Ari Parnes, James Field, and Charles D. Chalmers, et al., v. Digital Lightwave, Inc., et al.

HARVEY J. GOLDSCHMID
General Counsel

ERIC SUMMERGRAD
Deputy Solicitor

LUIS DE LA TORRE
Attorney

Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0606
(202) 942-0813 (de la Torre)

TABLE OF CONTENTS

CERTIFICATE OF INTERESTED PERSONS AND CORPORATE DISCLOSURE STATEMENT

TABLE OF AUTHORITIES

INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION

STATEMENT OF THE ISSUE

SUMMARY OF ARGUMENT

ARGUMENT

I. UNDER THE REFORM ACT, THE DISTRICT COURT SHOULD TAKE STEPS TO ASSURE THAT THE LEAD PLAINTIFF IS ABLE TO ACTIVELY OVERSEE THE CONDUCT OF THE LITIGATION AND MONITOR THE EFFECTIVENESS OF COUNSEL

A. Congress Intended, in the Reform Act, that the Lead Plaintiff Would Be Capable of Actively Overseeing the Litigation and Monitoring Counsel

B. Under the Reform Act, the Lead Plaintiff Should Be an Institution, Individual, or Properly Constituted Group

II. THE RECORD IN THIS CASE INDICATES THAT THE LEAD PLAINTIFF GROUP DID NOT PERFORM, OR WAS NOT ALLOWED BY COUNSEL TO PERFORM, ITS ROLE UNDER THE REFORM ACT

III. WHERE THE LEAD PLAINTIFF HAS NOT PERFORMED ITS ROLE, OR NOT BEEN ALLOWED TO PERFORM ITS ROLE BY COUNSEL, THE DISTRICT COURT SHOULD SUBJECT ANY PROPOSED SETTLEMENT AND FEE AWARD TO ESPECIALLY RIGOROUS SCRUTINY

CONCLUSION

CERTIFICATE OF COMPLIANCE

CERTIFICATION OF SERVICE

TABLE OF AUTHORITIES

CASES:

*In re Advanced Tissue Sciences Sec. Litig.,
1998 U.S. Dist. LEXIS 16926
(S.D. Cal. Oct. 20, 1998)

Amchem Products, Inc. v. Windsor,
117 S. Ct. 2231 (1997)

*In re Baan Company Sec. Litig.,
186 F.R.D. 214 (D.D.C. 1999)

Bateman Eichler, Hill Richards, Inc. v. Berner,
472 U.S. 299 (1985)

Bennett v. Behring Corp.,
737 F.2d 982 (11th Cir. 1984)

In re California Micro Devices Sec. Litig.,
168 F.R.D. 257 (N.D. Cal. 1996)

In re California Micro Devices Sec. Litig.,
965 F.R.D. 1327 (N.D. Cal. 1997)

*Camden I Condominium Ass'n v. Dunkle,
946 F.2d 768 (11th Cir. 1991)

*In re Cendant Corp. Litig.,
182 F.R.D. 144 (D.N.J. 1998)

Chill v. Green Tree Financial Corp.,
181 F.R.D. 398 (D. Minn. 1998)

In re Donnkenny Inc. Sec. Litig.,
171 F.R.D. 156 (S.D.N.Y. 1997)

Ehlert v. Singer,
185 F.R.D. 674 (M.D. Fla. 1999)

Epifano v. Boardroom Business Products, Inc.,
130 F.R.D. 295 (S.D.N.Y. 1990)

Fischler v. AmSouth Bancorporation,
1997 WL 118429 (M.D. Fla. Feb. 6, 1997)

*Gluck v. Cellstar Corp.,
976 F. Supp. 542 (N.D. Tex. 1997)

*Greebel v. FTP Software, Inc.,
939 F. Supp. 57 (D. Mass. 1996)

Holmes v. Continental Can Co.,
706 F.2d 1144 (11th Cir. 1993)

*Kirkpatrick v. J.C. Bradford & Co.,
827 F.2d 718 (11th Cir. 1987)

Metropolitan Edison Co. v. People Against Nuclear Energy,
460 U.S. 766 (1983)

*In re Milestone Scientific Sec Litig.,
183 F.R.D. 404 (D.N.J. 1998)

*In re Milestone Scientific Sec Litig.,
1999 WL 297019 (D.N.J. Mar. 25, 1999)

In re Oxford Health Plans Sec. Litig.,
182 F.R.D. 42 (S.D.N.Y. 1998)

Parker v. Anderson,
667 F.2d 1204 (5th Cir. 1982)

*Pettway v. American Cast Iron Pipe Co.,
576 F.2d 1157 (5th Cir. 1978)

*Piambino v. Bailey, 757 F.2d 1112 (11th Cir. 1985)

*Ravens v. Iftikar, 174 F.R.D. 651 (N.D. Cal. 1997)

Reiger v. Altris Software, Inc.,
1998 U.S. Dist. LEXIS 14705
(S.D. Cal. Sept. 14, 1998)

Robinson v. Shell Oil Co.,
519 U.S. 337 (1997)

*Sherleigh Assocs. LLC v. Windmere-Durable Holdings, Inc.,
184 F.R.D. 688 (S.D. Fla. 1999)

*Sherleigh Assocs. LLC v. Windmere-Durable Holdings, Inc.,
1999 WL 382648 (S.D. Fla. June 3, 1999)

In re Southeast Hotel Properties Limited Partner Investor
Litig., 151 F.R.D. 597 (W.D.N.C. 1993)

Steiner v. Frankino,
1998 U.S. Dist. LEXIS 21804 (N.D. Ohio July 16, 1998)

*Switzenbaum v. Orbital Science Corp.,
1999 WL 339040 (E.D. Va. May 21, 1999)

Takeda v. Turbodyne Technologies, Inc.,
1999 U.S. Dist. LEXIS 8965 (C. D. Cal. May 28, 1999)

United States v. Taylor,
487 U.S. 326 (1988)

Yousefi v. Lockheed Martin Corp.,
1999 U.S. Dist. LEXIS 8966 (C.D. Cal. May 25, 1999)

* Asterisks denote authorities chiefly relied upon.

STATUTES AND RULES:

Securities Exchange Act of 1934, 15 U.S.C. 78a et seq.

