Legal Brief:
Cendant Corp. Litig.

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
Nos. 00-2769, 00-3653

________________________________________________

IN RE CENDANT CORP. LITIG.,

New York City Pension Funds,
Appellants.

________________________________________________

On Appeal from the United States District Court
for the District of New Jersey

________________________________________________

BRIEF OF THE SECURITIES AND EXCHANGE
COMMISSION AS AMICUS CURIAE IN SUPPORT OF
APPELLANTS ON THE ISSUES SPECIFIED

________________________________________________

DAVID M. BECKER
General Counsel

MEYER EISENBERG
Deputy General Counsel

ERIC SUMMERGRAD
Deputy Solicitor

LUIS DE LA TORRE
Special Counsel (202/942-0813)

NATHAN A. FORRESTER
Senior Counsel (202/942-0861)

Securities and Exchange Commission
450 Fifth St., N.W.
Washington, DC 20549-0606

TABLE OF CONTENTS

TABLE OF AUTHORITIES

INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION

STATEMENT OF ISSUES

SUMMARY OF ARGUMENT

ARGUMENT

1. When the Lead Plaintiff Possesses the Qualities and Acts in the Manner Contemplated by the Reform Act, the Court Should Rely on the Lead Plaintiff's Judgment in Appointing Lead Counsel and Determining a Reasonable Attorney Fee.

2. If the Lead Plaintiff Does Not Possess the Qualities and Select and Retain Counsel in the Manner Contemplated by the Reform Act and Required by Rule 23, the Court Should Exercise Its Traditional Discretion To Protect the Interests of the Class.

3. The District Court's Reasons for Conducting an Auction Are Unclear and Facts in the Record Indicate That an Auction May Have Been Unwarranted.

CONCLUSION

TABLE OF AUTHORITIES

Cases Page

Ballan v. Upjohn Co., 159 F.R.D. 473 (W.D. Mich. 1994)

Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299 (1985)

Dunn v. H.K. Porter Co., Inc., 602 F.2d 1105 (3d Cir. 1979)

D'Hondt v. Digi Int'l Inc., No. CIV 97-5, 1997 WL 405668 (D. Minn. Apr. 3, 1997)

Fisher Brothers v. Cambridge-Lee Indus., Inc., No. 82-4921, 1987 WL 26480 (E.D. Pa. Nov. 30, 1987)

Gluck v. Cellstar Corp., 976 F. Supp. 542 (N.D. Tex. 1997)

Gunter v. Ridgewood Energy Corp., 223 F.3d 190 (3d Cir. 2000)

In re Advanced Tissue Sciences Sec. Litig., 184 F.R.D. 346 (S.D. Cal. 1998)

In re Amino Acid Lysine Antitrust Litig., 918 F. Supp. 1190 (N.D. Ill. 1996)

In re Auction Houses Antitrust Litig., 197 F.R.D. 71 (S.D.N.Y. 2000)

In re Baan Co. Sec. Litig., 186 F.R.D. 214 (D.D.C. 1999)

In re Bank One Shareholders Class Actions, 96 F. Supp. 2d 780 (N.D. Ill. 2000)

In re California Micro Devices Sec. Litig., 168 F.R.D. 257, later proceeding, 168 F.R.D. 276 (N.D. Cal. 1996), later proceeding, 965 F. Supp. 1327 (N.D. Cal. 1997)

In re Cendant Corp. Litig., 182 F.R.D. 144 (D.N.J. 1998), later proceeding, 109 F. Supp. 285 (D.N.J. 2000)

In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156 (S.D.N.Y. 1997)

In re Horizon/CMS Healthcare Corp. Sec. Litig., 3 F. Supp. 2d 1208 (D.N.M. 1998)

In re Lucent Technologies, Inc., Sec. Litig., 194 F.R.D. 137 (D.N.J. 2000)

In re McKesson HBOC, Inc. Sec. Litig., 97 F. Supp. 2d 993 (N.D. Cal. Dec. 22, 1999)

In re Milestone Scientific Sec. Litig., 183 F.R.D. 404 (D.N.J. 1998)

In re Network Associates, Inc. Sec. Litig., 76 F. Supp. 2d 1017 (N.D. Cal. 1999)

