Id.
       105
             See, e.g., The Pentium Papers, supra note 86, at 561.
       106
             See id. at 600. This case is described extensively in The Pentium Papers. Id. at 582-98.
       107
           See id. at 561 no.12. For example, the New York City Employees Retirement System
(NYCERS) filed a shareholder resolution asking Exxon Mobil Corporation to reinstate a policy that
prohibited discrimination based on sexual orientation. The $41 billion fund filed the resolution
shortly after Exxon Mobil canceled its anti-sexual orientation discrimination policy and eliminated
its domestic partnership benefits that existed at Mobil before the company completed its merger with
Exxon. NYC Fund Files Proposal at Exxon Mobil, PENSIONS & INVESTMENTS, Dec. 27, 1999, at
31.
ordinary users. The company planned to correct this flaw during the course of regularly scheduled
product updates. The flaw, however, was publicly disclosed in October 1994 after it was discovered
by a mathematician using the Pentium processor. Intel’s response to the discovery of the flaw was
the adoption of a need-based replacement program, where the company sought only to replace the
defective chips for those customers who were most likely to encounter problems from the flaw.108
This policy was highly criticized and failed to address concerns about the chip maker’s failure to
notify customers immediately after discovery of the error. This publicity adversely affected Intel’s
stock price, which suffered a temporary fall until Intel announced a more advantageous “no-
questions-asked” replacement policy.109

         Several lawsuits relating to the Pentium flaw were filed in December of 1994, including a
shareholder class action, a derivative action, and several consumer class actions.110 Four
institutional investors, the California Public Employees Retirement System (CalPERS), the College
Retirement Equities Fund, the Stanford Management Company, and Wells Fargo Institutional Trust
Company—all members of the shareholder class—examined the facts of the case and decided that
if the cases lacked merit they would each support a joint letter to plaintiffs’ counsel explaining their
concerns and asking counsel to respond with further information.111 The investors followed this
informal strategy for at least four reasons: First, it was an inexpensive way to examine the validity
of the case.112 Second, the investors sought to avoid formal court filings if alternatives were equally
effective.113 Third, any position taken by an informal letter was reversible if further information
were discovered as a result.114 Fourth, they felt that such an approach was consistent with their
fiduciary obligations, because by seeking further information, the institutional investors would
acquire all the information necessary to make further decisions dealing with the potential claim.115

        The investors determined after a detailed analysis that there were problems with the merits
of the suit and sent a letter to plaintiffs’ counsel in the shareholder class action and the derivative
action expressing their concerns. As it happened, plaintiffs’ lead counsel in the shareholder class
action had voluntarily dismissed that action the day before reading the letter.116 Ninety minutes after


       108
             See The Pentium Papers, supra note 86, at 587-88.
       109
             See id. at 589.
       110
          See id. at 591 (citing Whitaker v. Moore, Civ. No. 94-20844 (N.D. Cal. filed Dec. 12,
1994) (shareholder class action), and Gunther v. Moore, Civ. No. 94-200878 (N. D. Cal. filed
Dec. 21, 1994) (derivative action)). For a description of the consumer class actions filed see The
Pentium Papers, supra note 86, at 591-92.
       111
             See The Pentium Papers, supra note 86, at 582-83.
       112
             See id. at 583.
       113
             Id
       114
             Id.
       115
             Id.
       116
             Id. at 595.
sending the letter to counsel in the derivative action, the investors were informed that the derivative
suit would be dismissed as moot.117 Although the causative role of the investor letter in the ultimate
disposition of the Pentium litigations is not clear, Professors Grundfest and Perino argue that this
experience “strongly suggests” that institutional investors can effectively influence litigation through
informal, low-cost strategies such as the Pentium letter.118

        Informal investor participation as described by Grundfest and Perino could result in
substantial systemic benefits by cutting potentially meritless litigation off at the pass. Such informal
participation, however, is far from costless; the investors here were only able to overcome the
substantial barriers to collective action by taking advantage of a unique “Investors Forum”
sponsored by the Stanford Law School.119 Further, it is far from clear that the effort put forward by
these investors in developing the detailed analysis required for the Pentium letter is truly any less
costly than a corresponding effort to seek appointment as “lead plaintiff” under the PSLRA would
have been.120

         While the use of an informal device such as the Pentium letter may result in a “win-win”
solution where such a letter may serve to effectively curb meritless litigation, it must be recognized
that even such informal participation requires substantial efforts to coordinate investor action and
will not be an effective device except in the clearest cases of truly meritless claims. Further, it is
unclear how investors could see through the prosecution of a meritorious claim through such simple
informal steps. The next section will discuss the substantial direct benefits that may accrue to
institutional investors through formal participation in meritorious litigation as a lead plaintiff under
the PSLRA.

       DIRECT BENEFITS FROM INCREASED INSTITUTIONAL INVESTOR
       INVOLVEMENT

         Institutional investors have tremendous resources and economic expertise. As a lead plaintiff
in securities litigation under the PSLRA, they would possess the invaluable ability to formulate a
settlement that is both extremely profitable to the class yet fair to the defendant company.
Institutional investors are uniquely situated to skillfully negotiate a substantial settlement and have
the long-term insight needed to reject a defendant’s quick settlement offer. Further, because
institutional investors usually have the greatest financial stake in the outcome, they may be highly
motivated to vigorously pursue a meritorious claim rather than hastily accepting an inadequate
settlement offer. The cases below show specific examples of the enormous direct benefits
institutional investors may gain from participation as a lead plaintiff under the PSLRA.



