Former U.S. District Judge Gerald Rosen, the Special Master appointed to investigate alleged improper billing by class plaintiffs' firms in Arkansas Teacher Retirement System v. State Street Bank and Trust Company, recommended that the firms return up to $10.6 million of the $74.5 million in attorneys' fees awarded to them after reaching a $300 million settlement in the underlying class action. If upheld, the results of the Judge Rosen's report will likely have both negative and positive impacts. For example, it may create some barriers to the effective prosecution of plaintiffs' securities cases, but it also may lead to more detailed scrutiny of fee applications to the benefit of class members.
In his balanced Special Master's Report, Judge Rosen praised the "skilled and dedicated" plaintiffs' attorneys for six years of work leading to an "excellent" settlement of a complex case in which plaintiffs alleged that State Street engaged in unfair and deceptive practices in conducting foreign exchange transactions on behalf of its customers while failing to disclose mark-ups to clients from which State Street ultimately benefited.
In fact, Judge Rosen found that, "all other things being equal, the attorneys' fee award [of nearly $75 million] was fair, reasonable and deserved." However, according to Judge Rosen, "all other things were not equal." The investigation—which spanned over 14 months, cost $3.8 million, and encompassed written discovery, production of 200,000 pages of documents, 34 witness interviews and 63 depositions—resulted in, according to Judge Rosen, "a mixed narrative of good intentions, great talent, and undeniable accomplishment and result, undermined by serious albeit inadvertent mistakes compounded by a troubling disdain for candor and transparency that at times crossed the line into outright concealment of important material facts."
Double-Billing for Staff Attorneys in Lodestar Petitions
Judge Rosen's investigation arose after the Boston Globe notified one of the firms on November 8, 2016—less than one week after the Court approved the $300 million settlement—of its intent to publish an article revealing that class plaintiffs' firms, each and separately, included duplicative staff attorneys' names and billable hours (totaling 9,322.9 hours) in their lodestar reports. After conducting internal reviews, the plaintiffs' firms unanimously agreed that the double-billing resulted in a lodestar overstatement of $4,058,654.50. In response, one plaintiffs' firm submitted a November 10, 2016 letter to the Court explaining that the errors were inadvertent. (According to the docket, after submitting this letter, but before receiving a response from the Court, on December 8, 2016, the firm instructed its bank to disburse the fees, expenses, and service awards approved by the Court to plaintiffs' firms. The docket does not reveal any notice to the Court of the firm's intention to request these disbursements, despite them reporting the overstatement to the Court a few weeks prior.)
Judge Rosen ultimately agreed—finding that the "mistakes made were largely inadvertent," and attributing the errors to a combination of one firm's internal compartmentalization of its litigation practice and a lack of any formal agreement between the firms as to their sharing of staff attorneys. Judge Rosen explained that this firm's internal compartmentalization resulted in the preparation of the fee petition by a partner "who was not involved in the litigation, and knew nothing of the [staff attorney] cost-sharing arrangement" between the firms. Accordingly, Judge Rosen recommended that the firms should be required to return the entire lodestar overstatement of $4,058,654.50 in equal shares to the class.
In its June 29, 2018 objections to Judge Rosen's report, one plaintiffs' firm took exception to the recommendation that the firms should split the overstatement equally. In so arguing, the firm pointed to the fact that: (1) it received 24% of the total fee award in the State Street case; (2) it has paid 24% of the court-ordered costs for Judge Rosen's investigation; (3) it was responsible for only 21% of the total double-counted lodestar; and (4) the portion of the double-counted lodestar for which it was responsible is only 2% of the total aggregate lodestar originally submitted to the Court. Therefore, the firm asserted that it should be required to pay a smaller percentage of the overstatement than the other plaintiffs' firms.
One Firm's "Considered and Deliberate" Nondisclosure of a Fee-Sharing Agreement
"The most disturbing aspect of . . . the entire investigation," according to Judge Rosen, was "the pervasive secrecy and concealment" of one firm's relationship with a Texas lawyer, who introduced the firm to the lead plaintiff (ATRS) years before the class action arose, but did not work on the State Street case. The agreement between the Texas attorney and the class firm entitled the Texas attorney to 20% of every fee that the firm received for cases in which it served as lead class counsel and ATRS served as class representative. Thus, as a result of the State Street settlement, the Texas attorney received $4.1 million—an amount that the other two plaintiffs' firms split equally because, according to Judge Rosen, they were led to believe that the Texas attorney was local counsel who performed work of value in the case.
