class actions settlements

A tiny percentage of Volkswagen and Audi sunroofs will leak into the vehicle unless care is taken to keep the plenum clear of debris; a class action was brought over this.  Let's assume for the moment that plaintiffs are correct that this is something that Volkswagen is liable for, and that there are contractual remedies for VW not foolproofing the cars against this problem.  What's remarkable is how the parties settled the case in such a way so that wildly inefficient remedies would maximize attorneys' fees at the expense of the class.  The settlement is structured as follows:

1. A million class members will get nothing but a letter telling them to check the plenum when they go for their 40,000-mile service.
2. VW will perform an expensive preventative service action on some, but not all, VWs that might suffer this problem.
3. An $8 million settlement fund is set up to pay damages for some, but not all, VWs that have suffered damage

The economic expert for the plaintiff made some remarkable calculations.  For example, he valued the letter at over $29 million.  After all, if you get a letter informing you of a potential benefit, that letter is worth just as much as the benefit itself—never mind that Volkswagen dealers charge $400 to $800 for 40,000-mile service, and can easily choose to raise the price $30 to account for the extra labor in performing the extra task during the maintenance service.  So if Apple ever settles a class action by sending you a letter telling you you can buy a $700 iPad for $700, that is, according to the expert, indistinguishable from Apple writing each consumer a check for $700.

Let's look at #2 for a second.  According to the plaintiff's own expert, VW will spend $55 million on that service action.  According to the same expert, if VW does not perform the maintenance, those vehicles will suffer $24 million in damage.  (The expert then remarkably triple-counts this as a benefit to the class: the $24 million in damage avoided, plus $55 million in VW expenses for the service action, plus another $24 million for the avoided diminution of value of the vehicle that would have occurred if the vehicles suffered damage and then weren't repaired.  Thus, according to the expert, this component of the settlement is worth over $103 million.)  Spending $55 million to avoid $24 million in damage is the very definition of economic inefficiency. 

But consumers lose out.  Some of the class members who are getting nothing but a letter—including one of my clients—have suffered actual damage from sunroof leakage.  They're not getting paid under this settlement and are being forced to release their claims, which are no less meritorious than the claims that are getting paid.

The only possible reason for plaintiffs' attorneys to insist upon this convoluted remedy is to increase attorneys' fees.  By making Volkswagen engage in wasteful spending, they pump up the alleged value of the settlement and then argue that they're entitled to over $23 million in attorneys' fees and costs, to be paid separately by Volkswagen.

It would have been very easy to structure a settlement so that Volkswagen created a $48 million fund to cover repairs to every vehicle that suffered water damage from a sunroof leak.  Every VW owner who had the problem in the past or in the future would be able to collect; Volkswagen would be out of pocket $48 million instead of $70-$90 million; the attorneys could have made a plausible claim for $10 million in attorneys' fees and costs from the fund, which would still be close to twice an exaggerated lodestar.  Instead, the parties negotiated a settlement that made everyone—consumers and Volkswagen—worse off.  Well, everyone except the attorneys, if Judge Patty Shwartz buys the quack economic testimony and awards the full fee request.

Under Rule 23(e), a judge is not to approve a settlement unless it is "fair, adequate, and reasonable."  It is hard to see how this settlement is fair or reasonable; and it demonstrates the failure of legal ethics that the class attorneys could structure this settlement and make that fee request without fear of sanction, even as they put their own interests ahead of their clients.

The four-hour fairness hearing, consisting mostly of the economic expert rationalizing his calculation and the attorneys arguing over fees, was last Monday in a Newark federal courtroom.  I look forward to seeing how the judge will rule.