Section 15(c)(8), 15 U.S.C. 78o(c)(8)

Section 21D, 15 U.S.C. 78u-4

*Section 21D(a), 15 U.S.C. 78u-4(a)

Section 21D(a)(2), 15 U.S.C. 78u-4(a)(2)

Section 21D(a)(3), 15 U.S.C. 78u-4(a)(3)

Section 21D(a)(3)(A)(i)(II),
15 U.S.C. 78u-4(a)(3)(A)(i)(II)

*Section 21D(a)(3)(B), 15 U.S.C. 78u-4(a)(3)(B)

Section 21D(a)(3)(B)(i), 15 U.S.C. 78u-4(a)(3)(B)(i)

Section 21D(a)(3)(B)(ii), 15 U.S.C. 78u-4(a)(3)(B)(ii)

*Section 21D(a)(3)(B)(iii),
15 U.S.C. 78u-4(a)(3)(B)(iii)

*Section 21D(a)(3)(B)(iii)(I),
15 U.S.C. 78u-4(a)(3)(B)(iii)(I)

*Section 21D(a)(3)(B)(v),
15 U.S.C. 78u-4(a)(3)(B)(v)

Section 21D(a)(4), 15 U.S.C. 78u-4(a)(4)

Section 21D(a)(5), 15 U.S.C. 78u-4(a)(5)

Section 21D(a)(6), 15 U.S.C. 78u-4(a)(6)

*Section 21D(a)(7), 15 U.S.C. 78u-4(a)(7)

*Section 21D(a)(7)(C), 15 U.S.C. 78u-4(a)(7)(C)

Section 21D(a)(9), 15 U.S.C. 78u-4(a)(9)

Section 21D(c), 15 U.S.C. 78u-4(c)
Fed. R. Civ. P. 23

LEGISLATIVE HISTORY:

141 Cong. Rec. H14038-39 (Dec. 6, 1995)

141 Cong. Rec. H14048 (Dec. 6, 1995)

141 Cong. Rec. H14050 (Dec. 6, 1995)

141 Cong. Rec. S8895 (June 22, 1995)

141 Cong. Rec. S8897 (June 22, 1995)

141 Cong. Rec. S9055 (June 26, 1995)

141 Cong. Rec. S9065 (June 26, 1995)

141 Cong. Rec. S9075-77 (June 26, 1995)

141 Cong. Rec. S9172-73 (June 27, 1995)

141 Cong. Rec. S9212 (June 28, 1995)

141 Cong. Rec. S9321 (June 28, 1995)

141 Cong. Rec. S17934 (Dec. 5, 1995)

141 Cong. Rec. S17956 (Dec. 5, 1995)

141 Cong. Rec. S17967 (Dec. 5, 1995)

141 Cong. Rec. S17969 (Dec. 5, 1995)

141 Cong. Rec. S17980 (Dec. 5, 1995)

141 Cong. Rec. S17982-84 (Dec. 5, 1995)

141 Cong. Rec. S19054 (Dec. 21, 1995)

141 Cong. Rec. S19084 (Dec. 21, 1995)

*Conference Report on Securities Litigation

Reform, H.R. Conf. Rep. No. 104-369 (1995)

Report on the Common Sense Legal Reform Act of 1995, H.R. Rep. No. 104-50 (1995)

Report on the Private Securities Litigation

Reform Act of 1995, S. Rep. No. 104-98 (1995)

MISCELLANEOUS:

SEC Office of the General Counsel, Report to the President and the Congress on the First Year of Practice Under the Private Securities Litigation Reform Act of 1995 (Apr. 1997)

*Elliott J. Weiss & John S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 Yale L.J. 2053 (1995)

INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission is the agency principally responsible for the administration and enforcement of the federal securities laws. It has long expressed the view that legitimate private actions under these laws serve an important role. Such actions work to compensate investors who have been harmed by securities law violations and, as the Supreme Court has repeatedly recognized, they "provide `a most effective weapon in the enforcement' of the securities laws and are `a necessary supplement to Commission action.'" Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 310 (1985).

In adopting the Private Securities Litigation Reform Act of 1995 ("Reform Act" or "Act"), Section 21D of the Securities Exchange Act of 1934, 15 U.S.C. 78u-4, Congress affirmed the importance of private securities litigation. Conference Report on Securities Litigation Reform, H.R. Conf. Rep. No. 104-369, at 31 (1995) ("Conf. Rep."). Congress sought through the Reform Act's lead plaintiff provisions, 15 U.S.C. 78u-4(a), to ensure more effective representation of investors' interests in private securities class actions by transferring control of the actions from lawyers to investors. Conf. Rep. 32-35.

This may be the first court of appeals decision to address the lead plaintiff provisions. The Commission wishes to assure that the Court is accurately and completely informed about the meaning and objectives of the provisions, how they appear to have been misapplied in this case, and what the Commission believes the law requires be done to give effect to the statute.

STATEMENT OF THE ISSUE

The Commission will address the following issue 1:

Whether, if the lead plaintiff has not performed its role under the Reform Act of actively overseeing the conduct of the litigation and monitoring the effectiveness of counsel, or has not been allowed to perform that role by counsel, the district court should consider that as a factor in evaluating any proposed settlement and fee award in the case.

SUMMARY OF ARGUMENT

The lead plaintiff group in this case was not able or allowed to perform its role under the Reform Act. The Act contemplates that the lead plaintiff will select and retain counsel with the approval of the court, and will actively oversee the conduct of the litigation and monitor the effectiveness of counsel for the protection of the class. Under the Act, the district court should take care, in appointing the lead plaintiff, that it is able to perform this function.

Particular concerns arise where the lead plaintiff applicant is a proposed group of individuals. If a group is appointed, it should generally be small in size, usually no more than three to five persons in number. It should provide appropriate, reasonably available information to the court about its members, structure, and intended functioning, to allow the court to determine if such a group will be able to actively oversee thelitigation. And the court should not appoint competing lead plaintiff applicants as "co-lead plaintiffs." The court should likewise inquire into, and actively exercise its discretion to review, proposals for multiple lead counsel.

