Amicus Curiae Brief — California Public Employees' Retirement System v. Felzen

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No. 97-1732

* FILED

NOV 10 1998

CALIFORNIA PUBLIC EMPLOYEES’ RETIREMENT SYSTEM

AND FLORIDA STATE BOARD OF ADMINISTRATION,

Petitioners,

PAUL FELZEN, et al,

Respondents.

ON WRIT OF CERTIORARI TO THE UNITED STATES COURT

OF APPEALS FOR THE SEVENTH CIRCUIT

BRIEF OF AMICUS CURIAE

COUNCIL OF INSTITUTIONAL INVESTORS

IN SUPPORT OF PETITIONERS

CARTER G. PHILLIPS

BRADFORD A. BERENSON*

PAUL J. ZIDLICKY

DAVID W. JONES

BRIAN C. KALT

SIDLEY & AUSTIN

1722 Eye Street, NW

Washington, DC 20006

(202) 736-8000

Counsel for Amicus Curiae

November 10, 1998 *Counsel of Record

\ fy

QUESTION PRESENTED

Whether a shareholder who, pursuant to Federal Rule of

Civil Procedure 23.1, appears in federal district court and

presents objections to a proposed dismissal or settlement of a

derivative action, must also intervene pursuant to Federal Rule

of Civil Procedure 24 to appeal an adverse decision.

TABLE OF CONTENTS

Page

TABLE OF AUTHIORIGIGS .. i56 Ws ev eaavaree iv

INTEREST OF AMICUS CURIAE ...............55: l

SUMMARY OF ARGUMENT ..................... 2

ARISUMEENT ... o.oo scene es hae pelee cede pe 4

I OBJECTING SHAREHOLDERS PLAY A

VALUABLE ROLE IN ENSURING THE

FAIRNESS AND INTEGRITY OF SETTLEMENTS

IN SHAREHOLDER DERIVATIVE LITIGATION .

A. The Settlement of Shareholder Derivative Actions

Is Fraught With Potential for Conflict of Interest

and Unive .. ... sc a bheetineeeiee

B. Objecting Shareholders Are Essential to Ensuring

Fairness in Derivative Settlements ...........

REQUIRING SHAREHOLDER OBJECTORS TO

INTERVENE TO OBTAIN APPELLATE REVIEW

WOULD HINDER EFFECTIVE MONITORING OF

DERIVATIVE SUIT SETTLEMENTS ..........

A Appellate Review of Shareholders’ Objections Is

Essential to the Effective Monitoring of

Derivative Suit Settlements ................

B. Requiring Intervention to Secure the Right to

Appeal Would Cut Off Appellate Review of

Some Derivative Settlements and Erect Unfair

and Unnecessary Barriers to Effective Policing of

1. An Intervention Requirement Would Unduly

Limit and Increase the Costs of Appeals by

Shareholder Objectors.... ssi‘ (a

2. An Intervention Requirement Would Provide

No Corresponding Benefit _ . )

CONCLUSION .............

. 29

TABLE OF AUTHORITIES

CASES

Alleghany Corp. v. Kirby,

333 F.2d 327 (2d Cir. 1964), aff'd

en banc by an equally divided court,

340 F.2d 311 (2d Cir 1965) ............

Bell Atlantic Corp. v. Bolger,

2 F.3d 1304 (3d Cir 1993) ..........

Braun v. Fleming-Hall Tobacco Co.,

92 A.2d 302 (Del. Ch. 1952) .......... ,

Burks v. Lasker,

441 US. 471 (1979)

In re Chambers Dev. Sec. Litig.,

912 F. Supp. 822 (W_D. Pa. 1995) .

City of Detroit v. Grinnell Corp.,

495 F.2d 448 (2d Cir. 1974)

Cohen v. Beneficial Indus. Loan Corp..,

337 US 541 (1949) ....

Cohen v. Young,

127 F.2d 721 (6th Cir. 1942)

Daily Income Fund, Inc. v. Fox,

464 US. 523 (1984)

15,20

. 20

. 4,5,6,7

Dietrich Corp. v. King Resources Co.,

596 F.2d 422 (10th Cir 1979) ........... 1. Siae

Ficalora v. Lockheed Cal. Co..,

751 F.2d 995 (9th Cir. 1985) .................. 20

In re General Motors Corp. Engine Interchange e'

594 F 2d 1106 (7th Cir 1979) ............ .. 20

In re General Motors Corp. Pick-Up Truck

Fuel Tank Prods. Liab. Litig.,

55 F.3d 768 (3d Cir 1995) ............... eae

In re General Tire & Rubber Co. Sec. Litig.,

726 F.2d 1075 (6th Cir 1984) ....... eae

Girsh vy. Jepson,

sae F.26 133 G6 Cer. 1975) ... 2.20 i... 11,13,19

Gluck v. Cellstar Corp.,

976 F. Supp. 542 (N.D. Tex. 1997) __. in oe

Greenfield vy. Villager Indus., Inc.,

483 F.2d 824 (3d Cir 1973) ........ Fs Oh 7

Greenspun v. Bogan,

492 F.2d 375 (ist Cir 1974) ...... nA 13

Kamen v. Kemper Finan. Servs.,

S00U.S.90(1991) ......... a 5

Lipscomb v. Wise,

643 F.2d 319(SthCir 1981)... .. 27,28

Malchman v. Davis,

706 F.2d 426 (2d Cir 1983) .............0.4.. 20

In re Oracle Sec. Litig.,

829 F. Supp. 1176 (N.D. Cal. 1993) ............ 12

In re Pacific Enters. Sec. Litig.,

47 F.3d 373 (Sth Cir. 1995) ............... 15,20

In re Pittsburgh & Lake Erie R.R. Co. Sec.

& Antitrust Litig.,

543 F.2d 1058 (3d Cir. 1976) ............ 18,19,27

Ragsdale v. Turnock,

Pe fot lt ee eee ee ee 23

Rosenbaum v. MacAllister,

64 F.3d 1439 (10th Cir 1995) .......... _. . passim

Saylor v. Bastedo,

oe 8 BM TF 8 me ee Oe . 22

Saylor v. Lindsley,

456 F.2d 896 (2d Cir. 1972) ............... 8,9,10

Seigal v. Merrick,

619 F.2d 160 (2d Cir 1980) ...... oF Mee @, €: 16

Strawbridge v. Curtis,

7 US. (3 Cranch) 267 (1806) ee aes Uys ae

Stromberg Metal Works v. Comfort Control, Inc.,

77 F.3d 928 (7th Cir. 1996) a OPES wack Ut 22

Thompson v. Freeman,

648 F.2d 1144 (8thCir 1981) .................

Tryforos v. Icarian Dev. Co.,

vue F260 1298 (7 Cer. 1975)... 2... cee.

Turner/Ozanne v. Hyman/Power,

pe Be te Le ee

United States Catholic Conference v. Abortion

Rights Mobilization, Inc.,

ee th en ee

In re Urcarco Sec. Litig.,

148 F.R.D. 561 (N_D. Tex. 1993) ..............

In re Warner Communications Sec. Litig.,

618 F. Supp. 735 (S.D.N_Y. 1985), aff'd,

798 F.2d 23 (2d Cir. 1986) ............

In re Wells Fargo Sec. Litig.,

991 F. Supp. 1193 (N.D. Cal 1998) ......

Zimmerman v. Bell,

800 F.2d 386 (4th Cir 1986) .. .s«ddd..

STATUTES & RULES

Private Securities Litigation Reform Act of 1995, Pub.

