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The Class Action Paradox

The Class Action Paradox. Exercising Your Legal Rights Amid the Market Collapse. June 17, 2009. Presentation to the Board of Retirement of the Fresno County Employees' Retirement Association. Presented by: Joseph J. Tabacco, Jr. Nicole Lavallee Kevin Shelley.

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The Class Action Paradox

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  1. The Class Action Paradox Exercising Your Legal Rights Amid the Market Collapse June 17, 2009 Presentation to the Board of Retirement of the Fresno County Employees' Retirement Association Presented by: Joseph J. Tabacco, Jr. Nicole Lavallee Kevin Shelley

  2. History of Our Relationship with FCERA • Portfolio Monitoring • Berman DeValerio retained in November 2000 to identify losses over $500,000 and evaluate cases at no charge • Fall 2006 agreement incorporates significant upgrade online monitoring system • Firm receives electronic data from custodian bank • Quarterly reports notify FCERA of material losses • Staff can access case info on secure client website

  3. Representing FCERA in Litigation • Securities Class Actions • Bondholder representatives with Fresno County in WorldCom (settled for $6.13 billion) • Named plaintiff in Adelphia ($460 million) • Co-lead plaintiffs in BristolMyers-Squibb ($300 million) • Named plaintiff in Openwave Systems ($20 million) • Co-lead plaintiffs in Warnaco ($12.85 million) • Other cases: • Firm has represented FCERA in several non-securities fraud matters

  4. The Class Action Paradox • Amid rampant fraud, tumbling markets and failed regulation, investors are filing a record number of complaints • Once in court, however, plaintiffs must overcome legal barriers erected by Congress and the Supreme Court over the last 15 years Source: NERA Economic Consulting

  5. Congress Eroded Investor Rights • Private Securities Litigation Reform Act (1995) • Raised pleading standards beyond any other type of private lawsuit • Required plaintiffs to plead detailed facts showing defendant knew acts were wrong • But, at the same time, stopped plaintiffs from gathering testimony and documents to back claims • Established ‘lead plaintiff’ provision • Securities Litigation Uniform Standards Act (1998) • Funneled securities class actions to federal court, where plaintiffs’ burdens are greater

  6. The Supreme Court Ruled Against Investors • Central Bank (1994) • Eliminated claims against third parties who aid and abet fraud • Dura Pharmaceuticals (2005) • Required that plaintiffs prove that defendant’s misrepresentation (or other fraudulent conduct) proximately caused plaintiffs’ economic loss • Tellabs (2007) • Required that plaintiffs demonstrate an inference of scienter that is cogent and at least as compelling as any opposing inference of non-fraudulent intent • Stoneridge (2008) • Limited ability to sue third parties who engaged in deceptive acts

  7. And the S.E.C. Went M.I.A. The Securities and Exchange Commission: Enforcement Staff Declining • Referred fewer fraud cases and obtained less in penalties • Reduced responsibility of auditors to evaluate management’s assessment of internal controls • Voted against granting major shareholders access to proxy Source: Securities and Exchange Commission

  8. Fraud in a Downturn Financial PressureDuring an economic downturn, pressureto meet financial targets increases,along with consequences of failure. OpportunityCompanies may prioritize revenue-producingactivities and cut back on risk management,creating new opportunities for fraud. RationalizationIncreasing pressure and opportunitiesmake it easier for employees to rationalize fraudulent activities. Source: “Financial fraud: Does an economic downturn mean an uptick?” Deloitte Financial Advisory Services, 2008

  9. U.S. Financial Collapse Spurs Claims • March 2008 • JP Morgan acquires Bear Stearns for $10 a share • July • FDIC seizes IndyMac • September • Lehman Bros. files for bankruptcy • AIG rescued by U.S. government • Fannie Mae and Freddie Mac seized • WaMu is largest bank failure in U.S. history • December • Madoff Investment Securities exposed as Ponzi scheme • April 2009 • Bank of America CEO Kenneth Lewis says Merrill Lynch’s problems not disclosed at time of merger • June • SEC sues Countrywide founder Angelo Mozilo for securities fraud

  10. Recession Continues to Prompt New Suits • As woes spread, new sectors become vulnerable to fraud: high-tech, retail and services • Declining revenues, shrinking executive pay and job insecurity provide motives for fraud • Investors in asset-backed securities file suits

  11. New Study: Institutional Investors’ Cases Are More Successful Lawsuits led by institutional investors: • Are more likely to survive pleading phase • 86% of cases with institutional lead plaintiffs survive motion to dismiss, compared with 56% of cases led by individuals • Settle for more money • Settlements led by institutional investors averaged $104.2 million, compared with $9.8 million for individual lead plaintiffs • Median settlement was four times larger - $15.7 million for institutional plaintiffs, compared with $4.3 million for individual plaintiffs • Are more likely to result in higher quality corporate governance changes C.S. Agnes Cheng et al., “Institutional Monitoring Through Shareholder Litigation,” April 29, 2009

  12. Funds Are Active in Largest Recoveries Source: RiskMetrics Group

  13. Class Actions Face New Legal Challenges • Recession changes dynamics of litigation • Fewer deep-pocket defendants • More bankruptcies, which complicate recoveries • Steep odds for claims against third parties involved in fraud • Loss causation difficult to prove • Amid widespread market declines, plaintiffs must link fall in defendant’s stock price to specific disclosures

  14. Strategies for Taking Legal Action • Legal options • Consider filing individual opt-out claims in state court • Cast wider net to recoup losses • Use settlements to strengthen corporate governance

  15. Strategies for Making Policy Changes • Advocate Policy Change • Back reinvigorated SEC to • Increase case referrals • Boost enforcement • Give shareholders meaningful chance to propose directors • Fight to amend securities laws • Restore third-party liability, overriding Stoneridge and Central Bank • Return to reasonable standards for proving fraud in court, blunting Tellabs New SEC Chairman Mary Schapiro

  16. Thank You Joseph J. Tabacco, Jr. Nicole Lavallee Kevin Shelley 425 California Street Suite 2100 San Francisco (415) 433-3200 jtabacco@bermandevalerio.com nlavallee@bermandevalerio.com kshelley@bermandevalerio.com

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