In re Oracle Sec. Litig., 136 F.R.D. 639 (N.D. Cal. 1991)

In re Quantum Health Resources, Inc. Sec. Litig., 962 F. Supp. 1254 (C.D. Cal. 1997)

In re Wells Fargo Sec. Litig., 157 F.R.D. 467 (N.D. Cal. 1994)

Kahree v. Western Electric Co., 82 F.R.D. 196 (D.N.J. 1979)

Kramer v. Scientific Control Corp., 534 F.2d 1085 (3d Cir. 1976)

Raftery v. Mercury Finance Co., No. 97 C 624, 1997 WL 529553 (N.D. Ill. Aug. 15, 1997)

Sherleigh Associates LLC v. Windmere Durable Holdings, Inc., 184 F.R.D. 688, later proceeding, 186 F.R.D. 669 (S.D. Fla. 1999)

Switzenbaum v. Orbital Sciences Corp., 187 F.R.D. 246 (E.D. Va. 1999)

Vincelli v. National Home Health Care Corp., 112 F. Supp. 2d 1309 (M.D. Fla. 2000)

Wenderhold v. Cylink, 188 F.R.D. 577 (N.D. Cal. 1999)

Wrighten v. Metropolitan Hospitals, Inc., 726 F.2d 1346 (9th Cir. 1984)

Statutes

Private Securities Litigation Reform Act of 1995

Private Securities Litigation Reform Act of 1995, Section 101(b)

Securities Exchange Act of 1934, Section 15(c)(8), 15 U.S.C. 78o(c)(8)

Securities Exchange Act of 1934, Section 21D, 15 U.S.C. 78u-4

Securities Exchange Act of 1934, Section 21D(a)(2), 15 U.S.C. 78u-4(a)(2)

Securities Exchange Act of 1934, Section 21D(a)(3), 15 U.S.C. 78u-4(a)(3)

Securities Exchange Act of 1934, Section 21D(a)(3)(A)(i)(II), 15 U.S.C. 78u-4(a)(3)(A)(i)(II)

Securities Exchange Act of 1934, Section 21D(a)(3)(B)(iii)(I), 15 U.S.C. 78u-4(a)(3)(B)(iii)(I)

Securities Exchange Act of 1934, Section 21D(a)(3)(B)(iii), 15 U.S.C. 78u-4(a)(3)(B)(iii)

Securities Exchange Act of 1934, Section 21D(a)(3)(B), 15 U.S.C. 78u-4(a)(3)(B)

Securities Exchange Act of 1934, Section 21D(a)(3)(B)(v), 15 U.S.C. 78u-4(a)(3)(B)(v)

Securities Exchange Act of 1934, Section 21D(a)(3)(B)(i)-(iii), 15 U.S.C. 78u-4(a)(3)(B)(i)-(iii)

Securities Exchange Act of 1934, Section 21D(a)(3)(B)(iii)(I)(bb), 15 U.S.C. 78u-4(a)(3)(B)(iii)(I)(bb)

Securities Exchange Act of 1934, Section 21D(a)(4), 15 U.S.C. 78u-4(a)(4)

Securities Exchange Act of 1934, Section 21D(a)(5), 15 U.S.C. 78u-4(a)(5)

Securities Exchange Act of 1934, Section 21D(a)(6), 15 U.S.C. 78u-4(a)(6)

Securities Exchange Act of 1934, Section 21D(a)(7), 15 U.S.C. 78u-4(a)(7)

Securities Exchange Act of 1934, Section 21D(a)(9), 15 U.S.C. 78u-4(a)(9)

Securities Exchange Act of 1934, Section 21D(c), 15 U.S.C. 78u-4(c)

Legislative History

H.R. Conf. Rep. No. 104-369 (1995)

S. Rep. No. 104-98 (1995)

Federal Rules

Fed. R. Civ. P. 23

Fed. R. Civ. P. 23(a)(4)

Other Authorities

Court-Awarded Attorney Fees, Report of the Third Circuit Task Force, 108 F.R.D. 237 (Oct. 8, 1985)

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 (1995)