None of this occurred here. The lead plaintiff group in this case did not and was not allowed to perform its lead plaintiff role. At least one of the members of the group, appellant Chalmers, was not even apprised that he had been named as a group member until well after a settlement in the case was agreed to and submitted to the court for approval. These problems were not known when the lead plaintiff was appointed because plaintiff's counsel failed to provide sufficient information to the district court.

Where the lead plaintiff has not performed its role, or not been allowed to do so by counsel, the district court should subject any proposed settlement and attorney fee award to especially rigorous scrutiny. The Reform Act makes the nature and extent of the lead plaintiff's participation in the conduct of the litigation an important factor in evaluating the proposed settlement and fee. This approach effectuates the Reform Act, comports with the traditional view of the role of courts in reviewing class action settlements and fee awards, and fits comfortably within existing standards for their review.

ARGUMENT

This case points to the need for guidance as to how district courts should apply the lead plaintiff provisions of the ReformAct. The lead plaintiff in this case was, in our view, an overly large group of investors who did not, and were not given any opportunity to, oversee the management of the litigation brought in their names. As a result, the case became a class counsel-driven litigation, of the sort the Act was intended to curb.

Appellant Charles D. Chalmers did not know he was appointed a lead plaintiff until after counsel had submitted a proposed settlement for court approval (see Doc 51 - Pgs 1-3, 6-8 & Ex B; Doc 75 - Pgs 98-103). Despite repeated requests over a six-week period, lead counsel did not provide him a copy of the stipulation of settlement the firm had filed with the court until after the court had preliminarily approved it and asked at that hearing if the lead plaintiff group had seen it (see Doc 51 - Ex. B; Doc 88 - Pgs 17-19). The record shows that Chalmers' experience was similar to that of other group members (see Doc 51 - Pgs 7-8; Doc 53; Doc 55; Appellant's Brief at 14, 24). Indeed, this lack of involvement appears to have been by design. One of the lead counsel informed the district court that, regardless of what the Reform Act provides, they considered communication with the group pointless. Counsel stated that "the language [of the Reform Act] is one thing and the practicalities are another" (Doc 75 - Pg 43; see id. 48-49; Doc 61 - Pgs 7-8). The district court expressed concern that lead counsel had given the court a mistaken impression about lead plaintiff involvement, chastised lead counsel for "a very poor job of communication"with Chalmers, and recognized that Chalmers had had no input into the settlement (see Doc 75 - Pgs 13-14, 46, 143-44).

A district court should seek to avoid these problems by assuring that the lead plaintiff in a securities class action is an institution, an individual, or a group capable of actively overseeing the litigation and monitoring counsel. Since the adoption of the Reform Act, district courts have articulated means by which this can be accomplished. We begin by discussing how we believe a district court should conduct the selection of lead plaintiff and what attributes a lead plaintiff should have.

Where, however, this has not been done, and it becomes apparent that the nominal lead plaintiff did not have an opportunity to, or was not able to, actively oversee the litigation and supervise counsel, the district court should give especially rigorous scrutiny to proposed settlements and requests for attorney fees. Such enhanced scrutiny is needed to compensate for the lack of the oversight that the Reform Act contemplates the lead plaintiff will provide.

I. UNDER THE REFORM ACT, THE DISTRICT COURT SHOULD TAKE STEPS TO ASSURE THAT THE LEAD PLAINTIFF IS ABLE TO ACTIVELY OVERSEE THE CONDUCT OF THE LITIGATION AND MONITOR THE EFFECTIVENESS OF COUNSEL.

A. Congress Intended, in the Reform Act, that the Lead Plaintiff Would Be Capable of Actively Overseeing the Litigation and Monitoring Counsel.

The Reform Act prescribed a new mechanism by which courts in securities class actions were to select the lead plaintiff. The Act sets out a procedure and criteria for appointment early in the litigation of "the most adequate plaintiff" as "leadplaintiff." The most adequate plaintiff is the "person or group of persons" that "the court determines to be most capable of adequately representing the interests of class members." 15 U.S.C. 78u-4(a)(3)(B). And, most importantly, the Act establishes a presumption that this plaintiff is the named plaintiff or movant who (so long as it otherwise satisfies Rule 23 requirements for adequacy of representation and typicality of claims) "has the largest financial interest in the relief sought by the class." 15 U.S.C. 78u-4(a)(3)(B)(iii)(I).

Lead counsel is to be chosen by the lead plaintiff. Under the Act, "[t]he most adequate plaintiff shall, subject to the approval of the court, select and retain counsel to represent the class." 15 U.S.C. 78u-4(a)(3)(B)(v). 2

The reason for the lead plaintiff and lead counsel provisions is made abundantly clear in the Act's legislative history. They arose from Congress' concern, expressed in the House, Senate, and Conference Committee Reports on the bill, that some class action securities litigation had become a "lawyer-driven" enterprise, in which law firms sought to bring cases and then sought out plaintiffs in whose name they could sue. 3

Congress sought to "protect[] investors who join class actions against lawyer-driven lawsuits by giving control of the litigation to lead plaintiffs with substantial holdings of the securities of the issuer." Conf. Rep. 32; accord S. Rep. 4 (Congress "intends * * * to empower investors so that they -- not their lawyers -- exercise primary control over private securities litigation"), 6 ("to transfer primary control of private securities litigation from lawyers to investors"), 10 ("The lead plaintiff should actively represent the class[;] * * * the lead plaintiff -- not lawyers -- should drive the litigation."). This concern was expressed repeatedly during the floor debate. 4

Congress viewed this problem as stemming from the fact that the lead counsel in the case commonly had a greater financial stake in the litigation than the plaintiffs. S. Rep. 6-7; H. Rep. 17-18. In adopting a presumption that the lead plaintiff would be the class member with the largest financial interest in the litigation, Congress "intended to increase the likelihood that parties with significant holdings in issuers, whose interests are more strongly aligned with the class of shareholders, will participate in the litigation and exercise control over the selection and actions of plaintiff's counsel." Conf. Rep. 32. In Congress' judgment, "[i]nstitutional investors and other class members with large amounts at stake willrepresent the interests of the plaintiff class more effectively than class members with small amounts at stake." Id. at 34.

In particular, Congress wanted to "encourage institutional investors to take a more active role in securities class action lawsuits." Id. Congress "believe[d] that increasing the role of institutional investors in class actions will ultimately benefit shareholders and assist courts by improving the quality of representation in securities class actions." Id.

