gavelCLASS ACTION GONE BAD? YOU BE THE JUDGE – Part 1 of a 6 Part Series

Class Action law suits have been around for quite some time. In theory, a class action enables justice to be served where there are many people are involved. Class actions can be brought at the state level, or at the federal level. This 6 part story is about class action lawsuits, and specifically about a class action suit that was brought about during the proposed merger of Sirius and XM. This series does not accuse any party of doing anything beyond the scope of law, but does delve into a side of class action suits that many may find distasteful. In many, if not most ways, this series deals with conjecture, theory, and circumstantial evidence. I am not laying down an accusation, or alleging any specific illegal activity, but am painting a broad brushed picture that could have readers doing a bit of their own version of “connect-the-dots”.

When most people think of class action lawsuits, they picture a company that produced a product that caused “harm” to many people. A “harmed” person gains representation of an attorney, and file suit. If it is determined that the “harm” is widespread, a class of “harmed” parties can be formed, and the suit becomes a Class Action. Such cases are litigated, a settlement or judgment is made, and the case is resolved. “Harm” was caused, a solution was decided upon, and the class all participate in the fruits of the decision.

In theory, this all seems workable, but all too often, the only real winners are the attorneys. Many, if not most settlements often boil down to credits on future purchases, vouchers, or coupons. Where cash is involved, the settlements are typically quite small. Regardless, to participate in the settlement, there are often several hoops to jump through that can make participation cumbersome. The class gets a small benefit from the suit, and the attorneys often get millions. While the system may indeed have flaws, the theory behind it is sound. A group of similarly affected parties joins in one suit.

As with anything, people sometimes find a way to use the system to their own advantage. Class action attorneys often seek out suits, and even go so far as to find plaintiffs to bring about the action. What would it mean to a law firm if a class action suit could be brought out of virtually thin air? It would mean billable hours, fees, and a constant slate of work for the firm to keep the cash flow rolling. It is sad to say that all too often it is less expensive for the defendant to settle a case than to fight in court. A law firm that can find that sweet spot, of cases that will garner a settlement, and is willing to exploit it can get settlements and go for years without getting to the point where a judge makes the decision.

With publicly traded companies, there is a huge potential for what could well be termed an abuse of the class action lawsuit. For example, an airline company has a large percentage of their fleet go down for repairs all at the same time causing a huge loss of revenue. A plaintiff (someone who holds shares of stock) could argue that management breached their responsibility by not doing regular maintenance on the fleet. OR…Let’s say a company decides to make a business move such as a merger, and a plaintiff (again, a shareholder) challenges that the Board of Directors breached their fiduciary responsibility somehow in the process. A class action suit could be brought.

A breach of fiduciary responsibly. How is this proven? How is it argued? Where are the facts? Many of the arguments in such a case are subjective and boil down to conjecture. Herein is a problem that allows a class action law firm to virtually pull a suit out of thin air. The arguments are subjective and opinionated. There is little factual information for either side to go on, and more often than not, a judge would rather err in caution by letting a suit proceed than to dismiss it out of hand. At least if it is allowed to proceed, the “harm”, if it exists at all, can have remedy. Thus, a class action suit is born. In many cases such as this, the suit is brought by an investor who then seeks class action status on behalf of all investors. The problem is that the company, and by extension the shareholders, tend to foot the bill for the suit, and thus harm their own bottom line or investment. In theory, the lead plaintiff in a case participates equally in the settlement with the other members of the class.

Now, knowing that the settlements are often quite small, there would seem to be a natural hurdle that would dictate whether something is egregious enough to bring a suit in the first place. If the reward of the suit is only nominal in nature, a person becomes less likely to go through the trouble of filing a suit. This creates a natural hurdle.

Here is where things get interesting. What if a person were to become a “professional plaintiff”? What if a person were to work regularly with class action law firms bring suit after suit, and then getting “consulting fees” through a third part law firm? What if filing class action lawsuits was a profitable activity?

The concept is actually pretty simple. Buy a small stake in several publicly traded companies, and wait for something to happen. A bad quarter, a merger or a buyout are all activities that can happen that can allow the allegation of poor decision making by management. The key ingredient is that the facts can not be readily determined on one side or another. The case centers on the idea that the company can not prove one way or the other that their actions were indeed responsible. This creates a lot of dialogue, requests for documents which must be reviewed, filings, delays, and by extension, a lot of billable hours for the law firm filing the suit.

If the plaintiff prevails, these billable hours and fees will most often be paid by the defendant as part of the settlement. More often than not, it becomes less expensive for a defendant to simply settle the case and admit no wrong doing than to fight the case, causing delays and fees that may become overly burdensome. Not a bad gig for the class action law firm involved or the “professional plaintiff”.

As if that was not enough, consider this. Often when a suit is settled, the terms of the settlement offer indemnification to the company on the issue that brought the original suit. In effect, it strips away the ability for such a suit to be brought again in the future, and in essence protects the company from being sued again for the same issue. For the company being sued, this can sometimes represent a silver lining in an otherwise frustrating situation.

If the settlement gives shareholders virtually nothing, gives the law firm a ton of billable hours and fees, and give the company some indemnification, what are you as a shareholder left with? A voucher, coupon, or small cash reward that you have to jump through hoops for, and the loss of all of your rights should there have been a real issue that was somehow not brought out in the original case.

Frustrated yet? The rest of this series boils down many possibilities that will have you the shareholder thinking twice about investing in the markets, as well as how class action lawsuits work. This issue is not specific to only to Sirius. Class action suits happen all of the time. Where you the investor may want to be real concerned is that the same players, law firms and plaintiffs, tend to turn up again and again. If a company you are invested in becomes the target of a class action firm or a plaintiff that seems to have a habit of entering into such litigious actions what are you as a shareholder to do?

In the proposed merger between Sirius Satellite Radio and XM Satellite Radio, a class action lawsuit arose. The class action suit alleged a breach of fiduciary responsibility, among other things, on the part of the management and Board of Directors of Sirius Satellite Radio. The suit was brought forward by Greg Brockwell and Terry Johnson. This series will center on Brockwell, who became Lead Plaintiff in the case.

Mr. Brockwell is an interesting person to say the least. He seems to have had shares in many companies, and also often seems to express “concern” in the court system, via class action suits, over the actions of those companies. Is Mr. Brockwell a profession plaintiff? I have no direct evidence to say that he is. For all I know, he simply has an uncanny ability to be invested into companies that he ultimately becomes “concerned” about and decides to sue. Stop back to Sirius Buzz for segment 2 of this story detailing the “Beginnings Of The Suit.”

Stay tuned for segment 2 of this series “The Beginnings Of The Suit”

Position – Long Sirius, Long XM