Alison Frankel

How limited is liability of limited-partner private equity funds?

Alison Frankel
Jul 31, 2013 19:26 UTC

The California Public Employees’ Retirement System, the largest public pension fund in the United States, rarely takes a stand as an amicus in trial court. But in an amicus brief filed earlier this month, Calpers warned that the future of private investment in California is at stake in a dispute over a few million dollars in unpaid bonuses to former employees of the now-defunct HRJ Capital. Unless a state-court judge overturns a colleague’s ruling that limited-partner investment funds are on the hook for liabilities of the general partner and fund manager, Calpers said, California risks losing its stature as an incubator of start-up business.

Lawyers for the former employees, meanwhile, contend that Calpers and the funds are drastically overstating the significance of a narrow, fact-based opinion with no precedential impact. On Thursday, both sides will make their cases to Judge Patricia Lucas of Santa Clara Superior Court.

Here’s the much-condensed backstory on the litigation that may – or may not – change the private equity industry. Darren Wong and Duran Curis once held coveted jobs with HRJ Capital and HRJ Capital Management, a fund-of-funds established by former San Francisco football stars Harris Barton and Ronnie Lott. But HRJ, which managed 22 limited-partner private equity funds, ran into trouble in the financial crisis. When management of the funds was eventually assumed by another company, Capital Dynamics, Wong and Curis lost their jobs. Their lawyers at Kirkland & Ellis eventually claimed Wong and Curis were owed about $4 million in unpaid bonuses and millions more in unpaid management fees.

Among the defendants Wong and Curis blamed for failing to pay up were several of the funds managed by HRJ. These funds were set up, like most private equity funds, as limited partnerships that contracted with a sponsoring general partner. The general partner was, in turn, responsible for managing the funds. with responsibility for managing the funds. I’m collapsing some of HRJ’s structural layers for the sake of simplicity, but Wong and Curis essentially said that through the various partnership and management agreements between HRJ entities, HRJ Capital and HRJ Capital Management were agents of the limited-partner funds, which had authorized the HRJ entities to act on their behalf. That agency relationship, as the plaintiffs explained in a summary judgment brief, made the funds liable for HRJ’s obligations to Wong and Curis.

The funds’ counsel at Orrick, Herrington & Sutcliffe said reality was quite to the contrary. There was nothing in the contracts that authorized the fund manager to bind the limited partner funds to HRJ’s obligations. Indeed, according to the funds, the agreements expressly stated that the managing entities were solely responsible for their employees. The funds paid their management fees to the general partner entities, they argued. What HRJ did with the fees was not their problem.

Underemployed Cooley Law grads lose the war, but win the battle

Alison Frankel
Jul 30, 2013 20:07 UTC

Jesse Strauss of Strauss Law had two goals when he filed a fraud suit on behalf of 12 graduates of Thomas M. Cooley Law School. The first was to win compensation for the Cooley grads, who had paid tens of thousands of dollars of tuition in the misguided expectation that a Cooley law degree would lead to a full-time legal career. The second, he told me, was to dispel similar misguided expectations by anyone else considering enrollment at Cooley. A ruling Tuesday by the 6th Circuit Court of Appeals will probably spell the end of the hope that Cooley graduates can get any of their money back from the school, but it should also expose the law school as a highly questionable investment for prospective lawyers.

“Based on my clients’ reactions, everyone is proud of their involvement in this suit,” Strauss said. “We’ve done real justice.”

The Cooley suit, like 14 other class actions Strauss and co-counsel have filed against law schools that purportedly misrepresented employment and salary data about their graduates, claimed that the school deceived prospective students about their future job prospects. In reporting on the job status of its graduates, the grads alleged, Cooley failed to distinguish between those with legal careers and those with other kinds of jobs; a graduate working at Starbucks, for instance, would be counted in Cooley’s survey as employed in business. The school also claimed that its salary data was an average of all graduates’ incomes, but as the 6th Circuit noted, the reported number was actually an average of the salaries of graduates who responded to the law school’s survey.

