The misguided attack on incentive awards in class actions

By Alison Frankel
May 13, 2014

U.S. District Judge Colleen McMahon of Manhattan included a highly unusual warning in her recent opinion approving the $15 million settlement of a securities class action against the clothing retailer Aeropostale: She’s no longer following the standard operating procedure of awarding extra fees to plaintiffs who lead class actions. “This opinion should serve notice that this court, at least, will not routinely decide to ‘tip’ lead plaintiffs simply because their names appear in the caption,” she wrote, “and will view with some skepticism conclusory arguments that they actually made a meaningful substantive contribution to the lawsuit.”

The award of incentive fees is apparently something of a bugaboo for McMahon, who said she has “always been troubled by the practice,” though she’s previously approved the payments. Unprompted by Aeropostale or objectors to the settlement, the judge raised doubts at a hearing last week about a request by the City of Providence for $11,000 in reimbursement for the 150 hours its legal department expended on the case. McMahon reluctantly approved the request, but only “after much soul searching” and assurances from class counsel at Labaton Sucharow that it received legitimate help from the city’s legal staff. Going forward, McMahon said, she’s not going to be so amenable. Lead plaintiffs, she said, ought to know what is expected of them in class action litigation and shouldn’t sign up for the job if they expect to be paid for it.

“For the most part, I fail to see why a party who chooses to bring a lawsuit should be compensated for time expended in appearing at a deposition taken in order to insure that he is actually capable of fulfilling his statutory obligations, or responding to document requests, or performing what are essentially duplicative reviews of pleadings and motions that his lawyers are perfectly capable of reviewing for him,” McMahon wrote.

I’ll be curious to see if the judge actually follows through with her threat and disallows an incentive award to the lead plaintiff in a future class action (assuming that any future lead plaintiff decides that recovering a few thousand bucks is worth the risk of a tart opinion denying the request). With all due regard to Judge McMahon, I hope she reconsiders before she refuses to reimburse a lead plaintiff for the time and effort of representing a class that obtains a successful result. As a matter of policy, judges ought to be encouraging class representatives to take an active role in suits brought in their name, not suggesting that their contributions are worthless.

Law professors Theodore Eisenberg of Cornell and Geoffrey Miller of New York University conducted the only major study of incentive awards in class actions — a 2006 paper in the UCLA Law Review. According to their article, federal judges began approving fees to compensate lead plaintiffs for their efforts almost 25 years ago, and by 2000, such payments were considered routine. Even when Congress passed the 1995 law reforming private securities class actions, it left open the prospect of extra compensation for lead plaintiffs. Though the 1995 law was generally “unfriendly to routine incentive payments,” the professors noted, it nonetheless included statutory language indicating that lead plaintiffs may receive “the award of reasonable costs and expenses (including lost wages).”

Eisenberg and Miller looked at 374 class actions that received final approval between 1993 and 2002, including securities, mass tort, consumer credit, employment discrimination, antitrust and shareholder derivative cases. They found that courts exercised broad discretion in deciding whether to award incentive fees, and how much, but across the sample, 28 percent of the cases included extra compensation for lead plaintiffs. The average award to each class representative was $15,992 and the median was $4,357, constituting a tiny fraction of the total class recovery. The law professors concluded that incentive payments serve a valid purpose. “Given the modest frequency and size of incentive awards, and their possible benefits, courts that flatly refuse to grant them in any cases (rather than supervise their scope in particular cases), and laws that forbid them, may generate inefficiencies in class action litigation,” they wrote.

It’s been a long time since the paper came out, so I reached out to NYU law professor Samuel Issacharoff, who is known for his appellate work on behalf of class action lawyers. Issacharoff said incentive fees remain routine across the spectrum of class actions, reflecting the U.S. Supreme Court’s recognition in the 1985 case Phillips Petroleum v. Shutts that name plaintiffs take on a more demanding role than passive class members. Especially when lead plaintiffs can expect defendants to challenge their fitness to represent the class, Issacharoff said, “that’s a great deal to ask somebody to do.” Awards usually range between $5,000 and $50,000, he said.

Issacharoff said McMahon’s throwaway line about her reluctance to compensate the City of Providence for time spent reading its lawyers pleadings is especially unfair. Defendants often argue that lawyers for the class are running the case instead of their clients. As a result, plaintiffs lawyers typically ask even lead plaintiffs who don’t have law degrees to review filings to avert those accusations — so review by Providence’s legal department certainly wasn’t superfluous, he said.

The city’s lead outside lawyer, Jonathan Gardner of Labaton, told me he was glad the judge changed her mind about reimbursing his client for its work on the case. (The requested award was calculated by determining an hourly rate for Providence lawyers based their yearly salary, then multiplying that rate by the hours they spent on the class action.) “The authorizes this type of reimbursement to incentivize institutional investors to step up as lead plaintiffs,” he said. “We think that should be encouraged.”

I do too.

For more of my posts, please go to WestlawNext Practitioner Insights

Follow me on Twitter

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/