The opinion of the court was delivered by: Jed S. Rakoff, U.S.D.J.
By motions filed earlier this year, the two respective plaintiffs in these consolidated class actions each sought to be appointed "lead plaintiff," a position that carries with it enhanced responsibility for the conduct of the litigation and - dare one mention it -- increased legal fees for the law firm representing whichever plaintiff is chosen to lead. The choice presented a classic dilemma, in the sense of a choice between two less-than-perfect plaintiffs. Still, a choice had to be made if the case were to proceed, and so on April 23, 2009, the Court issued a "bottom- line" Order granting the motion of the Public Employees' Retirement System of Mississippi ("MissPERS") to be lead plaintiff, appointing one of MissPERS' counsel, Bernstein Litowitz Berger & Grossman LLP ("Bernstein Litowitz"), as lead counsel, and denying the motion of Iron Workers Local No. 25 Pension Fund ("Iron Workers Fund") to be lead plaintiff. This Opinion states the reasons for those rulings.
Each of the plaintiffs sought to represent a putative class of investors who purchased from defendant Merrill Lynch & Co., Inc. and/or its affiliates "certificates" backed by pools of subprime mortgages and the like. The central thrust of the complaints was that defendants failed to disclose the extent of the underlying risk. The complaints sufficiently overlapped that the Court ordered them consolidated (-- two other actions have been similarly consolidated since --), and both plaintiffs sought to be appointed lead plaintiff in the consolidated action pursuant to the relevant provisions of the Private Securities Litigation and Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 77z-1(a)(3)(B)("Appointment of lead plaintiff").*fn1
After receiving written submissions, the Court held an evidentiary hearing on April 1, 2009, at which the Court was made aware of problematic relationships between plaintiffs and their counsel (discussed below) that arguably affected the pending motions.
The Court therefore invited, and received, further briefing before issuing its "bottom-line" ruling on April 23, 2009.
It is axiomatic, and the parties here do not dispute, that the lead plaintiff provisions of the PSLRA were intended to curtail the vice of "lawyer-driven" litigation, i.e., lawsuits that, because of the huge potential fees available in contingent securities fraud class actions, were initiated and controlled by the lawyers and appeared to be litigated more for their benefit than for the benefit of the shareholders they ostensibly represented. See, e.g., In re Doral Fin. Corp. Sec. Litig., 414 F. Supp. 2d 398, 401 (S.D.N.Y. 2006) ("[the PSLRA] was enacted to address perceived abuses in securities fraud class actions created by lawyer-driven litigation"); In re Pfizer Inc. Sec. Litig., 233 F.R.D. 334, 337 (S.D.N.Y. 2005) ("One of the principal legislative purposes of the PSLRA was to prevent lawyer-driven litigation."). To help combat this problem, the lead plaintiff provisions of the PSLRA required that a court "appoint as lead plaintiff the member or members of the purported plaintiff class that the court determines to be most capable of adequately representing the interests of class members." 15 U.S.C. § 77z-1(a)(3)(B)(i). Further, the provisions created a "rebuttable presumption" that the "most adequate" plaintiff is, inter alia, the person or group of persons that "has the largest financial interest in the relief sought by the class." 15 U.S.C. § 77z-1(a)(3)(B)(iii)(I)(bb). "The theory of these provisions was that if an investor with a large financial stake in the litigation was made lead plaintiff, such a plaintiff -- frequently a large institution or otherwise sophisticated investor -- would be motivated to act like a 'real' client, carefully choosing counsel and monitoring counsel's performance to make sure that adequate representation was delivered at a reasonable price." In re Razorfish, Inc. Sec. Litig., 143 F. Supp. 2d 304, 307 (S.D.N.Y. May 3, 2001) (citing Elliott 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, 2089 (1995)); see also In re Donnkenney Inc. Sec. Litig., 171 F.R.D. 156, 157-58 (S.D.N.Y. 1997).
Accordingly, each of the plaintiffs, in their initial papers on these motions, focused much of their attention on demonstrating that they had a substantial financial interest. MissPERS, in particular, emphasized that it had purchased 177,500 of the underlying certificates, compared with the Iron Workers Funds' 100,000. But the Iron Workers Fund argued that it alone held an interest in one of the classes of certificates at issue here, and that MissPERS could therefore "not fairly and adequately protect the interests of the class." 15 U.S.C. § 77z-1(a)(3)(B)(iii)(II)(bb).
At the evidentiary hearing, however, the Court was made aware of an arrangement between the Iron Workers Fund and its counsel, Coughlin Stoia Geller Rudman & Robbins LLP ("Coughlin Stoia"), that cast in doubt the adequacy of the Fund to serve as lead plaintiff in any event. Specifically, the evidence showed the Fund had entered into a contractual arrangement with Coughlin Stoia whereby, in return for Coughlin Stoia's providing free "monitoring" of the Funds' investments, the Fund agreed that, if Coughlin Stoia recommended bringing a securities class action and the Fund approved doing so, Coughlin Stoia would be retained, on a contingent fee basis, to represent the Fund. As Dennis Kramer, the Fund's administrator, testified:
Q: [by the Court] ... what you've chosen to enter into, as I understand it, is a contract where the monitoring counsel will also be the counsel who represents you if a lawsuit is brought, is that right?
A: [by Mr. Kramer] Yes, that's true.
Q: And the only way they get paid is if they bring such a lawsuit and recover, is that right?
Transcript, April 1, 2009 ("Tr.") at 8.
Going far beyond any traditional contingency arrangement of which the Court is aware, this practice, on its face, creates a clear incentive for Coughlin Stoia to discover "fraud" in the investments it monitors and to recommend to the Fund's non-lawyer administrator (and, through him, to the trustees) that the Fund, at no cost to itself, bring a class action lawsuit. In other words, the ...