John C. Coffee, Jr., Securities Class Auctions, Nat'l L.J., Sept. 14, 1998, at B6

Richard B. Schmitt, Pension Fund Plays Crucial Role In Suit, Wall St. J., Dec. 17, 1998, at B19

U.S. Securities and Exchange Commission, Office of the General Counsel, Report to the President and the Congress on the First Year of Practice Under the Private Securities Litigation Reform Act of 1995 (Apr. 1997)

INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission respectfully submits this brief as amicus curiae. The brief addresses legal principles that the Commission believes are important to this Court's consideration of the district court's decision to conduct a sealed-bid auction to select class counsel and establish "a benchmark of reasonableness" for attorney fees in this case under the Private Securities Litigation Reform Act of 1995 ("Reform Act" or "Act"), Section 101(b), codified at Securities Exchange Act of 1934 ("Exchange Act"), Section 21D, 15 U.S.C. 78u-4.

The Commission, the agency principally responsible for the administration and enforcement of the federal securities laws, has long expressed the view that legitimate private actions under those laws serve an important role. These actions work to compensate investors who have been harmed by securities law violations, and, as the Supreme Court has repeatedly recognized, they "provide `a most effective weapon in the enforcement' of the securities laws and are `a necessary supplement to Commission action.'" Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 310 (1985) (citation omitted).

In adopting the Reform Act, Congress affirmed the importance of private securities litigation. H.R. Conf. Rep. No. 104-369, at 31 (1995) ("Conf. Rep."). In the Act, Congress established a specific procedure and criteria for the appointmentof the lead plaintiff in a securities class action. Furthermore, it assigned to that lead plaintiff the responsibility for selecting and retaining proposed class counsel, subject to review by the district court. Through these provisions, Congress sought to ensure more effective representation of investors' interests in securities class actions by transferring control of the actions from lawyers to investors.

In this case, the district court appointed as lead plaintiff a group of three public pension funds claiming large combined losses. The court did not rely, however, on the lead plaintiff's judgment and efforts in selecting and retaining proposed class counsel. Instead, the court conducted an auction to select lead counsel and establish a benchmark for awarding attorney fees in the case.

That decision has important implications for the proper functioning of the Reform Act. The court's resort to an auction could discourage institutions from stepping forward to lead class actions. Institutions and other large investors, whose participation Congress sought to encourage, may understandably be reluctant to invest time and money in selecting counsel and negotiating advantageous fee agreements if these actions are at serious risk of being overridden by the court. Even if they are not deterred from participating, they may find it difficult to workwith unfamiliar counsel and thus may play a less active and effective role on behalf of the class.

Accordingly, the Commission submits this brief to discuss legal principles about the role of the lead plaintiff under the Reform Act in selecting, retaining, and compensating class counsel. These are principles that the Commission believes district courts should follow in appointing lead counsel and awarding attorney fees in securities class actions and that this Court should consider in its review here.

STATEMENT OF ISSUES

1. What is the role of the Reform Act lead plaintiff as it relates to the selection, retention, and compensation of lead counsel?

2. In a Reform Act case, should, or under what circumstances should, a district court order an auction to select, and set a fee schedule for, lead counsel?�¹

SUMMARY OF ARGUMENT

The Reform Act provides that "[t]he most adequate plaintiff shall, subject to the approval of the court, select and retain counsel to represent the class." This lead counsel provision means that, in general, the lead plaintiff which is appointedaccording to the procedure and criteria specified in the Act selects and retains the proposed class counsel and that the court reviews the lead plaintiff's proposal.

Through the Reform Act, Congress sought to encourage institutions and other large investors to become lead plaintiff, and contemplated that such investors would seek out well-qualified counsel, engage in hard, arms-length bargaining at the outset of the cases, and negotiate fee agreements favorable to the class. Evaluating the circumstances of each case, these investors could structure the agreements in such a way as to give counsel the right incentives and hold down costs. Where the lead plaintiff possesses the qualities and acts in the manner contemplated by Congress, the court should rely, in appointing lead counsel and in awarding attorney fees, on the lead plaintiff's judgment and efforts. Indeed, failing to do so could enhance counsel's control and deter institutions from participating.