L. No. 104-67, 109 Stat. 737(1995) .......

eT ae Bote ai Ras

woe see

_ 1S

vill

, ¥ ©: 3 2S errr ee sy 4,11,21,23,24

BU. iatinccaSeaccdbecebhadennak eee 23

BR ik eo LE PANE CEES: 23

TOO vie ROA 2 RCT 24

LEGISLATIVE HISTORY

Private Securities Litigation Reform Act of 1995,

HR. 104-98 at 32, reprinted in 1995

BPOCC ATG F580 eR A TAT 10

H. Conf. Rep. No. 369, 104th Cong,

Ist Sess. 34 (1995), reprinted in

OTE USER Fee Fe eek ee CM 25

OTHER AUTHORITIES

ABA Committee on Standards of Judicial

Administration, Standards “gE 2 lo yo TENG

Cmte... CR SIRI 17

Administrative Office of the United States Courts,

Judicial Business of The United States Courts

Re n> s ae Geau hve becuase: ipa

William L. Cary & Melvin A. Eisenberg, Corporations

PEPE COD SESE Fi BESS IN SIN 05 8 6 15

John C. Coffee, Jr., Class Wars: The Dilemma of the

Mass Tort Class Action, 95 Colum. L. Rev. 1343

is Mato NG: 2. eS). 408

John C. Coffee, Jr., Understanding the Plaintiff's

Attorney: The Implications of Economic Theory

for Private Enforcement of Law Through Class

and Derivative Actions, 86 Colum. L. Rev. 669

SOP UDI PETE COTO

John C. Coffee, Jr., The Unfaithful Champion: The

Plaintiff as Monitor in Shareholder Litigation,

48 Law & Contemp. Probs.5(1985) _.......

Deborah A. Demott, Shareholder Derivative Actions:

Law @ Prectiee (1994)... ees

Timothy A. Duffy, Comment, Zhe Appealability of

Class Action Settlements by Unnamed Parties, 60

U. Chi. L. Rev. 933 (1993) ...............

W.J. Dunn, /ntervention by Other Stockholders in

Stockholders Derivative Action, 69 A.L.R.2d 562

REG ae FIT 5 aa) a Ty a ee OD

Federal Judicial Center, Empirical Study of Class

Actions in Four Federal District Courts: Final

Report to the Advisory Committee on Civil Rules

PRR a a eee eee ota ot

Ralph C. Ferrara et al., Shareholder Derivative

Litigation: Besieging the Board (1995) _.. .

10,14,15

. 6,15,22

Daniel R. Fischel & Michael Bradley, Zhe Role of

Liability Rules and the Derivative Suit in

Corporate Law: A Theoretical and Empirical

Analysis, 71 Cornell L. Rev. 261 (1986) .........

13 William Meade Fletcher, Cyclopedia Corporations

CROCE 25. gaa Ss 6 cd OER VGA

Joseph A. Grundfest & Michael A. Perino, Joint

Written Testimony Before the Subcommittee on

Securities of the Senate Committee on Banking,

Housing, and Urban Affairs (July 24,1997) ......

Robert Leflar, /nternal Operating Procedures of

MOC SD BSS OS 17,18

Jonathan R. Macey & Geoffrey P. Miller, 7he

Plaintiffs’ Attorney's Role in Class Action and

Derivative Litigation: Economic Analysis and

Recommendations for Reform, 58 U. Chi. L. Rev.

FOE. DFS a. BIAS acca

Geoffrey P. Miller, Some Agency Problems in

Settlement, 16 J. Legal Stud. 189 (1987) ........

5 Moore's Federal Practice § 23.1.10{2}[a] (1998) ....

Jon O. Newman, A Study of Appellate Reversals, 58

— FX Ff erererrr fear

Bert S. Prunty, 7he Shareholders’ Derivative Suit:

Notes on Its Derivation, 32 N.Y.U. L. Rev. 980

(1957) See None ida ee tan ates

Deborah L. Rhode, Class Conflicts in Class Actions,

34 Stan. L. Rev. 1183 (1982) ................... 8

Steven Shavell, Zhe Appeals Process as a Means of

Error Correction, 24 J. Legal Stud. 379 (1995) .... 17

Elliot J. Weiss & John S. Beckerman, Let the Money

Do the Monitoring: How Institutional Investors

Can Reduce Agency Costs in Securities Class

Actions, 104 Yale L.J. 2053 (1995) .......... 12,13

Ralph K. Winter, Paying Lawyers, Empowering

Prosecutors, and Protecting Managers: Raising

the Cost of Capital in America, 42 Duke L.J. 945

RIESE Ge Fly pei ay go Ua Ee 9

7C Charles Alan Wright et al., Federal Practice &

i a Sab area iia 6,7,9,13

Es Lule Oat Gwar Gbe te whe kak ae bd we Oks 23

DURE aa te cee Ove els yi aise 27

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1998

CALIFORNIA PUBLIC EMPLOYEES’ RETIREMENT SYSTEM

AND FLORIDA STATE BOARD OF ADMINISTRATION,

Petitioners,

PAUL FELZEN, ef al,

Respondents.

ON WRIT OF CERTIORARI TO THE UNITED STATES COURT

OF APPEALS FOR THE SEVENTH CIRCUIT

BRIEF OF AMICUS CURIAE

COUNCIL OF INSTITUTIONAL INVESTORS

IN SUPPORT OF PETITIONERS

INTEREST OF AMICUS CURIAE’

The Council of Institutional Investors (the “Council’”) is an

organization of public, Taft-Hartley and corporate pension

funds that seeks to address investment issues that affect the

security of pension plan assets by encouraging institutional

investors to take an active role in protecting those assets. The

Council was founded in 1985 in response to controversial

takeover activities that threatened the financial interests of

' Pursuant to Rule 37.6 of the Rules of this Court, amicus states that no

counsel for a party authored this bref in whole or in part, and no person or

enuty other than amicus and their counsel made any monetary contnbution to

the preparation or submission of this bnef. Pursuant to Rule 37.3, amicus

states that petitioners and respondents have granted consent to file this bnef.

pension fund beneficiaries. Since that time, the Council has

grown to over 100 members who control pension assets in

excess of $1 trillion and represent millions of plan beneficiaries

and participants. The Council is recognized as a significant

voice for investors on issues of corporate governance, executive

compensation, and corporate accountability to shareholders,

see, e.g., In re Wells Fargo Sec. Litig., 991 F. Supp. 1193,

1198 (N_D. Cal. 1998), and consistently has been a proponent

of meaningful shareholder participation in major decisions that

affect corporate viability.

The interests of the Council are directly implicated by this

case. Consistent with its view that participation by shareholders

in corporate decision making generally provides substantial

benefits, the Council believes that such participation is essential

to judicial assessment of the fairness of voluntary settlements in

shareholder derivative actions. The Council believes that the

decision below, if affirmed, would erect a substantial and

unnecessary barrier to full participation by objecting

shareholders in the review of proposed settlements in cases

where such participation is most needed.

