My recent posts on securities fraud opt-out litigation settlements (here and here) provoked a number of interesting responses, including one comment that was so detailed that I thought it would make an interesting guest blog post. The commentator accepted my invitation to be a D & O Diary guest blogger. I am pleased to present the latest D & O Diary guest post, below.
The potential implications of the recent high dollar opt-out settlements, as discussed in your postings here and here, should not be taken lightly. To the contrary, while certainly not a trend, they could portend the dawning of a new era in shareholder litigation and lead to a dangerous future of far greater exposure for corporate defendants and, in some cases, their D&O insurers (if not by the individual defendants themselves). In short, these latest developments suggest that a class action settlement may not be the end of the day for the defense side, both with respect to defense costs and indemnity expense. As Yogi Berra once said, “it ain’t over till it’s over,” and it may not be over until the last large opt-out plaintiff has settled or presented its case to a jury.
In the past, a good percentage of shareholders who opted-out of a class action settlement did so for either moral or personal reasons partially or wholly unrelated to money. As such, opt-outs generally were not a concern to the defense side, and all interested persons were able to cap and account for the costs of shareholder litigation. Of course, this is not to suggest that the issue of opt-outs was ignored in the settlement documentation. Rather, virtually every class action settlement agreement contains (and has forever contained) a provision pursuant to which the settling defendants could “blow up” the settlement if shareholders owning a certain percentage of shares elected not to participate in the settlement. A typical “blow provision” contains opt-out percentages ranging from 2%-5% or more. While the enumerated percentage may have been triggered in a few stray cases, neither the company nor its D&O insurer felt the threat of future exposure justified their invoking their rights under the “blow provision.” The settlement, for all intents and purposes, put a cap on the amount of money a company and its D&O insurer knew they would spend for a claim and allowed them to reserve and ultimately pay a liquidated amount.
In light of recent developments, however, this may no longer be the case. Indeed, the number and, more importantly, the potential severity of opt-out claims and settlements may have a profound impact on whether and how companies, their D&O insurers and other categories of defendants (i.e., accountants, attorneys, underwriters, etc.) respond to a situation where the “blow provision” is implicated.
Let’s assume that shareholders who own 3% of a public company defendant’s stock elects to opt-out and go it alone in private litigation (or in combination with a sufficient number of other shareholders so as to constitute a “mass action,” but not a “class action”). What are a company and its D&O insurer to do? How about a non-settling accounting or law firm? At present, there is no simple solution, no “magic bullet” to avoid additional, and potentially severe, exposure both for defense and indemnity.
Moreover, such a situation could have implications on the proposed class action settlement, as the company and its D&O insurer (as well as, where applicable, settling accountants, attorneys, etc.) may invoke the settlement agreement’s “blow provision,” and elect simply to “roll the dice” and try the class action, although that may be the least attractive option to someone who likes certainty and hates surprises. Of course, a decision to blow up a settlement could have wide-ranging business (and marketing) implications, particularly for a D&O insurer which develops a reputation of being a company which blows up settlements and leaves its insureds exposed to personal liability by way of a jury trial or otherwise. And, in any event, from where will the money to defend and ultimately settle the opt-out case come? The company? The D&O insurer which had not exhausted its policy’s limit as part of the class action settlement? The company’s outside accountants, attorneys, and whoever else had a hand in the transaction that gave rise to the lawsuit? Or, perhaps, the D&O’s themselves. In the few mega-opt-out cases to date, the plaintiffs pursued recovery from virtually everyone person and entity with any potential for exposure. And, we assume that most of these categories of defendants paid something toward the settlement.
One alternative might be to negotiate in the class action settlement a provision which allows the defendants to reduce the settlement amount they are to pay ( i.e., a “clawback”), should the number of opt-outs exceed an agreed number. As a second alternative or as an adjunct, the class action settlement could be on an “opt in” basis, whereby class members must take affirmative steps to become part of a class and a class action settlement. Or thirdly, the D&O insurer could decide to exhaust (if it hasn’t done so already) and leave the opt-outs behind, to fight with the Company and the D&O’s (although, this is not a realistic approach from a cash-flow standpoint). Quite simply, none of these choices is attractive, and none address the underlying problem: what do we do with the opt-outs?
The implications for plaintiffs’ counsel could be equally as profound. In a class action settlement situation, class counsel must apply to the court for an award of attorneys’ fees, and the quantum awarded is within the full discretion of the presiding judge. Depending on the size of the settlement and, oftentimes, the amount of work performed by plaintiffs’ counsel, courts have been known to award attorneys’ fees of anywhere between 7% and 30% (or more) of the gross settlement figure. Regardless of the quantum, however, the ultimate decision on attorneys’ fees was not one the lawyers or their clients were empowered to make. The final decision belonged to the court. In stark contrast, in the case of a “mass action” or individual opt-out action, the opt-out plaintiffs and their counsel are free to negotiate any fee arrangement they choose, without court involvement or intervention, capped only by governing ethical rules and the parties’ respective views. To the point, unlike in a class action setting, court approval of their private fee arrangement is unnecessary.