When the above is not true of the lead plaintiff, or when its counsel proposal is inadequate under general class action standards, the court can and should exercise its traditional discretion to protect the interests of the class. The court's review function under the lead counsel provision could take the form of stricter review, in-depth inquiry, and modification of the lead plaintiff's lead counsel proposal. Moreover, the lead plaintiff or its efforts could be so problematic ordeficient concerning counsel that the court must move beyond its review function altogether and assume a more active role. However, the court should do so only in circumstances very different from the model envisioned by the Act.

The court should not itself conduct an auction unless it has evaluated the lead plaintiff's own selection and retention of counsel, has particular concerns about the lead plaintiff or its efforts, and, if feasible, has directed it to undertake a proper competitive selection process. It is not sufficient that the court merely prefers a process that it, rather than the lead plaintiff controls, or assumes that an auction is inherently superior to a negotiated agreement.

Because the Commission is uncertain about the district court's reasons for conducting an auction in this case, the Commission expresses no view on the ultimate issue of whether the court abused its discretion. However, given indications that the auction may have been unwarranted and given the important implications for the Reform Act, the Commission urges this Court to analyze the district court's decision according to the principles discussed in this brief.

ARGUMENT

I. When the Lead Plaintiff Possesses the Qualities and Acts in the Manner Contemplated by the Reform Act, the Court Should Rely on the Lead Plaintiff's Judgment in Appointing Lead Counsel and Determining a Reasonable Attorney Fee.

The Reform Act's lead counsel provision states that "[t]he most adequate plaintiff shall, subject to the approval of the court, select and retain counsel to represent the class." 15 U.S.C. 78u-4(a)(3)(B)(v). This provision means that, in general, the lead plaintiff appointed by the district court pursuant to the Act selects and retains the proposed class counsel, and that the court reviews the lead plaintiff's proposal. Where the lead plaintiff possesses the qualities and acts in the manner contemplated by Congress, the district court should rely, in appointing lead counsel and in awarding attorney fees, on the lead plaintiff's judgment and efforts.

One court has stated that the lead counsel provision "[g]iv[es] the Lead Plaintiff primary control for the selection of counsel" and "was a critical part of Congress' effort to transfer control of securities class actions from lawyers to investors." Gluck v. Cellstar Corp., 976 F. Supp. 542, 550 (N.D. Tex. 1997). The Act rejected the prior practice by which the first plaintiff to file suit or counselthemselves could select class counsel. ² Because the lead counsel provision places responsibility on the lead plaintiff for selecting and retaining the proposed class counsel, the provision must be understood in the larger context of the Act.

The Act prescribed a new mechanism for selecting the lead plaintiff. Specifically, the Act set out a procedure and criteria for appointment early in the litigation of "the most adequate plaintiff" as "lead plaintiff." The most adequate plaintiff is the "person or group of persons" that "the court determines to be most capable of adequately representing the interests of class members." 15 U.S.C. 78u-4(a)(3)(B). The Act further established a presumption that this plaintiff is the named plaintiff or movant that (if it otherwise satisfies Rule 23 requirements for adequacy of representation and typicality of claims) "has the largest financial interest in the relief sought by the class." 15 U.S.C. 78u-4(a)(3)(B)(iii)(I)(bb).

In enacting the Reform Act, Congress expressed concerns about plaintiff counsel conduct, settlements, and attorney fee awards in securities class actions.�³ Among other things, Congress was concerned that in some cases class counsel were taking too large a portion of the settlement award to cover their own fees and were not making sufficient efforts to optimize the recovery for the class. ⁴

Congress sought to address these concerns through new, higher standards for appointment of the lead plaintiff. As the district court in this case stated, the rationale of these provisions is that "plaintiffs with the assets necessary to have made large investments will also be able to negotiate the most advantageous counsel rates to the class" and have "the most to gain from any marginal increase in dollars recovered per share." In re Cendant Corp. Litig., 182 F.R.D. 144, 148-49 (D.N.J. 1998), later proceeding, 109 F. Supp. 2d 285 (D.N.J. 2000); accord Sherleigh Assocs. LLC v. Windmere-Durable Holdings, Inc., 184 F.R.D. 688, 691(S.D. Fla. 1999) (holder of "largest financial stake can best prosecute the claims" and "is presumed best able to negotiate with and oversee counsel"). ⁵

