By Nicole Lavallee
More and more, pension funds are weighing the pros and cons of opting out of a large class action securities case in favor of an individual action.
Although we are aware of no comprehensive studies to date, funds clearly are pursuing opt-out actions in greater numbers. This is partly a function of loss size. Opt outs make the most sense in cases where institutions have lost large amounts of money. Thus, as market-cap damages have soared to record highs in recent years, it is only logical to see a jump in the number of funds choosing to go it alone.
Understandably, many institutional investors have questions about the process. Below are some key points to remember when considering an individual action.
Know Your Losses
Monitoring your investment portfolio for potential losses is an important first step. You can only assess which securities fraud cases are worth your attention if you are aware of the pending cases and your potential losses in such cases.
As monitoring counsel for many funds, we typically recommend opting out only in cases where damages are very large and the class settlement offers relatively little satisfaction to a client or where the particular circumstances are such that an opt-out action provides the client with discernable benefits.
Generally, “mega cases,” where settlements may top $1 billion, tend to better lend themselves to individual actions than smaller cases for a number of reasons. First, even if a class recovery is large, the size of the class wide damages tends to be so massive that no one investor is likely to see a meaningful recovery of estimated damages.
Second, an individual case does not offer the same economies of scale as a class case.
In an opt-out action, the costs of litigation will come from the recovery obtained by the individual plaintiff such that the plaintiff cannot benefit from splitting those costs with other class members. To justify an opt-out action, the investor would need to recover enough money above and beyond what it would have received in the class case. Indeed, the size of the damages must justify the additional effort and expense, since opt-out cases may consume as much time to prosecute as the corresponding class action.
Third, the bigger the losses, the more seriously the defense will take your individual claim. That, in turn, means you may be able to obtain a more significant settlement.
Opt-Out Timing
A fund typically has several opportunities to opt out of a case. Even at the very beginning of litigation, a fund may decide that it makes sense to opt out based on a variety of factors such as: the size of the losses; a lack of confidence in the presumptive lead plaintiff or lead counsel; or a concern over the jurisdiction.
An investor may also decide to opt out once the court certifies the class. At this point in the case, the institution will have a better sense of the direction of the case, from the strength of the claims and the timing of the class period to the depth of the prosecution and the sensitivity of the judge.
More likely, however, a fund would decide to opt out at settlement time. At this point, funds will know the dollar amounts involved – the plan of allocation as well as the attorney fees – and can assess whether their recovery share is reasonable and adequate.
At any stage though, consideration must be given to issues relating to the statute of limitations.
Size of Losses
Where a fund’s losses are significant, an opt-out case may make sense for several reasons.
Consider these examples in which state pension funds have recovered more money than class members:
In 2005, Berman DeValerio reached confidential settlements in an opt-out action involving McKesson/HBOC. All three funds involved – the Utah State Retirement Board, the Public Employees’ Retirement Association of Colorado and the Minnesota State Board of Investment – received recoveries that substantially exceeded their pro-rata shares of the corresponding class action settlement.
More recently, after the AOL Time Warner securities fraud class action settled for $2.5 billion this past March, at least nine public funds and institutions opted out and negotiated substantial settlements. Many of the AOL Time Warner opt outs estimated that their recoveries far exceeded what they would have received under the corresponding class action settlement.
The University of California, for example, said its recovery of $246 million was between 16 and 24 times what it would have been in the class settlement. The California State Teachers’ Retirement System (CalSTRS) reported that its $105 million settlement represented 6.5 times what it would have recovered from the class. The State of Alaska said that its $50 million settlement was a whopping 50 times more than it would have gained from the class – a recovery of approximately 83 cents on the dollar for its claimed investor loss of $60 million. And the Ohio State Pension Funds estimated that its $144 million opt-out recovery (net of attorneys’ fees) represented $135 million more than the $9 million it would have recovered in the class settlement.
In 2005, five New York City pension funds opted out of the $6.1 billion WorldCom class action securities litigation settlement. The pension funds asserted that their recovery under the opt-out settlements was three times greater than it would have been under the class settlement.
Similarly, in 2007, CalSTRS opted out of the $400 million settlement of the securities fraud class action against Qwest Communications and obtained an opt-out settlement of $46.5 million. According to Jack Ehnes, CalSTRS’ chief executive, the pension fund recovered 30 times more than it would have under the class settlement.
So, while there are no guarantees, our experience shows that large pension funds sometimes may achieve higher recoveries through opt-out actions. But the situation has to be right.
Banding Together
In some instances, funds can achieve greater economies of scale if they opt out and band together. If several funds with losses opt out into a single action, they share their costs and increase their net recoveries. Funds that join together can gain leverage with defendants, who may be more likely to settle the case.
But there may be times when funds are better off pursuing individual actions as just that: individuals. One reason stems from the fact that most opt outs are brought in state courts, either where the plaintiff or the defendant is based.
Filing a case in a retirement fund’s home jurisdiction, rather than in a distant federal court, may offer advantages. The judge may be viewed as more receptive to a local plaintiff. Defendants may be motivated to settle by the prospect of a jury that is more sympathetic to local retirees than an out-of-state corporation accused of fraud.
In addition, state court cases often proceed faster than those in federal court. But be careful what you wish for. A state action that speeds ahead of the federal case may leave your lawyers with a heavier workload, since they cannot rely on existing legal arguments and company documents produced in discovery.
The Downside
Defendants settle cases to put the accusations behind them and to gain closure. And defendants won’t pay out a settlement if too many members opt out. Although we have yet to see this happen, there is a theoretical risk that the case could be compromised for all investors if a critical mass chooses to pursue individual actions. Some courts may also look with disfavor on opt-out cases.
Moving Target
As with other issues in securities litigation, there are no quick answers for funds searching for opt-out advice. Each fact pattern gives rise to unique issues and there is no one-size-fits-all solution. However, institutional investors with established portfolio monitoring procedures and the benefit of case recommendation services offered by reputable law firms are poised to make the proper evaluations when necessary.
Nicole Lavallee is a partner in the firm’s San Francisco office.
*In August 2017, our firm name changed to Berman Tabacco. Case references and content published before that date may refer to the firm under our prior name, Berman DeValerio.