Opinion

Alison Frankel

N.Y. judge: Defendant can’t settle unless class can be certified

By Alison Frankel
January 16, 2014

I’ve been writing a lot recently about the struggles of the 5th Circuit Court of Appeals to find consensus on the constitutionality of a settlement class that sweeps in uninjured claimants. Two different 5th Circuit panels have reached different conclusions on that issue in a pair of overlapping appeals in BP’s epic class action settlement of claims stemming from the 2010 Deepwater Horizon oil spill: Judge Edith Clement, in an opinion last October, said that trial judges may not approve certification of a class that includes members who lack constitutional standing; but last week, two judges on another 5th Circuit panel upheld certification of the BP class, with Judge Eugene Davis citing decisions by other federal circuits that acknowledged the reality of uninjured class members swept into global settlements. The 5th Circuit’s divide highlights the complexity of the underlying question, which is as important for defendants as it is for plaintiffs: Can a defendant buy global peace through a class action settlement when the class might not otherwise be certifiable?

A federal district judge in Manhattan who has been notably skeptical of class actions provided her answer to that question Wednesday: No. U.S. District Judge Katherine Forrest refused to approve a $1.7 million securities class action settlement between the audit firm Schwartz Levitsky Feldman and investors in China Automotive Systems, one of the many U.S.-listed Chinese companies accused of swindling investors through accounting fraud. Forrest had previously rejected a motion by class counsel at Pomerantz Grossman Hufford Dahlstrom & Gross to certify the investor class, finding both that the name plaintiffs weren’t typical investors because they bought and sold shares in the class period, and that shareholders hadn’t satisfied the Basic v. Levinson efficient-market test for classwide reliance. In Wednesday’s ruling, the judge said that shareholders hadn’t given her any reason to change her mind about class certification so her duty to absent investors with legitimate claims prevents her approval of the settlement.

“At no point during this litigation, including most significantly after the court’s ruling on class certification for litigation purposes, did plaintiffs sufficiently support predominance by showing that the question of reliance can be demonstrated on a representative (e.g. class) basis,” Forrest said. “If this court were to certify the proposed settlement class in light of the evidentiary findings it previously made and without anything more from plaintiffs, it would effectively allow plaintiffs who potentially did not rely on materials setting forth the alleged misstatements to collect from the settlement fund…. Doing so would prevent those plaintiffs with real claims from obtaining the maximum amount to which they may be entitled.”

Forrest’s reasoning seems on its face to be at odds with the 2nd Circuit Court of Appeals’ 2012 decision in In re American International Group Securities Litigation, but the judge insisted it’s not. In the AIG case, the appeals court ruled that when “intractable management problems” preclude certification of a securities fraud class for litigation purposes, the class can still be certified for settlement. “Because settlement eliminates the need for trial, a settlement class ordinarily need not demonstrate that the fraud-on-the-market presumption applies to its claims in order to satisfy the predominance requirement,” the AIG opinion said.

Forrest, however, concluded that the 2nd Circuit’s intention in AIG was to ensure that trial-court judges “engage in a sufficiently thorough analysis of the various issues and interests in play in Rule 23 settlement class certifications -and that that be an analytically distinct inquiry from that involved in certification of a litigation class.” Forrest said that under AIG, the China Automotive plaintiffs were free to seek approval of a settlement class, despite her rejection of the litigation class, but that class counsel still had to solve the problems she’d previously identified. It would otherwise be inconsistent with Supreme Court precedent, she said, for her to approve the settlement.

Class counsel Jeremy Lieberman of Pomerantz told me the consequence of Forrest’s stated concern for the rights of absent class members is that no China Automotive shareholders will benefit from the audit firm settlement. “We’re very disappointed with the judge’s decision,” he said. “We are considering appeal.” (Shareholders previously attempted an interlocutory appeal of Judge Forrest’s rejection of certification of the litigation class, but the 2nd Circuit declined last October to take the appeal.)

You may be wondering why the audit firm, which is represented by Gibson, Dunn & Crutcher, agreed to settle this case at all. The answer is that Schwartz Levitsky Feldman reached an agreement in principle with China Automotive investors last April, before Judge Forrest denied certification of the litigation class and before the 2nd Circuit refused to hear an appeal of her ruling. The auditor half-heartedly supported the shareholders’ motion for approval of the settlement, which said only that the audit firm “did not object” to the motion, not that it had agreed to it.

The settlement agreement also gives the auditor the right to walk away “in the event that the court denies lead plaintiffs’ anticipated motion to certify a class action on behalf of the class for the purposes of settlement.” So you can see why class counsel are so distressed by Forrest’s ruling.

Auditor counsel Lee Dunst of Gibson Dunn declined to comment.

(Reporting by Alison Frankel)

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