Through the Reform Act, Congress "intended 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." Conf. Rep. 32; accord S. Rep. 4, 6, 10. In Congress' judgment, "[i]nstitutional investors and other class members with large amounts at stake will represent the interests of the plaintiff class more effectively than class members with small amounts at stake." Conf. Rep. 34. In particular, Congress wanted to "encourage institutional investors to take a more active role in securities class action lawsuits." Congress believed that increasing their role in class actions "will ultimately benefit shareholders and assist courts by improving the quality of representation." Id. at 32.

The law review article cited in the legislative history as "provid[ing] the basis for the `most adequate plaintiff' provision," S. Rep. 11 n.32, explained that institutions should be "in a position to negotiate fee arrangements with plaintiffs' lawyers before class actions are initiated[,] * * * [which] may well * * * differ substantially from the fee structures that courts currently employ." Weiss & Beckerman, 104 Yale L.J. at 2106-07. The authors stated that "a court might well feel confident in assuming that a fee arrangement an institutional investor had negotiated with its lawyers before initiating a class action maximized those lawyers' incentives to represent diligently the class' interests, reflected the deal a fully informed client would negotiate." Id. at 2105.

Thus, the Reform Act "would allow market forces * * * to play a dominant role in determining who served as plaintiffs' lead counsel in class actions, how lead counsel would be compensated, and the settlement terms that counsel for the plaintiff class would be inclined to propose." Id. at 2058.

Moreover, a fee agreement negotiated up front by the lead plaintiff could provide a court with "a measure of needed foresight to meet its obligations to [the class]," Cendant, 182 F.R.D. at 151, in determining a reasonable attorney fee. In that way, the court "need not be compelled to learn by hindsight - to be told at theend of months or years of litigation, `this is what we seek for services rendered.'"��Id. ⁶ As the district court noted, "a court's expertise is rarely at its most formidable in the evaluation of counsel fees." Id. at 150. ⁷

The district court described "favorable attorneys' fees" as an "important class interest[] that must be pursued by lead plaintiffs" and indicated that "a leadplaintiff presumed to have identity of interests with the rest of the class might also be presumed to be motivated by appropriate price and quality considerations." 182 F.R.D. at 148, 150. The court further recognized the importance of the lead plaintiff being able to perform its role by refusing to appoint competing movants as "co-lead plaintiffs." Id. at 147-48. ⁸

As another judge in that district stated in In re Lucent Technologies, Inc., Sec. Litig., 194 F.R.D. 137, 155-56 (D.N.J. 2000), the lead plaintiff should have "actively sought out and made an informed decision regarding the choice of lead counsel." It should select counsel based on "deliberate and in depth evaluation," "independent decision-making," and "independent, arms length negotiations."

Even more specifically, in appointing lead counsel in In re McKesson HBOC, Inc. Sec. Litig., 97 F. Supp. 2d 993, 1000 n.10 (N.D. Cal. 1999), the court stated that "any fee agreement that [the institutional lead plaintiff] has reached with its counsel may set an upper limit on attorney's fees." In appointing a group of New York City Pension Funds as lead plaintiff in Switzenbaum v. Orbital Sciences Corp., 187 F.R.D. 246, 251-52 (E.D. Va. 1999), the court noted that the group had "established mechanisms for making sound collective decisions together," had Corporation Counsel who could "monitor its actions and those of its proposed Lead Counsel," and had made "a specific proffer that [its chosen law] firm's contingent fees [we]re below what courts typically award."

In In re California Micro Devices Sec. Litig., 965 F. Supp. 1327, 1332 (N.D. Cal. 1997), a case brought before the Reform Act but decided after it, the court appointed two institutions as substitute class representatives after counsel had already been at work on the case. The court explained:

[The institutions] conducted an evaluation of the lawyers' fee requests with far more information than the court could. As regular investors in the securities markets, moreover, [the institutions] have an interest in establishing the optimal incentive level for initiating securities actions. Review and approval by [them] in this case can, therefore, be relied upon as an indicator of the reasonableness of the fees.