In failing to fully disclose the nature of its relationship with the Texas attorney, Judge Rosen found that the class firm:
- Breached its duties to ATRS in violation of Massachusetts Rule of Professional Conduct ("MRPC") 1.5(e), which requires disclosure of fee-sharing agreements to the client, and MRCP 7.2(b), which prohibits a lawyer from "giv[ing] anything of value to a person for recommending the lawyer's services";
- Breached its fiduciary duties to the class members by withholding material information on which some may have based a decision to either object or opt out;
- Breached its duties of "fairness, trustworthiness and transparency" to its co-counsel; and
- Breached its duties to the court in violation of Fed. R. Civ. P. 23(e)(3), which requires that "parties seeking approval [of a class action settlement] must file a statement identifying any agreement made in connection with the proposal," and MRCP 3.3, which imposes a "duty of candor toward the tribunal."
Judge Rosen made a point to note that the firm failed to disclose its relationship with the Texas attorney despite requests for interrogatories calling for production of such information. Judge Rosen further emphasized that there was no acceptance of responsibility for the "calculating and secretive nature of the conduct and its adverse ramification." He seemed annoyed by the fact that the firm expressed no contrition, remorse or apology, and instead rolled out "a phalanx of experts, who together with the firm, have erected a wall of legalistic and formalistic excuses and blame-shifting (largely to the Court)."
As a result of the nondisclosure, which was found to be "considered and deliberate," Judge Rosen recommended that the Court disgorge from the class firm the entire $4.1 million, and that this disgorgement be solely the responsibility of said firm. He further recommended that the class receive $700,000 of the disgorged sum, and that $3.4 million should be reallocated specifically to counsel for the ERISA plaintiffs. Judge Rosen reasoned that while the other two plaintiffs' firms were at least partially informed of the relationship with the Texas Attorney, the ERISA attorneys were told nothing. Moreover, Judge Rosen recognized that his investigation resulted in great expenditures of time and expense to the ERISA firms, which were "drawn into it through no fault of their own, either as to the double-counting or as to the [Texas attorney's] Arrangement."
In its objections to Judge Rosen's recommendation, filed just hours after the report was unsealed, the class firm defended its arrangement with the Texas attorney—arguing that "regardless of the master's personal animus toward bare referral fees, the Massachusetts Bar has reaffirmed its support for the practice time and again, as explained by the Supreme Judicial Court . . . , the Board of Bar Overseers, and lifelong Massachusetts practitioners, among others." The firm argued that the Court should credit the opinions as to the legality of such fees of its five experts who testified during Judge Rosen's investigation, including a former president of the Massachusetts Bar Association and legal ethics professors.
Misrepresentations in One Firm's Fee Petition
In submitting their fee petitions, several of the plaintiffs' law firms used a template prepared by one firm's settlement counsel, and modified the template to ensure the accuracy of the information submitted to the Court. However, according to Judge Rosen, a partner of one firm failed to take this latter step, and thereby submitted a Declaration with "numerous untrue statements." Through his Declaration, the partner represented that: (1) Exhibit A was a summary of time spent by attorneys and staff members of his firm; (2) the staff attorneys' billing rates were based on his firm's current and regular billing rates; and (3) the schedule was prepared from contemporaneous daily time records regularly maintained by his firm. However, as Judge Rosen discovered, none of the staff attorneys were employed by the firm, the firm did not maintain current or regular billing rates for any attorneys, and the firm did not maintain daily time records for the staff attorneys or all other attorneys working on the case.
While the partner testified that he did not give his sworn declaration a very "close read," Judge Rosen did not attribute these misrepresentations to mere negligence. He rather found that the partner intentionally and willfully identified the staff attorneys as members of his firm with "regular" billing rates as a means of "jack[ing] up" the firm's individual lodestar. Therefore, Judge Rosen found that sanctions were necessary pursuant to Fed. R. Civ. P. 11—emphasizing the fact that the partner had "numerous opportunities after signing [the Declaration] to correct the misrepresentations." Specifically, Judge Rosen recommended a sanction in the range of $400,000 to $1,000,000, as well as referral of the partner to the Massachusetts Board of Bar Overseers for consideration of appropriate discipline for his apparent violation of MRPC 3.3(a)(1), which imposes a duty to correct false statements of material fact previously made to a tribunal.
