In a companion post published earlier today, I discussed a Wall Street Journal op-ed piece decrying the cottage industry of abusive private state law actions following announced mergers or acquisitions. See here. In that discussion, I noted that the federal securities class action cottage industry suffered a decline after the passage of the Private Securities Litigation Reform Act in 1995, but there was still room for further reform of federal securities class actions. Lo and behold, just yesterday Judge Colleen McMahon gave final approval to a settlement of the federal securities class action In re Hi-Crush Partners L.P. Securities Litigation, Civil Action No. 12-Civ-8557 (S.D.N.Y.), which shows we still have a long way to go in securities class action reform. The order approving the settlement can be found here: Hi-Crush Securities Class Action Settlement Order.
The Hi-Crush class action arose out of an IPO of 11.35 million shares at $17 per share. The company allegedly inaccurately described a key contractual relationship in its registration statement after the contractor had already said it wanted to terminate the contract. When that information became known in the marketplace, the stock price dropped from $20 to $15 per share. The complaint asserted claims under section11 of the Securities Act of 1933 and section 10(b) of the Securities Exchange Act of 1934.
On a motion to dismiss all claims, Judge McMahon dismissed the section 11 claim but allowed a section 10(b) claim to survive. That was because the section 11 claim had to be founded on alleged misrepresentations or omissions in the July 2012 registration statement, but the section 10(b) claims covered securities transactions in the aftermarket through November 2012. The judge found no misrepresentation about the contractual relationship as of July 2012, but that later events rendered statements to shareholders in September 2012 on that issue potentially misleading. See the decision on the motion to dismiss here: Hi-Crush Decision on Motion To Dismiss. The section 11 claim was by far the more powerful cause of action, with tens of millions of dollars in potential damages and no requirement to prove scienter, which is an element of the section 10(b) claim. As a result, the guts of the claims asserted were dismissed, leaving a difficult, small value claim moving forward.
It is understandable, then, that the ultimate settlement of the action was for a mere $3.8 million. It probably should have been less, but the judge did not need to second-guess at that low level. It was in the attorneys’ fee award that Judge McMahon dropped the ball. Class action settlements are not permitted to be made contingent on a specific attorneys’ fee award, but the parties typically agree on what the plaintiff’s firm can seek without any challenge from the defense. That is a collusive aspect of the settlement process — no party is incented to try to minimize the legal fee award. In the end, Judge McMahon handsomely rewarded the plaintiff’s law firm but left little else for anyone else, i.e., the shareholders. The law firm, Kirby McInerney LLP, took home $1.27 million in fees, and another $106,451 in costs, out of a total settlement fund of $3.8 million, leaving about $2.4 million (less administrative costs) for the shareholders allegedly defrauded. A review of the judge’s approval order leaves little doubt that she rubber-stamped what was presented to her — there is no real analysis or discussion of the fee issue, and by all appearances the judge merely signed the final approval order put in front of her by counsel.
There is no way that this case should have resulted in handsome profits for plaintiff’s counsel. The core of the case was rejected by the court on the motion to dismiss. The dregs that remained afterward were hardly worth pursuing, but if they were pursued, it should have been for the purpose of generating real benefits to shareholders, not a payoff to the lawyers. The approval order notes (at p. 9) that the plaintiff’s lawyers “devoted over 1,594.75 hours, with a lodestar value of $900,705.00, to achieve the Settlement,” but the bulk of that surely was in pursuit of claims that the court concluded had no merit. (That included claims against underwriters in the IPO that undoubtedly increased costs for no purpose.) Plaintiff’s counsel should have been held accountable for causing major expenses in the defense of a flawed section 11 claim when considering the overall fee award; instead they were rewarded for doing so. In the end, they were paid more than $800 per hour, plus expenses, for bringing a near-worthless case. Amazingly, the judge approved an award for 25% above the purported lodestar in what was essentially a failed case. And the shareholders? Who knows what they will get. But there will be less than 20 cents available for each of the 11 million shares sold in the IPO. To be sure, they may not be entitled to much because there really wasn’t much of a claim. But why, under those circumstances, should the people responsible for causing this ruckus, the plaintiff’s lawyers, be getting much of anything at all?
The abuses in securities class action litigation continue even after the PSLRA. Plaintiff’s firms are now focused are trying to pursue section 11 claims because the bar for proving them is lower and defending them is more difficult. But unless plaintiff’s firms are held accountable for bringing flawed claims, and not rewarded for doing so, the abuses will continue. Judge McMahon is a good judge, and she did a good job on the motion to dismiss. But she mailed it in on the fee award instead of performing the key role in teaching the plaintiff’s lawyers to be more selective in their pursuit of profits.
January 6, 2015
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