Finally, the case of Gluck v. Cellstar Corp. is good evidence that the lead plaintiff and lead counsel provisions can work, if applied in the manner envisioned by Congress. The court in Gluck appointed the State of Wisconsin Investment Board ("SWIB") as the sole lead plaintiff, rejecting the motion of a rival group of plaintiffs, represented by other counsel, to be appointed "co-lead plaintiff." Noting that SWIB "has a significant financial interest in the litigation and [] conducted a thorough search for competent counsel," the court then appointed as lead counsel the law firm chosen by SWIB. 976 F. Supp. at 546.�⁹

SWIB and its counsel ultimately negotiated a settlement of approximately $14.5 million, and the court awarded attorney fees based on SWIB's fee agreement with its counsel. According to published reports, the settlement exceeded 40% of the estimated damages, which compares favorably to some estimates of the average settlement in securities class actions of between $0.07 and $0.14 per claimed dollar. S. Rep. 6; Richard B. Schmitt, Pension Fund Plays Crucial Role In Suit, Wall St. J., Dec. 17, 1998, at B19.

That a Reform Act lead plaintiff might negotiate a fee agreement that is different from one that might have been produced by a court-ordered auction or preferred by some commentators - e.g., one with a declining, rather than an increasing, fee percentage as the recovery increases - does not mean that the agreement is invalid as an indicator of the reasonableness of the fees. As commentators have suggested, attempts to simulate the marketplace may not produce one "perfect" fee structure even for a single case, and reasonable and knowledgeable people, applying their knowledge, skill, experience, and judgment to the circumstances of that case could reach different results.�¹⁰ Furthermore,Congress sought through the Reform Act to summon and effectuate the lead plaintiff's judgment.

Thus, where the lead plaintiff possesses the qualities and acts in the manner contemplated by Congress, a court should rely, in appointing lead counsel and awarding attorney fees, on the lead plaintiff's judgment and efforts. Indeed, failing to do so could enhance counsel's control of the litigation, which is contrary to Congress' intent. ¹¹ It could also deprive institutional investors of a core reason for serving as lead plaintiff, only adding to the already significant disincentives for them to do so. ¹²

II. If the Lead Plaintiff Does Not Possess the Qualities and Select and Retain Counsel in the Manner Contemplated by the Reform Act and Required by Rule 23, the Court Should Exercise Its Traditional Discretion To Protect the Interests of the Class.

The Reform Act's lead counsel provision preserves an important review function for the district court. It states that the lead plaintiff's selection and retention of proposed class counsel shall remain "subject to the approval of the court." 15 U.S.C. 78u-4(a)(3)(B)(v). The legislative history makes clear that the provision was designed to preserve "the court's discretion under existing law to approve or disapprove the lead plaintiff's choice of counsel when necessary to protect the interests of the plaintiff class." Conf. Rep. 35; S. Rep. 12.

A primary instance of when deference to the lead plaintiff in appointing lead counsel and awarding attorney fees may not be appropriate and when the court should exercise its traditional discretion to protect the class is when "the reality of the case" does not "accord[] with the[] [Reform Act's] assumptions." Cendant, 182 F.R.D. at 145. For instance, if no institution or individual with large claimed losses has sought to serve as lead plaintiff, and the court has been forced instead toappoint an individual or group of persons with small claimed losses, the court may be justified in not relying on the lead plaintiff. ¹³

Furthermore, deference would not be appropriate where the court has concerns that the proposed lead counsel does not meet the requirements historically imposed on class counsel under Federal Rule of Civil Procedure 23(a)(4): (1)�competence - experience and expertise - to conduct a class action in the relevant area of law; (2)�capacity, in terms of financial resources, diligence and personal motivation, to pursue the class action to a satisfactory conclusion; (3)�freedom from disabling conflicts of interest; and (4)�an appropriate number of counsel, so as not to cause delay, disorganization, or increased costs. ¹⁴ Somecourts have also considered the fee agreement between the lead plaintiff and the proposed counsel as a factor in determining whether to appoint the counsel.�¹⁵

When the court has concerns about these matters, its review function under the Reform Act can take the form of stricter review, in-depth inquiry, and modification of the lead plaintiff's counsel proposal. In a number of Reform Act cases, courts have modified a counsel proposal by limiting the number of law firms or conditioning their appointment on avoidance of certain potential problems.�¹⁶

A court with a concern about the lead plaintiff's process of selecting and negotiating with counsel could make inquiries such as the following, which are suggested by Professor Grundfest in his declaration in the McKesson case (at ¶ 9):

(a) What procedures did the lead plaintiff follow to identify a reasonable number of counsel with the skill and ability necessary to represent the class in the pending matter?

