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Just how much should the lawyers who won the largest settlement ever in a securities fraud class action — $3.19 billion for Cendant Corp. shareholders — get for their efforts? That question is about to be answered by the 3rd U.S. Circuit Court of Appeals, which heard oral arguments on May 22 on appeals over the legal fees and the settlement itself. But the three-judge panel is also being asked to resolve questions about what constraints, if any, a district court judge should have on choosing the lead plaintiffs’ counsel and on fixing the terms of the lead counsel’s engagement. One lawyer who appeared in opposition to the $262 million fee award also asked the court to tackle “pay to play,” the practice by which top class action plaintiffs’ firms make millions of dollars in political contributions to those who control public pension systems. These officers often wind up as lead plaintiffs in securities class actions, and under the securities reform act, the lead plaintiffs pick the lead counsel. The lawyer, Howard Sirota, of New York’s Sirota & Sirota, argued that “pay to play” corrupts the process of choosing lead counsel and runs counter to the intentions of Congress in passing the Private Securities Litigation Reform Act in 1995. When federal Judge William Walls of the U.S. District Court for the District of New Jersey chose two firms to serve in the coveted roles of lead plaintiffs’ counsel in the Cendant case in 1998, he ran an auction and invited bids instead of leaving the choice up to the lead plaintiffs. The three lead plaintiffs were the pension systems of New York state, New York City and California. The losses occurred in April 1998 after disclosures that earlier earnings had been overstated, causing the stock to plummet. Walls chose one unnamed firm as the lowest responsible bidder, but, noting the 1995 act, allowed the two firms representing the trio of pension systems to match the low bid. Such auctions by federal judges have been on the rise in the past few years. Those firms, New York’s Bernstein Litowitz Berger & Grossman and Philadelphia’s Barrack, Rodos & Bacine, did match the low bid. The $262 million awarded to the firms by Walls last August will be shared with about 40 other firms in the case, though lead counsel usually receive the lion’s share. New York state and California don’t oppose the fee award. But New York City’s pension system does, arguing in part that the firms were not entitled to seek a fee until they received approval from the city under the retainer agreement, which they allegedly did not do. New York City is also challenging the $262 million fee as excessive. Senior Assistant Corporation Counsel Lorna Goodman told Walls last August that the formula in the retainer contract negotiated with the two firms and the three pension systems would have produced a fee of $186 million, or $76 million less than the auction amount. Goodman said that because the lead plaintiffs had carefully negotiated a retainer agreement, there was no need for an auction. Goodman maintained then and now that under the securities reform act Walls acted inappropriately because he was required to find that lead plaintiffs’ choice of counsel was inadequate before he could hold an auction. The two firms have countered, before Walls and the circuit court, that there is no set cap under the retainer agreement. Harvard University Law School Professor Arthur Miller, arguing on behalf of the firms, told the panel last Tuesday that cap was an inappropriate term. But Senior Assistant Corporation Counsel Elizabeth Natrella told the judges that there is indeed a set cap, which is one reason the city negotiated for a clause calling for final fee approval before the firms could apply to the court. Walls rejected the city’s claim that the fee was excessive and above any cap, concluding that the amount was reasonable because the auction had functioned as a surrogate for the marketplace. In arguing before Walls, Goodman noted that the $262 million fee award broke down to an hourly rate of $10,861, as opposed to an hourly rate of $7,710 under the retainer. The Cendant appeal, particularly the part about the fees, has caught the attention of lawyers on both sides of securities class actions because it coincides with the creation of a task force last January by Chief Judge Edward Becker of the 3rd Circuit to study how lead counsel are selected. That panel, which has been conducting hearings, will produce recommendations in October. The task force is looking at the burgeoning bidding process. Becker noted in January that while many lawyers praise the auction process as lowering transactions costs and thereby benefiting the class, others say it is flawed in concept and practice, and can produce professional responsibility problems. The panel hearing the Cendant appeal is made up of Chief Judge Becker, former Chief Judge Dolores Sloviter and Judge Thomas Ambro, a member of the task force. In Becker’s last order in the case on May 15, he noted that Ambro was wearing two hats. He also pointed out that the panel and the task force face a similar question: “Whether the PSLRA constrains the freedom of the District Judge presiding over a class to fix the terms of engagement of class counsel.” THE AUCTION REMOVES THE TAINT As for the pay-to-play issue, Sirota, who represents a trust, originally brought it up before Walls. Sirota put together a three-firm bid with a proposed fee of 1 percent to 2 percent of the settlement, well below the 8.28 percent ultimately awarded to Bernstein Litowitz and Barrack Rodos. Walls rejected the bid as unreasonable. Walls also rejected Sirota’s pay-to-play argument, saying Sirota hadn’t provided evidence to show that political contributions played a role in the three pension systems choice of the two firms. Moreover, in his order awarding the $262 million in fees, Walls said his auction removed any speculation that political contributions tainted the selection of lead counsel. Sirota has produced a bound volume of several hundred pages showing political contributions by the two firms, as well as by New York’s Milberg Weiss Bershad Hynes & Lerach, and Philadelphia’s Berger & Montague, two other top plaintiffs’ class action firms. In particular, Sirota points to contributions to state officials who appoint members of pension boards, as well as the members themselves, in big states such as New York, California and Pennsylvania. He also cites big contributions to small states, like Louisiana, saying the extent of such donations is corrupting the process. Milberg Weiss gave $127,125 to New York state candidates since 1999, including $16,000 to state auditor Carl McCall’s campaign for the Democratic nomination for governor. The firm also gave $480,000 to California candidates and committees during that period, and more than $533,000 to Democratic national committees since 1991. Barrack Rodos gave the McCall campaign $10,000 last year, and $405,000 to the Democratic National Committee since 1995. Other recipients include candidates for treasurer and attorney general of Pennsylvania, and Louisiana Democrats, as well as more than $50,000 to federal candidates — all since 1999. Bernstein Litowitz has been pumping contributions into the California campaigns for state supreme court seats, Senate and Assembly seats, and the last gubernatorial race. A candidate for Louisiana state treasurer picked up $3,500 from the firm. “The real issue is how plaintiffs’ firms have adapted to the 1995 act and are now compromising public officials,” says Sirota. “Congress never saw this coming. They thought the lead plaintiffs would be the Fidelities [Fidelity Mutual Funds] of the world, not public pensions. But the funds won’t sue because they don’t want to tangle with corporations.” He points out that the Securities and Exchange Commission banned pay to play for bond counsel two years ago. During oral argument on May 22, Harvard Professor Miller, in defending Walls’ $262 million fee award, argued that the auction was proper because of the pay-to-play allegations. But the main argument by both New York City and Sirota was that the fee was excessive because the case was relatively easy. Cendant admitted liability immediately, there were no depositions taken, and the company handed over all the needed documents without a fight. Says New York City attorney Goodman: “There was also no risk of a nonrecovery. We’re not saying our lawyers didn’t do an excellent job. We’re just saying that it wasn’t worth $262 million.” That argument was successfully made in a related Cendant shareholder case in April when the 3rd Circuit slashed the fee of a plaintiffs’ firm because the case was relatively simple. The court strongly suggested a multiplier of three, which, if applied to the ongoing case, would reduce the fee by more than half. But lawyers for the two firms counter that they matched the low bidder and that the fee represents a fair market price that does not violate the 1995 reform act.

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