       117
             Id. at 596.
       118
             Id. at 600.
       119
             See id. at 577-82.
       120
          See id. at 583 (describing the need for a “significant degree of derail and substance” and
“analytic heft” in the Pentium letter). It is highly unlikely that the Pentium letter would have been
possible without the substantial contributions provided by the Stanford Law School and Professor
Grundfest himself.
       In re Cendant Corporation Litigation121

         In In re Cendant Corporation Litigation, three large pension funds acting as lead plaintiff
obtained the largest settlement ever in a shareholder class action.122 The Cendant litigation arose
shortly after two prior entities, HFS, Inc., and CUC International, Inc., merged to form Cendant
Corporation in December 1997. In April 1998, Cendant announced the discovery of substantial
accounting irregularities in a former CUC business unit, now part of the merged entity, and declared
that it would restate annual and quarterly net income and earnings per share for 1997 and possibly
earlier periods. The day after the announcement, Cendant stock plummeted forty-six percent. Sixty-
four separate shareholder actions were filed and consolidated.

        The plaintiffs in the various actions consisted of four categories of shareholders who held
stock in the prior entities and a derivative security. Fifteen plaintiffs or groups of plaintiffs filed
motions for appointment as lead plaintiff, and each sought to have its lawyer or lawyers selected as
lead counsel for the class. Pursuant to the PSLRA, a group of “Public Pension Fund Investors,”
known as the “CalPERS Group,” consisting of the nation’s three largest pension funds: the
California Public Employees’ Retirement System (CalPERS), the New York State Common
Retirement Fund (CRF), and the New York City Pension Funds (NYCPF), was appointed lead
plaintiff.123 The alleged losses of this group were over $89 million, compared to the $10.6 million
in losses claimed by the next largest group of plaintiffs. Further, the CalPERS Group fulfilled the
typicality factor, because it invested in each of the four types of securities involved in the action.

        Nine movants petitioned the court to be appointed co-lead plaintiff, on the basis of a variety
of assertions that diversity of representation would benefit the class, although none of these movants
purported to rebut the presumption that the CalPERS Group was the most adequate lead plaintiff.
One plaintiff sought appointment because it suffered the largest loss of private investors. Several
plaintiffs claimed that because the CalPERS Group invested more heavily in one type of security,
it would be inclined to emphasize certain claims over others. Opposing plaintiffs also argued that
the pension funds were biased and had “special relationships” with the underwriters. The U.S.
District Court for the Northern District of New Jersey rejected all of these claims, reasoning that
plaintiffs’ portfolios will always differ in composition, but the CalPERS Group had a sufficient
interest in each claim to ensure the adequacy of its representation of the class.124

        The CalPERS Group subsequently negotiated a $2.83 billion settlement, the largest ever in
a securities class action lawsuit.125 The agreement allowed shareholders to regain some of the losses
incurred when Cendant’s share price plunged by more than fifty percent when the accounting


       121
             182 F.R.D. 144 (D.N.J. 1998).
       122
         See id. (appointing pension fund as lead plaintiff); Mitchell Pacell, Cendant Agrees in Its
Settlement To Change Corporate Governance, WALL ST. J., Dec. 8, 1999, at A4.
       123
             See In re Cendant Corp. Litig., 182 F.R.D. at 147.
       124
             See id. at 149.
       125
        See Mitchell Pacelle, Cendant Agrees in Its Settlement To Change Corporate Governance,
WALL ST. J., Dec. 8, 1999, at A4.
problems were disclosed.126 The CalPERS Group recovered between forty and sixty percent of its
losses. Cendant Corporation also agreed to make substantial changes in its corporate governance
structure.127 Under the terms of the settlement, Cendant promised to ask shareholders to approve
changes to the terms of a director’s tenure such that all directors must face election annually—a very
unusual step because it makes top managers less secure in their jobs and the company more
vulnerable to takeover. The settlement also prohibited Cendant from repricing stock options without
a shareholder vote.128 In addition, the plaintiffs’ lawyers in the case were reportedly awarded “far
less than the usual one-third or 25%” of the settlement.129

        The Cendant litigation exemplifies the result sought by Congress in enacting the lead
plaintiff provisions of the PSLRA—the pension funds’ litigation strategy yielded an optimal
settlement for shareholders while significantly changing the structure of the defendant company to
foster corporate growth. Further, the direct benefit to the participating institutional investors of an
unprecedented settlement figure validated the investors’ decision to set aside the traditional passive
role in favor of formal appointment as lead plaintiff under the PSLRA.

       In re California Micro Devices Securities Litigation130

        In In re California Micro Devices Securities Litigation, an institutional investor, the
Colorado Public Employees Retirement Fund (ColPERA) objected to a proposed settlement in a
class action originally brought by two individual shareholders. After accepting the role of lead
plaintiff in the case, it negotiated a more favorable settlement for the class.131 This case presents a
further example of how formal institutional investor involvement in securities class action litigation
as a “lead plaintiff” can provide a direct material benefit to such investors, in the form of more
favorable settlements.

         The California Micro Devices litigation arose from an announcement by California Micro
Devices (CAMD) that it had issued materially false financial statements. The day after the
announcement, the first of several securities class actions was filed against CAMD. Before the court
could hold a case management conference to select class counsel, the law firm of Lieff, Cabraser,
Heimann & Bernstein (LCH&B) led an effort to negotiate a pre-certification settlement of the
litigation. LCH&B successfully negotiated a settlement with CAMD and sought to have it approved
by the district court. Citing numerous problems and concerns leading the court to believe that the
settlement was reached under “quasi-collusive” circumstances, the court denied the motions of



       126
             Id.
       127
             Id.
       128
             Id.
       129
             Id.
       130
        168 F.R.D. 257 (N.D. Cal. 1996); class cert. granted and motion granted, 965 F. Supp.
1327 (N.D. Cal. 1997).
       131
             See id.
LCH&B for preliminary approval of the proposed settlement and for appointment of LCH&B as
class counsel.132

        The district court cited many problems with the proposed LCH&B settlement. The court
found that the settlement agreement was hastened by LCH&B’s uncritical acceptance of CAMD’s
representation that it would be bankrupt if it did not settle the case.133 Further, the court found
numerous problems with the way in which LCH&B had defined the class, severely criticized the
manner in which counsel attempted to show the class members’ approval of the proposed settlement,
and determined that the class representatives did not fulfill Rule 23(a)(4) of the Federal Rules of
Civil Procedure.134 In addition, the court was clearly influenced by the input of institutional
investors who directly expressed their concerns with the proposed settlement to the court, including
the ultimate lead plaintiff chose, ColPERA.135