This objective also is reflected in Congress' decision to give the initial choice of lead counsel to the lead plaintiff. See id. at 35. As a result, Congress "expect[ed] that the plaintiff will choose counsel rather than, as is true today, counsel choosing the plaintiff." Id.; S. Rep. 11. 5

The meaning of the Reform Act's lead plaintiff provisions has been recognized by numerous courts, including the district court in this case (see Doc 75 - Pgs 13-14, 46, 143-44). In Sherleigh Assocs. LLC v. Windmere-Durable Holdings, Inc., 184 F.R.D. 688, 691 (S.D. Fla. 1999), the court stated that "[t]he underlying rationale [of the lead plaintiff provisions] is the person or group with the largest financial stake can best prosecute the claims" and "is presumed best able to negotiate with and oversee counsel." Accord 1999 WL 382648, at *1 & n.2 (S.D. Fla. June 3, 1999) (same case; referring to Act's goal of"redirecting control of securities litigation from plaintiffs' firms to plaintiffs themselves"); Ehlert v. Singer, 185 F.R.D. 674, 677 (M.D. Fla. 1999); Fischler v. AmSouth Bancorporation, 1997 WL 118429, at *2 (M.D. Fla. Feb. 6, 1997).

As the court explained in In re Cendant Corp. Litig., 182 F.R.D. 144, 148-49 (D.N.J. 1998), "plaintiffs with the assets necessary to have made large investments will also be able to negotiate the most advantageous counsel rates to the class" and have "the most to gain from any marginal increase in dollars recovered per share." Congress "sought to eliminate figurehead plaintiffs who exercise no meaningful supervision of litigation." Ravens v. Iftikar, 174 F.R.D. 651, 661 (N.D. Cal. 1997). 6

B. Under the Reform Act, the Lead Plaintiff Should Be an Institution, Individual, or Properly Constituted Group.

As noted, Congress anticipated that the lead plaintiff would often be an institutional investor. See, e.g., Gluck v. Cellstar Corp., 976 F. Supp. 542, 548 (N.D. Tex. 1997); Greebel v. FTP Software, Inc., 939 F. Supp. 57, 63-64 (D. Mass. 1996) (same).

As explained in a law review article cited in the Reform Act's legislative history as "provid[ing] the basis for the `most adequate plaintiff' provision," S. Rep. 11 n.32, "[i]nstitutions'large stakes give them an incentive to monitor, and institutions have or readily could develop the expertise necessary to assess whether plaintiffs' attorneys are acting as faithful champions for the plaintiff class." Elliott J. Weiss & John S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 Yale L.J. 2053, 2095 (1995) ("Weiss & Beckerman"). The authors further argue that institutions can obtain more favorable settlements, and should be "in a position to negotiate fee arrangements with plaintiffs' lawyers before class actions are initiated[,] * * * [which] may well * * * differ substantially from the fee structures that courts currently employ." Id. at 2107, 2121.

In In re California Micro Devices Sec. Litig., 168 F.R.D. 257, 275 (N.D. Cal. 1996), a non-Reform Act case, the court noted that institutional investors "will be willing and able to monitor[] attorney conduct in securities class actions much more rigorously than either figurehead plaintiffs or courts can do." Id.; accord 965 F. Supp. 1327, 1330-32 (N.D. Cal. 1997) (same case). Courts appointing institutions as lead plaintiff under the Reform Act have emphasized this same function. See Switzenbaum v. Orbital Sciences Corp., 1999 WL 339040, at *5, *6 (E.D. Va. May 21, 1999); Gluck, 976 F. Supp. at 546, 549.

But nothing in the Act gives an express preference to institutions. There may, moreover, be cases, such as this one, where no institution seeks to be lead plaintiff. The lead plaintiff, accordingly, may be an individual or a group.

While it may be appropriate for the court to appoint a "group of persons" as lead plaintiff, 7 the court should exercise great caution in doing so. It is not sufficient for counsel merely to aggregate large numbers of unaffiliated persons into a "group" and, because this assemblage collectively has the largest claimed losses, have it appointed as lead plaintiff. A "group of persons" within the meaning of the Act should, like an institution or single large investor, be able to actively oversee the conduct of the litigation and monitor the effectiveness of counsel. In short, the Act's allowance for a "group of persons" as lead plaintiff must be interpreted by reference to the Act as a whole and to the Act's purposes. 8

It is particularly unlikely that the proposed group will have this active oversight and monitoring capability where it consists of a large number of previously unaffiliated persons,who have little or no contact with one another, who by and large claim relatively modest individual losses, and who have no demonstrated incentive or ability to work together to actively oversee the litigation. The problem is made worse if the proposed group members have been enlisted to become lead plaintiff by counsel, without understanding the role of lead plaintiff, without themselves having taken the initiative to seek the role or form a proposed group, without any knowledge of the other members, and without any direct relationship with, perhaps even any knowledge of, the law firms that ultimately present themselves to the court as proposed lead counsel. 9

The Commission believes that ordinarily, in order to ensure adequate stakes, monitoring, coordination, and accountability, a group should have no more than three to five members, and in general the fewer the better. 10 But even if the proposed group is within this range its members should be evaluated for their incentive and ability to work together to oversee the litigation. The court should consider the marginal benefit of including each member in the group as weighed against the further division of decisionmaking authority and the other problems attendant to enlargement of the group, and should not hesitate to pare groups down to the minimum needed size. 11

District courts have routinely limited, and have even rejected, proposed groups that were improperly constituted. In In re Baan Co. Sec. Litig., 186 F.R.D. 214, 216 (D.D.C. 1999),the court noted that a number of courts "have determined that multiple lead plaintiffs will be unable to control the litigation, effectively negotiate retention agreements, and supervise the conduct of counsel." The court held that "[t]he Lead Plaintiff decision should be made under a rule of reason but in most cases three should be the initial target, with five or six the upper limit," and chose three members. Id. at 217. Many other cases have limited proposed groups. 12

To enable the court to assess whether the proposed group is capable of performing the lead plaintiff function, it should provide appropriate information about its members, structure, and intended functioning. Such information should include descriptions of its members, including any pre-existing relationships among them; an explanation of how it was formed and how its members would function collectively; and a description of the mechanism that its members and the proposed lead counsel have established to communicate with one another about the litigation. If the proposed group fails to explain and justify its composition and structure to the court's satisfaction, its motion should be denied or modified as the court sees fit.