SUMMARY OF ARGUMENT

Shareholder objectors who appear before district courts to

voice concerns regarding proposed settlements in shareholder

derivative actions under Federal Rule of Civil Procedure 23.1

(“Rule 23.1”) play an important role in policing the fairness of

such settlements and should not be required to intervene as

named plaintiffs to secure a right to appeal the rejection of their

objections. Rule 23.1, settled precedent, and substantial legal

commentary confirm that shareholder der. vative actions are

subject to unusual conflicts of interest that frequently undermine

confidence that a proposed voluntary compromise is in the best

interests of the corporation. The requirement of mandatory

“notice” to shareholders of a proposed settlement and their

subsequent participation in the settlement process provides an

important check against collusive or otherwise improper

settlements. Indeed, when objecting shareholders’ views have

been given studied consideration, they have resulted in

substantial modifications of settlement proposals that provided

tangible benefits to the corporation. All too often, however,

valid shareholder objections may be ignored or improperly

rejected by district courts that are denied a full adversarial

presentation by the named parties and operating under a strong

incentive to approve quick. settlements.

Under these circumstances, appellate review is an essential

component of effective shareholder participation. It provides a

direct avenue for correcting district court errors and a strong

incentive for district courts to consider shareholder objections

fully and fairly in the first instance. In contrast, denying or

discouraging appeals by objecting shareholders would insulate

erroneous decisions from review and would strengthen the

incentive of district courts to disregard shareholder objections.

A requirement of intervention under Federal Rule of Civil

Procedure 24 would produce precisely these untoward effects.

If such a requirement were imposed, some shareholder

objectors would be unable to intervene and would therefore be

shut off from appellate review. The remainder would be

saddled with substantial additional costs and burdens that create

no corresponding benefit to the litigation. Imposition of such

a@ requirement would thus limit participation by shareholder

objectors and thereby undermine the fairness of these

settlements.

ARGUMENT

I. OBJECTING SHAREHOLDERS PLAY A

VALUABLE ROLE IN ENSURING THE FAIRNESS

AND INTEGRITY OF SETTLEMENTS IN

SHAREHOLDER DERIVATIVE LITIGATION.

Rule 23.1 governs the conduct of derivative actions by

shareholders in federal courts and provides, in pertinent part:

The derivative action may not be maintained if it

appears that the plaintiff does not fairly and

adequately represent the interests of the shareholders

or members similarly situated in enforcing the right

of the corporation or association. The action shall

not be dismissed without the approval of the court,

and notice of the proposed dismissal or compromise

shall be given to shareholders or members in such

manner as the court directs.

Id. (emphasis added). As the language of Rule 23.1 confirms,

its drafters were aware that shareholder derivative actions are

susceptible to conflicting and divergent interests arising between

the named plaintiff (or plaintiff s counsel) and the corporation

(or similarly situated shareholders) on whose behalf the named

plaintiff purports to act. These concerns are amplified in the

context of voluntary settlements. When derivative claims are

compromised, the suing stockholder may face strong financial

incentives to “sell out” the interests of the corporation in return

for “payments from corporate assets” to plaintiff's counsel, who

often act as the controlling force in derivative litigation. Cohen

v. Beneficial Indus. Loan Corp., 337 U.S. 541, 548 (1949). To

police that potential for abuse, Rule 23.1 requires district court

approval of any such settlement and provides that notice of a

proposed compromise “shall” be provided to shareholders

before the district court considers the merits of the settlement

proposal. The notice requirement is designed to ensure that

settlements will not be approved without giving shareholders an

Opportunity to object. Such objections provide an important

corrective to the often considerable momentum behind

proposed derivative settlements and frequently result in

substantial enhancements to the fairness and value of such

settlements.

A. The Settlement of Shareholder Derivative

Actions Is Fraught With Pctential for Conflict

of Interest and Unfairness.

From the time of its earliest recognition in the United

States, both the relative merits and the potential abuses of

shareholder derivative litigation have been the subject of

discussion by courts, legislatures, and legal commentators. As

this Court explained nearly a half century ago, the shareholder

derivative suit arose at a time when “[cJorporate laws were lax

and were not self-enforcing, and stockholders, in face of gravest

abuses, were singularly impotent in obtaining redress of abuses

of trust.” Cohen, 337 U.S. at 547-48. Responding to this void

in legal remedies, “[e]quity came to the relief of the stockholder,

who had no standing to bring civil action at law against faithless

directors and managers,” id at 548, by allowing individual

shareholders “to bring suit to enforce a corporate cause of

action against officers, directors, and third parties,” Kamen v.

Kemper Fin. Servs., 500 U.S. 90, 95 (1991) (internal quotation

marks omitted). By placing litigation authority in the hands of

the individual shareholder, the derivative action became “the

chief regulator of corporate management and has afforded no

small incentive to avoid at least grosser forms of betrayal of

stockholders’ interests.” Cohen, 337 U.S. at 548.’

As the Cohen Court also noted, however, “the remedy

itself provided opportunity for abuse, which was not neglected.”

Id. Enabling individual shareholders to “represent” and act on

behalf of the corporation and other shareholders created the risk

that the interests of the named plaintiff shareholders would

diverge from the interests of the corporation and the other (de

facto party) shareholders. In some cases, the individual plaintiff

could “becomfe] faint hearted prior to the litigation’s

completion and would be willing to settle the action even

though it might not be in the best interests of all concerned.”

7C Charles Alan Wright et al, Federal Practice & Procedure

§ 1839, at 177 (1986) (citing Webster Eisenlohr, Inc. v.

Kalodner, 145 F.2d 316, 320 (3d Cir. 1944)).

In the worst cases, the shareholder plaintiff might enter into

“secret settlements in which any wrongs to the general body of

share owners were compounded by the suing stockholder, who

? See also 13 William Meade Fletcher, Cyclopedia Corporations § 5940, at

26 (1995) (“The derivative proceeding developed as an equitable device to

enable shareholders to enforce a corporate nght against faithless officers and

directors __ that the corporation had either failed or refused to assert on its

own”), Ralph C. Ferrara et al, Shareholder Derivative Liugation § 1.03, at 1-

14 (1995) (“Equity came to the relief of the stockholder, [and] . . . allowed him

to step into the corporation’s shoes and seek, on behalf of the corporation, the

restitution he could not demand on his own”), Bert S. Prunty, The

Shareholders’ Derivative Suit: Notes on Its Derivation, 32 N.Y.U. L. Rev

980, 980 (1957) (“The story of the derivative suit in its infancy and

adolescence 1s that of the lawmakers’ response to recogmized misuse of

economic organizations viewed against popularly accepted standards of

business conduct. The shareholders’ nght to command a judicial forum comes

in answer to a demonstration of need.”)

was mollified by payments from corporate assets.” Cohen, 337

U.S. at 548. As Judge Friendly explained:

accept a settlement that runs into high six figures or

more regardless of how strong the claims for much

larger amounts may be . . . . [A] juicy bird in the hand

is worth more than the vision of a much larger one in

the bush, attainable only after years of effort not

currently compensated and possibly a mirage.

Alleghany Corp. v. Kirby, 333 F.2d 327, 347 (2d Cir. 1964)

(Friendly, J., dissenting), aff'd en banc by an equally divided

court, 340 F.2d 311 (2d Cir. 1965). Given these dynamics,

special care is warranted in the conduct and oversight of

fellow shareholders. Burks v. Lasker, 441 U.S. 471, 485 n.16

(1979).