Class action activist asks SCOTUS to review charity-only settlements

Alison Frankel
Jul 29, 2013 20:59 UTC

The doctrine of cy pres – from the French for ‘cy pres comme possible,’ or ‘as near as possible’ – may have originated in trust law, but it has had its full flowering in class actions. Both defendants and plaintiffs lawyers have good reasons to resolve cases involving potentially large numbers of claimants with minuscule damages by directing money to charity instead of tracking down class members. Cy pres settlements wipe cases off the docket, which is good for defendants. And they generate fee awards, which is good for the class action bar. Class actions are, of course, overseen by federal judges, and the practice of naming a particular judge’s favorite charity as the recipient of cy pres funds in order to boost the odds of court approval has fallen into disrepute. Nevertheless, it’s the rare cy pres settlement that is rejected. Judges may ask for money to go to a different charity or may restrict attorneys’ fees, but courts usually conclude that there’s a benefit to class members in supporting charity rather than risking a trial of their claims.

Ted Frank of the Center for Class Action Fairness is not so sure. On Friday, Frank and lawyers from Baker Hostetler filed a petition for a writ of certiorari at the U.S. Supreme Court, asking the justices to review the 9th Circuit Court of Appeals’ approval of a $9.5 million settlement of class action allegations that Facebook’s now-dismantled “Beacon” program violated users’ privacy by revealing their online purchases. More than $6 million of that money was directed to the establishment of a new Internet privacy foundation with an advisory board that includes a Facebook representative and a plaintiffs’ lawyer from the case. Class counsel were also awarded $2.3 million in fees. Class members, meanwhile, received no direct compensation at all from the settlement. The new cert petition contends that the 9th Circuit’s split ruling in the case conflicts with cy pres decisions from the 2nd, 3rd, 5th, 7th and 8th Circuits.

“If allowed to stand, the circuit split created by the 9th Circuit’s decision creates an enormous incentive for forum-shopping by plaintiffs’ attorneys seeking to sue and settle nationwide class actions like this one,” the petition said. “Bringing suit within the 9th Circuit’s footprint now guarantees that minor things like compensating class members for their injuries, holding defendants liable to the extent the law allows, and preventing defendants from injuring class members in the exact same manner will not stand in the way of reaching a quick settlement to the mutual benefit of defendants and class counsel, at the expense of class counsel’s putative clients. The court should grant certiorari to resolve this circuit conflict, provide guidance to the lower courts on the use of cy pres awards, and correct a serious abuse of the class action mechanism that puts the interests of those it is intended to benefit, class members, dead last.”

Morgan Stanley could be to blame for Detroit’s blight: N.Y. judge

Alison Frankel
Jul 26, 2013 19:08 UTC

In 2012, five African-American Detroit homeowners and a Michigan legal services group asserted a notably creative legal theory in a class action against Morgan Stanley. Their lawyers at Lieff Cabraser Heimann & Bernstein and the American Civil Liberties Union acknowledged that Morgan Stanley didn’t write the supposedly predatory mortgages that victimized African-American borrowers in Detroit. Those housing-bubble mortgages were originated by New Century, a notorious subprime lender that went under in 2007. But the suit argued that New Century was writing loans to feed Morgan Stanley’s securitization machine. Because Morgan Stanley wanted to bundle certain types of subprime loans into its mortgage-backed securities, the theory went, its policies guided New Century’s predatory practices. So according to the homeowners’ suit, Morgan Stanley was actually responsible for the disparate impact of New Century’s discriminatory lending.

Morgan Stanley seemed downright incredulous at the audacity of the suit. Its lawyers at Wilmer Cutler Pickering Hale and Dorr moved to dismiss the class action, stacking up argument after argument about flaws in the homeowners’ legal theory. They’re pretty good arguments, too. The overarching theme of the bank’s defense is that New Century, not Morgan Stanley, is responsible for the loans it wrote. Morgan Stanley didn’t even buy the mortgages of four of the five homeowners who are name plaintiffs in the suit, the motion says, so how can its securitization policies be to blame?

The bank goes on to assert all sorts of technical deficiencies in the plaintiffs’ claims. The homeowners don’t have standing, the Morgan Stanley brief says, because they can’t show they would have qualified for loans on better terms absent discrimination. The plaintiffs waited too long to assert claims, it said, because the statute of limitations under the Fair Housing Act is two years (and under the Equal Credit Opportunity Act, three years), yet the most recent mortgage in the case dates back to 2006. Anti-housing discrimination laws, the bank said, apply to mortgage lenders but not securitizers. And even putting aside all of those arguments, the brief said, the plaintiffs cannot show that Morgan Stanley policies produced a disparate impact on African-Americans in Detroit. Morgan Stanley’s securitization policies were nationwide, not targeted to any racial group in any geographic area, the bank contends, so plaintiffs lawyers improperly cherry-picked Detroit. They also erred in analyzing all New Century lending in Detroit because not all of New Century’s subprime loans were purchased by Morgan Stanley, according to the brief. And finally, any disparate impact from New Century lending, the bank said, is the result of New Century practices that cannot be tied to a specific Morgan Stanley policy.