         Ultimately, the district court rejected the proposed LCH&B settlement and appointed
ColPERA as class representative under Rule 23(a) of the Federal Rules of Civil Procedure.136 The
court found that ColPERA was a more adequate lead plaintiff for several reasons. Specifically, the
district court held that institutional investors are better class representatives because:

                   (i)     “[i]nstitutional investors have financial interests in the outcome of securities
                           class actions which dwarf the interests of individual plaintiffs;”137

                   (ii)    “[i]nstitutional investors are . . . in a superior position to . . . determine
                           whether a company’s claims of imminent bankruptcy should be
                           [considered];”138 and

                   (iii)   “institutional investors have [a] fiduciary responsibility to the very investors
                           whom the securities class action is designed to primarily help.”139




       132
             See id. at 268.
       133
             See id. at 267.
       134
             See id. at 269-75.
       135
           See id. at 271-74. The information provided to the court by the institutional investors in
this case also serves as another example of the type of “informal” investor activism championed by
Professor Grundfest. See The Pentium Papers, supra note 86, at 599 n.226 (describing activism of
Investor Forum members in California Micro Devices).
       136
             In re California Micro Devices, 168 F.R.D. at 276.
       137
             See id. at 275.
       138
             Id.
       139
             Id.
ColPERA, which owned only 20,000 shares during the class period, was deemed the best choice for
class representative and had expressed a willingness to intervene in the action.140 In addition, the
court subsequently granted a motion by another institutional investor, the California State Teachers’
Retirement System (CalSTRS), to intervene as an additional class representative.141

        ColPERA and CalSTRS came to a new settlement agreement with the defendant that
contained more cash than the prior plan and included contributions from culpable directors who
previously were not part of the settlement.142 The court found that this was a fair settlement, relying
substantially on the nature of the class representatives who negotiated the agreement.143 Despite the
similarities between the first settlement and the pension funds on behalf of the class, the court wrote:

                   The settlement proposed here is not the “ordinary” class action circumstance. The
                   representative plaintiffs are large institutional investors who are sophisticated in
                   legal and business issues generally, and in the securities markets specifically.
                   Moreover, they have a fiduciary duty to exercise reasonable diligence in pursuing the
                   interests of their investors. ColPERA and CalSTRS have both the resources and the
                   incentive to monitor the efforts of class counsel. They have demonstrated this fact
                   by coming forward to be heard in this case and by selecting a law firm to represent
                   the . . . . The presence of interested and able class representatives reduces
                   substantially the agency problems associated with class actions and correspondingly
                   reassures the court about the bona fides of a proposed settlement.144

While the court admitted that some of the deficiencies that had been noted about the previous
settlement plan were merely lessened and not eliminated, it nevertheless approved the settlement
agreement in part because of the “presence and participation of an active and knowledgeable
representative plaintiff.”145

        Again, the participation of institutional investors in the formal role of class representative
here assured the court of the fairness and adequacy of a proposed settlement, where previously
negotiated settlement proposals had been considered irretrievably tainted by the potential for
collusive behavior. Not only did these institutional investors provide a system benefit to the court
in acting to assure that the settlement terms were fair and adequate, but they also provided a direct
benefit to themselves as members of the plaintiff class in negotiating a settlement containing terms
which were more favorable to the plaintiff class.146 Further, the very involvement of institutional

       140
             See id. at 276-76, n.10.
       141
             See In re California Micro Devices Sec. Litig., 965 F. Supp. 1327, 1329 (N.D. Cal. 1997).
       142
             See id. at 1330.
       143
             See id. at 1331.
       144
             Id. at 1330.
       145
             Id.
       146
          See id. at 1331 (“[T]he terms of the present deal offer class members far more cash up
front and a greater assurance of ultimately achieving further recoveries.”).
investors served to soothe the court’s concerns as to the propriety of the proposed settlement,
arguably accelerating favorable resolution for all parties. Direct benefits such as these must not be
overlooked by any institutional investor considering whether to participate in securities class action
litigation as a lead plaintiff.

UNIQUE CONCERNS FOR INSTITUTIONAL INVESTORS CONSIDERING
LEAD PLAINTIFF STATUS

         Although a typical individual investor is free to determine whether to participate in a
securities class action as a lead plaintiff through a relatively simple consideration of the costs and
benefits implicated by that role, institutional investors deciding whether to pursue appointment as
a lead plaintiff under the PSLRA must also consider other factors which may greatly impact their
decision. Many institutional investors, such as pension plans, must consider how acting as lead
plaintiff is consistent with the fiduciary duties imposed by the Employee Retirement Income
Security Act (ERISA)147 ERISA imposes and strictly enforces several substantial duties upon
institutional investors, which place substantial constraints on the activities of institutional investors
such as pension plans. Thus, any institutional investor subject to ERISA must consider how
litigating a securities class action case on behalf of plaintiffs that are not beneficiaries of its
investment plan comports with its fiduciary responsibilities. In addition, other plaintiffs in securities
class actions seeking appointment as lead plaintiff have argued that the fiduciary obligations of
institutional investors to their beneficiaries may prevent them from fairly and adequately
representing the investor class.

         This section addresses these concerns, which are unique to institutional investors seeking
appointment as lead plaintiff under the PSLRA. Further, this section will discuss how courts have
addressed concerns relating to the typicality and adequacy of institutional investor representation
of the class in light of the clear preferences and advantage the PSLRA has bestowed upon
institutional investors.

