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In the 1960s, counterculture guru Dr. Timothy Leary told young people to "turn on, tune in and drop out." Some plaintiff securities lawyers now give clients similar advice: "Opt out."
Opting out means exiting a securities class action and representing one's interests alone — going solo.
Why opt out or drop out or cop out? Possibly to get a bigger recovery.
A few years ago, a securities class action against WorldCom settled for $6.2 billion, then a record. But several large investors opted out and brought their own lawsuits, which they settled for far more than they would have received had they stayed in the class. For example, five New York pension funds settled individual opt-out cases cumulatively for $130 million, three times what they otherwise would have received.
This "opt out to get more" trend continued in the AOL/Time Warner and Quest cases. In the Quest case, the securities class action settled for $400 million, but opt-out cases cumulatively settled for $411 million.
Does this mark the end of the securities class action? I doubt that. To paraphrase Mark Twain, who once said that news reports of his death were exaggerated, recent predictions by a few observers that securities class actions are no longer practical are overblown.
In fact, there has been a recent uptick in securities class action filings. According to the Stanford Securities Class Action Clearinghouse, while only 116 securities class actions were filed in 2006, 174 were filed in 2007. And this year there has been a steady flow of such lawsuits in the wake of the subprime lending crisis, which is likely to generate additional cases.
As the Supreme Court repeated last year in the Tellabs case, securities class actions continue to protect investors and our public markets.
Justice Ruth Bader Ginsburg began her majority decision making that point, when she wrote: "This Court has long recognized that meritorious private actions to enforce federal anti-fraud securities laws are an essential supplement to criminal prosecutions and civil enforcement actions brought, respectively, by the Department of Justice and the Securities and Exchange Commission." Ginsburg was referring here to class actions such as the Tellabs case.
Notably, the Supreme Court said much the same two years earlier in the Dura Pharmaceuticals case.
Half of Americans own stock in publicly traded companies. Securities class actions generally offer the only practical redress for the majority of investors.
Opting out only works for some and is not feasible for most investors. Although it is too costly a remedy for all but a few investors, opting out can make sense for certain investors, who suffer tens or hundreds of millions of dollars in losses from a securities fraud — though not always even then.
Ironically, the strategy of opting out is a partial return to the past. Just 40 years ago, securities class actions were virtually nonexistent. Much changed after 1966, when Rule 23 of the Federal Rules of Civil Procedure was amended to establish a protocol for class actions. This gave investors, who could thereafter pool together, a powerful vehicle to protect their investments.
Before Rule 23 was amended, defrauded investors could theoretically bring their own lawsuits against a company and its stewards. But given the costs, the reality was that all but the largest victimized investors had no effective legal recourse.
In the last few years, we have witnessed a trend toward opting out by very large investors in huge cases. There are reasons for this.
Securities class actions are governed by the Private Securities Litigation Reform Act, which imposes a discovery stay pending the resolution of any motion to dismiss. That stay can delay prosecution of a case for a year or longer.
Opt-out groups are not bound by this stay, and can begin taking discovery when their lawsuit is filed, expediting their case.
Equally significant, the Securities Litigation Uniform Standards Act made the federal courts the exclusive venue for virtually all securities class actions, whereas opt-out investors can litigate in either state or federal courts.
Investors sometimes have advantages litigating in a state court. Some state courts push cases to trial faster than do federal courts, and many states have less rigorous pleadings requirements than those under federal law, which requires that a plaintiff plead the defendants' knowledge of the wrongdoing or recklessness with particularity. In a fraud lawsuit, this is often the most difficult element to allege (and prove).
Moreover, many states permit investors to bring claims against aiders and abettors of a securities fraud, but such claims cannot be brought under federal law.
Opt-out investors also need not fight battles over class certification. These fights have become increasingly costly and drawn out, particularly in the 2nd and 5th Circuits. Although once pro forma, class certification battles now often touch on issues relating to the merits of the lawsuit.
Finally, even if they ultimately settle for the same per share amount as investors in the related class action, opt-out groups can receive their settlement payments months before any funds are disbursed to class members.
Because they involve absent class members, class action settlements must be approved by the court after notice and a hearing in which potential class members have an opportunity to object to the settlement. Even without objections, this process slows down the disbursement of settlement funds. No comparable approval process delays the disbursement of funds in opt-out settlements.
But even with these advantages for some investors, there still must be a class action to opt out from. And plenty of large investors theoretically able to opt out are hesitant to do so because they do not want to subject themselves to the scrutiny, costs and risks of shouldering a lawsuit alone, including the burdens of document discovery and depositions.
So, although opting out is not a substitute for the securities class action, it can be an alternative for some large investors. Or as the psychedelic master, Dr. Leary, would say: "If you don't like what you're doing, you can always move to another groove."
Mark Labaton is a partner at Kreindler & Kreindler in Los Angeles, where he represents plaintiffs in securities, corporate governance, consumer and whistle-blower actions.
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© 2008 Daily Journal Corporation. All rights reserved.