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How to Stop a Class-Action Scam

Wall Street Journal, January 5, 2015

If you own any stock, you know the frustration of getting a notice announcing settlement of a lawsuit, commenced by a lawyer on behalf of a class composed of all shareholders—you included. The notice informs you that, under this settlement, you get nothing. What that really means is you get zilch but you must pay a pro rata share of your corporation’s legal expenses and of the legal fees for the lawyer who commenced the lawsuit—often millions of dollars. I recently experienced this frustration firsthand, but as I’ll explain the outcome was surprisingly gratifying.

The game works like this. Certain lawyers have an inventory of shareholders, owning very small amounts of shares in corporations, who are on call to act as plaintiff in a lawsuit. As soon as a corporation announces an asset acquisition or sale, the lawyer finds one of his ready-plaintiffs and files a class action to stop the transaction. Such behavior is ubiquitous. As an analysis of merger litigation in the February 2014 Texas Law Review showed, the likelihood of a shareholder suit exceeds 90%.

The defendant corporation, seeking to close the transaction and avoid costly litigation, accepts a quick settlement. Both sides agree to wallpaper the settlement with meaningless “supplemental disclosures,” supposedly to demonstrate that the plaintiff lawyer contributed something of value, and thereby justify his claim to millions in legal fees. Also, the corporation is forced to agree not to oppose the fee application.

Yet as Judge Richard Posner of the U.S. Court of Appeals for the Seventh Circuit and many other respected jurists have pointed out, such class-action settlements too often result in “a meager recovery for the class but generous compensation for the lawyers.” Judge Posner has also noted that it is important that there be objectors to challenge these settlements and judges willing to scrutinize them.

Case in point: On Nov. 10, 2014, I received a class-settlement notice regarding my Verizon stock. It concerned a September 2013 lawsuit commenced by a plaintiff’s lawyer filed only three days after Verizon announced its $130 billion purchase of Vodafone’s 45% minority stake in Verizon Wireless. The claim was that Verizon paid an “excessive and dilutive price” and that the company failed to disclose material information regarding the fairness of the transaction.

Yet the proposed nonmonetary settlement was limited to supplemental disclosures that added immaterial minutiae about the transaction, and Verizon’s agreement to obtain a fairness opinion from a financial adviser for “any transaction regarding assets of Verizon Wireless having a book value . . . in excess of $14.4 billion.” Oh, and the plaintiffs lawyer sought $2 million in legal fees.

This was preposterous on many grounds, not least of which is that Verizon had obtained two fairness opinions before closing the Vodafone purchase—and 97% of the Verizon shareholders who voted on the deal favored it.

On Nov. 19, 2014, I filed a 15-page objection with the court, as the notice informed me I could do if I opposed any part of the settlement. I later learned that two other shareholders also filed objections. In my objection, I detailed my reasons for concluding that this settlement was not in the interests of the shareholders the plaintiff’s counsel supposedly was representing. Shareholders received nothing, while the plaintiff’s attorneys were to be paid $2 million, coming directly from shareholders.

Secondly, I questioned the $126,496 in “expert fees” paid by the firm to carry out the suit. I asked the firm to identify their expert, and to produce documents reflecting his rates and hours worked. My questioning paid off. In less than 48 hours, the plaintiffs’ firm told the court that its figure for expert’s fees was a “clerical” error: The amount should have been $25,299 not $126,496. Although the firm produced a copy of its expert’s written report, it never produced any documents reflecting his rates or hours worked.

Happily, the New York Supreme Court judge on this case, Gordon v. Verizon Communications Inc., is Melvin L. Schweitzer, with an excellent reputation as conscientious, careful and courageous, and thus one who would not take the easy way to quickly close out a case by accepting any settlement. On Dec. 19, he rejected the proposed settlement and wrote that it would be “a misuse of corporate assets were plaintiff’s legal fees to be awarded.” As for the supplemental disclosures, he ruled that they “fail to enhance the shareholders’ knowledge about the merger” and provide “no legally cognizable benefit to the shareholder class.”

Judge Schweitzer went on to decry the “tsunami of litigation” that abuses a “body of law meant to protect shareholder interests . . . turned on its head to diminish shareholder value by,” among other means, “imposing additional gratuitous costs, i.e. attorneys’ legal fees on the corporation.”

So yes, fellow shareholders, there is a procedure to get justice for shareholders against class-action lawyers interested only in racking up legal fees. But it requires shareholders willing to assert objections—and a judge as good as Judge Schweitzer.

Mr. Walpin, an inspector general under President George W. Bush , is a New York attorney and a former president of the Federal Bar Council.