Tuesday, the Center filed its opening brief appealing the approval of a class action settlement against AOL.  We focused our appeal on the problematic cy pres award in that case:

This appeal presents a straightforward application of the Ninth Circuit precedent Six Mexican Workers v. Arizona Citrus Growers, 904 F.2d 1301 (9th Cir. 1990)—a precedent that the district court entirely failed to apply. For a cy pres award to a third party to be permissible it must actually be “cy pres”—as near as possible to actual class recovery. Id. at 1308. Here, there was a nationwide class of tens of millions of AOL members allegedly victimized by AOL practices, but the vast majority of the cy pres distribution went to local charities in the Los Angeles and Oklahoma areas; all of the cy pres was entirely unrelated to the class and unrelated to the claims of the case.

The potential of cy pres to create conflicts of interest and ethical dilemmas for the judiciary have garnered increasing attention in recent years. See, e.g., Adam Liptak, Doling Out Other People’s Money, N.Y. TIMES (Nov. 26, 2007) (available at http://www.nytimes.com/2007/11/26/washington/26bar.html); Martin H. Redish, et al., Cy Pres Relief and the Pathologies of the Modern Class Action: A Normative and Empirical Analysis, 62 FLA. L. REV. __ (forthcoming 2010) (available at SSRN: http://ssrn.com/abstract=1485047); Sam Yospe, Cy Pres Distributions in Class Action Settlements, 2009 COLUMBIA BUS. L. REV. 1014 (available at SSRN: http://ssrn.com/abstract=1492105); Amanda Bronstad, Cy pres awards under scrutiny, NAT’L L. J. (Aug. 11, 2008) (available at http://is.gd/dyFk0-). If courts are going to countenance cy pres distributions in class actions settlements at all, such distributions must be strictly tethered to the standard of class benefit, lest cy pres become a slush fund for plaintiffs, defendants, attorneys, and judges that creates the appearance of impropriety—or worse, actual impropriety.

The problems of potential conflicts of interest are not just a hypothetical concern in the case at bar. Neither the court nor the class was informed of the conflict of interest that one of the plaintiffs was the assistant director of development for one of the cy pres recipients. And yet still another cy pres recipient was a local charity where the spouse of the district court judge sits on the board. It is not exaggerating to say that this case is a poster child for the problem of cy pres abuse: indeed, in a story on the issue, the Wall Street Journal singled out the very settlement in this case as an example. Nathan Koppel, Proposed Facebook Settlement Comes Under Fire, WALL ST. J. (Mar. 2, 2010) (available at http://is.gd/dyl7A-).

For both precedential and sound public-policy reasons, this court should reverse the approval of the proposed class action settlement as an abuse of discretion.

Parties in a class action agree to submit to the jurisdiction of an Article I magistrate under 28 U.S.C. § 636(c).  Then they settle the case.  Objectors show up, but have not consented to have the case heard by a magistrate.  Does the magistrate still have jurisdiction or does an Article III judge have to weigh in? 

Section 636(c) requires consent by "parties."  Are unnamed class members parties under § 636(c)?  One can't just give the answer of a blanket "no"; the statute and federal rules are silent, and Devlin v. Scardelletti, 536 U.S. 1 (2002), says that class members are sometimes "parties," and sometimes not. 

The problem, of course, is the possibility of heads-I-win/tails-you-lose gamesmanship, with an objector throwing a wrench into the proceedings by protesting after the fact that the court didn't have jurisdiction.  See, e.g., Mark I, Inc. v. Gruber, 38 F.3d 369, 370 (7th Cir. 1994) (vacating final decision of magistrate made after two years of litigation on jurisdictional grounds). To a certain extent, the Mark I problem has been eliminated by Roell v. Withrow, 538 U.S. 580, 590 (2003), which allows a court to infer consent by acquiescence. More worrying is the possibility that an objector in good faith appeals a magistrate's ruling to an appellate court, only to learn that the appellate court does not have jurisdiction and she missed the deadline for appealing to the district court.

It's an interesting academic question, but litigants don't like the uncertainty of academic questions.  It's come up in an objection CCAF made, and we've asked the court for clarification—since no one else seems to have even thought of the issue.