        RECONCILING LEAD PLAINTIFF STATUS WITH ERISA FIDUCIARY
        DUTIES

        Institutional investors such as pension plans have five affirmative fiduciary duties under
ERISA. First, the fiduciary must act solely in the interest of the plan participants and beneficiaries
and for the exclusive purpose of benefitting the plan’s participants.148 Second, the fiduciary must
act with the care, skill, prudence, and diligence of a prudent person acting in like capacity.149 Third,
the fiduciary must diversify the plan’s investments in order to decrease its risk of loss.150 Fourth,
the fiduciary must act in accordance with the provisions of the plan documents to the extent that the




        147
              29 U.S.C. § 1104 (1994).
        148
              See id. § 1104(a)(1)(A).
        149
              See id. § 1104(a)(1)(B).
        150
              See id. § 1104(a)(1)(C).
documents comply with ERISA.151 Fifth, the fiduciary must refrain from engaging in any
transactions expressly prohibited under ERISA.152

         At least tow of these duties are implicated by an institutional investor’s decision to act as
lead plaintiff: the duty to act solely in the interest of its beneficiaries, and the duty to act with the
diligence and skill of a prudent investor. Because the PSLRA is a new statute, courts have not yet
addressed allegations of breach of fiduciary duty under ERISA arising from an institutional
investors’ involvement as a lead plaintiff in a securities fraud class action. Because ERISA fiduciary
duties are interpreted broadly, however, an institutional investor must be cognizant of the possibility
of such allegations arising from a decision to serve as lead plaintiff under PSLRA. This section
discusses the existing law of ERISA fiduciary duties in light of potential application to an
institutional investor acting as lead plaintiff in a securities class action under the PSLRA.

        The Duty of Loyalty

        The most basic duty imposed by ERISA on fiduciaries is a duty of loyalty to their plan
beneficiaries. An ERISA fiduciary153 must “discharge his duties with respect to a plan solely in the
interest of the participants and beneficiaries,” and for the “exclusive purpose of providing benefits
to beneficiaries.”154 The duty of loyalty applies in situations where the fiduciary is faced with a
potential conflict of interests, such as the situation where the trustee of a pension plan also has
responsibilities to the entity (e.g., employer or union) sponsoring the plan. Thus, litigation of the
duty of loyalty has arisen most often in the context of self-dealing transactions, such as where a plan
fiduciary uses plan assets to benefit non-beneficiaries.155

         ERISA fiduciaries are not completely forbidden from engaging in transactions which
incidentally benefit themselves or third parties; however, “their decisions must be made with an eye
single to the interests of the participants and beneficiaries” they represent.156 Fiduciaries violate the
duty of loyalty when acting in a manner which does not place the interest of their beneficiaries ahead
of all other interests, such as where a trustee issues a risky or low-interest loan to the employer or
corporation from a plan’s assets.157 Courts in such cases have broad discretion to award equitable

        151
              See id. § 1104(a)(1)(D).
        152
              See id. §§ 1104, 1106.
        153
          ERISA “fiduciaries” include plan managers and others who exercise discretionary control
over plan assets. See id. § 1002(21)(A).
        154
              Id. § 1104(a)(1)(A) (emphasis added).
        155
          See generally Wesley Kobylak, Annotation, “Dual Loyalty” Considerations in
Determining Propriety, Under Employee Retirement Income Security Act, (29 USC § 1001 et seq.)
of Actions of Officers of Sponsor Corporation Serving as Trustee of Employee Pension Plan, 64
A.L.R. Fed. 602 (1983).
        156
              See Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982).
        157
          See, e.g., Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983) (holding breach of
fiduciary duty when union pension fund issued a loan to union’s convalescent fund because the
relief, such as ordering all unlawful loans to be repaid with a reasonable rate of interest, or removing
the defendant as a fiduciary and prohibiting him from resuming fiduciary capacity until the plan
receives all sums owed.158

        The fiduciary duty of loyalty is implicated when an institutional investor acts as a lead
plaintiff in a securities fraud class action. By taking the lead in a case, the institutional investor
might be called upon to act in a manner that is not necessarily “solely in the [plan’s] interest” or for
the “exclusive purpose” of benefitting plan participants.159 As a lead plaintiff, an institutional
investor will also have obligations to the class of plaintiffs it represents, which could conceivably
be in conflict with its fiduciary duties to its beneficiaries.

       The Duty of Care

        In addition to the duty of loyalty, ERISA imposes a stringent duty of care, which requires
that the fiduciary act “with the care, skill, prudence and diligence under the circumstances then
prevailing that a prudent man acting in a like capacity and familiar with such matters would use in
the conduct of an enterprise of a like character and with like aims.”160 Courts consider this to be an
“unwavering duty on [trustees] to make decisions with single-minded devotion to a plan’s
participants and beneficiaries and, in so doing, to act as a prudent person would in a similar
situation.”161

        The “prudent person” test focuses on the process that the fiduciary undertakes in reaching
a particular decision involving plan assets. Most courts begin this inquiry by determining what the
plan trustees knew at the time the investment decision was made and then deciding whether or not
that decision was that of a “prudent person.”162 One district court has held that this duty only
requires the trustee to “vigorously and independently investigate the wisdom of a contemplated
investment; it matters not that the investment succeeds or fails.”163 Further, under federal Labor
Department regulations interpreting ERISA, a fiduciary may be subject to personal liability if it fails
to investigate fully the terms and consequences of an investment, fails to investigate the
qualifications of its advisors, or fails to acknowledge those facts and circumstances that, given the


administrators should have known the loan presented an unreasonable risk of not being timely and
fully paid); see also Marshall v. Kelly, 465 F. Supp. 341, 350 (W.D. Okla. 1978) (finding breach of
fiduciary duty when plan trustee renewed loan in employer company despite the declining financial
condition of the company and the declining security on the loans).
       158
             See Marshall, 465 F. Supp. at 354.
       159
             29 U.S.C. § 1104(a)(1)(A) (1994).
       160
             Id. § 1104(a)(1)(B).
       161
             Morse v. Stanley, 732 F.2d 1139, 1145 (2d Cir. 1984).
       162
         See Katsaros v. Cody, 744 F.2d 270, 279 (2d Cir. 1984); American Communications
Ass’n v. Retirement Plan for Employees of RCA Corp. & Subsidiary Cos., 488 F. Supp. 479, 483
(S.D.N.Y. 1980).
       163
             Donovan v. Walton, 609 F. Supp. 1221, 1238 (S.D. Fla. 1985).
scope of its duties, it knows or should “know are relevant to the particular investment or investment
course of action involved.”164 Conversely, courts have usually found that trustees have satisfied their
duty of care when they hire independent consultants to perform studies regarding a proposed
transaction and subject those studies to close scrutiny when making decisions regarding an
investment.165

