In Re: Cendant Corporation Litigation
264 F.3d 201 (1992)
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Rule of Law:
Under the Private Securities Litigation Reform Act (PSLRA), a district court must afford substantial deference to a properly-selected lead plaintiff's choice of counsel and negotiated fee agreement. A court may not select lead counsel through a competitive auction unless it first determines that the lead plaintiff is unable or unwilling to effectively perform its statutory duties.
Facts:
- On December 17, 1997, CUC International, Inc. and HFS Incorporated merged to form Cendant Corporation.
- On April 15, 1998, Cendant announced it had discovered significant accounting irregularities originating in former CUC business units and would need to restate its 1997 financial statements.
- Following the announcement, Cendant's stock price plummeted by 47%, causing massive shareholder losses.
- On July 14, 1998, Cendant announced it would also restate CUC's financial statements for 1995 and 1996, causing a further drop in its stock price.
- An internal investigation report filed with the SEC on August 28, 1998, revealed that Cendant's financial statements would be restated by approximately $500 million due to widespread fraud, resulting in total shareholder losses exceeding $20 billion.
- Ernst & Young (E&Y) served as CUC's independent public accountant during the period of the fraud and had issued unqualified audit opinions on the fraudulent financial statements.
Procedural Posture:
- Following Cendant's disclosures, at least sixty-four putative securities fraud class actions were filed nationwide against Cendant, its executives, and its auditor, E&Y.
- The Judicial Panel on Multidistrict Litigation consolidated all cases in the U.S. District Court for the District of New Jersey.
- The District Court appointed a group of three large public pension funds, the CalPERS Group, as lead plaintiff pursuant to the PSLRA.
- The District Court declined to approve the CalPERS Group's chosen counsel and retainer agreement, instead deciding to select lead counsel via a competitive auction.
- The firms originally chosen by the CalPERS Group exercised an option to match the lowest qualified bid from the auction and were appointed lead counsel by the court.
- The parties reached a settlement of approximately $3.2 billion, which the District Court approved.
- The District Court awarded lead counsel approximately $262 million in fees based on the results of the auction.
- Several class members, including the New York City Pension Funds (a member of the lead plaintiff group), appealed the fee award and the approval of the settlement to the U.S. Court of Appeals for the Third Circuit.
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Issue:
Does the Private Securities Litigation Reform Act (PSLRA) permit a district court to select lead counsel through a competitive bidding auction rather than approving the counsel selected and retained by the duly appointed lead plaintiff?
Opinions:
Majority - Becker, Chief Judge.
No, the Private Securities Litigation Reform Act (PSLRA) generally does not permit a district court to supplant the lead plaintiff's choice of counsel with a competitive auction. The court held that the PSLRA evidences a strong presumption in favor of the lead plaintiff's right to select and retain counsel, limiting the court's role to approving or disapproving that choice. The text, structure, and legislative history of the PSLRA demonstrate Congress's intent to empower a sophisticated lead plaintiff, typically an institutional investor, to control the litigation by selecting counsel and negotiating fees. The court's role is to ensure the choice is reasonable, not to substitute its own judgment for that of the lead plaintiff. An auction is only permissible as a remedy of last resort in rare circumstances where the lead plaintiff has demonstrated it is unable or unwilling to faithfully discharge its duties, which was not the case here. Although the district court's use of an auction was an error, it was harmless as to the selection of counsel because the firms chosen by the lead plaintiff were ultimately appointed. However, the fee award based on the auction was improper and must be vacated, as any fee should be governed by the original retainer agreement negotiated by the lead plaintiff, subject to judicial review for reasonableness.
Analysis:
This decision significantly clarifies the balance of power between the lead plaintiff and the court under the PSLRA. It curtails the discretionary authority of district courts to use competitive auctions for selecting lead counsel, establishing such auctions as an extraordinary remedy rather than a standard tool for case management. By creating a 'presumption of reasonableness' for fee agreements negotiated by a properly-selected lead plaintiff, the court strengthens the lead plaintiff's role as the primary agent for the class and alters the landscape for judicial review of attorney's fees in securities class actions. The ruling reinforces the PSLRA's core purpose of having sophisticated, interested plaintiffs, rather than courts or lawyers, drive the litigation.