Courts have rejected proposed groups that did not sufficiently explain or justify their composition. In Ravens, 174 F.R.D. 651, the court denied without prejudice a proposed group's lead plaintiff motion, in part because it failed to describe the members' "background, experience and capabilities." Id. at 662-63. In Switzenbaum, 1999 WL 339040, at *5, the court rejected a proposed group that showed such "inability to manage itself" that it did not satisfy the minimum requirements of Rule 23. It "chose[] not to provide meaningful information about the identity of its seven members other than to offer their names, a summary of the transactions by which they purchased [the] securities, and the `simple mathematical' conclusion that they have the largest financial interest." Id. at *4. It was "unable to agree on who its members are," "invit[ed] the Court to select a reconstituted group of managers instead," "alternatively describ[ed] itself to include approximately 200" persons, "more people than could possibly manage the case," and "has never been forthcoming about any of these conflicts at all." 13

These cases belie the contention that a proposed group is under no obligation to provide class members or the court with any more information about itself than the minimal information and "conclusory assertions about its competence" discussed in Switzenbaum, 1999 WL 339040, at *4. The mere fact that onesection of the Reform Act, 15 U.S.C. 78u-4(a)(2), requires a plaintiff to provide certain minimum information in a certification attached to a complaint does not preclude the court from requiring additional information where necessary to make a proper lead plaintiff determination. Nor does the contention that the Act contemplates a "tight time frame" for lead plaintiff motions preclude careful inquiry into how a proposed group is constituted. There is no reason why a careful analysis cannot be done within the time frames indicated by the Act. 14

And plaintiff's counsel who argue that an approach of minimal information and unlimited groups is quicker and simpler forget that the pre-Reform Act "race to the courthouse" to file complaints and selection of counsel on a "first-come, first serve" basis could also be described as "simple" or "swift and inexpensive." Congress disposed of those practices with the Act because it viewed them as harmful in the long run of litigation. See Conf. Rep. 33. Such an approach ignores the long-term benefits, both in terms of effectively run litigation andmaximized recovery, that could result from a properly constituted and functioning lead plaintiff group.

Finally, consistent with the lead plaintiff's active oversight role, the courts should not appoint competing movants as "co-lead plaintiffs." The Commission believes that to do so would be contrary to the language and purposes of the Reform Act. 15 Such appointments would dissipate a lead plaintiff's ability to negotiate effective legal retention agreements and to oversee the conduct of the litigation and monitor the effectiveness of counsel for the protection of the class. 16

II. THE RECORD IN THIS CASE INDICATES THAT THE LEAD PLAINTIFF GROUP DID NOT PERFORM, OR WAS NOT ALLOWED BY COUNSEL TO PERFORM, ITS ROLE UNDER THE REFORM ACT.

In this case, the lead plaintiff group was proposed in a manner that gave little assurance that it would actively oversee the litigation. Its proponents did not provide adequateinformation to the district court. They proposed a large and uncoordinated group, without being forthcoming with the court about difficulties it would have in acting as lead plaintiff.

The March 24, 1998 memorandum supporting the lead plaintiff motion described the proposed group as a long list of 214 class members with $3.6 million in combined losses. The only information it provided about the proposed group was the members' names, data relevant to their loss calculations, and the bare minimum facts required in statutory certifications under 15 U.S.C. 78u-4(a)(2). The memorandum argued that it was appropriate to appoint all 214 persons because each had "stated a willingness to serve as a representative party on behalf of the Class" in the certification forms. Doc 15 - Pg 10. It urged the court to take into account the "financial stake represented by the entire Movant group as a whole" for purpose of determining the presumptively most adequate plaintiff under the Act. Id.

While inviting the court to appoint all 214 of its members, the proposed group stated (id. at 3) that they "believe that this litigation could be managed more efficiently if only a subgroup of these potential representatives were appointed." It stated (id.) that it "proffer[s] as the Proposed Lead Plaintiffs ten (10) of its members who together account for a predominant financial interest within the group of Movants."

No description of these ten persons was provided, no basis given for appointing so many persons with such divergent loss amounts, and no information provided about the structure andintended functioning of the "subgroup." The court was not told whether the "subgroup" members knew they had, in fact, been put forward as lead plaintiff, with whom they had been put forward, and what being a lead plaintiff means. The court was not told that there had been no communication among subgroup members and that none was envisioned. Nor was it told that one of the group members was an attorney, which lead counsel would later claim created problems for communication among members. Doc 60 - Pgs 2-4; Doc 61 - Pg 5. Nor was the court informed that counsel considered at least three of the subgroup members to be "small investors" (Doc 61 - Pg 7) whose views would be given less weight than other members' (see id.; Doc 48 - Pgs 2-3).

The memorandum merely stated (Doc 15 - Pgs 10-11) that "[i]n addition to signing the requisite certifications," each of the ten persons "has also selected and retained competent and experienced counsel to represent them." It did not disclose the manner in which they "selected and retained" counsel. Nor did it state that each member knew who all of the proposed counsel were. 17 It asserted without any further elaboration that the members "have and will protect the interests of the Class." Doc 15 - Pg 16. The district court relied on counsel's representations and, because of the inadequacy of thoserepresentations, a proposed group was appointed that had significant defects.

The end result of this process is clear. Not only was the lead plaintiff group not in a position to oversee the litigation, it was not even made clear to the group that the group was the lead plaintiff. Members were not kept apprised of the status of the litigation until after a tentative settlement had been reached. And even if they had been apprised of these events, it would have been extremely difficult for ten strangers, who had not worked together before, to coordinate in actively overseeing the litigation and the lawyers. The record is clear that the conduct of this case was dominated by counsel. 18

III. WHERE THE LEAD PLAINTIFF HAS NOT PERFORMED ITS ROLE, OR NOT BEEN ALLOWED TO PERFORM ITS ROLE BY COUNSEL, THE DISTRICT COURT SHOULD SUBJECT ANY PROPOSED SETTLEMENT AND FEE AWARD TO ESPECIALLY RIGOROUS SCRUTINY.

