The opinion of the court was delivered by: Shirley Wohl Kram, U.S.D.J.
This Opinion considers the fairness of a settlement (the "Settlement") reached in the shareholder derivative litigation arising from alleged accounting and compliance misconduct by directors and officers of America Online, Inc. ("AOL") and AOL Time Warner, Inc. ("AOLTW") in the years preceding and following AOL's merger with Time Warner, Inc. ("Time Warner").*fn1 For the following reasons, the Settlement and form of notice are approved.
The Settlement resolves several different tracks of litigation: (1) an action filed in the Southern District after the Company ignored, and eventually refused, shareholder demands to investigate allegedly improper and illegal conduct at AOLTW (the "Demand Action"); (2) actions filed, without the plaintiffs first having made a demand upon the Company, in federal court and in the Delaware Court of Chancery (the "No-Demand Actions"); (3) lawsuits filed under Title 8, Section 220 of the Delaware General Corporation Law, seeking production of documents relevant to the alleged misconduct (the "Section 220 Actions"); and (4) a complaint filed on behalf of the Company against AOLTW's auditor, Ernst & Young, and investment banks Morgan Stanley and Smith Barney (the "Auditor and Investment Bank Action"). Each track of litigation arises from common allegations of misconduct.
Plaintiffs allege that declining internet stock values in 1999 and 2000 led AOL personnel, with the knowledge or reckless disregard of that company's directors, to routinely override and abuse internal policies and procedures with respect to the negotiation, contracting, and accounting of revenues.*fn2 Those same directors comprised half of the board at the merged entity when AOLTW failed to rein in the continuing misconduct at the AOL business division. Plaintiffs argue that directors and senior officers of AOLTW "breached their fiduciary duties to the Company and its shareholders by . . . knowingly (or with conscious disregard of obvious facts) ignoring the clear and longstanding 'red flag' warnings of systemic corporate governance and compliance breakdowns and widespread instances of management override of compliance controls." (Pls.' Br. 11.) In addition, Plaintiffs argue that the defendants breached their fiduciary duties to the Company by failing to design sufficient internal governance controls to evaluate the effectiveness of their financial and operational compliance processes.
Since the first shareholder derivative complaint was filed, Plaintiffs have engaged in extensive investigation, reviewing millions of corporate documents obtained through discovery and in response to their Section 220 document requests. Additionally, Plaintiffs have participated in numerous depositions, consulted with experts, and prepared submissions assessing the strengths and weaknesses of their claims in the context of settlement negotiations overseen by a court-appointed special master. The parties ultimately entered into a stipulation of settlement after months of negotiations mediated by the special master.
The Settlement consists of two major components--(1) extensive governance and compliance provisions at the board and management level, and (2) an acknowledgment by the Company that the derivative actions were a "substantial factor" in the Company's ability to obtain an approximately $200 million recovery from its director and officer liability insurance carriers. (Stipulation of Settlement ¶ 7.1.) The governance and compliance provisions focus on the centralized oversight of compliance systems, the increased independence of the board of directors and compliance personnel, the design and implementation of an expanded operational audit to complement the Company's enhanced financial audit procedures, and a funding commitment to fully implement and support all governance and compliance systems for at least four years from the effective date of the Settlement. The monetary recovery will help to offset the substantial losses alleged by the derivative actions. Further, the Settlement narrowly limits the use of those funds to ensure that the bulk of the proceeds are available for the direct benefit of the Company.
The Court held a preliminary approval hearing on April 26, 2006, before preliminarily approving the Settlement and setting the stage for the distribution of notice shortly thereafter. The Plaintiffs proceeded to publish a summary notice in the Wall Street Journal and New York Times on May 17, 2006, and sent out over a million notices to shareholders. In addition, Plaintiffs set up a website and toll-free telephone number to provide shareholders with information about the Settlement. The notice period yielded just ten responses, with only seven of those ten objecting to some aspect of the Settlement or Plaintiffs' request for attorney's fees. Only one objector appeared at the final approval hearing, and this objection solely contested Plaintiffs' application for attorney's fees.
A. Standard for Approval of Shareholder Derivative Settlements
"Before approving the settlement of a derivative action, the Court must be satisfied that the compromise 'fairly and adequately serves the interests of the corporation on whose behalf the derivative action was instituted.'" Mathes v. Roberts, 85 F.R.D. 710, 713 (S.D.N.Y. 1980) (quoting Republic Nat'l Life Ins. Co. v. Beasley, 73 F.R.D. 658, 667 (S.D.N.Y. 1977)). In applying this standard, courts commonly inquire into "whether the compromise is fair, reasonable and adequate," In re Metropolitan Life Derivative Litig., 935 F. Supp. 286, 291 (S.D.N.Y. 1996) (quoting Weinberger v. Kendrick, 698 F.2d 61, 73 (2d Cir. 1982), cert. denied, 464 U.S. 818 (1983)), with respect to both "the negotiating process leading up to settlement as well as the settlement's substantive terms." D'Amato v. Deutsche Bank, 236 F.3d 78, 85 (2d Cir. 2001). A court should not engage in mere "rubber stamp approval" of the settlement, yet it must "stop short of the detailed and thorough investigation that it would undertake if it were actually trying the case." City of Detroit v. Grinnell Corp., 495 F.2d 448, 462 (2d Cir. 1974).
"Public policy, of course, favors settlement." In re Metropolitan Life, 935 F. Supp. at 291 (citing Weinberger, 698 F.2d at 73; Williams v. First Nat'l Bank, 216 U.S. 582, 595 (1910); TBK Partners, Ltd. v. Western Union Corp., 675 F.2d 456, 461 (2d Cir. 1982)). As the Second Circuit has long recognized, "[t]here are weighty justifications, such as the reduction of litigation and related expenses, for the general public policy favoring the settlement of litigation." Weinberger, 698 F.2d at 73. "Moreover, because shareholder derivative actions are 'notoriously difficult and unpredictable, . . . settlements are favored.'" Mathes, 85 F.R.D. at 713 (quoting Schimmel v. Goldman, 57 F.R.D. 481, 487 (S.D.N.Y. 1973)). With this policy in mind, the Court addresses the procedural and substantive fairness of the Settlement.
B. Procedural Fairness: The Negotiation Process
"A court reviewing a proposed settlement must pay close attention to the negotiating process, to ensure that the settlement resulted from 'arms-length negotiations and that plaintiffs' counsel have possessed the experience and ability, and have engaged in the discovery, necessary to effective representation of the class's interests.'" D'Amato, 236 F.3d at 85 (quoting Weinberger, 698 F.2d at 74). Further, the Second Circuit has noted that that "a court-appointed mediator's involvement in . . . settlement negotiations helps to ensure that the ...