On April 7, 2008, Judge William Alsup, of the United States District Court of the Northern District of California, issued two opinions in two options backdating lawsuits involving Zoran Corporation and CNET Networks. These opinions, which rejected proposed settlements in two separate lawsuits, may have far-reaching consequences that could extend outside the realm of options backdating lawsuits (or securities litigation generally).
I first learned of this story on Ideoblog, which had an April 25, 2008 post chiding the "poor plaintiffs’ lawyers, [who] like so many others, fell for the notion that backdating was the scandal of the century." (Larry Ribstein, "Backdating's latest victims: plaintiffs' lawyers," (April 25, 2008) busmovie.typepad.com/ideoblog.) Following the link trail, I found more information on the Wall Street Journal's Law Blog, Law.com, and extensive detail and commentary about the story from The D&O Diary, which has extensive coverage of options backdating lawsuits. What I read should serve as a wake-up call to all class action/complex action practitioners, whether aligned with the plaintiffs' bar or the defense bar.
To briefly summarize the facts, the parties to the Zoran case entered settlement negotiations, resulting in a February 26, 2008 stipulation of settlement. "At the preliminary approval hearing, the plaintiffs’ damages expert, at the court’s request, presented a report calculating the plaintiffs’ maximum damages as $16 million (including prejudgment interest), which incorporated both the alleged damaged cause to company by the defendants’ option grants as well as by option grants to the rank-and-file employees." (Kevin LaCroix, "Uh-Oh! Serious Options Backdating Settlement Problems," (April 24, 2008) www.dandodiary.com.) The proposed settlement included: the payment of up to $1.2 million of the plaintiffs’ attorneys’ fees and costs; the repricing or cancellation of certain officer defendants’ options (which repricing or cancelation was represented to the court to have a value of $1.65 million); the company’s adoption of certain corporate governance reforms; and, the grant of a broad claims release. (Ibid.)
Judge Alsup would have none of it. The Court began its discussion by declaring that the class action procedure can “lend itself to abuse,” noting that “one form of abuse is a collusive settlement.” Judge Alsup said that a collusive settlement “usually comes with a cash award to counsel, a broad release of claims, and a cosmetic non-cash recovery for the abused shareholders.” Judge Alsup explained the obligation of reviewing courts to ensure that absent shareholders are treated fairly. The obvious outcome was the Court's determinatio that the proposed settlement “falls short of deserving preliminary endorsement.”
Meanwhile, In the Court's CNET Networks opinion, issued on the same day, Judge Alsup refused even to evaluate the a proposed settlement. The case was stayed pending directed discovery related to whether the plaintiff had satisfied the demand requirement. The parties then presented a joint motion to lift the stay for the purpose of seeking a preliminary approval of a settlement. The Court commented that the actions of the parties were “disappointing” because the parties did not, as they had represented to the court, conduct any discovery or file an amended complaint.
The D&O Diary is concerned that Judge Alsup's decisions "could well have an in terrorem effect on other litigants in other" options backdating suits, despite the fact that the decisions lack any precedential value. But I am interested in whether these decisions have even broader consequences. Judge Alsup's concerns are as relevant to proposed settlements in consumer fraud or wage & hour class actions as they are in an options backdating derivative suit. The Wall Street Journal's Law Blog notes, "It’s perhaps too soon to say what impact Alsup’s rulings might have on other pending settlements." (Ashby Jones, "Recent Rulings Pose Potential Threat to Backdating Settlements," (April 24, 2008) http://blogs.wsj.com/law/.) Of course it's too soon to know about the ultimate impact of these rulings, but it isn't too soon to contemplate that impact. The decisions of Judge Alsup essentially require some testing of the merits of a claim before a settlement will receive even preliminary approval. If this analysis gains any momentum in other courts, plaintiffs and defendants alike may find it very difficult to receive preliminary approval for early settlements, particularly where the plaintiff's attorneys receive all or most of any cash changing hands.