By Neil L. Selinger
Historically, in the wake of corporate fraud, most investors have sought to recoup their losses by filing a claim in the settlement of a class-action lawsuit. Although this passive approach minimizes an investor's expenditure of time and effort on the matter, there is increasing evidence that allowing someone else to shoulder the risks and run the case is not the best way in high-profile frauds for pension fund trustees to recoup their funds' losses.
A new trend is coming into play with institutional investors finding more reasons to opt out of classes and go their own way. While still not a common occurrence in securities fraud cases, opting out is becoming a viable alternative, worthy of conscientious board members' consideration.
WorldCom Inc., which made U.S. history as the largest corporate accounting fraud on record, was also the first securities case to generate a large-scale institutional opt-out movement. Some 80 pension funds opted out of the class litigation. Most of those cases have settled for hundred of millions of dollars in the aggregate, many at substantial premiums over the class recovery. For example, the New York City Retirement Systems achieved a $78.87 million settlement for their WorldCom case, recovering roughly 100% of their WorldCom bond damages in the process. In contrast, those who participated in the WorldCom class action will receive an estimated 45% return of their bond damages. An added benefit of the opt-out case is an expeditious payment, unlike class cases, where payment is delayed by a lengthy claims administrative process and is also subject to appeal.
When confronted with losses caused by fraud, deciding the best course of action for your fund requires a case-by-case analysis, considering such questions as:
• What is the magnitude of the loss? Opting out and pursuing an individual action takes a greater commitment of time and resources than remaining a member of the class. The time and expense involved with prosecution and discovery can often only be justified if there is a sufficient amount at stake. In most cases, a $5 million claim would not ordinarily justify an opt-out lawsuit strategy, whereas a $50 million claim might be another matter. Another factor is the size of the loss relative to the size of the fund.
• Do noteworthy factual differences exist between your fund and the class as a whole? If so, a trustee might be well advised to chart a course for the fund differing from the legal strategy employed by the class. For example, in one corporate fraud case, a private money manager had face-to-face conversations with senior executives of the corporate defendant. In those communications, representations were made to the client that went to the heart of the alleged fraud. This personal contact gave rise to certain claims that the class representatives could not, and did not, assert, leading the client to opt out and pursue an individual action.
• How strong is your case? It does not make sense to pursue any suit unless you have a good chance of winning. A fund must be willing to go to trial, and be confident it can succeed.
cWhat is your fiduciary duty? A trustee must consider all of his or her options and make an informed decision. Ask your counsel to analyze alternatives and check out the underlying facts to determine if there might be a different claim that can and should be asserted on behalf of your fund. There are no hard and fast rules; every situation involves unique issues.
The lessons learned from WorldCom confirm that opting out of class actions can result in a greatly enhanced recovery for fund beneficiaries. In the end, informed decision-making by trustees is the best way to analyze a fund's options and maximize the fund's recovery when it has been victimized by corporate wrongdoing. This approach is likely to become more common in future megacases, as fund trustees elect to be proactive in suing for redress.
Neil L. Selinger, a senior principal of Lowey Dannenberg Bemporad & Selinger PC, White Plains, N.Y., served as outside litigation counsel for the New York City Retirement Systems in its WorldCom Inc. case, working in conjunction with the New York City law department and the New York City office of the comptroller. Mr. Selinger also served as liaison counsel for the individual WorldCom actions, responsible for coordinating proceedings in the numerous opt-out cases.