Well, perhaps someone did think of it.  A so-called professional objector has the incentive to sandbag, since the business model is to lose at the district court level and then threaten a colorable appeal that would delay the class counsel payday unless paid off; a defendant is likely indifferent to delay.  What astonishes me most, however, is that plaintiffs' attorneys asking the court for $2900/hour, and presumably concerned about "professional objectors" coming in and holding up the settlement and their attorneys' fees, didn't anticipate this potentially fatal flaw.  If the attorneys who think they're worth $2900/hour are missing this basic issue-spotting that I caught, maybe I'm worth $3000/hour and even more underpaid than I thought.  (And in that case, you, loyal reader, have just benefited from $1500 worth of my time.)

If you're a Sears Holding Corporation (SHLD) shareholder like me, there's a pretty big chance that you got a letter in the mail informing you of a derivative shareholder settlement where the attorneys got $925,000 and the shareholders got the privilege of paying the attorneys $925,000.  The deadline for objecting was June 25.

All well and good, except that my particular notice letter arrived on June 28.  That's because, though the settlement occurred on April 28, and the court approved notice on May 11, the parties didn't bother to ask brokers to provide a list of shareholders until June 1, and then, after receiving the list, didn't bother to mail the notice to tens of thousands of shareholders until June 22 or June 23. 

I was in Chicago yesterday to object to the problematic notice.  While there I met another shareholder who didn't object to the appalling settlement because she also got her notice after the deadline.

The parties initially argued that it was alright to structure notice so that half the shareholders would receive it only after the fact, but after they gauged the judge's reaction to my argument, the parties volunteered to send new notice.  The http://www.searsholdingsderivative.com/ website has not been updated as of Saturday morning, but the new deadline will be August 20, with a new fairness hearing August 27.

The law firm involved, Vianale & Vianale, brings zero-damages lawsuits against corporations alleging technical violations of Section 8 the Clayton Act antitrust law but seeking injunctive relief, and threatens to cost the defendants millions of dollars in litigation expenses if they don't settle.  This is of no benefit to shareholders, because the law in question, when it is enforced, results in the FTC politely requesting a corporation to correct the technical violation; there has not been a government fine issued for "interlocking directorates" in my adult lifetime, and for at least several years before.  The Center will be objecting to this settlement: how can attorneys claim to represent the shareholders when rational shareholders would never agree ex ante to bring a lawsuit that is guaranteed to make them worse off, win or lose?

It generally seems that the majority of my readers are plaintiffs' law firms checking up on me, but if you happen to stumble across this post and happen to own SHLD, you might get a postcard letting you know that you have another opportunity to object.  Of course, unless you own hundreds of thousands of dollars worth of stock, it might be economically irrational to spend two 44-cent stamps to object; and if you did own that much stock, the opportunity cost of the time you spend objecting is probably pretty high, even if it's just to say "My name is X, my address and phone is Y, I own Z shares of stock, and I join in the objection of Theodore H. Frank."  But unfortunately, plaintiffs' attorneys regularly ask courts to view the rational silence of class members or shareholders as acquiescence in their extortionate theft of shareholder money.

I've previously written about the problem of cy pres, charitable donations used to expand the apparent value of class action settlements that often serve as double-compensation for the trial lawyers. One particular Ohio law firm, Dworken & Bernstein, has demonstrated this problem first-hand by regularly negotiating for cy pres awards in settlements that otherwise are pretty lackadaisical in terms of class benefits, getting the settlement approved by claiming the cy pres award is a benefit to the class (even when it benefits a charity affiliated with the judge, or is a local charity despite the fact that the money is supposed to be going to a national class), and then taking personal credit for the donation in ceremonies with oversized checks, as if the money being donated was the law firm's rather than that of their clients. (The website's stock photo of the grateful child with the flower is particularly compelling.)