The potential for collusion, conflict of interest or agency

problems is especially acute in derivative litigation because of

the unusual degree to which plaintiff s counsel, rather than the

Greenfield v. Villager Indus., Inc., 483 F.2d 824, 832 n.8 (3d

Cir. 1973) (“[C]Jounsel for the class representative and not the

* See also 7C Charles Alan Wright et al, Federal Practice & Procedure

§ 1839, at 177 (1986) (“Special caution is warranted in the context of

derivative suits masmuch as plaintff is affecting a nght that belongs to the

corporation.”), 13 William Meade Fletcher, Cyclopedia Corporations § 6020,

at 303 (1995) (“The requirement of court approval is intended to protect the

interests of other shareholders . . . by prohibiting derivative plainuffs.._. from

settling with defendants for their own personal interests.”’).

named parties .. . direct and manage these actions”).‘ Indeed,

“fo}ne of the risks flowing from shareholders’ difficulty in

monitoring derivative litigation is that plaintiffs’ counsel and the

defendants will structure a settlement such that the plaintiffs’

attorneys’ fees are disproportionate to any relief obtained for

the corporation” and thereby “settle in a manner adverse to the

interests of the plaintiffs by exchanging a low settlement for

high fees.” Bell Atlantic Corp. v. Bolger, 2 F.3d 1304, 1310

(3d Cir. 1993). Moreover, in a derivative action, “both sides

have a right to be reimbursed their legal expenses when there is

a settlement, but not when there is an adverse judgment. These

rules obviously create strong pressure for settlement and explain

why even a plainly frivolous action may sometimes be settled.”

John C. Coffee, Jr., The Unfaithful Champion: The Plaintiff as

Monitor in Shareholder Litigation, 48 Law & Contemp. Probs.

5, 24 (1985).°

Commentators agree that such conflicts of interest create

the “risk that the representative plaintiff will collude with the

defendant to forgo the derivative claims in exchange for a

settlement that is only favorable to the representative plaintiff

* See Damel R. Fischel & Michael Bradley, The Role of Liability Rules and

the Derivative Suit in Corporate Law, 71 Cornell L. Rev. 261, 271 & n.26

(1986) (noting that the “real party in interest is the attorney”), cf Deborah L.

Rhode, Class Conflicts in Class Actions, 34 Stan. L. Rev. 1183, 1203 (1982)

(“{A]s a practical matter, once a class is certified, named plaintiffs generally

are neither highly motivated nor well situated to monitor the congruence

between counsel's conduct and class preferences.”).

* See also Saylor v. Lindsley, 456 F.2d 896, 900 (2d Cir. 1972) (notng fact

that “{a) relatively small settlement may well produce an allowance bearing a

tugher ratio to the cost of the work than a much larger recovery obtained only

after extensive discovery, a long tnal and an appeal,” thereby creating the

danger that a plaintiffs’ attorney will settle a derivative claim for less than its

expected value in return for this proportionately higher fee “allowance”)

and his or her attorneys.” 5 Moore's Federal Practice

§ 23.1.10[2}{a], at 23.1-58 (1998); see also 7C Charles Alan

Wright et al., Federal Practice & Procedure § 1839, at 191

(“[{T]he Court should be on the lookout for signs of bad faith or

collusion among the parties to the proposed settlement.”). As

one commentator described the problem:

[E}ffective control is almost entirely in the hands of

the attorney. The most obvious examples of attorney

suits, in which the named plaintiff figures only in a

boli hoon eatin tiltintheenin at

brought by entrepreneurial lawyers in hopes of

obtaining an award of attorney’s fees. The attorney

including the decision whether to settle.

Geoffrey P. Miller, Some Agency Problems in Settlement, 16 J

Legal Stud 189, 213-14 (1987); see also Ralph K. Winter,

Paying Lawyers, Empowering Prosecutors, and Protecting

Managers: Raising the Cost of Capital in America, 42 Duke

L.J. 945, 948 (1993) (“[P]laintiffs [in derivative and class

actions] are generally figureheads __ because the real incentive

for bringing such actions is the quest for attorney’s fees.”).

Assumption of control over the litigation by plaintiffs’

attorneys creates an additional risk in the context of settlement

of a shareholder derivative suit because “[t]here can be no

blinking at the fact that the interests of the plaintiff in a

stockholder’s derivative suit and of his attorney are by no means

congruent.” Saylor v. Lindsley, 456 F.3d 896, 900 (2d Cir

1972). The risks faced by plaintiff and his attorney in

proceeding to trial vary substantially because “[flor the plaintiff,

a defendant’s judgment may mean simply the defeat of an

expectation, often of relatively small amount, for his lawyer it

can mean the loss of years of costly effort by himself and his

staff” Jd. at 900-01. Commentators and scholars uniformly

acknowledge this substantial danger of conflicting interests

between shareholder plaintiffs and their counsel in the

settlement context.

The danger that a proposed settlement will not be in the

best interests of the corporation, or even of the named plaintiffs,

is further threatened because, as federal legislators have

recognized, such cases increasingly are dominated by a small

cartel of law firms that recruit “[p]rofessional plaintiffs who

own a nominal number of shares in a wide array of public

companies” and have no real interest in monitoring their

Reform Act of 1995, H.R. 104-98, at 32, reprinted in 1995

US.C.C._AN. 679, 731; see also Jn re Urcarco Sec. Litig., 148

F.RD. 561, 563 (N_D. Tex. 1993) (noting that plaintiffs “have

among their ranks one of the unluckiest and most victimized

investors in the history of the securities business”), Deborah A.

Demott, Shareholder Derivative Actions § \ 05, at 1-13 (“A

striking feature of derivative litigation in the post-Depression

era is the frequency with which the same plaintiffs make their

appearance.”’).

For these reasons, the settlement of shareholder derivative

actions must be closely monitored to ensure that the terms of

* See Deborah A. Demott, Shareholder Derivative Actions § 7.05, at 7-27

(1994) (“The potential divergence in interests between the plaintiff and the

plaintiff’ s attorney is most likely to matenalize in the setiiement context ”),

John C. Coffee, Jr, Understanding The Plaintiff's Auorney: The Implications

of Economic Theory for Private Enforcement of Law Through Class and

Derivative Actions, 86 Colum. L. Rev. 669, 677-78 (1986) (arguing that the

chent in a denvative suit “generally has only a nomunal stake in the outcome

of litigation” and cannot closely monitor and control his attorney's conduct)

the proposed settlements are fair and meaningful, and not the

product of improper collusion or conflicts of interests.

B. Objecting Shareholders Are Essential to

Ensuring Fairness in Derivative Settlements.

Rule 23.1 provides two institutional safeguards designed to

protect shareholders’ interests from the acute potential for

abuse inherent in derivative settlements (1) district court

approval of settlements, and (2) the opportunity for

shareholders to raise objections to the proposed settlement ’

Although the requirement of district court approval stands as a

bulwark against improper settlement of derivative actions, Rule

23.1 recognizes that the district court’s judgment should be

informed by the views of shareholders who have a concrete

stake in the resolution of the derivative action. As this Court

has recognized, the dual requirements of district court approval

and notice to shareholders are “intended to prevent plaintiffs

from selling out their fellow shareholders,” Burks, 441 US. at

485 n.16, and to prevent circumstances “where the action

would disserve the legitimate interests of the company or its

shareholders,” Daily Income Fund, Inc. v. Fox, 464 U.S. 523,

532 n.7 (1984).

Thus, under Rule 23.1, the district court has a duty to

dc «mine whether the proposed compromise reasonably

protects the interests of the corporation and its shareholders.

