Judge Accuses Coughlin Stoia of 'Shocking Conflict of Interest,' but How About Other Firms?

Judge Raps Coughlin for 'Shocking Conflict,' but How About Others?

David Bario

The American Lawyer

It's not every day that a federal judge accuses a prominent law firm of engaging in "the most obvious conflict of interest" he's ever seen, only to be told that the practice in question is nearly universal.

As first reported by Kevin LaCroix at the D&O Diary, that's what happened earlier this month at a hearing in a newly consolidated class action involving mortgage-backed securities. Manhattan federal district court Judge Jed Rakoff was questioning lead plaintiff candidates, and the administrator of the Iron Workers Local 25 pension fund told the judge that his lawyers at Coughlin Stoia Geller Rudman & Robbins had alerted him that the fund had a cause of action against Credit Based Asset Servicing. The law firm, he said, monitored the fund's portfolio for potential securities litigation prospects at no cost, taking payment only if it brought a successful suit.

The fund administrator didn't seem to think that was a problem, but Rakoff, from our reading of the hearing transcript, just about fell off the bench. "If that isn't a gross conflict of interest in violation of the most elementary fiduciary duties, I don't see what is," said the flabbergasted Rakoff.

Cue David Rosenfeld, the fund's lawyer from Coughlin Stoia, who offered a response familiar to third graders everywhere: Everybody does it. "This portfolio monitoring is not something that's unique to our firm," he protested, explaining that the fund was not obligated to hire Coughlin to bring any suits it recommended.

The judge, far from mollified, called the representative for the other proposed lead plaintiff, Mississippi's state pension fund, which sued Merrill Lynch earlier this year. The representative, a lawyer from the Mississippi attorney general's office, opened the judge's eyes even further when he told him that the fund has 12 plaintiffs firms monitoring its investments for free. The fund's class action firm, Bernstein Litowitz Berger & Grossmann, is one of the monitoring firms, though not the one that first suggested the suit. "This is a commonplace practice," the representative said. A rattled Rakoff called for additional briefs and set another hearing for Wednesday.

Defense lawyers from Paul, Hasting, Janofsky & Walker (for Credit Based) and Skadden, Arps, Slate, Meagher & Flom (for Merrill) watched the goings-on "with eyes wide open," one of them told us. "At times we were trying to keep from giggling," he said, adding that although he was aware that plaintiffs firms monitor pension fund portfolios, "what was not clear to any of us ... is the extent of this and the formalization -- that we'll do this for free, and you'll hire us for a continued case. That connection was news to me."

Did the judge overreact? Or did he uncover an ethical morass encompassing a huge swath of the plaintiffs bar? We couldn't reach the lawyers who attended the hearing, but a partner in another large securities class action firm told us that the practice is indeed common. "Most big firms monitor about 100 funds," he told us. "You hope they retain you, but there's no obligation." Smart clients have multiple plaintiffs firms keeping tabs on their portfolios and play them off against one another to make sure they get the best advice, he said. And Rakoff's response? "If anything, it's a little bit embarrassing for the judge," this partner said.

As for whether these arrangements present inherent conflicts, Coughlin argued in a brief submitted after the hearing that since its monitoring contract with the pension fund didn't authorize the firm automatically to file any suits -- and since the fund was under no obligation to use Coughlin if it chose to go ahead with an action -- there was no conflict. The firm cited several cases upholding the practice and included an opinion from a legal scholar giving it a green light.

Choosing lead plaintiffs in securities cases seems to bring out Rakoff's feisty side. Last year, he made headlines when he chastised Labaton Sucharow for putting forward a lead plaintiff who couldn't identify the stock in question, saying he would "not be party to a sham."

This article first appeared on The Am Law Litigation Daily blog on AmericanLawyer.com.