Public choice aficionados would be fascinated by recent Ohio developments where the Dworken firm has lined up multiple charities to support pernicious legislation, HB 427, that would enshrine this conflict of interest and breach of fiduciary duty to one's clients into Ohio law. On May 18, I testified before an Ohio House committee on the subject. class action settlements

I'm quoted in a May 23 Maryland Daily Record story on professional objectors (and don't miss the correction at the bottom of the story).

Because class action settlements bind class members absent from court proceedings, and because class action attorneys are negotiating their fees as part of the same settlement as the class settlement (even when they engage in the fiction of negotiating seriatim), Fed. R. Civ. Proc. 23(e) requires class action settlements to receive court approval as "fair, adequate, and reasonable" to ensure that class attorneys are not breaching their fiduciary duty to the class.

This permits legitimate objections to the settlement. But it also permits holdups. If class attorneys are awarded a $4 million fee, but appeals of a class action settlement approval take two to three years, the time-value of money means that it's worth hundreds of thousands of dollars to the class attorneys to pay the objectors to go away. This leads to rent seeking.

A reform to the Federal Rules of Civil Procedure was meant to address this problem: an objection cannot be withdrawn in district court without court approval. This certainly rids the system of the more blatant holdup payments that do nothing to benefit the class—though, given that the resulting proceeding will be non-adversary and any approval will not be appealed, there's little incentive for district courts not to rubber-stamp objection withdrawals.

Of more concern is that there is no parallel rule in the Federal Rules of Appellate Procedure. Simply by filing a notice of appeal, a holdup objector can avoid the need for court approval: indeed, appellate court mediators will formally encourage settlement to lighten the appellate court's docket. There's some reduction in the value of the objection, because the buyoff comes later rather than sooner, affecting the time-value of money for both the objector and the class counsel, but there's no real reduction in the incentive for rent-seeking.

Worse, the structure leads to perverse incentives: a rent-seeking or "professional" objector is likely to be financially better off if the district court denies the objection, permitting an immediate appeal—especially since many district courts are reluctant to award attorneys' fees to objectors even if the objection improved the settlement.

This can lead to low-quality objections. Of course, even professional objectors can make legitimate objections: they object to bad settlements as well as reasonable settlements, and even win occasionally: see, e.g., Synfuel Tech. v. DHL Express, 463 F.3d 646 (7th Cir. 2006). But low-quality objections hurt consumers in four ways: first, poor objections lead to poor precedent that encourages judges to rubber-stamp bad settlements over objections; second, one would expect that class counsel anticipates the expense of buying off professional objectors, and builds that into the settlement fee, increasing the cost of class action litigation to the detriment of consumers; third, to the extent the settlement legitimately provides class members with benefits, rent-seeking delays reduce the value of the settlement to the class if the class counsel has not negotiated interest-bearing escrow accounts (which is why courts should condition findings of fairness on the establishment of such accounts); and fourth, there is a signaling problem whereby it is difficult for legitimate objections to be treated as legitimate objections because the objector cannot distinguish himself from rent-seeking objectors. (Indeed, an intelligent Bayesian would expect most objectors to be rent-seeking: for the same reasons we have class actions to aggregate litigation, an objector has no financial incentive to spend time and money petitioning the court over an unfairness to a settlement where an excessive attorneys' fee might deprive the class member of a few dollars or even less. This is why thoughtful courts do not equate lack of formal objections with class members' approval of the settlement.)

The Center for Class Action Fairness resolves the signaling problem in a unique way: we announce in advance that we refuse to settle unless the settlement results in an objectively fair and reasonable settlement, and we refuse to request a fee for more than 4.4% of the additional pecuniary benefit to consumers resulting from our objections (with that fee coming from class attorneys' fees, rather than from consumers); to date, we've never settled an objection. Our interests are to put consumer welfare first. This hasn't stopped class counsel from trying to tar us with the "professional objector" brush, but we can demonstrate that they're being dishonest if they accuse us making a bad-faith objection for profit.