       The duty of care under ERISA could be implicated if an institutional investor rashly decides
to pursue a position as lead plaintiff. An investor’s beneficiaries could assert that the fiduciary
breached its duty of care if the institutional investor failed to thoroughly investigate the merits of
the case before participating. Stringent application of this duty could require an institutional
investor to hire outside consultants to conduct exacting studies that analyze the feasibility of
becoming involved in a case a lead plaintiff. A plan could also be required to expend significant
time and financial resources in choosing appropriate class counsel. These considerations could
make election to act as a lead plaintiff under the PSLRA significantly more burdensome, and
application of a very stringent view of the duty of care could significantly deter institutional
investors from seeking lead plaintiff status.

       Analysis

        An institutional investor must attempt to reconcile its duties as lead plaintiff under the
PSLRA with its duties of loyalty and care as an ERISA fiduciary. Well before such an investor
seeks appointment as a lead plaintiff under the PSLRA, they must seek out experienced and
competent counsel to advise them on the propriety of such actions in light of their ERISA
obligations. There are innumerable situations where the competing obligations of these two roles
could conflict. Thus, an institutional investor has a lot to consider when determining whether its
decision to represent an entire class of plaintiffs comports with its ERISA fiduciary duties to plan
participants.

         For example, an institutional investor, as lead plaintiff, may be required to litigate against
a defendant corporation with which the fund had a prior beneficial relationship. By acting as an
adversary to these parties, the institutional investor might harm a positive business relationship an
thereby limit its investment opportunities—which may not be in the beneficiaries’ best interests.
Or, an institutional investor might acquire inside information about a corporation through litigation
that limits its future ability to trade the stock that was the subject matter of the securities fraud
dispute. Further, an institutional investor acting as lead plaintiff could face competing obligations
if offered a settlement which greatly benefits its beneficiaries, but not other members of the plaintiff
class. This tension could arise where an institutional investor retains an interest in the defendant
corporation, yet other members of the plaintiff class do not. The various settlement possibilities
could clearly result in a tension of interests between the investor’s beneficiaries and the remainder
of the plaintiff class. All of these possibilities must be considered by an institutional investor
contemplating participation as lead plaintiff.




       164
         See 29 C.F.R. § 2550.404a-1(b)(i) (2000); see also Whitfield v. Cohen, 682 F. Supp. 188,
194-95 (S.D.N.Y. 1988).
       165
             See Donovan, 609 F. Supp. at 1244.
         An institutional investor might be justified in fearing exposure to fiduciary liability when
considering the degree of loyalty and care necessarily required for every investment decision under
ERISA. To be sure, an institutional investor has to be confident that acting as a lead plaintiff will
benefit its plan participants. This necessitates a great deal of pre-filing research; an institutional
investor simply will not act without being sure that a particular claim has merit. The institutional
investor also has to litigate in accordance with the PSLRA and adequately protect the interests of
all plaintiff class members, but by proceeding with the utmost duty of loyalty to its own participants,
an institutional investor would necessarily serve the interests of the plaintiff class as a whole—at
the very least, it would pay more attention than a plaintiffs’ lawyer who usually acts almost
exclusively for his own financial benefit. Therefore, ERISA, rather than acting as a hindrance to
a potential lead plaintiff, actually causes an institutional investor to be a superior lead plaintiff
because its fiduciary considerations require such an enormous degree of caution.

         In observing its fiduciary duties and conducting a careful review of the merits of potential
litigation, an institutional investor might find itself in a position of being compelled to take on lead
plaintiff status in securities class action litigation. ERISA fiduciaries not only have obligations to
avoid acting rashly; they also have affirmative obligations to act when such action would be
prudent.166 In some cases, it is entirely possible that an institutional investor could be placed in a
position relative to securities class action litigation where the potential benefits of their involvement
are so great that their duties to their beneficiaries actually require them to litigate as lead plaintiffs.

        In short, before an institutional investor can seek to act as lead plaintiff, the investor must
conduct a “careful and impartial investigation” to determine that litigating the case is in the best
interest of its beneficiaries.167 Once the investor has made that determination, however, any
“incidental” benefits which the investor provides in the role of lead plaintiff—whether to the
plaintiff class, or to the legal system itself—are legitimate under ERISA. Institutional investors may
ultimately be compelled to litigate as lead plaintiffs, because after evaluation it appears that this is
the most prudent course of action to take to benefit their beneficiaries. Further, because institutional
investors have these stringent independent obligations to their beneficiaries to carefully investigate
potential litigation, they are thereby better, more effective class representatives should they go
forward with the litigation. In the end, then, the duties imposed by ERISA are complementary to
the role of institutional investors under PSLRA. Because these waters are as yet uncharted,
however, institutional investors must act carefully and with appropriate consideration of the many
factors involved.

        OTHER UNIQUE PROBLEMS FACING INSTITUTIONAL INVESTORS AS
        LEAD PLAINTIFFS

        In addition to the internal considerations that institutional investors must address before
deciding whether to act as a lead plaintiff, they must also be prepared to encounter resistance from
competing prospective lead plaintiffs. Despite the clear preferences for institutional investor
involvement expressed by Congress when enacting the PSLRA, there are a wide array of arguments
that have been articulated in opposition to institutional investors seeking to serve as a lead plaintiff
in securities class action litigation.