The question remains, however, what a court should do when it becomes apparent later in the litigation that the lead plaintiff (whether a person or group) has not been able to actively oversee the litigation. If this occurs during the course of litigated proceedings, the court may be able to take steps to reconstitute the group or otherwise assure that it is willing and able to carry out its statutory role.

A more difficult situation arises where, as here, these deficiencies only become apparent when a settlement is proposed. If Rule 23 minimum standards for adequacy of representation are met, it would not be appropriate for the court to reject the settlement out of hand. But the less the lead plaintiff has been allowed or able to oversee the conduct of the litigation and monitor the effectiveness of counsel, the more the litigation would seem to be lawyer-driven, and the greater the need for judicial oversight of the proposed settlement and attorney fee.

One purpose of the Reform Act was to encourage settlements that are, on balance, more beneficial to investors and less driven by lawyers' interests. If the safeguard of an active lead plaintiff does not function in a particular case, the court should apply especially rigorous scrutiny to any proposed settlement and attorney fee. 19

Ultimately, what that scrutiny consists of rests in the district court's discretion. But, expanding on cases applying Rule 23, we believe the court's review should include the following inquiries. The court should determine whether eachlead plaintiff "operated under a proper understanding of [its] representational responsibilities." See Amchem Products, Inc. v. Windsor, 117 S. Ct. 2231, 2251 (1997). If the lead plaintiff is a group of persons, the court should consider whether the group "established mechanisms for making sound collective decisions together * * * [and] monitor[ing] its actions and those of its proposed Lead Counsel." Switzenbaum, 1999 WL 339040, at *5 (appointing lead plaintiff under Act). The court should consider the plaintiff's role in the conduct of the litigation "in terms of active involvement and time spent," see Epifano v Boardroom Business Products, Inc., 130 F.R.D. 295, 299 (S.D.N.Y. 1990).

Furthermore, the court should consider lead counsel's stake in the litigation compared to the lead plaintiff's, and if the lead plaintiff is nominally a group but did not function as one, in relation to each member of the group individually; the greater the difference in financial interests, the greater the "potential for abuse." See Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718, 727 (11th Cir. 1987); Piambino v. Bailey, 757 F.2d 1112, 1139 (11th Cir. 1985). The court should require specific information about whether "[c]ounsel consulted regularly and frequently with the class representatives throughout the case." See Parker v. Anderson, 667 F.2d 1204, 1212 (5th Cir. 1982).

The court should inquire into counsel's efforts to facilitate involvement by the lead plaintiff in the conduct of the litigation. It should determine whether lead counsel established an organized procedure for communicating with thelead plaintiff person or group or whether representation was splintered among numerous firms, each with its own practices about consulting with a lead plaintiff, who may or may not have made known the plaintiff's views to the other group members and the other lead counsel. It should inquire whether group members communicated with one another. See In re Southeast Hotel Properties Limited Partner Investor Litig., 151 F.R.D. 597, 607 (W.D.N.C. 1993) (class representative "was very active in conferring with other class members"). Courts should consider questioning lead plaintiffs about all of these matters, perhaps asking for detailed affidavits or even bringing the lead plaintiff into court to testify; the court should not limit its review to representations of counsel or boilerplate affidavits.

This approach comports with the traditional view of the role of courts in reviewing class action settlements and fee awards. It also fits comfortably within existing standards for review of settlements and fee awards.

When a class action settlement is proposed, district courts already consider the class representative's level of participation in the action as part of a Rule 23 adequacy of representation determination. See Kirkpatrick, 827 F.2d at 727 (representatives' participation cannot be "so minimal that they virtually have abdicated to their attorneys the conduct of the case"). Moreover, it is well-established that "the district judge has a heavy duty to ensure that any settlement is `fair,reasonable, and adequate' and that the fee awarded plaintiffs' counsel is entirely appropriate." Piambino, 757 F.2d at 1139.

The settlement should not be approved unless the district court finds that "it `is fair, adequate and reasonable and is not the product of collusion between the parties.'" Bennett v. Behring Corp., 737 F.2d 982, 986 (11th Cir. 1984). In evaluating the settlement, the district court considers various factors, including the substance and amount of opposition to the settlement. Id. This is logically related to, and permits consideration of, participation by the lead plaintiff.

This is not to say that the views of lead plaintiffs should ultimately prevail. Lead counsel are correct that a number of courts have stated that weight must be accorded class counsel's views and that "the assent of named plaintiffs is not a prerequisite to the approval of a settlement." E.g., Pettway v. American Cast Iron Pipe Co., 576 F.2d 1157, 1216 (5th Cir. 1978). But courts have made clear that there are limits to reliance on class counsel and that class representatives' views matter. See, e.g., id. at 1216; Holmes v. Continental Can Co., 706 F.2d 1144, 1149-50 (11th Cir. 1983).

The proposed attorney fee award must also be found to be "appropriate." See Piambino, 757 F.2d at 1139. District courts in this Circuit view 25% as a "`bench mark' percentage fee award which may be adjusted in accordance with the individual circumstances of each case." Camden I Condominium Ass'n v. Dunkle, 946 F.2d 768, 775 (11th Cir. 1991). In "evaluating,setting, and reviewing percentage fee awards in common fund cases," the courts consider various factors, including whether there are any substantial objections by class members or other parties to the settlement terms or the requested fees. Id. at 772 n.3, 774-75. The Reform Act specifically requires that the class notice contain a statement of attorneys' fees or costs sought so that class members can make informed judgments about the matter and, if they wish, express their views to the court. See 15 U.S.C. 78u-4(a)(7)(C).

Again, in light of the objectives and requirements of the Act, a court should consider the lead plaintiff's degree of participation in the litigation in evaluating a proposed fee. As with a settlement, the greater the lead plaintiff's participation, the greater its ability to serve as a check on attorneys preferring their own interests to the best interests of the class. Regardless of whether a lead plaintiff objects to a proposed settlement or fee, and regardless of whether counsel disagrees with the specific objections the lead plaintiff is able to make, the court should more carefully scrutinize a proposed settlement and fee where the lead plaintiff has not actively overseen the conduct of the litigation and monitored the effectiveness of counsel.

CONCLUSION

For the foregoing reasons, the Commission urges the Court to reflect in its opinion the principles discussed in this brief.

