An Economic Analysis of the Private Securities Litigation Reform Act: Auctions as an Efficient Alternative to Judicial Intervention
Gray, Charles H., William and Mary Law Review
In 2001, the Third Circuit affirmed a district court's approval of a $3.2 billion settlement in a securities class action case brought principally against Cendant Corporation. (1) The district court selected lead counsel in this "mega case" through an auction (2)--a new, innovative tool for class action litigation. (3) Although the Court of Appeals for the Third Circuit ultimately held that the lower court erred in conducting an auction to determine who would represent the class, (4) use of court ordered auctions in securities litigation is on the rise. The law firms who represented the class in this case received a court-approved $262 million in fees and an additional $14.6 million in expenses. (5) With the realistic possibility of billions of dollars at stake, it is imperative that individual investors, institutional investors, and law firms that anticipate representing potential classes know and understand the implications of the Private Securities Litigation Reform Act (PSLRA) (6) and, specifically, the role court-ordered auctions could play in securities litigation.
The PSLRA was designed to combat perceived failures in class action securities litigation. The legislative history behind the PSLRA, passed in 1995, reveals that Congress intended to reduce "abuse in private securities lawsuits," especially "the manipulation by class action lawyers of the clients whom they purportedly represent." (7) Through the PSLRA, Congress tried to correct the typical scenario of lawyers seeking clients instead of clients seeking lawyers. (8) To further this goal, the PSLRA provides increased access to the litigation system to more savvy and involved potential plaintiffs. (9) Lead plaintiffs under the PSLRA are now chosen not based on the timeliness of their filing, but upon the stake that they have in the litigation. (10) These plaintiffs, given an increased ability to control their own fate, began to participate with greater frequency in the class action process. (11)
Congress wished to provide the whole class, instead of a select few, with the best, most efficient litigation tools and measures. In every class action litigation, the plaintiff class is comprised of the lead plaintiff, who has the single largest stake in the litigation, and other nonparticipatory parties. To ensure that the rights of nonactive parties are represented, Congress has provided some limitations on the power vested in lead plaintiffs. The PSLRA provides that, upon the appointment of the lead plaintiff, she "shall, subject to the approval of the court, select and retain counsel to represent the class[,]" (12) thereby explicitly involving the court in the process of deciding who will represent the class. A qualified lead plaintiffs power to select counsel for the class is thus far from absolute.
Early interpretations of the PSLRA gave a broad range of freedom to lead plaintiffs in selecting and retaining counsel. (13) The only perceived limitation was that the counsel chosen withstand judicial approval. Still, the fact that courts maintain authority to approve or reject a lead plaintiff's selection indicates that the power of the lead plaintiff to choose legal counsel for the class is not absolute. Instead, lead counsel must be qualified to best represent the class in the eyes of the court.
The PSLRA still has wrinkles. The potential for corruption in choosing and retaining counsel still exists. Infirmities such as overbilling, inadequate representation of the class, and improper focus on the needs of the lead plaintiff are problems still remaining, even after enactment and enforcement of the PSLRA. These problems arise, not because of the inherent nature of the PSLRA, but because the language of the Act allows self-interested lead plaintiffs to ignore the interests of the rest of the class.
A competitive bidding system for the determination of lead counsel is the most effective way to close the gaps left open by the PSLRA. …