        166
              See Whitfield, 682 F. Supp. at 194.
        167
              See Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982).
        Attacks on Typicality of Institutional Investors

        Opponents of institutional investors as lead plaintiffs have articulated a number of attacks
on the typicality of institutional investors as class representatives. They allege potential conflicts
of interest, arising both from continued ownership of stock in defendant companies, and from pre-
existing business relationships with such defendants. Courts have generally rejected such challenges
upon institutional investors, but in some cases have found the concerns raised serious enough to
warrant appointment of “co-lead” plaintiffs.

        Conflicts of Interest

         Some prospective lead plaintiffs have argued that institutional investors who continue to own
stock in the defendant company are inadequate plaintiffs under the PSLRA because its claims and
defenses differ from those plaintiffs who no longer have an interest in the defendant company.168
Jill Fisch, the author or a law review article discussing the role of institutional investors in securities
fraud class actions, has endorsed this point of view.169 Fisch argues that institutional investors with
a financial interest in the defendant are poorly suited to represent plaintiffs who no longer invest in
the company.170 Further, institutional investors have broad financial holdings and a diversified
portfolio.171 Therefore, under Fisch’s argument, securities damage awards that transfer money from
present stockholders to past stockholders would not be a goal for most institutional investors.172
Thus, as discussed above, an institutional investor is faced with a conflict regarding whether it
should seek a damage award optimal for the class or for its beneficiaries exclusively.

        Another problem with an institutional investor with current holdings in a defendant company,
according to Fisch, is the threat of collusion.173 She contends that an institutional investor “may seek
to obtain favorable investment opportunities, better access to corporate information, or influence
over corporate governance decisions, in exchange for cooperation in addressing the concerns of
securities fraud defendants.”174 This would result in an institutional investor litigating a claim in a
manner inconsistent with the needs of the plaintiff class.175 Further, she argues that the risk of



        168
           See, e.g., Gluck v. Cellstar Corp., 976 F. Supp. 542, 548 (N.D. Tex. 1997) (rejecting
plaintiff class members’ argument that institutional investor with current holding is an inadequate
lead plaintiff).
        169
         See Jill E. Fisch, Class Action Reform: Lessons From Securities Litigation, 39 ARIZ. L.
REV. 533, 546 (1997) [hereinafter Class Action Reform].
        170
              See id.
        171
              See id.
        172
              See id.
        173
              See id. at 548.
        174
              Id.
        175
              See id.
collusion during settlement discussions is increased by the fact that institutional investors often
conduct business through informal, private contacts with issuers.176

        Judicial Treatment of Typicality Challenges

         Plaintiffs who attach an institutional investor’s appointment as lead plaintiff often argue that
a conflict arises because an institutional investor has close relationships with necessary defendants,
or has an interest in limiting recovery because it still has holdings in the security at issue. Large
diversified investors or pension plans might necessarily have relationships with brokers,
underwriters, or even the defendant corporation. Some argue that an institutional investor would
try to obtain favorable investment opportunities, better access to corporate information, or influence
over governance decisions in exchange for cooperation in securities fraud actions.177 Courts have
not addressed these challenges uniformly; this section addresses a few responses to such arguments.

         Most courts addressing these issues have rejected these arguments and, in contrast, view
contemporaneous stock ownership in securities fraud litigation as a benefit of institutional investors’
involvement. Courts have taken a broader view of the role of the lead plaintiff in securities class
action litigation, and have declined to consider only the interests of the plaintiff class.178 For
example, in Gluck v. Cellstar Corp.,179 the U.S. District Court for the Northern District of Texas
considered the possible consequences for the defendant company, the plaintiff class, and the
institutional investor through its role as lead plaintiff.180 Even though a lead plaintiff that retains
current holdings in a company may litigate a case under a strategy that considers the long-term
interests of the defendant, the court held that this was not a conflict of interest.181 In fact, it found
that this approach was the most financially efficient method to litigate a securities fraud claim
because all parties involved in the lawsuit economically benefitted from the all-encompassing
litigation strategy.182

        Not all courts, however, dismiss challenges to institutional investors out of hand. In In re
Cendant Corp. Litigation,183 conflict of interest issues prompted the court to appoint a co-lead
plaintiff in addition to an institutional investor with regard to one aspect of the litigation where it
found a conflict of interest. The institutional investor and prospective lead plaintiff, the California
Public Employees Retirement System (CalPERS), held substantial investments in excess of
$300 million in Merrill Lynch, which was the underwriter of the stock offering at issue in the


        176
              See id.
        177
              See id.
        178
              See, e.g., Gluck v. Cellstar Corp., 976 F. Supp. 542, 548 (N.D. Tex. 1997).
        179
              Id. at 542.
        180
              See id. at 543.
        181
              See id. at 548.
        182
              See id.
        183
              182 F.R.D. 144 (D.N.J. 1998).
securities fraud action and a defendant in the case. The investment was much larger than the
approximate $6.4 million it had at stake in the litigation. The court recognized that this conflict
could affect CalPERS’ duty to vigorously prosecute the claims against Merrill Lynch and, therefore,
harm the class.184 To resolve this conflict, the court appointed an individual investor to serve as co-
lead plaintiff when dealing with the Merrill Lynch claims.185

        As discussed in the previous section, Jill Fisch concluded that investors with current holdings
in the defendant company fall within the category of conflicted plaintiffs.186 She stated that these
investors would not want to transfer money from present stockholders to past stockholders.187
Further, other authors have argued that current investors would prefer that sanctions be imposed on
individuals responsible for the fraud rather than the company itself, and that investors with a
continued interest in the health of the business would find it more difficult to justify large
compensatory payments.188

         Actual experience may validate these concerns to some degree. To cite one example, the
first proposed settlement in the California Micro Devices case discussed above was argued to be
flawed based on, inter alia, the lack of payment from outside directors rather than the company.189
In that case, the settlement ultimately negotiated by the institutional investor appointed lead plaintiff
then did contain contributions from outside directors and corporate officers.190 The court agreed
with the investors’ concerns here; however, it was not the case that the priorities of the institutional
investors were seen as being in conflict with the concerns of the class as a whole.

