Class action fee award system is broken. Here’s how to fix it: law profs

April 10, 2015

A couple of weeks ago, I wrote about a fee opinion by U.S. District Judge Lewis Kaplan of Manhattan, who decided that a request by class counsel for 13 percent of a $346 million settlement with underwriters of IndyMac mortgage-backed securities was just too much. Even though the 13 percent request was in line with the fee deal plaintiffs’ firms had negotiated in advance of the litigation with the lead plaintiff, a public pension fund, Kaplan cut the fee award to 8 percent, based on his own experience with securities class actions and skepticism about the hours reported by class counsel.

That example is a paradigm of the problems with the current system of awarding fees in securities class actions, at least as those problems have been pinpointed in an upcoming Columbia Law Review article by law professors Lynn Baker and Charles Silver of the University of Texas and Michael Perino of St. John’s University. In “Is the Price Right: An Empirical Study of Fee-Setting in Securities Class Actions,” the professors dipped into the dockets of 434 settlements announced between 2007 and 2012, looking at (among other things) how pre-set fee agreements with counsel factored into lead plaintiff selections; how fee requests and awards varied by the volume of cases handled by different jurisdictions and even individual judges; and why judges in about 15 percent of the settlements cut the requested fees.

Their overall conclusion is that in the vast majority of cases, fees are determined after the fact, based only on the size of settlement and the biases of the court. The professors argue that their findings show one of the goals of the Private Securities Litigation Reform Act of 1995 – to encourage lead plaintiffs to exercise oversight by negotiating fee arrangements with class counsel at the onset of a case – has not been met. They also concluded plaintiffs lawyers may be exploiting market inefficiencies by requesting higher fees from courts with a low volume of securities cases. And judges who slash fee requests without real analysis of benchmarks, they said, create uncertainty that, in the long run, hurts investors because it discourages class action lawyers from investing in cases.

“Taken as a whole,” the professors wrote, “our findings suggest that the current system of ex post fee setting in securities class actions is deeply flawed.”

Judges seem to accord little weight to pre-set fee deals when they are picking lead plaintiffs, citing such arrangements in only about 5 percent of lead plaintiff orders, according to the professors. Yet the study found that those pre-negotiated fee deals have a “substantial moderating effect” on fee requests. In cases involving public pension fund lead plaintiffs that have negotiated fee agreements with class counsel, the average fee request was for 13.76 percent of the settlement. By contrast, in cases with pension fund plaintiffs but without evidence of pre-set fee agreements, fee requests averaged 22.19 percent.

Overall, the mean fee request was about 26 percent in cases without pre-set fee agreements and about 18 percent in cases with them. The study found the same pattern in fee awards, which averaged about 25 percent when lead plaintiffs didn’t negotiate fees in advance and just under 18 percent when they did.

Plaintiffs lawyers seem to have realized that they can request and receive bigger fees outside of the three jurisdictions that handle the most securities class actions. The Southern District of New York and the Central and Northern Districts of California handled nearly half of the cases in the professors’ study. In those districts, fee requests averaged about 23 percent of settlement funds, compared to 26.2 percent in low volume districts. Average fee awards in the low volume districts (25.7 percent) were nearly four percent higher than those in the three higher volume jurisdictions (21.8 percent). And those differences, according to the professors, escalate as the value of settlements increases. Courts that handle a lot of securities class actions tend to give lower percentage awards in cases with big settlement funds. Low volume courts don’t insist upon such discounts.

“We cannot chalk up those differences solely to the idiosyncrasies of individual judges,” the study said. “The more experience courts or judges have with securities class actions, the more parsimonious they appear to become. Lawyers appear to be anticipating what the court is likely to do, asking for lower fees (particularly as cases get larger) when they appear in courts with large numbers of class actions or before high frequency judges and asking for higher fees in other situations.”

In 85 percent of the cases in the study, plaintiffs lawyers were awarded the fees they asked for. In the remaining 15 percent the professors said, they couldn’t find a meaningful way to predict why judges cut fees. That modeling failure – which was accompanied by paltry explanations from fee-slashing judges – led them to conclude either that fee reductions “are for all intents and purposes, random events,” or that some unobservable factors account for fee cuts.

“Either scenario raises serious questions about how fees are set in securities class actions (and in class actions of other types),” they wrote. “We speculate that the unpredictability of fee cuts derives from the fact that fee reductions are primarily the product of subjective assessments by judges based on their own idiosyncrasies, biases, and heuristics rather than the objective facts of any given case. Temperament, judicial philosophy, experience with class action litigation, personal wealth, pre-judicial work history, personal earnings history, political ideology, and other individual and largely unobservable judicial characteristics may well-consciously or unconsciously-drive judges’ decisions about whether and how much to reduce fees.”

There are so many other interesting tidbits of information in the 78-page study that my copy was a rainbow of Highlighter neon by the time I got to the end. Among them:

*Lodestar crosschecks are a waste of everyone’s time and effort because there is no statistically significant difference between fees awarded when judges use a lodestar check and those granted under just a percentage basis.

*Lead plaintiff contests truly are a proxy for the value of a case. Cases with multiple lead plaintiff motions had a median settlement value of $62.1 million compared to $26.9 million for cases with only one lead plaintiff candidate.

*Courts seem to pay little attention to objections to fee requests. Objectors filed challenges to requested fees in only 19 of the 62 cases in which judges awarded less than class counsel wanted.

But the bottom line, according to professors Baker, Silver and Perino, is that courts aren’t doing their part in setting the “right price” for securities class action lawyers. “The courts facilitate, rather than prevent, the exploitation of market imperfections by class counsel, enabling them systematically to obtain higher fees from courts and judges that see securities class actions less frequently than from more experienced courts,” they wrote. “And although judges do sometimes cut class counsel’s fees, we found those decisions to be unpredictable. That is, judicial fee cuts are as likely to result in fees that are further from the ‘right price’ as they are to move them closer to that ideal.”

Their solution? Plaintiffs need to negotiate fees when they hire class counsel. The fee terms should be disclosed to judges and should be a factor in the court’s selection of lead counsel. And when the case is over, judges ought to respect the pre-set fee agreements unless the litigation process gives them a good reason not to.

“Judges should keep uppermost in their minds that they are creating incentives for attorneys,” the professors wrote. “Realizing this, their only object should be to select fee terms that motivate lawyers to maximize net recoveries for claimants. Choosing a fee arrangement for any other reason would disserve class members by discouraging their lawyers from representing them zealously, thereby creating a serious risk that class members would be denied due process of law.”

I suspect Judge Kaplan might have a different view, but that conclusion makes a lot of sense to me.

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I am baffled by the notion that lead plaintiffs should have a role in negotiating or setting fees for the class action attorneys. In practice, aren’t the lead plaintiffs really selected by the attorneys wanting to make big money off the class action? All too often, the original harmed parties are the shareholders, who when a company is sued are also the ones ending up footing the bill in the end. Somehow the attorneys make big bucks, but shareholders are doubly victimized, first by the alleged wrongdoing, second when their company foots the bill for lawyers.

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