See, e.g., Girsh v. Jepson, $21 F.2d 153, 157 (3d Cir. 1975)

(holding that the district court has a responsibility to assess the

interests of the corporation when reviewing a proposed

” See Fed. R. Civ P. 23.1 (“The action shall not be dismissed without the

approval of the court, and notice cf the proposed dismissal or compromise

shall be given to shareholders or members in such manner as the court

lirects.”)

compromise). There are institutional reasons, however, why a

district court may be poorly situated to fulfill this duty on its

own.

First, the parties to the proposed settlement are unlikely to

present “an unbiased portrayal of the merits of the derivative

claims.” Jn re Oracle Sec. Litig., 829 F. Supp. 1176, 1185

(N.D. Cal. 1993). Indeed, “[t}he effort to obtain court approval

entails the suspension, if not the termination, of hostilities’

thereby depriving the district court of “the full benefit of the

adversarial process.” Bolger, 2 F.3d at 1310. The

“presentation of plaintiffs’ counsel [may be] biased because the

settlement offers them a substantial fee, regardless of the benefit

conferred on the corporation and its shareholders,” while the

“presentation on behalf of the [defendants may be] similarly

biased in favor of settlement, because the settlement absolves

them of liability without requiring them to part with any return

consideration.” Oracle, 829 F. Supp. at 1185. As a result,

rather than providing to the district court a full and fair airing of

issues occasioned by the settlement, “plaintiffs’ attorneys’ and

defendants’ interests coalesce and mutual interest may result in

mutual indulgence” whereby the parties “spotlight the

proposal’s strengths and slight its defects.” Bolger, 2 F.3d at

1310.

Second, in considering a settlement proposal, a district

court may have relatively limited knowledge of the underlying

* “Once a settlement is agreed, the attorneys for the plaintiff stockholders link

arms with their former adversaries to defend their joint handiwork.”

Alleghany Corp., 333 F 2d at 346-48 (Friendly, J., dissenting), see a/so Elhot

J. Weiss & John S. Beckerman, Let the Money Do the Monitoring: How

Institutional Investors Can Reduce Agency Costs in Securities Class Actions,

104 Yale L.J. 2053, 2066 (1995) (arguing that district court “settlement

hearings typically are not adversanal in character”).

action, derived solely from the pleadings and the few briefs that

may have been filed prior to settlement discussions. This lack

of information makes it difficult for the district court to assess

whether the proposed settlement is in the best interests of the

corporation. Accordingly, settled precedent prohibits a district

court from approving a settlement based “solely on the advice

of the attorneys before it.” 7C Charles Alan Wright ef ai.,

Federal Practice & Procedure § 1839, at 186; see also

Greenspun v. Bogan, 492 F.2d 375, 378 (1st Cir. 1974) (“It is

well established that a court should not merely rubber stamp

whatever settlement is proposed by the parties to a shareholder

derivative action.”); Cohen v. Young, 127 F.2d 721, 725 (6th

Cir. 1942) (“The rule provides for notice to shareholders __. in

order that the court may have the benefit of that broader

information.”’).

Third, there is a strong institutional bias in favor of

settlement. Many courts proceed “from the familiar axiom that

a bad settlement is almost always better than a good trial,” and

therefore may pay inadequate attention to shareholder

objectors. /n re Warner Communications Sec. Litig., 618 F.

Supp. 735, 740 (S.D.N.Y. 1985), aff'd, 798 F.2d 25 (2d Cir.

1986). Because “judges generally feel pressured to move their

dockets,” they have an interest in approving settlements that is

at odds with their duty to carefully consider objections and

closely scrutinize the fairness of a settlement. Elliot J. Weiss &

John S. Beckerman, Let the Money Do the Monitoring: How

Institutional Investors Can Reduce Agency Costs in Securities

Class Actions, 104 Yale LJ. 2053, 2067 (1995); see Girsh, 521

F.2d at 157 (reversing district court where objector denied the

ability to develop and present her objections to the settlement

proposal). Empirical studies reflect that the median lengths of

fairness hearings in the two districts for which data were

available were, respectively, 38 and 40 minutes. John C

Coffee, Jr., Class Wars: The Dilemma of the Mass Tort Class

Action, 95 Colum. L. Rev. 1343, 1348 & n.14 (1995) (arguing

that empirical evidence suggests that “courts have little ability

or incentive to resist [proposed] settlements”). The typical

brevity of these hearings “seems inconsistent with careful

judicial scrutiny of the settlement’s fairness,” id. at 1348 n.14,

or of the often complex issues raised by objections.

The choices and incentives faced by the district court are

straightforward:

Judges’ calendars are crowded with cases, and despite

various reform efforts, the workload only seems to

increase. If the judge approves the settlement, the

result will be to remove a potentially complex and

time-consuming case from the judge’s calendar; if she

rejects it she faces a substantial probability of further

litigation.

Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs’

Attorney's Role in Class Action & Derivative Litigation:

Economic Analysis and Recommendations for Reform, 58 U.

Chi. L. Rev. 1, 45-46 (1991). As a result, for some district

courts, “settlement hearings are typically pep rallies jointly

orchestrated by plaintiffs’ counsel and defense counsel” where

the district courts “engage in paeans of praise for counsel or

lambaste anyone rash enough to object to the settlement.” /d.

at 46-47.

These problems explain why shareholder objectors “play an

important role by giving courts access to information on the

settlement’s merits,” and help to compensate for the

institutional weaknesses that can blind the district court to an

unfair settlement. Bolger, 2 F.3d at 1310; see also Deborah A.

Demott, Shareholder Derivative Actions § 7:01, at 7-4

(“{O]bjectors to the settlement . . . may call the court’s attention

to deficiencies that are not likely to be highlighted by the

settlement’s proponents.”); cf Federal Judicial Center,

Empirical Study of Class Actions in Four Federal District

Courts: Final Revort to the Advisory Committee on Civil Rules

58 (1996) (“Objections represent an outside source of

information about the substance of the settlement and its impact

on class members. The settling parties at this stage have little

Or no incentive to present negative information about the

settlement, so objections from class members and others may be

a crucial source of information about defects in the

settlement.”). Indeed, even where there is little or no response

by shareholder objectors, that inaction itself provides the court

with additional information regarding the settlement’s fairness.

See Jn re Chambers Dev. Sec. Litig., 912 F. Supp. 822, 841

(W.D. Pa. 1995) (“The mild response of the class is a factor in

favor of settlement on the terms proposed.”).°

Thus, it is not surprising that the efforts of non-party

shareholder objectors in a wide variety of cases have resulted

“in significant improvement of the settlement.” William L. Cary

& Melvin A. Eisenberg, Corporations 1057 (1988). For

example, in /n re Pacific Enters. Sec. Litig., 47 F.3d 373 (9th

Cir. 1995), shareholders joined an objection to a proposed

settlement with the result that the district court “ultimately

lowered the attorneys’ fee award fram $8 million to $4 million.”

Id. at 375, 377. Similarly, in Alleghany Corp., 333 F.2d at 331-

32, an objecting shareholder brought critical information and

arguments to the district court’s attention, resulting in an

increase of the settlement amount from $1 million to $3 million.

And, in Rosenbaum v. MacAllister, 64 F.3d 1439 (10th Cir.

* Accord Bolger, 2 F.3d at 1313-14; Zimmerman v. Bell, 800 F.2d 386, 391

(4th Cir. 1986), Deborah A. Demott, Shareholder Derivative Actions § 7.02,

at 7-7; Ralph C. Ferrara et al., Shareholder Derivative Litigation § 14.05{2],

at 14-23.