Apple asks Obama to take a stand on injunctions and essential patents

Alison Frankel
Jul 25, 2013 20:25 UTC

If there were any doubt that the tech world remains transfixed by the question of whether courts should order injunctions based on standard-essential patents, check out the Federal Trade Commission’s newly released response to commenters on the Google antitrust settlement it proposed in January. Many of the 25 letters that the FTC received focused on settlement provisions barring Google from seeking an injunction based on infringement of an essential patent until a fair licensing rate is determined by a court or arbitrator. The FTC said that its final settlement with Google, which was disclosed Wednesday, holds Google accountable for its commitment to license essential technology on fair and reasonable terms. Potential licensees, the agency said, must be protected from “opportunistic behavior” and permitted “to negotiate licensing terms without facing the threat of an injunction.”

It’s no secret that the executive and judicial branches of the U.S. government have recently frowned upon the grant of injunctions to holders of standard-essential patents. In January, as you may recall, the Justice Department and U.S. Patent and Trademark Office issued a joint policy statement recommending “caution in granting injunctions or exclusion orders based on infringement of … patents essential to a standard.” Judge Richard Posner of the 7th Circuit Court of Appeals said flat-out in a case involving cross-allegations by Apple and Motorola that injunctions should not be issued on the basis of essential technology. And when Motorola appealed the ruling to the Federal Circuit, the FTC weighed in with an amicus brief that described the threat of injunction in licensing talks as “the essence of hold-up.”

The White House itself is now confronted with an Aug. 4 deadline on the issue, in the form of a request by Apple to disapprove an exclusion order against certain Apple iPhones and iPads that was entered by the U.S. International Trade Commission on June 4. Apple contends that the ITC order, which was based on the commission’s finding that Apple infringed a Samsung patent covering essential technology for telecom communications, puts the ITC (and, by extension, the United States) at odds with the anti-injunction predisposition of other parts of the U.S. government and the rest of the world. Samsung, meanwhile, contends that “there are no policy reasons” to overrule the commission in this particular case, nor should the administration establish “a bright-line rule prohibiting exclusion orders for SEP infringement” because such a bar would encourage potential licensees to refuse to negotiate reasonable terms. (Hat tip to Florian Mueller of Foss Patents, who was first to write about the Apple and Samsung submissions.)

Judge grants investors rare early discovery in securities case vs SAC

Alison Frankel
Jul 24, 2013 20:23 UTC

It’s safe to say that the besieged hedge fund SAC Capital has lots more to worry about than a class action by investors in Elan Corporation, one of the companies whose shares the fund supposedly traded on the basis of inside information. The New York Times and The Wall Street Journal reported Wednesday that federal prosecutors in New York are on the verge of indicting SAC, the culmination of an insider trading investigation in which four onetime fund employees have pleaded guilty and two more, including the star portfolio manager Michael Steinberg, are facing criminal charges. SAC founder Steven Cohen is busy defending against Securities and Exchange Commission allegations that could knock him out of the industry, and SAC outside investors have pulled $5 billion out of the fund.

Amid those woes, a ruling Tuesday by U.S. Magistrate Kevin Fox of Manhattan – granting Elan investors early access to materials the SEC and the Justice Department have turned over to former SAC portfolio manager Mathew Martoma – is the equivalent of a flea bite. But for the securities class action bar, Fox’s order is big news: It’s a very rare instance of a judge permitting shareholders to obtain discovery before they’ve survived a defense dismissal motion.

As you know, the Private Litigation Securities Reform Act bars investors from serving discovery demands on class action defendants until shareholder pleadings have been tested by a defense dismissal motion and deemed adequate by the judge overseeing the case. In the 18 years since PSLRA was passed, federal judges have generally stuck by that stricture and refused to let shareholder lawyers obtain discovery even from defendants that have already settled with the SEC or the Justice Department. Only in very unusual circumstances – when, for instance, class action plaintiffs are competing with other claimants for a limited pool of resources or when shareholders need trading records to establish their standing – have judges bent the rule on pre-dismissal discovery. For years, class action lawyers have complained long and loud about the consequences of Congress’s restriction on discovery, which has led to the phenomenon of confidential witnesses who later recant accusations against their former employees. But aside from recently persuading U.S. Senior District Judge Jed Rakoff that the securities class action system is awry, they haven’t made much headway.