(b) What procedures did the lead plaintiff follow in inviting competent counsel to compete for the right to represent the class?

(c) What procedures did lead plaintiff follow to negotiate a fee and expense reimbursement arrangement that promotes the best interests of the class?

(d) On what basis can lead plaintiff reasonably conclude that it has canvassed and actively negotiated with a sufficient number of counsel and obtained `the most qualified representation at the lowest cost?'

(e) Did the lead plaintiff make inquiries into the full set of relationships between the proposed lead counsel, and the lead plaintiff and other members of the class, and did the lead plaintiff reasonably conclude either that there are no such relationships or that they do not affect the exercise of plaintiffs' fiduciary obligations [to the class]?

Furthermore, there may be cases in which the lead plaintiff or its efforts may be so problematic or deficient as they relate to the selection and retention of leadcounsel that the court must move beyond its review function altogether and assume a more active role. This is in keeping with the remedial discretion the courts have traditionally exercised under Rule 23. E.g., Kahree v. Western Electric Co., 82 F.R.D. 196, 200 (D.N.J. 1979) (appointing class counsel where plaintiffs' actions indicated that they could not be trusted to act in best interests of class).

In such circumstances, the court could direct the lead plaintiff to engage in a proper process of selecting, negotiating with, and retaining counsel. In Network Associates, 76 F. Supp. 2d at 1030, 1033, a provisionally-appointed lead plaintiff had "lumped itself in [a 1700-person proposed lead plaintiff] confederation," had not investigated a recent "imbroglio involving [its chosen law] firm," and "did not seek competitive bids from prospective counsel." The court directed it to "interview multiple firms and to solicit competitive fee arrangements" and "provide under seal to the Court a full description of [its counsel] selection process, its conclusion, and its reasons." Id. at 1031, 1034.

In certain cases, the court might itself conduct an auction for lead counsel. This is a remedy that the courts have used under Rule 23. ¹⁷ The Commissionbelieves that the Reform Act does not foreclose this remedy in a securities class action in which the lead plaintiff does not appear willing or able to perform the selection, retention, and monitoring functions envisioned by Congress. ¹⁸

However, given the Reform Act's creation of a specific procedure and criteria for appointment of the lead plaintiff and its assignment to that plaintiff of a large role in selecting and retaining lead counsel, the Commission believes that the district court should take responsibility for those matters away from the lead plaintiff only where the circumstances of the case clearly and substantially depart from the Reform Act model. The district court should not itself conduct an auction unless the court has evaluated the lead plaintiff's own selection and retention of counsel; has particular, articulable concerns about the lead plaintiff or its lead counsel proposal; and, if feasible, has directed the lead plaintiff to undertake a proper competitive selection process. It is not sufficient justification for a court-ordered auction that the court merely prefers a process that it, rather than the lead plaintiff, controls, or assumes that an auction is inherently superior to a negotiated agreement as a basis for determining a reasonable attorney fee.

III. The District Court's Reasons for Conducting an Auction Are Unclear and Facts in the Record Indicate That an Auction May Have Been Unwarranted.

The district court's opinions in this case reflect a sophisticated understanding of the problems surrounding the appointment of lead plaintiff and lead counsel in class actions. However, although the opinions refer to a court's legal authority to order an auction, they are less than clear about the reasons for ordering one here. Moreover, an auction may not have been appropriate. Because of the stakes for the proper functioning of the Reform Act, the Commission urges this Court to review in accordance with the foregoing analysis the district court's decision to conduct an auction.

