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 AT BALTIMORE (ISSN #0007-6899) 750 N. Lake Shore Drive Periodicals postage paid Chicago, Illinois 60611 at Chicago, Illinois and at additional offices 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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