Respectfully submitted,

HARVEY J. GOLDSCHMID
General Counsel

ERIC SUMMERGRAD
Deputy Solicitor

LUIS DE LA TORRE
Attorney

Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0606
(202) 942-0813 (de la Torre)

August 1999

FOOTNOTES

1 The Commission takes no position on issues not referenced in this brief, such as disputes about class certification or the merits of the settlement or attorney fee.

2 Other provisions of the Act reveal concerns about plaintiff counsel conduct, settlements, and attorney fee awards in securities class actions. See, e.g., 15 U.S.C. 78u-4(a)(2) ("Certification Filed With Complaint"), (a)(4) ("Recovery by Plaintiffs"), (a)(5) ("Restrictions on Settlements Under Seal"), (a)(6) ("Restrictions on Payment of Attorneys' Fees and Expenses"), (a)(7) ("Disclosure of Settlement Terms to Class Members"), (a)(9) ("Attorney Conflict of Interest"), and (c) ("Sanctions for Abusive Litigation"); 78o(c)(8) ("Prohibition of Referral Fees").

3 Congress was especially concerned that in some such cases lawyers engage in abusive practices and "often receive a disproportionate share of settlement awards." Conf. Rep. 36; accord id. at 31-33; Report on the Private Securities Litigation Reform Act of 1995, S. Rep. No. 104-98, 6-12 (1995) ("S. Rep."); Report on the Common Sense Legal Reform Act of 1995, H.R. Rep. No. 104-50, 14-20 (1995) ("H. Rep.").

4 See, e.g., 141 Cong. Rec. S8895 (Sen. D'Amato), S8897 (Sen. Domenici) ("So what we have and what is wrong with this system is very, very fundamental. Lawyers, not clients, control these cases.") (June 22, 1995); 141 Cong. Rec. S9055 (Sen. Frist) ("the lawyer-driven nature of these lawsuits tends to shortchange investors who have truly been defrauded"), S9065 (Sen. Grams), S9075-76, 77 (Sen. Hatch), S9077 (Sen. Murray) ("[investors] have a right to have more of a say in steering the course of litigation") (June 26, 1995); 141 Cong. Rec. S9172 (Sen. Hatfield), S9173 (Sen. Mikulski) (June 27, 1995); 141 Cong. Rec. S9212 (Sen. Domenici), S9321 (Sen. Dodd) (June 28, 1995); 141 Cong. Rec. S17934 (Sen. D'Amato) ("[Bill] will empower real investors, especially pension funds and other institutional investors, to take control of the lawsuit."), S17956 (Sen. Dodd), S17967, S17969 (Sen. Domenici) ("Unlike the current lawyer-driven system, under this new law the investors with the greatest stake in the outcome of the litigation will control the case."), S17980 (Sen. Murray) (under bill, "investors will have more of a say in the outcome of their suit"), S17982 (Sen. Frist), S17983 (Sen. Dole), S17984 (Sen. Moseley-Braun) ("Many investors also support this bill because it gives them, rather than the lawyers who are supposed to be working for them, control of any class action suits filed. It is the client, rather than the attorney, that is supposed to control a lawsuit, and part of the reason this bill is so necessary is that this simple principle has somehow gotten lost in recent years.") (Dec. 5, 1995); 141 Cong. Rec. H14038 (Rep. Cox) ("What we are seeking to do here is to protect investors so that they are in charge of these kind of lawsuits."), H14039 (Rep. Bliley) (bill "puts control of class action lawsuits back in the hands of the real shareholders, where it belongs"), H14048 (Rep. Harman) (bill "ends abusive practices and restores investor control over lawsuits"), H14050 (Rep. Deutsch) (Dec. 6, 1995); 141 Cong. Rec. S19054 (Sen. Hatch), S19084 (Sen. Reid) ("Defrauded investors are not adequately compensated because attorneys, not investors, control these class actions.") (Dec. 21, 1995).

5 Congress "d[id] not intend to disturb the court's discretion under existing law to approve or disapprove the lead plaintiff's choice of counsel when necessary to protect the interests of the plaintiff class." Id. at 35; S. Rep. 11.

6 Accord, e.g., In re Baan Company Sec. Litig., 186 F.R.D. 214, 218 (D.D.C. 1999); Gluck v. Cellstar Corp., 976 F. Supp. 542, 549, 550 (N.D. Tex. 1997); In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156, 157 (S.D.N.Y. 1997); Greebel v. FTP Software, Inc., 939 F. Supp. 57, 61 (D. Mass. 1996); Yousefi v. Lockheed Martin Corp., 1999 U.S. Dist. LEXIS 8966, at *18 (C.D. Cal. May 25, 1999); In re Milestone Scientific Sec. Litig., 1999 WL 297019, at *10 (D.N.J. Mar. 25, 1999).

7 The Act refers to a "group of persons," as an alternative to a "person," in the provision that establishes a presumption that the "most adequate plaintiff" to lead a securities class action is the one with the largest claimed financial loss. 15 U.S.C. 78u-4(a)(3)(B)(iii)(I). The law review article cited in the legislative history as "provid[ing] the basis for the `most adequate plaintiff' provision," S. Rep. at 11 n.32, suggests that Congress used the "group of persons" language because "if several institutions were interested in becoming involved, they could either compete to become lead plaintiff or agree to work together." Weiss & Beckerman, 104 Yale L.J. at 2108. The article also suggests that Congress used this language to encompass associated or affiliated institutions (e.g., different funds from the same mutual fund group), which had filed separate claims in pre-Act class actions. See id. at 2090 n.200.

8 See Greebel, 939 F. Supp. at 63-64; see also Robinson v. Shell Oil Co., 519 U.S. 337, 341 (1997); United States v. Taylor, 487 U.S. 326, 333 (1988); Metropolitan Edison Co. v. People Against Nuclear Energy, 460 U.S. 766, 774 (1983).

9 In its 1997 report on the Act, the Commission's Office of General Counsel stated that some lawyers, "[t]aking advantage of [the Act's] provision" allowing appointment of a "group of persons" as lead plaintiff, have attempted "to recruit investors as additional clients." SEC Office of the General Counsel, Report to the President and the Congress on the First Year of Practice Under the Private Securities Litigation Reform Act of 1995 65 (Apr. 1997). Specifically, some lawyers have "phrased [notices to the class under the Act] in a way more likely to attract clients, rather than competition from investors (and other law firms) independently vying to be named lead plaintiff." Id. at 66. See Sherleigh, 184 F.R.D. at 694 n.4.

