ATTORNEY: LOUIS C. LUDWIG
POMERANTZ MONITOR JULY/AUGUST 2019
During a settlement hearing on June 18 in the matter of In re RH, Inc. Securities Litigation, U.S. District Judge Yvonne Gonzalez Rogers of the Northern District of California took plaintiffs’ and defendants’ counsel to task for failing to disclose the existence of a confidential side deal between the parties. By all indications, the agreement in question related to a so-called “blow” or “blow-up” provision. Blow provisions provide settling defendants with an option to terminate the settlement agreement if a specified threshold of investors elect to exclude themselves (or “opt out”) of the settlement. Opt-out thresholds can be pegged to the dollar amount of the defendants’ potential exposure to opt outs, the percentage of the shares purchased by class members, the percentage of shares outstanding, or the percentage of shares traded. From a settling defendants’ standpoint, the rationale is obvious: if too many class members opt out of the settlement, those same class members are likely to pursue their own cases against the defendants based on the same underlying conduct alleged in the class action. This makes the value of the class action settlement far less attractive to the defendants. No one wants to pay millions to settle a class action, only to be subjected to massive subsequent claims from investors who have opted out of the class. Where a defendant cannot sufficiently minimize its liability exposure in potential post-settlement “opt out” cases, settlement of the class action becomes a significantly less palatable proposition. The catch, as it were, is that the presence of an excessive number of opt-outs cannot and will not be known until the settlement has been inked, preliminarily approved by the court, and notice has gone out, making the blow provision a kind of insurance policy for defendants.
While the blow provision-related side deal in RH was referred to in the parties’ settlement agreement, it went unmentioned in the motion for preliminary approval. In response to the omission, the judge ordered the parties to file the confidential agreement with the court under seal and advised both firms that she had informed the entire Northern District bench of the incident and of the firms’ respective identities.
Given that the RH court characterized the settlement as a good deal for the class, counsels’ decision to bury the confidential agreement, and thereby incur the court’s ire, seems like a major unforced error. Certainly, failing to acknowledge the existence of a blow provision in preliminary approval motion is indefensible; indeed, plaintiffs’ counsel in RH acknowledged their “poor job” of disclosing the agreement at the June 18 hearing. Courts have a duty to assess the fairness, reasonableness, and adequacy of proposed class action settlements, an objective that is thwarted where the settlement is presented in an incomplete or misleading manner. On the other hand, plaintiff’s counsel was correct in noting that such agreements are “standard” in securities cases. Moreover, it is also quite common for the settling parties to request that blow provisions, which are typically memorialized in separate agreements like the one in RH, be subject to confidential treatment, i.e., that they not be publicly disclosed, even to class members. However, the court itself needs to be informed of the provision.
On the surface, this type of secrecy seems antithetical to the informative aims of class action settlements: settlement proponents (plaintiffs and their counsel) are required to provide adequate notice of the settlement’s material terms to the class; in turn, class members are able to make an informed decision on whether to remain part of, opt out of, or object to, the settlement. More generally, absent class members who are not class representatives, and are therefore not directly involved with the litigation, should be kept abreast of critical developments by the plaintiffs and counsel who seek to represent their interests. This is especially true in cases such as RH, where a class had already been certified prior to the parties’ negotiating a settlement, thus creating, arguably, an even stronger presumption in favor of notice than in instances where a class is certified for the settlement purposes only. A previously-certified class has achieved a continuing and ongoing right to all material information about the case, making it difficult to advance the view that the blow provision’s terms have no bearing on individual class members’ decisions on how to proceed with respect to their claims, as has been argued in the settlement-only class certification context.
Still, there are good reasons for both plaintiffs and defendants to resist public dissemination of the details of the blow provisions. Most prominently, publishing the number or percentage of opt-outs necessary to “blow up” a settlement may give excessive leverage to opt-out activists and threaten the stability of the settlement. Specifically, a group of class members with knowledge of the terms of the blow provision (and holding the requisite number of shares to trigger it) could band together for the purpose of preventing the settlement, or simply extracting special concessions from the settlement proponents. Even if the group did not initially have enough shares to trigger the termination provision, it could seek to recruit enough additional class members to do so. In cases where the claimed damages per share differ significantly among class members, tying the opt-out threshold to a specified dollar value could serve to impede this type of opt-out activism by making it more difficult to assemble the right mix of class members to trigger the blow provision.
Some courts have found these concerns sufficiently persuasive to warrant non-disclosure of supplemental agreements containing the opt-out threshold. Such courts will typically permit counsel to submit the supplemental agreement to the court through confidential means, so that the court’s mandate to review the settlement’s fairness is not impeded. Other courts have required that the supplemental agreement be publicly filed, reasoning that class members are entitled to review all aspects of the deal, even where that entails the possibility of a concerted effort to upend the settlement. Regardless, it does not appear that counsel risk any prejudice by not filing supplemental agreements memorializing blow provisions so long as they (a) refer to the existence of any such agreement in their motion papers and (b) file a timely request for confidential review of the agreement, e.g., a motion to file under seal. Alternately, the settling parties might elect simply to inform the court about the existence of the agreement and their non-intention to submit it in any form, confidential or otherwise, absent a specific order to do so. This course of action is not recommended, not only because it is likely to raise the court’s suspicions about the content of the agreement, but also because the court is then forced to issue a request for information in order to carry out its duty to evaluate the settlement’s fairness.
Plaintiffs and their counsel have no real interest in ensuring that a blow provision or appurtenant side agreement be included as part of a settlement – it is inevitably a condition imposed by defendants for purposes of limiting their own exposure to future cases brought by opt-out class members. Nevertheless, these agreements have become standard practice. This is unsurprising in light of research demonstrating that the number of opt-outs – and the potential for separate opt-out litigation – has increased in recent years. Large class action settlements represent a disproportionate percentage of cases that ultimately face an opt-out: between 2012 and 2014, three of four settlements of $500 million or greater involved opt-outs. Consequently, members of the securities plaintiffs’ bar must learn to effectively balance the informational risk posed by opt-out thresholds with both the notice due to class members and the court’s independent obligation to fully review the terms of class-wide settlements.