        Similar conflict of interest arguments were raised and rejected in Gluck Cellstar
Corporation.191 The U.S. District Court for the Northern District of Texas found in that case that
concerns about the health of the defendant were a legitimate factor for an institutional investor to
balance and that it was the proper lead plaintiff even thought is had current holdings in the
defendant.192 While this district court might be right that balancing these concerns is an appropriate
step, there could be a case where considering the long-term interests of the defendant company



        184
              See id. at 149.
        185
              See id. at 150,
        186
              See Class Action Reform, supra note 169, at 546.
        187
              See id.
        188
         See Janet Cooper Alexander, Rethinking Damages in Securities Class Actions, 48 STAN.
L. REV. 1487, 1504 (1996).
        189
         See id. at 1505 (citing In re California Micro Devices Sec. Litig., 965 F. Supp. 1327 (N.D.
Cal. 1997).
        190
              See In e California Micro Devices Sec. Litig., 965 F. Supp. at 1331.
        191
              See Gluck v. Cellstar Corp., 976 F. Supp. 542 (N.D. Tex. 1997).
        192
              See id. at 548.
would, in fact, be opposed to the interests of the class and render the fund an inadequate
representative.

       This conflict is at the heart of whether a pension fund is entitled to a PSLRA presumption
or whether another prospective plaintiff has succeeded in rebutting that presumption. Regardless
of whether an opponent is successful in raising these issues, however, such a conflict could lead to
discovery regarding trading history and professional relationships. As discussed below, this fact
could make institutional investors reluctant to open the door to disclosure of such information.

        Discovery Under the PSLRA as a Deterrent to Institutional Investors

        Even if a challenge to the institutional investor’s appointment as lead plaintiff is
unsuccessful, discovery into an investor’s trading history, its relationships with underwriters,
brokerage houses, and directors and officers of companies might be fair game for a party opposing
to the lead plaintiff. Even if another prospective plaintiff is unsuccessful in leveling charges of a
conflict of interest against an institutional investor seeking lead plaintiff status, discovery into these
questions could make public certain information that an investor would not want to divulge, such
as a plan’s entire trading history and business relationships with other companies. Although some
unwanted information might be discovered, however, the PSLRA does limit the type of information
that could be obtained.

        The PSLRA confines discovery about prospective lead plaintiffs to cases in which a member
of the plaintiff class demonstrates a reasonable basis for determining that the presumptively most
adequate plaintiff is incapable of adequately representing the class.193 There is, however, no clear
definition of “reasonable basis.” Some post-PSLRA courts have refused to allow defendants to
conduct discovery regarding a lead plaintiff and have prohibited other potential lead plaintiffs from
discovering information by simply stating that no “reasonable basis” had been shown.194 On the
other hand, the structure of the PSLRA pertains to the appointment of a lead plaintiff only—a
defendant can still discover information once the class is certified.195 Therefore, avoiding discovery
at one point is of little use if the same information is required to be disclosed later. Institutional
investors may be more or less sensitive to the disclosure of this sort of information; however, the
potential for this discovery is yet another factor institutional investors must consider before seeking
lead plaintiff status under PSLRA.

THE FUTURE OF THE PSLRA

        Since 1995 when the PSLRA was enacted, many institutional investors have advanced
themselves in securities class actions suits as the lead plaintiff. As is apparent from the discussion
throughout this article, however, the question of whether or not an investor should seek to act as a
lead plaintiff in securities class action litigation is not easily answered. There are a wide array of
unique costs and benefits for institutional investors contemplating such activities. In light of the


        193
              See PSLRA, 15 U.S.C. § 77z-1(a)(3)(B)(iv) (Supp. V 1999).
        194
         See Gluck, 976 F. Supp. at 546; See also Greebel v. FTP Software, 939 F. Supp. 57, 59 (D.
Mass. 1996).
        195
              See Gluck, 976 F. Supp. at 546.
complexities involved in making this decision, one might expect that the PSLRA might not have yet
completely altered the face of securities class action litigation.

        At least one district court has noted that the practice of plaintiffs’ lawyers under the PSLRA
is not markedly different than the pattern developed before the PSLRA was enacted. In In re
Network Associates, Inc. Securities Litigation,196 the U.S. District Court for the Northern District
of California emphasized that the current strategy, as was true before the PSLRA, is still for
plaintiffs’ lawyers to file dozens of class action lawsuits after a substantial drop in any publicly
traded stock.197

        Under the PSLRA, the plaintiff in the first-filed suit is required to publish an initial notice
inviting other lead plaintiff candidates to step forward.198 The purpose of this notice requirement
is to encourage other investors to come forward and compete for the lead role.199 The Northern
District of California, however, noted that plaintiff’s lawyers have found a way to manipulate this
notice mechanism such that practice under the PSLRA “remarkably resembles the old regime.”200
In practice, a plaintiff’s lawyer in a first-filed suit will publish a notice which asks individual
investors to complete a form and then return it to that lawyer. The lawyer tries to accumulate as
many forms as possible, in an effort to cobble together the “group” with the greatest aggregate
financial interest in the litigation. At the same time, other lawyers who were not the first to file suit
also try to create the largest compilation of investors. As the Northern District of California
observed, “[t]he race to the courthouse has been replaced by a race to both the courthouse and thence
to the publisher.”201

        In In re Network Associates, the plaintiffs’ lawyers in the case used boilerplate forms for
individual plaintiffs to complete in their attempt to acquire the largest group. The form skirted
around the issue of serving as lead plaintiff, asking only that “the investor has reviewed the
complaint and ‘If necessary, I authorize the filing of a similar complaint on my behalf. . . . and I am
willing to serve as a representative party on behalf of the class, including providing testimony at
deposition and trial, if necessary.’”202 The form did not provide information regarding the
responsibility of being the lead plaintiff nor did it authorize and retain any particular counsel to seek
such a responsibility on their behalf.203 Competing class counsel each argued that the other lawyer



        196
              76 F. Supp. 1017 (N.D. Cal. 1999).
        197
              Id. at 1021.
        198
              15 U.S.C. § 77z-1(a)(3)(A)(i).
        199
              House Conference Report, supra note 7 at 33-34, reprinted in 1995 U.S.C.C.A.N. at 732-
33.
        200
              In re Network Assocs., 76 F. Supp. at 1021.
        201
              Id.
        202
              Id. at 1021-22.
        203
              Id.
had disguised its notices causing investors to believe that returning the form was a prerequisite to
participation in any ultimate recovery for the class.