Assuming the recent spate of opt-outs is not an anomaly, the evolution of this process ultimately could lead to a regime whereby (1) smaller or less well-known plaintiffs’ counsel prosecute the class action aspect of a securities fraud litigation and then apply to the court for a fee award if/when a settlement is reached, while (2) the bigger, more well known plaintiffs’ firms transform a good portion of their practice to representing large, typically institutional, opt-out clients, thereafter negotiate a huge settlement with the defendants (and their D&O insurer?), and then collect whatever amount they have pre-negotiated with the client(s). Equally inviting to prospective opt-out counsel, they oftentimes would be relieved from having to devote the time, resources and money typically necessary to prosecute a securities fraud claim, as all of the work, including paper discovery and depositions, already will have been completed by the class action counsel in the context of the class action litigation. In other words, work much less and recover much more. Now that’s capitalism!
In short, a new opt-out regime may be upon us, and companies and their D&O insurers alike, as well as class counsel and their class members, should be sensitive to the possibility that the number of litigated opt-out cases could escalate and cause heretofor non-existence problems for all of them, absent a reasonable and realistic solution. It may be that nothing can be done, short of legislated changes to Rule 23 of the Federal Rules of Civil Procedure governing class actions, and complimentary judicial activism. But people need to begin talking about the problem now, before the
whole team of horses has left the barn.
Reading Rick’s comments made me wonder how likely it is that defendants or their insurers would ever elect to exercise the “blow provision” or if they did, what would cause them to do it? Would it be opt outs of a certain number? Or of a certain size? Clearly, there would have to be some development that convinced them that they were not getting the benefit from the class settlement for which they thought they had bargained, and that they would be better off without the class settlement. That still seems only a theoretical possibility, even with the magnitude of the recent opt out settlements.
I also wonder how much the opt-out phenomenon is a D & O insurance problem. Most of the recent prominent opt out settlements have come in association with mega class action settlements, where the class settlement (plus defense expense) far exceeded the amount of the D & O insurance. Perhaps one exception is the recent Qwest opt-out settlement, where insurers for Joseph Naccio reportedly (here) contributed $1.5 milllion on his behalf in settlement of the individual investor opt-out claim against him. But even with that exception, I wonder whether D & O insurers have been called upon to make significant contributions to the recent wave of opt out settlements, since the policies for the companies involved were long ago depleted in connection with the class settlement and defense expense.
And along those lines, I think it is important to note that the settling defendants in the recent CalSTRS opt-out settlements in the Qwest and AOL Time Warner cases involved numerous non-D & O defendants, including investment banks and auditors. We don’t know how much each of these defendants contributed. But in view of these defendants’ contributions toward settlement, the companies’ contribution might well have been relatively slight, particularly if CalSTRS remains a shareholder of the companies.
These considerations make me wonder how big of a problem opt outs may be (or become) for D & O insurers. Based on the publicly available details of the recent prominent opt outs settlements, I don’t think there is enough data to know for sure. But the threat of opt out cases dragging on after the class case has been settled unquestionably has important implications for D & O insurers’ severity assumptions. It also has important implications for D & O policyholders’ limits selection. (My prior post, here, has further thoughts about opt outs and severity assumptions and limits selection.)
I also wonder whether the apparent proliferation of opt out settlements may be an artifact of the massive corporate frauds from earlier in this decade, and whether opt out settlements will largely fade out as those cases finally work their way through the system. On the other hand, a more depressing possibility is that the plaintiffs’ bar has developed a lasting addiction to opt out cases and that institutional investor opt outs will go on even after the last of the mega cases is finally resolved. Although I appreciate the sentiment of Rick’s suggestion that revisions to Rule 23 may be needed, I wonder what specific revisions could eliminate the opt out curse. You can’t make anyone join a class of which they do not want to be a part.
A final thought: all those would-be reformers who want to do away with class litigation need to take a good hard look at the alternative to resolving everything in one lawsuit. The alternative is not pretty.
In any event, special thanks to Rick for his excellent guest blog post. The D & O Diary is always interested in responsible readers’ guest post submissions on appropriate topics. Authors interested in submitting a guest post should feel free to contact me any time.
“I never said half the things I really said”: Rick’s reference to baseball great Yogi Berra made me reflect that although Berra was a fifteen time All-Star and league MVP three times, and appeared in fourteen World Series (including ten championships), he is now mostly remembered for his Yogiisms, a list of which may be found here.
We here at The D & O Diary find these words good rules to live by: “You can observe a lot by watching” and “If you can’t imitate him, don’t copy him.” Alas, it is true, as Berra observed, that “a nickel ain’t worth a dime anymore.”