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A task force of federal judges, law professors and attorneys has come out with a report warning against the use of an innovative means for selecting lead counsel in class action cases. The auction method — in which judges ask lawyers who want to serve as lead counsel to submit a bid as to what they would require by way of fees and expenses — is a relatively new means for selecting counsel in a class action. The method was pioneered in 1990 by Judge Vaughn R. Walker of the Northern District of California in In re Oracle Securities Litigation, 131 F.R.D. 688. Since then, six other district judges, in the 2nd, 3rd, 5th and 7th Circuits have used auctions. The task force is the first to conduct a broad review of the auction process. According to Gregory P. Joseph, who served as the task force’s co-chairman, a half year of research went into their findings, including testimony from some 50 witnesses. Judges predicted the report, which is available online at www.ca3.uscourts.gov, will be read with interest by courts and practitioners alike. “It’s a very helpful report,” said Judge Jed S. Rakoff, of the Southern District of New York, whose decision in In re Razorfish Inc. Securities Litigation, 143 F. Supp. 2d 304 (S.D.N.Y. 2001) declining to use the auction method in a securities class action is cited by the report. “So much of what we do as judges is done on a case by case basis,” he said. “Here, we have a much more comprehensive treatment of the issue.” The report may prove especially useful in light of the record-setting pace of class action filings this year. The precipitous drop in stock prices, especially in the high-tech sector, has generated an unprecedented number of lawsuits alleging securities fraud. According to the Securities Class Action Clearinghouse, a research Web site maintained by Professor Joseph A. Grundfest at Stanford Law School, 325 securities class actions (not counting multiple filings) have already been filed this year. That number is more than 40 percent higher than the previous record of 236 filings in 1998. Recoveries in class actions, which have skyrocketed over the last few years, also may be on the verge of yet another quantum jump. Although the $3.1 billion settlement in In re: Cendant Corp. Litigation, 182 F.R.D. 144 (D.N.J. 1998), may have set a record, as Professor John C. Coffee of Columbia Law School recently pointed out in an article for the Law Journal, it could prove to be a short-lived one in light of the dizzying declines in stock prices — in some cases, hundreds of billions of dollars — of the issuers who are now facing securities class actions. In such cases, awarding attorneys’ fees using the traditional 30 percent-of-recovery arrangements between counsel and plaintiff could produce enormous fees for plaintiffs’ lawyers. Proponents say this is one major reason to use the auction process, since the attorneys’ percentage of recovery in auction cases is generally significantly less. Judge Milton Shadur of the Northern District of Illinois, an enthusiastic supporter of auctions, noted that in each of the three cases in which he used an auction, the bids came in between 6 and 7.5 percent of the total recovery for the class. “I must say that when you get results that consistent, you have a sense that it’s working,” he said. But critics of auctions say that under the traditional arrangement, where the plaintiffs choose their counsel, the judge must evaluate the attorneys’ fees for reasonableness anyway. “It may be true that you may get slightly lower fees with an auction,” Joseph conceded. “But it is our position that the risks inherent in an auction are not necessarily worth any savings.” He said the principal risk of the auction process was the investment the judge must make early in the case, during which time he is hearing from only one side — the plaintiff’s. “In a perfect world, you would not want to have a judge so heavily influenced and potentially invested so early on,” Joseph said. And in at least the Cendant case, the auction process backfired. There an auction-generated fee award ended up exceeding an earlier fee negotiated between plaintiff and counsel by nearly $100 million. The plaintiffs appealed and in August of this year, the 3rd U.S. Circuit Court of Appeals threw out the fee award and remanded the issue to the lower court with instructions to avoid giving the plaintiffs’ lawyers a “windfall.” Critics of auctions cite this case as proof of the risks inherent in the process that outweigh its potential benefits. But Judge Shadur noted that the judge in that case rejected an initial bid that would have resulted in an award of attorneys’ fees of only $16 million. “If the bidding process had gone ahead in its pure form, you would have had a drastically different result,” he said. With securities class actions, auctions raise another concern — namely, whether they are consistent with goals of the Private Securities Litigation Reform Act of 1995. “There is a tension between auctions, which try to discipline class actions by a market process, and the Reform Act, which tries to discipline class actions by an empowered gatekeeper,” said Samuel Issacharoff, a professor at Columbia Law School. “The two are not necessarily compatible.” Indeed, the report concluded that auctions are inconsistent with the act, “which is to assure that the ‘most adequate’ plaintiff will choose counsel and negotiate a reasonable fee.” The Reform Act envisions an “empowered plaintiff,” usually a sophisticated institutional investor with a large stake in the case, explained Joseph, co-chairman of the task force. “It’s hard to see what is empowered about a plaintiff who can’t even pick his own lawyer.” Two courts reached a similar conclusion just this year. In Razorfish, Judge Rakoff rejected the auction idea, writing that auctions were not “remotely consistent with the Reform Act.” The 3rd Circuit held likewise in August in In re Cendant Corp. Litigation, 00-2520. But courts elsewhere have found that auctions are reconcilable with the Reform Act. For instance, in In re Bank One Shareholders Class Actions, 148 F. Supp. 2d 967 (N.D. Cal. 2001), Judge Walker held that where the lead plaintiff did not conduct a true market search and negotiation in choosing counsel, the court could trump lead plaintiff’s choice. Judge Shadur, who has held similarly that the act does not preclude auctions, said that it only mandates a presumptive lead plaintiff. “Presumptive means presumptive,” he said, “It doesn’t mean that it’s irrebutable.” Judge Shadur added that lead plaintiffs have a fiduciary responsibility to the rest of the class. That is what drives him and other judges such as Judge Walker to seek the best financial arrangement between lead counsel and the entire class, he said. He said this issue was “strikingly absent” from the report. “It’s where the task force has really fallen down,” he added.

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