Opt-Outs, Claims Severity and D & O Insurance Limits

In the latest of the securities class action opt out settlements, California’s teacher pension fund reached a $46.5 million settlement in its separate case against Qwest Communications, its accountants and investment banks, and certain former directors and officers. According to news reports (here), the parties resolved the pension fund’s case, which was pending in the San Francisco Country (Cal.) Superior Court, in December 2006, but the settlement only recently came to light as a result of a California Public Records Act request of the Associate Press. The pension fund had opted out of the $400 million settlement of the class action lawsuit against the Qwest defendants. A description of the class settlement as well as a number of the opt out lawsuits may be found here.

The settlement reportedly included a $1.5 million payment on behalf of Qwest’s former CEO Joseph Nacchio. According to Nacchio’s counsel (here), Nacchio’s settlement contribution was “made with insurance funds.” Nacchio is scheduled to go to trial in federal court in Denver on March 19, 2007, on a 42-count insider trading indictment, in which it is alleged that Nacchio sold $101 million of Qwest stock based on inside knowledge that the company would not meet revenue targets. A February 4, 2007 Denver Post article discussing the criminal case against Nacchio can be found here.

The $46.5 million settlement with the California State Teachers’ Retirement Systems’ (CalSTRS) is apparently only one of several settlements that the Qwest defendants have recently reached with opt-out plaintiffs. According to a February 3, 2007 Rocky Mountain News article entitled “Qwest Quietly Settles Lingering Lawsuits” (here), the Qwest defendants have also reached settlements in undisclosed amounts with the New York City Employees' Retirements System, Stichting Pensioenfunds of Netherlands, and the Teachers’ Retirement System of Louisiana.

According to the statement of its Chief Executive in a January 31, 2007 CalSTRS press release (here), the pension fund will receive “about 30 times more than it would have recovered if it had taken part in the class action.” CalSTRS is one of the largest public pension funds in the country, second only to the California Public Employment Retirement System (CalPERS).

A copy of CalSTRS complaint against the Qwest Defendants may be found here, and the December 29, 2006 Amended Settlement Agreement can be found here.

The CalSTRS opt-out settlement in Qwest follows the December 2006 opt out settlement by the State of Alaska in connection with claims against AOL Time Warner (refer here). The State of Alaska reportedly received a settlement of $50 million on its claimed investor loss of $60 million, or about 83 cents on the dollar. The attorney for the State of Alaska claimed that the state received “50 times more than we would have gotten if we had remained in the class.” The lawyer also said that the state was able to take advantage of Alaska’s favorable blue sky laws. (A description of the AOL Time Warner class settlement can be found here.)

These opt-out settlements follow the settlement by five New York City public pension funds that did not join the $6.1 billion World Com settlement. According to news reports (here), the pension funds received $78.9 million on their $130 million claimed fraud losses to their equity and bond portfolio. The city’s counsel claimed that the funds wound up with “three times more than they would have received if they joined the class action.”

The emergence of large separate opt-out settlements represents a potentially very significant development in securities fraud litigation. Certainly if institutional investor defendants perceive that they can substantially increase their recoveries by pursuing their claims individually rather than collectively in the form of a class action, the utility of the class litigation, at least for institutional investors, could be significantly reduced.

While class lawsuits have been demonized for years, they do offer unarguable advantages in certain respects, most obviously when they afford the opportunity to resolve numerous disputes in a single proceeding. Following the adoption of the Private Securities Litigation Reform Act of 1995, there are certain procedural advantages to the federal securities class action litigation, most significantly the stay of discovery while motions to dismiss are pending. If a company is forced to defend itself in multiple proceedings in multiple courts, particularly if it is also forced to defend a class lawsuit also, the costs and complexity of defense escalate enormously. And if individual investor recoveries really do exceed class recoveries as a percentage of investor losses, then the aggregate cost of final resolution could escalate significantly as well.

But some caution may be required before it can be conclusively determined that opt-outs will fare better than class members. Typically, the percentage of a plaintiffs’ attorney’s fee recovery in an individual case is higher, because it is applied against a smaller fund. (A class attorney can accept a lower percentage because the fund is so much larger, and the resulting fee is larger as well.) So the individual plaintiffs’ recovery net of fees would have to take this larger plaintiffs’ fee percentage into account.

From the plaintiffs’ attorney’s point of view, the prospective class fee will almost always be larger than the prospective fee representing an opt out investor, and indeed a plaintiffs’ lawyer’s incentive to take on an opt out case is going to be limited to cases where the individual investor’s prospective recovery is very large. To put this into context, the median 2006 securities class action settlement, according to NERA (here), was $7.7 million. If half of all settlements are below $7.7 million, there are going to be relatively few instances where the potential incremental benefit from an opt out case will sufficiently outweigh the associated friction costs. There are not going to be very many occasions where there will be plaintiffs’ lawyers eager to pursue these cases, either. So, on its face, the opt out lawsuit would appear to be a phenomenon restricted to only the largest cases and settlements.

Nevertheless, in these largest cases, the emergence of opt out cases could require a reassessment of the assumed range of claims severity. In assessing potential severity, it may not be sufficient to look at class action settlement data alone. It may also be necessary to crank into the calculus the possibility of opt-outs, with the potential for heightened defense expense and settlement exposure. This dimension of added exposure could also have important implications about D & O insurance limits adequacy. The limits required to defend the company and its directors and officers in a multi-front war with opt-out institutional investors and the class, and required to settle all of the lawsuits (particularly if opt-outs expect recover percentages approaching 100% of investor losses), could be significantly higher than may have been assumed in the past.

The Lies, Damned Lies Blog takes a closer look at the plaintiffs’ firms involved in the CalSTRS opt out settlement with the Qwest defendants, here.

UPDATE: On February 7, 2007, CalSTRS announced (here) a separate $105 million settlement in its separate opt out action involving its claims investor loss at AOL Time Warner. Refer here for a more detailed discussion of CalSTRS AOL Time Warner settlement.

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