Early ripples from 2nd Circuit decision on tolling statute of repose

Alison Frankel
Jul 23, 2013 21:48 UTC

Three weeks ago, the 2nd Circuit Court of Appeals ruled in a case called In re IndyMac Mortgage-Backed Securities Litigation that the filing of a class action does not stop the clock on the three-year time bar for federal securities claims. According to the appeals court, the U.S. Supreme Court’s famous 1974 ruling in American Pipe v. Utah, which said that the statute of limitations can be tolled by the filing of a class action, does not apply to the statute of repose because that absolute time bar gives defendants substantive rights that cannot be abridged. The 2nd Circuit’s decision, as I’ve reported, was at odds with a 13-year-old ruling from the 10th Circuit, which found in Joseph v. Q.T. Wiles that a pending class action tolls the statute of repose as well as the statute of limitations.

When plaintiffs lawyers on the losing side of the 2nd Circuit’s IndyMac decision ask the Supreme Court to take their case (as I’m pretty sure they will), they might want to point to a just-released exchange of letters in a securities class action against Transocean in federal court in Manhattan. Transocean and the Georgia pension fund suing it over allegedly false statements in a 2007 proxy filing are fighting over whether the 2nd Circuit’s ruling disposes of the fund’s claims. That, of course, is of great interest to them. But of more general significance is that tolling of the statute of repose has so quickly shown itself to be an issue, even outside the context of mortgage-backed securities litigation. The broader the impact of the ruling, the likelier it is to be reviewed by the Supreme Court.

In the Transocean case, the statute of repose reared its head when the original lead plaintiff in the securities class action was dismissed for lack of standing. That plaintiff, a union pension fund, filed a class action making claims based on the Transocean proxy in September 2010, three days before the three-year anniversary of the proxy filing date in 2007. The DeKalb County Pension Fund made its first appearance in the union fund’s class action in December 2010, when its lawyers at Scott + Scott moved for DeKalb’s appointment as lead plaintiff. In March 2012, the union fund was tossed from the case, leaving DeKalb as the only remaining name plaintiff.

Detroit’s eligibility problem: Can state officials OK its bankruptcy?

Alison Frankel
Jul 22, 2013 23:16 UTC

The biggest municipal bankruptcy proceeding in U.S. history is less than a week old but it’s already promising to generate enough legal controversy to gainfully employ the platoons of lawyers vying for a role in the Chapter 9 case. A state court judge in Lansing, Michigan, has teed up a fight over Michigan Governor Richard Snyder’s right to authorize Detroit’s petition for Chapter 9 protection. That’s a novel procedural question, as I’ll explain below. I don’t think doubts about Snyder’s authorization will stop U.S. Bankruptcy Judge Steven Rhodes from pushing Detroit’s Chapter 9 proceeding forward – but they may well impact Rhodes’s eventual determination of the city’s eligibility for Chapter 9 protection.

The issue, as in the bankruptcies of the California cities of Stockton and San Bernardino, is state constitutional safeguards for the pension benefits of municipal workers. Anticipating that the city would try to cut retirement benefits, two sets of pension beneficiaries, as well as Detroit’s two retirement systems, sued in Ingham County Circuit Court before Detroit entered Chapter 9, in an attempt to block the city’s bankruptcy. Their argument, in a nutshell, is that Michigan’s governor is bound to uphold the state constitution, which includes a provision barring the impairment of pension rights for state workers, so he cannot authorize a bankruptcy filing that contemplates any pension reductions. Detroit’s emergency manager, Kevyn Orr of Jones Day, filed for Chapter 9 before any ruling in the three state-court pension suits. But last week, after the Chapter 9 petition, the pensioners returned to court to argue that because the petition was filed under improperly granted gubernatorial authority, it must be withdrawn.

On Friday, Ingham County Judge Rosemarie Aquilina agreed. Aquilina, who sits in the state capital of Lansing, ruled that Governor Snyder’s authorization of a Chapter 9 petition that “threatens to diminish or impair accrued pension benefits” was a violation of the state constitution. She ordered Snyder to instruct Orr to withdraw the petition and barred him from granting Orr permission to file any other Chapter 9 petition that didn’t safeguard pension rights.