1995), a shareholder objector was successful in obtaining the

reversal of an attorneys’ fee award “equal to more than $900

per hour for every attorney, paralegal, and law clerk who

worked on the case.” /d at 1447-48. These and other

representative cases reflect that shareholder objectors make

tangible and important contributions to the fairness of derivative

settlements when their views are given proper consideration by

the district court."°

Il. REQUIRING SHAREHOLDER OBJECTORS TO

INTERVENE TO OBTAIN APPELLATE REVIEW

WOULD HINDER EFFECTIVE MONITORING OF

DERIVATIVE SUIT SETTLEMENTS.

Appellate participation by shareholder objectors is critical

to ensuring that derivative settlements are in the best interests

of the corporation. Appellate review provides an avenue for

correcting errors and creates a powerful incentive for district

courts to ensure that shareholder objections are given full and

fair consideration during the settlement process. By contrast,

a broad ruling that shareholder objectors must intervene to

secure the night to appeal a derivative settlement would erect an

unnecessary and costly barrier to shareholder participation and

undermine the fairness and integrity of derivative settlements

without providing any offsetting benefit. -

'© See also Bolger, 2 F.3d at 1310 (noting case where “objectors’ ardent(]

resistance to the settlement persuaded [the] court to look more closely at the

proposal than would normally be the case” and caused the court to reject the

proposal) (internal quotat-on marks omitted; alteration in onginal), Seiga/ v

Merrick, 619 F.2d 160, 162-63 (2d Cir. 1980) (highlighting role of objectors

in modifying settlement by providing information regarding proper valuation

method)

A. Appellate Review of Shareholders’ Objections

Is Essential to the Effective Monitoring of

Derivative Suit Settlements.

The right to appeal an adverse judgment stands as “a

fundamental element of procedural fairness as generally

understood in this country.” ABA Comm. on Standards of

Judicial Admin., Standards Reiating to Appellate Courts § 3.10

comment. at 18 (1994). Thus, although the right to an appeal

is not mandated by the Constitution, “[i]t is almost axiomatic

that every losing litigant in a one-judge court ought to have a

right of appeal to a multijudge court.” See Robert Leflar,

Internal Operating Procedures of Appellate Courts 4 (1976)

(Leflar, Appellate Courts). The principal function of

intermediate appellate courts is the development of the law

through the correction of error. See id. at 3 (“[T]he task of the

appellate court is to determine if prejudicial errors were

committed at the trial level and to correct them.”). Indeed, the

general rate of reversible error by district courts is significant,

and, according to the most recent statistics, the federal courts

of appeals remand or reverse in approximately 15% of non-

prisoner, private civil appeals. See Administrative Office of the

United States Courts, Judicial Business of the United States

Courts 100-03, Table B-5 (1997)."'

Apart from reversal, the possibility of appellate review itself

provides a powerful incentive for the district court to render

more careful findings of fact and to develop a better record,

producing more accurate results in the district court ex ante.

See Steven Shavell, Zhe Appeals Process as a Means of Error

Correction, 24 J. Legal Stud. 379, 408-11, 425-26 (1995)

'* See also Jon O. Newman, A Study of Appellate Reversals, 58 Brook. L

Rev. 629, 633 (1992) (reporting rate of 27% in civil cases in the Second

Circuit)

(demonstrating that the appeals process “induc[es] trial court

judges to make fewer errors because of their fear of reversal”).

Thus, direct review not only permits appellate courts to correct

errors that have already occurred, it helps to prevent future

errors from occurring, and thereby ensures uniform and proper

application of the law. See Leflar, Appellate Courts, at 4

(“[G]rowth and development in the law cannot be achieved if

some courts move ahead while others hold back.”’).

The important functions of appellate review apply with

special force in the context of settlement of shareholder

derivative actions. As described in Part I, shareholder

derivative suits are fraught with the potential for collusion and

conflicts of interest. Once a proposed settlement has been

reached, the district court no longer has the benefit of an

adversarial presentation by the parties regarding the benefits and

burdens of the settlement proposal. And, laboring under an

ever-expanding caseload, the district court may have a natural

incentive to favor quick approval of a settlement that will

remove a complex case from its docket at the expense of full

and careful consideration of objections. These factors work

together to enhance the risk of error by the district court in

fairness hearings and to reduce the likely influence of

shareholder objectors at the district court level. In light of these

systemic obstacles to accurate assessment of proposed

_ settlements, appellate review is critical to ensuring the fairness

of shareholder derivative settlements.

For instance, in /n re Pittsburgh & Lake Erie R.R. Co. Sec.

& Antitrust Litig., 543 F.2d 1058 (3d Cir. 1976), plaintiff

stockholders sued on behalf of a company charging that a third

party (which owned 93% of the stock) had raided the

company’s assets. /d. at 1061. Prior to trial, the parties

reached a settlement providing that the company would pay

$2.1 million into a settlement fund, which would have gone to

plaintiffs and their lawyers. /d Irving Trust Company, an

objector who was a pledgee of 22.5% of the company’s stock,

complained that the settlement was unfair because it would

transfer value from the company to the plaintiffs and their

attorneys. /d. at 1063. The district court rejected the objections

and approved the settlement. Jd. The Second Circuit reversed,

holding that Irving Trust’s objections should have been

sustained because the settlement provided the COmpany with, at

best, “a minimal if non-existent benefit,” in exchange for its

substantial $2.1 million payment. /d. at 1070."

The availability of appeal also causes trial courts to

consider the objections of shareholders more carefully in the

first instance. For example, in Girsh v. Jepson, 521 F.2d 153

(3d Cir. 1975), the Third Circuit reviewed a trial court’s

dismissal of objections interposed by a shareholder to a

proposed compromise of a class and derivative action. /d at

157. At the district court ievel, the shareholder informed the

district court of her “intention to object” and asked for an

extension of time “to file papers in support of her objections.”

Id. at 156. The district court dismissed her objections and

approved the settlement agreement. /d The Third Circuit

reversed, holding that the “district court did not live up to its

fiduciary responsibilities” because it denied the objecting

shareholder “meaningful participation” in the hearing. /d. at

158. The Girsh Court also set forth the proper procedures

district courts should follow when reviewing a proposed

settlement. /d. at 156-57.

" See also Rosenbaum, 64 F 3d at 1447 (reversing award of attorneys’ fees

based on arguments of non-intervening shareholder objector), /n re General

Motors Corp. Pick-Up Truck Fuel Tank Prods. Liab. Litig., 55 F 3d 768,

809-10, 812-13 (3d Cir. 1995) (reversing class action settlement where the

court was too dismissive of the objectors and too willing to accept the parties’

optumistic valuation of the settlement)

Since Girsh, other district courts have followed the factors

outlined in that case (including the requirement to consider the

reaction of shareholders) to guide their assessment of proposed

shareholder derivative settlements. See, e.g., Jn re Chambers

Dev. Litig., 912 F. Supp. at 836 (stating that the factors

enunciated in Girsh are the “Rand-McNally” of “settlement

review”). Other circuit courts have adopted similar standards

through appellate decisions that guide and bind their lower

courts and ensure careful consideration of and a “reasoned

response” to shareholder objections. /n re Pacific Enters. Sec.

Litig., 47 F.3d at 377 (stating that “conclusory” rejection of an

objection is inadequate because the district court must

“explain{] why the derivative settlement is fair”). It is only

through regular appellate review of derivative settlements that

such beneficial rules can be articulated and refined, and

compliance with them enforced.’

