On The Case

Securities fraud defendant agrees to pay $217.5 million to opt-outs. A portent?

(Reuters) - On Friday, VEREIT, the successor to a scandal-beset real estate investment trust previously known as American Realty Capital Properties, reached an agreement with four hedge funds represented by Lowenstein Sandler. VEREIT said it would pay the funds $42.5 million to resolve their suits claiming ARCP defrauded investors by inflating a key accounting metric in a 2014 financial report. That’s on top of the $85 million settlement VEREIT entered earlier this month with several other big funds, including BlackRock, PIMCO and Clearline, represented by Bernstein Litowitz Berger & Grossmann; and a $90 million settlement in June with Vanguard funds represented by Boies Schiller Flexner.

In all, VEREIT has pledged to put up $217.5 million to appease big institutional investors comprising nearly a third of ARCP’s investor base at the time of the alleged fraud.

Notably, those big investors all chose to litigate outside of a securities class action that’s moving forward against ARCP in federal court in Manhattan. U.S. District Judge Alvin Hellerstein certified a shareholder class in 2017, selecting Robbins Geller Rudman & Dowd as lead counsel for the class. By then, however, the funds represented by Lowenstein and Bernstein Litowitz had opted out of the class and were deep into their own parallel litigation before Judge Hellerstein, which proceeded all the way through summary judgment motions.

The Vanguard funds, meanwhile, brought a separate suit in federal district court in Phoenix. U.S. District Judge Roslyn Silver denied ARCP’s motion to transfer the case to New York, so even as the company defended the class action and opt-out suits in New York, its lawyers were also briefing the Arizona case. That was surely no small expense: Milbank Tweed Hadley & McCloy, Paul Weiss Rifkind Wharton & Garrison and Kirkland & Ellis were among the firms defending the company and its executives in the Phoenix case.

Is this the future for defendants accused of securities fraud: facing a multitude of far-flung suits by well-counseled, well-capitalized investment funds?

If so, the business lobby has only itself to blame. As you know, the U.S. Supreme Court put shareholders on notice in its 2017 ruling in California Public Employees Retirement System v. ANZ Securities that if they want to preserve their right to bring individual securities fraud claims, they have to file their own suits within the three-year statute of repose, even if there’s already a class action under way. The U.S. Chamber of Commerce, the Washington Legal Foundation, the Securities Industry and Financial Markets Association and the Clearing House Association all urged the justices to uphold the strict time limit for individual investor suits.

Shareholders' lawyers argued at the time that by refusing to toll the statute of repose, the Supreme Court would force investors to flood the courts with duplicative filings by investors that might otherwise have been perfectly willing to wait for the class action to settle. The five justices in the majority weren’t convinced, calling their concern “overstated.”

Vanguard, BlackRock, PIMCO and the other funds that sued ARCP had already filed their individual cases when the Supreme Court issued its ruling in CalPERS, but they had done so in response to the 2nd U.S. Circuit Court of Appeals holding under the high court’s review. So, in that regard, it’s fair to think about the ARCP/VEREIT case as a predictor of how big investors will behave now that the Supreme Court has confirmed the 2nd Circuit’s analysis. In other words, when big funds believe there’s real money at stake in a securities fraud case – as they sensed in the ARCP case, in which the company’s former CFO has been sentenced to prison for lying to investors – they’re going to protect their interests by filing and litigating their own suits. And based on the example of the ARCP case, judges are going to force individual funds to litigate their claims alongside the class – and force companies to mount parallel defenses in the class and opt-out litigation.

I talked to a shareholders’ lawyer at a top plaintiffs’ firm about this phenomenon. He said the Supreme Court’s ruling has changed the way his firm thinks about cases. Now, when a regular client has lost money in a particular investment, the firm outlines the potential benefits of filing an individual suit instead of participating in or leading a class action. “That’s an easy sell for plaintiffs’ lawyers,” he said.

For defendants, on the other hand, it’s a hassle. Vigorously-fought opt-out suits, especially if they’re being prosecuted by powerful shareholders’ firms like those in the ARCP litigation, are an extra expense. They also create a settlement conundrum. If you attempt to settle class claims first, opt-out investors are going to demand a premium. But if you settle opt-out claims first, you risk establishing a floor for the class. “If this is the future of securities litigation, it’s a very messy future on many levels,” the shareholders’ lawyer told me.

I’d argue that the big opt-out settlements for major institutional investors shows why the system needs securities class actions to protect small investors. If Congress reins in securities fraud litigation or the Securities and Exchange Commission allows corporations to impose mandatory individual arbitration of shareholder disputes, the big funds will be fine. In cases like the ARCP litigation, they’ve shown they don’t need the leverage of a class action to retain excellent counsel and battle for just compensation for themselves. It’s the small investors, who can’t justify going their own way, who will be hurt.

I sent emails to lead VEREIT lawyer Scott Edelman of Milbank and class counsel Darren Robbins of Robbins Geller, asking about the impact of the opt-out settlements on the class litigation. Neither got back to me.