Appeals court restricts Dodd-Frank protection for whistle-blowers

Alison Frankel
Jul 18, 2013 18:59 UTC

If Khaled Asadi, a former GE Energy executive who lost his job after alerting his boss to concerns that GE might have run afoul of the Foreign Corrupt Practices Act, had sued his old employer in New York or Connecticut, things might have worked out differently for him. Several federal trial judges in those jurisdictions have ruled that whistle-blowers who report corporate wrongdoing internally are protected by the Dodd-Frank Act of 2010, even though the statute defines whistle-blowers as employees who report securities violations to the Securities and Exchange Commission. But Asadi, who worked in GE Energy’s office in Amman, Jordan, filed a claim that the company had illegally retaliated against him in federal district court in Houston. And on Wednesday, the 5th Circuit Court of Appeals – with hardly a nod to contrary lower-court decisions in other circuits – ruled that Asadi is not a whistle-blower under Dodd-Frank because he talked to his boss and not the SEC.

The 5th Circuit opinion, written by Judge Jennifer Elrod for a panel that also included Judge Stephen Higginson and U.S. District Judge Brian Jackson (sitting by designation), highlights the tension between whistle-blower provisions in Dodd-Frank and the Sarbanes-Oxley Act of 2002. SOX, as you recall, directs employees to report possible wrongdoing up the corporate chain of command. SOX whistle-blowers must exhaust administrative remedies before they can sue and may only recover back pay. Dodd-Frank, on the other hand, directs whistle-blowers to bring their concerns to the SEC and permits them to sue for double the pay they lost through corporate retaliation. You can see why employees would rather bring claims under Dodd-Frank than SOX: They can get to court without clearing as many procedural obstacles and can recover twice as much money. You can also see why defendants argue that employees who went to their bosses instead of reporting to the SEC don’t qualify as Dodd-Frank whistle-blowers.

The SEC tried to solve this problem in 2011, when it implemented its final rule on Dodd-Frank whistle-blowers. In the provisions that dealt with anti-retaliation protection, the commission incorporated a reference to Sarbanes-Oxley, holding that Dodd-Frank gives employees a private cause of action against their employers if they have suffered retaliation for reporting violations to the SEC, cooperating with an SEC investigation or “making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002.”

UBS ‘likely’ to settle with FHFA before January trial: bank co-defendants

Alison Frankel
Jul 17, 2013 19:03 UTC

Remember UBS’s attempt to play what it considered a get-out-of-jail-free card in the megabillions litigation over mortgage-backed securities UBS and more than a dozen other banks sold to Fannie Mae and Freddie Mac? UBS’s lawyers at Skadden, Arps, Slate, Meagher & Flom came up with an argument that could have decimated claims against all of the banks: When Congress passed the Housing and Economic Recovery Act of 2008 and established the Federal Housing Finance Agency as a conservator for Fannie Mae and Freddie Mac, UBS said, lawmakers explicitly extended the one-year statute of limitations on federal securities claims – but neglected to extend, or even mention, the three-year statute of repose. UBS argued that FHFA’s suits, which in the aggregate asserted claims on more than $300 billion in MBS, were untimely because they were filed after the statute of repose expired.

The judge overseeing almost all of the FHFA MBS suits, U.S. District Judge Denise Cote, denied UBS’s motion to dismiss in 2012. The bank, she said, was splitting hairs: Congress clearly intended to give FHFA a chance to evaluate its potential causes of action and believed it was doing so when it extended the statute of limitations. The judge subsequently applied the same reasoning to other banks’ motions to dismiss FHFA suits on timeliness grounds, but she also granted UBS permission to take the issue to the 2nd Circuit Court of Appeals. Cote said that whichever way the appeals court ruled, its decision would help resolve the FHFA litigation. If she were reversed, FHFA’s claims would be drastically narrowed; if she were upheld, the banks would be more inclined to settle.

In April, as you probably recall, a three-judge 2nd Circuit panel affirmed Judge Cote. In the appeal, UBS stood alone among the FHFA bank defendants as a party, though the other banks filed an amicus brief endorsing UBS’s position that Congress failed to extend the statute of repose. Since the 2nd Circuit’s ruling, UBS and FHFA have been engaged in whirlwind discovery, which is scheduled to close in September. Judge Cote has set an inviolable January trial date for FHFA’s case against UBS.