Thus, appellate review of derivative settlements serves to

correct errors that have occurred and to guide the actions of

trial courts and thereby reduce the chances that errors will occur

in the first place.

" See also Ficalora v. Lockheed Cal. Co., 751 F.2d 995, 997 (9th Cir. 1985)

(remanding for “reasoned judgment” that the settlement “1s not the product of

fraud or overreaching by, or collusion among, the negotiating partes”), City

of Detroit v. Grinnell Corp., 495 F.2d 448, 463 (2d Cir. 1974) (settung forth

factors relevant to the review of a proposed settlement), cf Malchman v

Davis, 706 F.2d 426, 432, 434 (2d Cir 1983) (reversing approval of

settlement because distnct court failed to consider objections fully), /n re

General Motors Corp. Engine Interchange Litig., 594 F.2d 1106, 1131 (7th

Cur. 1979) (“[W]e hold that the trial court abused its discretion by failing to

undertake a careful examination of the conduct of the settlement negotations

and by preven_ng the plaintuff-objectors from showing that the negotiations

prejudiced the best interests of the class.”)

B. Requiring Intervention to Secure the Right to

Appeal Would Cut Off Appellate Review of

Some Derivative Settlements and Erect Unfair

and Unnecessary Barriers to Effective Policing

of Others.

Requiring objecting shareholders to intervene formally to

secure the nght to appeal the rejection of their objections to a

by some objectors and increase the costs for others. Moreover,

while increasing the costs of objecting to derivative suit

settlements, the added burden of intervention would produce no

corresponding benefit to the litigation.

1. An Intervention Requirement Would

Unduly Limit and Increase the Costs of

Appeals by Shareholder Objectors.

In the decision below, the Seventh Circuit acknowledged

that monitoring by shareholder investors “is often useful” and

that objectors’ participation on appeal may “be justified.” Pet

Cert. 6a. However, the court of appeals concluded that such

shareholder objectors “must intervene as parties in order to

appeal from adverse decisions.” /d at 2a. That view should be

rejected.

As an initial matter, requiring intervention would prevent

an entire category of objections from being considered on

appeal because some shareholder objectors could not, as a

matter of law, intervene in the action Specifically, the

“contemporaneous ownership” rule requires the representative

plaintiff in a shareholder derivative action to have been “a

shareholder __ . at the time of the transaction of which the

plaintiff complains.” Fed R. Civ. P. 23.1; see also Rosenbaum

v. MacAllister, 64 F 3d 1439, 1443 n.2 (10th Cir 1995). To

object to a proposed compromise, however, a person “need

only own stock in the corporation at the time of the settlement

hearing, and appear at the settlement hearing to raise his or her

objections.” Jd; see also Ralph C. Ferrara et al., Shareholder

Derivative Litigation § 14.04, at 14-10 (noting that “the ALI’s

Principles of Corporate Governance and other courts have

suggested that all shareholders of record at the time of the

settlement hearing have standing to object”). As a result, the

entire category of objectors who obtained their stock after the

transaction at issue in the case — shareholder objectors who

have every bit as concrete and material an interest in the district

court’s resolution of the proposed settlement as shareholders

who satisfy the contemporaneous ownership requirement —

would “be held ineligible for intervenor status” and therefore

could not raise any objections on appeal. Rosenbaum, 64 F 3d

at 1443 n.2; see Saylor v. Bastedo, 78 F R.D. 150, 152-53

(S.D.N_Y. 1978).

In addition, another class of objectors would be unable to

intervene because their intervention would destroy diversity

jurisdiction over their claims. See Strawbridge v. Curtis, 7 U.S.

__(3 Cranch) 267, 267 (1806) (requiring complete diversity).

Federal law limits the ability of such non-diverse shareholder

objectors to intervene in these cases. See 28 U.S.C. § 1367(b)

(barring jurisdiction over non-diverse intervenors). As the

Seventh Circuit recently noted, the plain language of § 1367(b)

requires that “[p)laintiffs . . . intervening under Fed. R. Civ. P

24 must satisfy the requirements of [complete diversity].”

Stromberg Metal Works v. Comfort Control, Inc., 77 F.3d 928,

932 (7th Cir. 1996) (Easterbrook, J), see also 7urner/Ozanne

v. Hyman/Power, 111 F.3d 1312, 1319 (7th Cir. 1997)

(“Section 1367 precludes intervention by parties seeking to

‘intervene as plaintiffs under Rule 24 . . . when exercising

supplemental jurisdiction over such claims would [destroy

complete diversity].”).

Moreover, even for shareholders who are diverse and have

standing under Rule 23.1 to intervene as plaintiffs, the right to

intervene would not be assured. In contrast to the mandatory

requirements in Rule 23.1, which guarantee a shareholder

objector the right to receive notice and to participate at the

district court level, there is no comparable guarantee that a

shareholder objector who first learns of a suit through notice of

a proposed (and impending) settlement will be entitled to

become a formal party. Indeed, a district court’s grant of

intervention would be predicated on its determination that the

intervening parties’ interests were not adequately protected,

Fed. R. Civ. P. 24(a), a determination inconsistent with the

requirement that the shareholder plaintiffs “adequately represent

the interests of the shareholders” from the outset. Fed. R. Civ.

P. 23.1; see also 7C Charles Alan Wright ef al, Federal

Practice & Procedure § 1909, at 313. Further, Rule 24’s

requirement of a “timely application” prejudices would-be

intervenors to a derivative suit, since Rule 23.1 requires notice

only upon a settlement, which is so late in the litigation process

that intervention is disfavored. See, e.g., Ragsdale v. Turnock,

941 F.2d 501, 504 (7th Cir. 1991) (“Once parties have invested

time and effort into settling a case it would be prejudicial to

allow intervention.”). Thus, it is not surprising that motions to

intervene often are denied in shareholder derivative cases. See

generally W.J. Dunn, /ntervention by Other Stockholders in

Stockholder's Derivative Action, 69 A.L.R.2d 562, at § 2a

(1960).

Finally, the costs of intervention are substantial. To

intervene, a motion and supporting papers must be prepared.

See Fed. R. Civ. P. 24(c). Upon intervention, an objector must

file a pleading based upon reasonable investigation stating the

claims or defenses that he will advance, see id, and provide

initial discovery disclosures pursuant to Federal Rule of Civil

Procedure 26(a)(1). Thereafter, the intervenor is subject to

broad discovery from both plaintiff and defendants. See Fed. R.

Civ. P. 26(b). In particular, intervenors may be required to

produce detailed information relating to their ability to represent

the corporation adequately.

Given the risk of collusion and conflict of interest in

shareholder derivative suits, these costs are likely to be greatest

in those cases where the right to appeal is most important.'*

Because shareholder objectors pose a threat to potentially unfair

and collusive settlements, the parties to these suits have a strong

incentive to obstruct any vigorous objection to the settlement at

both the district court and appellate levels.

Indeed, the additional costs associated with intervention

stand in marked contrast to the efficient procedures expressly

mandated by Rule 23.1, which permit shareholders to air their

objections in court without assuming the burdens associated

with formal intervention. See Fed. R. Civ. P. 23.1. The

drafters of Rule 23.1 plainly intended to entitle shareholders to

present their concerns regarding a proposed settlement to the

district court, free from strategic behavior or sharp litigation

tactics designed to increase the cost of objection. It was

precisely to avoid the risks associated with imposing additional

obstacles to challenging proposed derivative settlements that the

Third Circuit ruled that intervention was not required to ensure

appellate rights on appeal. See Bolger, 2 F.3d at 1310.