        The district court, extremely critical of the lawyers’ conduct on all sides, held that as a
threshold matter, such aggregation was not proper under the PSLRA in light of the statute and its
legislative history.204 As noted by the court, “[t]he whole point of the reform was to install a lead
plaintiff with substantive decisionmaking ability and authority.”205 Allowing aggregation of
unrelated plaintiffs defeats the entire purpose of the PSLRA’s lead plaintiff provisions; as such, the
court held that “[a]rtificial aggregation of the type here proposed should never be allowed for any
purpose, including to serve as lead plaintiff or to sponsor a subgroup as lead plaintiff.”206 After
allowing limited discovery and holding hearings to sort out the mess created by plaintiffs’ counsel,
the court appointed the Board of Pensions and Retirement of the City of Philadelphia as the sole lead
plaintiff for the class.207

         The purpose of the PSLRA was ultimately effectuated because the court was willing to take
an active role in assuring that the PSLRA’s lead plaintiff mechanisms were not manipulated by
plaintiffs’ lawyers, and a single institutional investor was eventually appointed as lead plaintiff. The
lawyers, however, manipulated the strict PSLRA notification requirements and plaintiffs’ lack of
sophistication regarding class action lawsuits in an attempt to bypass congressional reform. Other
courts have been unwilling to reject the principle of plaintiff aggregation outright, as did the court
in Network Associates.208 It remains an open question whether the future of securities class actions
under the PSLRA will be characterized by this sort of manipulation, or rather by the increased
institutional investor involvement and guidance which Congress had sought.

CONCLUSION

        The PSLRA has provided institutional investors with an opportunity to take control of
securities fraud class actions if they so choose. Institutional investors, as lead plaintiffs in securities
fraud cases, have the power to limit the role of plaintiffs’ lawyers and “professional plaintiffs” who




        204
              Id. at 1022-23.
        205
              Id. at 1024.
        206
              See id. at 1027.
        207
              Id. at 1031.
        208
           See, e.g., D’Hondt v. Digi Int’l., Inc., Nos. CIV. 97-5 JRT RLE, CIV. 97-295 JRT RLE,
CIV. 97-156 JRT RLE, CIV. 97-538 JRT RLE, CIV. 97-351 JRT RLE, CIV. 97-440 JRT RLE, 1997
WL 405668, at *3 (D. Minn. Apr. 3, 1997) (“In our view, when, as here, the putative class may total
in the hundreds of thousands, if not millions, an arbitrary limit on the number of proposed Lead
Plaintiffs would be unrealistic, if not wholly counterproductive.”); In re Oxford Health Plans, Inc.
Sec. Litig., 182 F.R.D. 42, 51 (S.D.N.Y. 1998) (appointing three competing plaintiffs and plaintiff
groups as co-lead plaintiffs).
stand to profit from filing a complaint irrespective of the culpability of a defendant.209 Institutional
investors, such as pension funds, effectuate the purpose of the PSLRA by ensuring that they, and not
their lawyers, control securities class action litigation.

         Many institutional investors, however, may be reluctant to seek the role as lead plaintiff.
Institutional investors must first address whether accepting such a role is worthwhile, in light of the
unique burdens they may have to bear. Institutional investors must consider how their
responsibilities as ERISA fiduciaries impact their decision whether or not to litigate in a securities
class action. Further, an institutional investor must also be prepared to address conflict of interest
allegations or opposing class members’ claims that its sophistication renders it indequate to
represent the class. And, in rebutting such claims, an institutional investor might e forced to disclose
more private information than it would like to about trading histories and involvement in other
litigation.

        In the final analysis, however, the benefits of lead plaintiff status for institutional investors
will often be overwhelming. When acting as lead plaintiff, an institutional investor can exercise
much more control over litigation strategy, settlement negotiations, and costs than a passive class
member. Institutional investors usually have the greatest financial stake in the plaintiff class, and
therefore more effective prosecution and settlement of meritorious claims will provide direct
financial benefits to institutional investors and their beneficiaries. Further, i institutional investors
often have a continuing interest in the defendant company, which may compel them to consider the
long-term interests of the company along with the interests of the plaintiff class. Such balanced
consideration is likely to result in better resolutions from a systemic point of view. The financial
and legal expertise of institutional investors will allow them to negotiate settlements that not only
bring fair returns to the plaintiff class members but also result in beneficial changes to the defendant
company that may foster corporate growth.

         Although the PSLRA imposes no statutory duty to serve as lead plaintiff, institutional
investors may find themselves subject to a fiduciary obligation under ERISA to take an active role
where their involvement is likely to provide positive results for their beneficiaries. In light of these
considerations, institutional investors will increasingly find themselves compelled to step forward
and become involved in securities class action lawsuits. Such involvement yields optimal results
for institutional investors directly, provide a systemic benefit in securing the best representation of
the plaintiff class, and ensures that the litigation strategy employed in such actions will be best for
all involved in the long-term.




        209
         See In re Party City Sec. Litig., 189 F.R.D. 91, 103 (D.N.J. 1999) (discussing the purpose
of the PSLRA).

								
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