Moreover, Judge Rosen partially blamed the partner for the double-billing error that triggered the entire investigation. He found that "had [the partner] fully and accurately described the reason why the [staff attorneys] were being included on the . . . petition—and that these [staff attorneys] were not employees of [the firm] and did not have current billing rates with [the firm]—the entire double-counting error may well have been avoided." Judge Rosen reasoned that if the partner had been truthful in his Declaration, the attorney responsible for submitting the fee petition would likely have noticed the discrepancy.
In its objections to Judge Rosen's recommendation, also filed within hours of the report being unsealed, the partner's firm bashed the report as being "riddled with factual and legal errors"—asserting that "if this report were subjected to the same extreme, misguided analysis being applied to the partner's mistakes, the submission of the report itself would be sanctionable conduct." Moreover, the firm argued that Judge Rosen made a "transparent attempt to generate a soundbite" by frequently stating that the partner's inaccurate declaration was an intentional means of jacking up his firm's lodestar.
Hours and Rates of Class Plaintiffs' Counsel
Partners of the plaintiffs' firms were billed at hourly rates of $535 to $1,000, associates at hourly rates of $325 to $725, staff attorneys at hourly rates of $335 to $515, and contract attorneys at hourly rates of $415 to $515. Judge Rosen generally found that the hours and rates billed by each of the law firms were "reasonable and accurate, and consistent with applicable market rates for comparable attorneys in comparable markets for comparable work."
Specifically, as to the staff attorneys, who were responsible for approximately 70% of the work billed in the case, and were described by the Boston Globe as performing nothing more than "low-level" document review, Judge Rosen, to the contrary, found them to be "highly qualified professionals who performed sophisticated and important work that contributed greatly to the successful settlement." His investigation revealed that "[m]ost, if not all, of the staff attorneys had specialized experience and/or skills that made them particularly equipped to perform comprehensive document review and spot important issues in the case."
However, there were exceptions to these findings. The first exception applied to the brother of the managing partner of the same plaintiffs' firm that had the above Declaration problem. The managing partner's brother worked a total of 406.6 hours at an hourly rate of $500—totaling $203,200 in fees ($365,760, after the 1.8 lodestar multiplier). Judge Rosen found that his work did not justify a rate of $500/hour because the work consisted only of unsupervised document review for approximately ten hours per week from his own law firm's office in Quincy, MA. Unlike other staff attorneys on the case, this individual failed to produce any substantive memoranda or other work product. Moreover, Judge Rosen reasoned that the attorney's background in the area of criminal law "has no relevance to the allegations in the State Street case," and that "[h]e was no more qualified to review documents than any other attorney with six years of general practice experience." In light of these findings, Judge Rosen recommended that the attorney's rate be set at half of the submitted rate ($250/hour), and that the firm must return $182,880 to the class.
The second exception applied to the contract attorneys staffed on the case. These contract attorneys recorded 2,833.5 hours, resulting in total billings of $1,325,588 ($2,386,058 after application of the 1.8 lodestar multiplier). Judge Rosen recommended that the $2,386,058 should be disgorged from the firm and returned to the class, and that the costs of the contract attorneys should simply be reimbursed to the plaintiffs' firms "dollar-for-dollar" at a more reasonable rate of $50/hour, totaling $141,675. Judge Rosen declined to treat the contract attorneys as the functional equivalent of associates or staff attorneys because they were "rented," did not receive health insurance or other employment benefits, and did not receive W-2s from the firm. In other words, Judge Rosen found the billable rates unreasonable because "a law firm does not face the same long-term financial commitments and risks inherent in an employment relationship" when hiring contract attorneys.
One firm vigorously opposed Judge Rosen's recommendation in its June 29, 2018 objections—arguing that "[t]he controlling and relevant case law, including from within the First Circuit, expressly rejects the special master's recommendation that the time of the firm's [contract] lawyers be treated as a cost." The firm went on to state, "No matter what the special master's academic views on best practices may be with respect to the treatment of [contract] attorneys in the context of class action fee applications, those views should not displace the controlling law or the relevant facts."
