The U.S. Supreme Court will soon decide an unusual, yet important, case brought by investors in bonds issued by Lehman Brothers, the infamous investment bank that collapsed in September 2008. The case, CalPERS v. ANZ Securities, Inc., is not about whether those investors were defrauded: It is widely known that Lehman concealed its exposure to subprime mortgage loans and complex derivatives, just as it used accounting gimmicks to hide risks. The investigation after Lehman’s bankruptcy showed incontrovertibly that its investors had been wronged.
Nor is the case about whether those investors could properly recover in class action litigation alleging that Lehman and others violated the federal securities laws. Various lawsuits filed by Lehman bond investors were consolidated in federal court in New York and then settled in 2011, three years after Lehman’s bankruptcy filing. That settlement has not been challenged. But the date of that settlement – and the three-year time period – are important.
The challenge before the Supreme Court involves the question of what to do about investors who opted out of that 2011 settlement. So-called “opt outs” are increasingly common in securities litigation, particularly among large sophisticated institutional investors. Most people don’t realize it, but anyone with a retirement or investment account potentially can benefit from recoveries in these cases. The central rationale behind an opt-out is that the class action settlement is inadequate. Some institutions determine that they could do better by detaching themselves from the class, going it alone in separate litigation. Any investor has the right to opt-out, and many of the largest and most sophisticated institutions do so.
CalPERS, the largest pension fund in the U.S., opted out of the 2011 class action settlement in the Lehman case. It had purchased millions of dollars of bonds and had suffered serious harm when the truth about Lehman’s condition became known. CalPERS had filed an individual lawsuit in the Northern District of California, but that lawsuit was consolidated with all of the other Lehman cases in New York for pre-trial purposes before the class action was settled. No one questions whether CalPERS filed its lawsuit within the applicable three-year statute of limitations. CalPERS initially arrived on time.
The strange problem CalPERS faces before the Supreme Court arose later, after the settlement of the class action, when CalPERS opted out to pursue its individual claims. Again, no one doubts that CalPERS had the right to opt out. Federal Rule of Civil Procedure 23 and due process allow such opt outs, and CalPERS was well within its federal and constitutional rights in opting out. However, after CalPERS settled its claims with some defendants, the federal district court dismissed CalPERS’ opt out case as time barred, asserting that it was filed more than three years after the relevant date for statute of limitations purposes, a time period set by Section 13 of the Securities Act of 1933. This is why the three-year time period was so important. According to the court, the CalPERS opt out case was filed too late.
I call CalPERS’ problem “strange” because the Supreme Court already had made it clear, back in 1974, that if a class action is filed in a timely manner, then the statute of limitations period will be tolled for all members of that class. This earlier ruling, in a case called American Pipe & Construction Co. v. Utah, was common sense: If a lawsuit is filed in a timely manner, members of the class should not be precluded from going forward with an individual lawsuit later. For example, if class certification later were denied, a member of the putative class nevertheless should be able to proceed – even if that individual lawsuit was filed after the limitations period had expired and new claims otherwise would be barred.
The result in American Pipe has been accepted law for decades. The result comports with widely-held notions of fairness and common sense. If you are part of a group that meets a deadline, you should not later be disqualified merely because the group you are a part of is disbanded. Imagine a race in which all runners are required to arrive before 9 a.m. in order to participate. You are part of a group that arrives on time and plans to run together. You have your race numbers pinned on and you are waiting in line before 9 a.m., ready to go, but for various reasons the members of the group disband, many of them deciding not to participate, or perhaps being told they cannot participate or run together as a group. After those people leave, you then attempt to run in the race on your own. But it is now after 9 a.m. Should you be permitted to run? Of course, the answer is yes. You arrived on time. Why would anyone disqualify you simply because members of your group now are not running? The Supreme Court followed this common sense reasoning in American Pipe and held that Federal Rule 23 allowed putative class members to intervene in litigation after class certification was denied, even though the limitations period had run.
Yet the district court in CalPERS v. ANZ Securities rejected this reasoning, holding instead that the opt out case was filed too late. The Second Circuit agreed, essentially ruling that three years is three years, regardless of whether the opt out filer had been part of a class that filed suit in a timely fashion. The Supreme Court granted certiorari, accepting CalPERS’ petition to review the case. The case generated a flurry of briefing from various interested parties and oral argument was held in mid-April.
If the Supreme Court reverses the Second Circuit, CalPERS will proceed with its opt out case, and other institutions in future cases will not need to file individual lawsuits at the beginning of class actions. But if the Supreme Court reverses, it will throw a wrench into securities class actions, because it will create an incentive for unnamed class members to file individual pleadings early on, even if they are not sure whether they might later opt out. Large institutional investors in particular will need to file such individual actions, to preserve their later rights, at significant cost. District courts will then need to address these individual cases early on, even if those plaintiffs ultimately would have decided later not to opt out. The costs and inefficiencies will be particularly great for claims brought under statutory provisions, such as Section 11 of the 1933 securities laws, which typically require a lengthy amount of time to resolve. It would become too risky for such plaintiffs to wait and see, as they frequently do now. One of the Supreme Court amici curiae briefs, filed by 10 distinguished civil procedure and securities law professors, demonstrated just such a risk of wasteful protective filings. (I was not part of that brief; nor was I compensated in any way related to this case or this post.)
Instead of opting out only when they are dissatisfied with a class action settlement, institutional investors likely would opt out as a matter of standard practice. That prophylactic litigation would benefit lawyers for both plaintiffs and defendants, who would have more clients to represent and cases to pursue and defend, but these new filings would burden the courts without any commensurate benefits. By precluding CalPERS from opting out of the Lehman litigation, the Supreme Court would create incentives for future plaintiffs to undertake individual cases that generate deadweight losses. Even if the Court sees a rationale for barring CalPERS in this particular case, upholding the Second Circuit would be penny wise, pound foolish. The better approach would be to recognize that when class action litigation is filed in a timely manner, it is filed in a timely manner, period, even for class members who later opt out.
The Supreme Court rarely decides securities cases and has not yet weighed in on litigation arising from the 2007-08 financial crisis. The upcoming decision in the CalPERS case will give all of us a unique view of how the Justices are thinking about investors, particularly the large institutions that invest our retirement savings.
This post comes to us from Professor Frank Partnoy at the University of San Diego School of Law.