The Commission understands from Reform Act cases in which it has appeared, or been asked to appear, as amicus curiae, that some law firms contacted by investors in response to the notices forward the investors' names on to other law firms, which compile lists of names therefrom, from responses to their own notices, and from other sources. This list is then presented to the court as a lead plaintiff "group," typically with the alternative of a "subgroup" or "steering committee" of fewer but often still numerous names, enough to include clients of multiple law firms. The firms representing the largest or largest number of investors on the list or representing investors who posed a threat of competition for lead plaintiff,present themselves to the court as lead counsel. See, e.g., Baan, 186 F.R.D. at 215, 217; Sherleigh, 184 F.R.D. at 692-93 & n.1, 699-701; Milestone, 1999 WL 297019, at *15. If competition is encountered, the number of subgroup members and proposed lead counsel may be enlarged to absorb competitors or outstrip their losses. See, e.g., Switzenbaum, 1999 WL 339040, at *3-5. The investors' role in this process is unclear.

10 There may, of course, be unusual circumstances that warrant departure from these limits. They might include pre-existing relationships among the members or other factors indicating that they have a special capacity to provide able and unified decisionmaking independent of counsel.

11 Only the financial interest of the "person or group of persons" that the court "shall appoint as lead plaintiff" is considered in determining the presumptive lead plaintiff. See 15 U.S.C. 78u-4(a)(3)(B)(i) & (iii). Any other approach would be "playing a shell game with the statute." Baan, 186 F.R.D. at 217; accord Switzenbaum, 1999 WL 339040, at *3 & n.6.

12 See, e.g., In re Oxford Health Plans Sec. Litig., 182 F.R.D. 42, 46 (S.D.N.Y. 1998); Chill v. Green Tree Financial Corp., 181 F.R.D. 398, 409 (D. Minn. 1998); Takeda v. Turbodyne Technologies, Inc., 1999 U.S. Dist. LEXIS 8965, at *17 (C.D. Cal. May 28, 1999); Yousefi, 1999 U.S. Dist. LEXIS 8966, at *18; In re Advanced Tissue Sciences Sec. Litig., 1998 U.S. Dist. LEXIS 16926, at *19-23 (S.D. Cal. Oct. 20, 1998); see also In re Milestone Scientific Sec. Litig., 183 F.R.D. 404, 417-18 (D.N.J. 1998); Baan, 186 F.R.D. at 216-217.

13 See, e.g., Donnkenny, 171 F.R.D. at 157-58 (where six formerly competing, unrelated investors had not justified their "group," appointing one member with significantly more losses than the others); Sherleigh, 184 F.R.D. at 692 & n.1.

14 The Reform Act's "mixed inquisitorial/adversarial model for developing a record to make the Lead Plaintiff decision" is not inconsistent with resolving the motions "with dispatch." See Baan, 186 F.R.D. at 215. The Commission assumes that in evaluating proposed groups courts will make their best judgments based on reasonably available information. Proponents of groups offer no basis for contending that it would be "[]expensive" or "cost[ly]" or time-consuming to include additional information about its own proposed group's members, structure, and intended functioning in its own lead plaintiff motion. Nor do they give any reason to assume that "discovery would frequently be needed" if a proposed group provided appropriate information about itself. Lead plaintiff submissions would establish a record and the arguments, and the court could conduct the inquiry.

15 The Act establishes a procedure and criteria for evaluating competing lead plaintiff motions. See 15 U.S.C. 78u-4(a)(3)(B)(iii) ("the person or group of persons" who "filed a complaint or made a motion" and has "the largest financial interest") (emphasis added). The statute speaks in the singular, of the court appointing a "lead plaintiff," not lead plaintiffs. See 15 U.S.C. 78u-4(a)(3) & (a)(3)(A)(i)(II). It provides a mechanism for identifying "the most adequate plaintiff," not the two or more most adequate plaintiffs. 15 U.S.C. 78u-4(a)(3)(B)(i)-(iii). And it refers to a "person or a group of persons," not a combination of multiple groups or multiple persons not part of one group.

16 See Advanced Tissue, 1998 U.S. Dist. LEXIS 16926, at *13-14; Cendant, 182 F.R.D. at 147-48; Gluck, 976 F. Supp. at 549-50; Reiger v. Altris Software, Inc., 1998 U.S. Dist. LEXIS 14705, at *16-18 (S.D. Cal. Sept. 14, 1998); Steiner v. Frankino, 1998 U.S. Dist. LEXIS 21804, at *15-16 (N.D. Ohio July 16, 1998); see also Milestone, 183 F.R.D. at 417-18.

17 Nor did the memorandum describe the intended duties and responsibilities of the four proposed law firms, the lines of authority among them, or the manner in which the counsel would function with the proposed lead plaintiff group. See Milestone, 183 F.R.D. at 419, motion denied, 1999 WL 297019; Baan, 186 F.R.D. 214 (appending SEC amicus brief discussing issues raised by proposals for multiple lead counsel).

18 See Doc 18 - Exs B & G; Doc 51 - Pgs 1-2, 7-8 & Ex B; Doc 53; Doc 55; Doc 59 - Ex 1; Doc 60; Doc 61 - Pgs 6-7; Doc 75 - Pgs 13-14, 43-54, 58-60, 98-103, 108-111, 127, 132-39, 143-44; Doc 88 - Pgs 17-19, 59; Appellant's Brief at 7-12, 14-15, 24.

19 Similarly, the Commission, in urging district courts to actively exercise their traditional discretion to review proposals for multiple lead counsel, has argued that where it appears that the lead plaintiff has not played an active, effective role in choosing counsel, greater scrutiny is warranted. See Baan, 186 F.R.D. 214 (appending SEC amicus memorandum). Although the Act gives the lead plaintiff a large role in the choice of lead counsel, and contemplates that a court would impose additional or different counsel on the lead plaintiff only in very unusual circumstances, the selection of counsel remains "subject to the approval of the court." 15 U.S.C. 78u-4(a)(3)(B)(v).