Judge Rosen's Recommendations for Best Practices Going Forward
In light of these findings, Judge Rosen opined on the lessons learned from his investigation. First, he recommended that two of the plaintiffs' firms should hire outside consultants to ensure compliance with professional conduct norms.
Specifically as to one firm, Judge Rosen recommended that it adopt policies and practices to establish and regularly evaluate its current billing rates, as well as to require contemporaneous and accurate time-keeping.
As to the other firm, Judge Rosen cautioned against floating finder's fee agreements similar to the arrangement with the Texas attorney, as well as "its almost obsessive secrecy and compartmentalization of responsibility—with one part of the firm being completely in the dark about what another part of the firm is doing."
U.S. District Court Judge's Refusal to Recuse Himself
The decision on whether the class plaintiffs' firms will be disgorged of $10.6 million, or a portion thereof, is ultimately in the hands of the U.S. District Court, which has handled the State Street action since 2011. On June 8, 2018, one plaintiffs' firm moved for the presiding judge to recuse himself in light of some "inflammatory" statements that he made during a May 30, 2018 hearing—alluding to the possibility that the firm's arrangement with a Texas attorney may have involved public corruption in the form of payments to a former Arkansas state senator. In requesting the judge's recusal, the firm pointed to the fact that "there is not a single finding suggesting that attorneys' fees awarded by the court were used to pay elected or other officials."
However, on June 21, 2018, the judge denied the motion for self-recusal because "a reasonable person could not question [his] impartiality in this case." In a June 28, 2018 Memorandum and Order, the Court explained its decision—reasoning that it is its duty to ensure that ATRS remains a typical and adequate class representative that is "not complicated by unique issues and potential conflicts of interest." In other words, the judge found his questions regarding the origins of the class firm's relationship with ATRS to be pertinent to this inquiry. The Court further reasoned that, while such questions need not be resolved at this time, it is foreseeable that the Special Master's report may trigger questions as to whether "all of those millions of dollars stopped with [the Texas attorney]."
The plaintiffs' firm has since, on July 10, 2018, filed a mandamus petition with the U.S. Court of Appeals for the First Circuit, seeking an order recusing the U.S. District judge. The plaintiffs' firm argues that "[i]n each instance, the court will be asked to review a course of action that was set in motion by the court itself, again allowing a reasonable person to question the court's impartiality." In so arguing, the firm contends that the judge must decide whether the firm was at fault for failing to disclose the $4.1 million payment to the Texas Attorney, or whether, as the firm appears to contend, it was the fault of the judge himself for "neglecting" to ask for such information. Moreover, the plaintiffs' firm argues that it is reasonable to doubt the judge's impartiality based on his ordering of plaintiffs' counsel to pay $3.8 million for Judge Rosen's investigation, which was originally expected to cost $2 million.
Significance to Institutional Investors
It is unfortunate that certain distinguished plaintiffs' firms have gotten themselves into this dilemma. The fallout may cause barriers to the effective prosecution of plaintiffs' securities cases. For years, plaintiffs' firms have been acting as "private attorney generals" to police the markets and supplement the SEC's efforts. Since the SEC is unable by itself to police the markets, the plaintiffs' securities attorneys have, in general, uncovered additional misconduct and enhanced investor recoveries.
Developments in this case could have negative impacts, including: (1) Institutions may be less anxious to step forward and become lead plaintiffs; and (2) Motions to become lead plaintiffs could encounter additional challenges, especially as to the facts surrounding the institution's retention of class counsel.
However, there could be positive benefits as well, including: (1) more detailed scrutiny of fee applications; (2) more scrutiny of lead plaintiffs' affidavits relating to settlements; (3) more scrutiny of lead plaintiffs' applications for "awards" for becoming lead plaintiffs; (4) a greater tendency to select lead plaintiffs first, and then have separate hearings on the selection of lead counsel; and (5) possible amendments to Fed. R. Civ. P. 23.
As the Special Master noted, counsel's accomplishments were overshadowed by fee application issues. Hopefully, moving forward, this situation will not repeat itself.
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