‘* Even small increases in costs imposed on the monitoring function will have

a substanual effect on the incentive and ability of shareholders to restrain

unfair settlements. Plaintiffs and their attorneys typically have a large stake in

the settlement and can afford to litigate aggressively. By contrast, because of

collective acuon problems endemuc to derivative suits, Bolger, 2 F.3d at 1310,

objectors act to protect only their own individual interests. Therefore, it takes

only a marginal increase in lugating costs to dissuade potential objectors from

participating. Cf id. at 1309 (“[T}he costs of policing typically outweigh any

pro rata benefits to the shareholder ”’)

Evidence from a related context confirms the operation of

the incentives described above. Responding to similar abuses

inherent in securities class actions, Congress passed the Private

Securities Litigation Reform Act of 1995, Pub. L. No. 104-67,

109 Stat. 737 (1995), which had as one of its purposes the goal

of increasing the role of institutional investors as lead plaintiffs

in class actions. See H. Conf. Rep. No. 369, 104th Cong, Ist

Sess. 34 (1995), reprinted in 1995 U.S.C.C_AN. 730, 733

(“Institutional investors and other class members with large

amounts at stake will represent the interests of the plaintiff class

more effectively than class members with small amounts at

stake.”). Faced with the threat of institutional investor

participation, the plaintiffs’ bar responded by attempting to

drive up the litigation costs for institutional investors. As a

result of these efforts, “[i}nstitutional investors are only rarely

stepping forward to become lead plaintiffs. They are often

vigorously attacked by traditional plaintiffs’ counsel when they

do.” Joseph A. Grundfest & Michael A. Perino, Joint Written

Testimony Before the Subcommittee on Securities of the Senate

Committee on Banking, Housing, and Urban Affairs (July 24,

1997), see also Gluck v. Cellstar Corp., 976 F. Supp. 542, 547-

48 (N.D. Tex. 1997) (detailing one such struggle).

As a final note, even if respondents were correct in their

suggestion that intervention would be “unhesitatingly granted”

for the limited purpose of appeal, Resp. Opp. to Cert. 16, that

fact would counsel against imposing an additional intervention

requirement. Put simply, if every objecting shareholder were

permitted to intervene to secure the right to advance his

objections on appeal, then the intervention process would be an

empty formality that imposes additional costs but provides no

benefits to the district court or court of appeals.

2. An Intervention Requirement Would

Provide No Corresponding Benefit.

The substantial costs of intervention would create an

additional barrier to effective shareholder policing of derivative

settlements without any corresponding benefit, either to the

efficiency or to the fairness of the litigation process.

First, an intervention requirement would add nothing to the

character or substance of the appeals brought by objecting

shareholders. As owners of the corporation, shareholder

objectors suffer a concrete injury when an unfair settlement

diminishes the value of their investment; indeed, Rule 23.1

expressly solicits the views of these shareholders as a means of

policing the potential abuses endemic to shareholder derivative

litigation. The challengés they raise on appeal would be the

same challenges raised and rejected by the district court. See

Bolger, 2 F.3d at 1310 (holding that participation as an objector

before the trial court is sufficient to permit “the same objections

he now raises... . on appeal”). There is simply no basis for

concluding that shareholder objectors, who are recognized as

adding value to the analysis of a settlement proposal at the

district court level, are not equally well-positioned to provide

guidance and insight at the appellate level.

Second, historical experience makes clear that the

imposition of an intervention requirement will provide little or

no benefit to appellate courts. For many years, numerous state

courts and federal circuit courts have routinely allowed

shareholder objectors to appeal adverse rulings without any

intervention requirement. See, e.g., Rosenbaum v. MacAlister,

64 F.3d 1439, 1443 (10th Cir. 1995); Bolger, 2 F.3d at 1307-

10; Jn re General Tire & Rubber Co. Sec. Litig., 726 F.2d

1075, 1087 (6th Cir. 1984) (affirming denial of intervention but

addressing shareholder’s objections on appeal), /n re Pittsburgh

& Lake Erie R.R. Co. Sec. & Antitrust Litig., 543 F.2d 1058,

1064 (3d Cir. 1976) (holding that objector has standing to

appeal); 7ryforos v. Icarian Dev. Co., 518 F.2d 1258, 1263

n.22 (7th Cir. 1975) (Stevens, J.) (stating that the “law is clear”

that non-party objectors may appeal); Braun v. Fleming-Hall

Tobacco Co., 92 A.2d 302, 308 (Del. Ch. 1952) (reviewing

appeal of non-intervening objector). There is no evidence in

_ these jurisdictions of a proliferation of meritless appeals or

“unwieldy” appellate litigation of settlement objections. Indeed,

requiring intervention would create an extra layer of largely

wasteful appeals from the denial of intervention.

Third, cases from other contexts have acknowledged the

appellate rights of non-parties whose interests have been

concretely and adversely affected by the decision of the district

court. There is a long pedigree of cases that “clearly establish

that nonparties can achieve standing to appeal.” 15A Charles

Alan Wright et al., Federal Practice & Procedure § 3902.1 at

132; see also Timothy A. Duffy, Comment, 7he Appealability

of Class Action Settlements by Unnamed Parties, 60 U. Chi. L.

Rev. 933, 940-41 (1993) (describing deep-rooted common-law

origins of right of unnamed class members to appeal). The

readiest example is that of an appellant, not a party, who has

nevertheless been enjoined, held in contempt, or otherwise

directly affected by an order of the district court. See, e.g.,

United States Catholic Conference vy. Abortion Rights

Mobilization, Inc., 487 U.S. 72, 76 (1988) (“The right of a

nonparty to appeal an adjudication of contempt cannot be

questioned.”); 7hompson v. Freeman, 648 F.2d 1144, 1447 n.5

(8th Cir. 1981) (holding that non-party may bring “appeal to

contest the district court’s jurisdiction to bind it to the terms of

the court’s injunction”). Similarly, when a party is denied

statutory attorney fees by the district court, that party’s attorney

has standing to appeal. See, e.g., Lipscomb v. Wise, 643 F.2d

319, 320 (Sth Cir. 1981); Dietrich Corp. v. King Resources

Co., 596 F.2d 422, 424 (10th Cir. 1979). In Dietrich, the court

noted that intervention wes irrelevant to appellate rights; the

controlling factor was that denying the attorney the right to

appeal would render the district court’s determination

unreviewable. See id In Lipscomb, the fees were sought

pursuant to 42 U.S.C. § 1973/(e), and the court of appeals

concluded that if the statutory provision of fees were to have

any meaning, the non-party whose interest was implicated must

be able to seek appellate review. Lipscomb, 643 F.2d at 320-

21.

The same is true here: If objecting non-party shareholders

are not entitled to appeal after their objections lodged under

Rule 23.1 have been rejected, then the concrete and important

interests they represent will never receive an appellate hearing.

The consequence of such a requirement would be more

collusive and unfair derivative settlements. As Congress and the

drafters of the Federal Rules of Civil Procedure were plainly of

the view that objecting shareholders could make valuable

contributions to district court review of such settlements, there

is no sound reason in law or policy to bar or discourage them

from playing a similar role on appeal.

CONCLUSION

The judgment of the court of appeals should be reversed.

Respectfully submitted,