Here, the lead plaintiff is a group of three large institutional investors that "collectively manage over $340 billion in assets on behalf of millions of governmental employees and retirees * * * [and] hav[e] suffered losses in excess of $89 million" in this case. Institutions' Memorandum of Law, June 12, 1998, at 4. The lead law firms were originally selected both "through an RFP process"conducted by the New York State fund and "a rigorous selection process" conducted by the New York City funds. Pugh Decl. ¶¶�3-8. A "complex schedule with fees based on the amount of recovery and the stage of the litigation" was negotiated with both law firms. Id. ¶ 10. The institutions also "hammer[ed] out [with counsel] procedures to be followed to keep [the institutions] informed and actively involved in the litigation." Id.

Nowhere does the district court state that the institutions' counsel proposal, retention agreement, or the process or judgments underlying them are invalid. In fact, the court granted the institutions' counsel a right of first refusal of the low bid in the auction.

Moreover, the court indicated that it had not reviewed the details of the retainer agreement before the auction. 109 F. Supp. at 292. Thus, the court's reluctance to "rely solely on [the lead plaintiff's] judgment" in appointing lead counsel, the court's interest in employing "other mechanisms to aid the Court," and its use of an auction to establish a benchmark of reasonableness for attorney fees, 182�F.R.D. at 150, does not mean that, as lead counsel put it (Memorandum of Law dated May 4, 2000, at 14), the court "reject[ed] the retainer agreement." Indeed, the agreement would appear to be another marketplace valuation of the case, inaddition to the auction results, and to corroborate what lead counsel call the district court's "recogni[tion] at the outset of this case that [fees of 20 to 33%] *�*�* would not be appropriate here" (id. at 26).

At the August 19, 1998 hearing (Tr. 46), the district court remarked that "one can make the argument *�*�* that because of that economic power that at times [large investors] get a little complacent economically and therefore * * * they are not as cost effective as they should be." But the court never offered this in its opinions as a rationale for holding an auction. Nor did the court ever state that this hypothetical concern, which is at variance with the premise of the Reform Act, applied here. The same is true of the court's remark at the August 4, 1998 hearing (Tr. 110) that "at times familiarity or a long time association between a client and a lawyer or any other provider of services, may limit arms length bargaining."

More significantly, the court noted allegations that "considerations other than the interests of the class might have influenced the [lead plaintiff] group when it retained its attorneys." 182 F.R.D. at 148. When the party making this charge was unable "to present any proof of this alleged wrongdoing" at a hearing on the lead plaintiff motions, "the allegation was dismissed by the Court" as unproven and "unimpressive." Id. at 148-49; 109 F.�Supp. at 297 n.7. Nevertheless, the courtremarked that an auction "remove[d] any speculative doubt" about the allegations. 182 F.R.D. at 151. ¹⁹

The problem in this case may have been that the district court was not informed, and did not inquire, about the lead plaintiff's process of selecting and negotiating with counsel, and was not aware of the details of the retainer agreement, before deciding to conduct an auction. In a case, according to the court, in which "the potential for a lot of money is involved" (Tr. of August 19, 1998 hearing at 45) and that had been described by a plaintiff's attorney in print as "such a no brainer" (Tr. of August 4, 1998 hearing at 13), the court may have believed that, without an auction, it would be unable to dispel, for the benefit of the class, "any speculative doubt" that the lawyers were being favored over the class.

Because of the Commission's uncertainty about the reasons for the district court's decision, the Commission expresses no view on the ultimate issue of whether the court abused its discretion in ordering an auction. However, given the nature of the record and the important implications for the Reform Act, the Commission urges this Court to review the district court's decision according to the principles discussed in this brief.

CONCLUSION

For the foregoing reasons, the Commission urges the Court to reflect in its opinion the principles set forth in this brief.

Respectfully submitted,

DAVID M. BECKER
General Counsel

MEYER EISENBERG
Deputy General Counsel

ERIC SUMMERGRAD
Deputy Solicitor

LUIS DE LA TORRE
Special Counsel (202/942-0813)

NATHAN A. FORRESTER
Senior Counsel (202/942-0861)

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0606

December 2000

Footnotes

http://www.sec.gov/litigation/briefs/cendnt.htm