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A class action is a form of lawsuit in which a large group of people collectively bring a claim to court or in which a class of defendants is sued. Class action lawsuits offer a number of advantages because they aggregate a large number of individualized claims into one representational lawsuit.

As the Securities & Exchange Commission former enforcement chief, William R. McLucas, once said, private securities law claims, (referring to the class action bar), are the “bull work of enforcement” of the federal securities laws.

But for class actions, and class wide claims, many violations of the federal securities laws would go unpunished. The problem is that small recoveries do not provide the incentive for any individual to bring a individual action to prosecute their rights but a class action solves this problem by aggregating the relatively paltry potential recoveries into something worth someone’s (usually an attorney’s) labor.1

For example, thousands of shareholders of a public company may have losses too small to justify separate lawsuits, but a class action can be brought efficiently on behalf of all shareholders.

The Tension Between Individual and Class Action Claims

Recently, however, a tension has developed between class action claims and individual claims on behalf of individual investors.

For example, between 2005 and 2009, Medical Capital Holdings, Inc. raised $2.2 billion through six rounds of deals from investors. Dozens of independent broker-dealers sold the notes. Medical Capital in substantial part was a ponzi scheme, and certain of the proceeds from investors were used to make movies (with Cheech Marin), host expensive parties and purchase a 118 foot yacht.

In 2009, the Securities and Exchange Commission charged Medical Capital Holdings Inc. and its founders last summer with securities fraud.

Since that time, there have been numerous class action lawsuits filed against the company and its directors, but there has been several hundreds of claims filed by individual investors against approximately 40 different brokerage firms among other things, the failure to conduct due diligence with respect to the recommendation to purchase Medical Capital notes. In a 2005, as one executive admitted in an e-mail, Medical Capital, which had issued $1.7 billion of securities, lacked audited results.

A group of Securities America investors filed the class action in U.S. District Court for the Northern District of Texas in 2009. Securities America is owned by Ameriprise Financial Services, which reported a profit of $1.1 billion in 2010 on revenue of nearly $10 billion.

However, on February 18, 2011, Judge W. Royal Furgeson Jr., of the United States District Court for the Northern District of Texas, issued a temporary injunction halting FINRA securities arbitration claims pending against Securities America in connection with the sale of Provident Royalties LLC and Medical Capital Holdings Inc., and instead of being able to sue the brokerage firms and their agents in FINRA arbitration for fraud, failure to conduct due diligence, and the violation of the federal securities laws, these investors would be required to remain in the class action, where they, at least according to the latest calculations would receive less than 10% of their losses or approximately ten cents on the dollar.

The Tensions Are Not New

The tension between class actions and the claims of individual investors is not new.

In 2007, we represented an individual investor, an early retiree from Detroit, who received a lump sum retirement benefit, and based upon misrepresentations made by her Ameriprise stockbroker, including the amount of income that these funds would otherwise safely generate, invested in a series of proprietary and otherwise aggressive mutual funds, resulting in the loss of substantially her entire life-savings. She subsequently filed for bankruptcy.

In 2004, in connection with the settlement of a class action, Ameriprise Financial Services paid $100 million to 2.4 million customers (or approximately $41 to each customer) based upon claims against Ameriprise relating to the sale of proprietary or self-space funds, undisclosed kick-backs from certain funds, and the provision of “canned” investment in pushing its own funds, which were among the poorest performing mutual funds on the market. In re American Express Financial Advisors Securities Litig., Civil Action No. 1-04-cv-1773 (S.D.N.Y.).

However, when it came time to draft a settlement order, which would be binding and have preclusive effect on all the members of the class, Ameriprise, with the complicity of class counsel, drafted the broadest possible settlement barring all class members from “instituting, commencing or prosecuting, either directly or in any other capacity, any and all Released Claims against any and all Released Persons.” As part of the settlement, the lawyers for the class received approximately $32 million in legal fees.

Here, the Released Parties, included all present and former agents of Ameriprise, and all Released Claims all “claims are alleged to arise out of the common course of conduct that was alleged, or could have been alleged, in the Action.”

While our client was provided notice of the settlement of the class action and the opportunity to request to be excluded prior to consulting with our firm, she failed to opt out of the class. Rule Rule 12204(a)(2) of the FINRA Code of Arbitration Procedure provides that Arbitration Panels can determine whether a claim is part of a class action. However, so can federal judges. After the Arbitration Panel denied Ameriprise’s request to dismiss our claims as part of the class action, a week before our FINRA arbitration hearing was scheduled to begin in Detroit (after almost 12 months of protracted litigation in discovery), we received an emergency motion before the United States District Court for the Southern District of New York, filed by one of the nation’s most preeminent and most expensive law firms, seeking to enjoin the arbitration and seeking legal fees and costs associated with bringing the motion (which exceeded $50,000).

While the Judge was sympathetic our claims, which included claims for common law fraud, the sale of unsuitable investments, breach of fiduciary duty, and the failure to supervise, and was separate and apart from the class action claims, the Judge stated that if she found that if she found any of our claims are included in her final order dismissing the class action, she would entertain Ameriprise’s application for costs and attorney’s fees. Based upon these representations, faced with the possible imposition of costs and fees, we withdrew our FINRA arbitration.

Similarly, in 2009, we represented an individual investor in a claim against a stockbroker for the fraudulent sale of an annuity to a senior citizen for whom an annuity was wholly unsuitable, (at least for the customer, as the broker reaped commissions in excess of $10,000).

At or about the same time, we brought our individual action against the broker and his brokerage firm, a class action was filed against the annuity company for the failure to disclose a small administrative fee. However, once again, when the class action was settled (there class counsel made $9 million in fees), the settlement Order was written so broadly to include all claims, including all claims against agents of the annuity company, i.e. our stockbroker, for fraud or misrepresentation in connection with the sale of the annuity. This time, however, we were successful in opting out, or excluding our client from the class settlement.

This practice continues. On March 4, 2011, the United States District Court for the Northern District of California approved a Class Action Settlement in In Re Countrywide Financial Corporation Securities Litigation, No. Cv-07-05295 (N.D. Ca. 2007), which included the release of all claims against the “underwriters” and their “agents” of Countrywide securities. Accordingly, any claims against the stockbrokers associated with these underwriters, which include Morgan Stanley, Merrill Lynch, Citigroup, Wachovia, UBS Financial Services, and others, and which include claims for the recommendation of unsuitable investments, the failure to conduct due diligence, breach of fiduciary duty, and the failure to supervise, are also included.

The same is true in all other cases, including pending cases against the issuers and underwriters or FannieMae, FreddieMac, American Home Mortgage, and the countless issues of the preferred and debt securities of Wachovia, Merrill Lynch, Morgan Stanley, and others, including Charles Schwab (YieldPlus).

Now, we advise each of our clients, in writing, even at the investigatory stage of any claim that “It is very important that should you receive notice or learn that any claim, or any security that is the subject of this arbitration, is also the subject or becomes the subject of a Class Action, you must advise us immediately and also may be required to opt-out and request to be excluded from any such Class Action, or else your arbitration claim may later be determined to have been included, and thereby barred in connection with the settlement or disposition of any Class Action.”

Defective Financial Products

Nonetheless, the tension between Class Actions and individual claims, or the rights of individual claimants, persists particularly in “defective product” cases.

The class action bar is typically more vigilant that the public investors arbitration bar. When a case emerges, class counsel filing the complaint is required under the Private Securities Litigation Reform Act to issue a press release, advising the public and prospective members of the class that the entity with the largest financial interest in the outcome of the case, may petition the court to be appointed as lead plaintiff.

Typically, as a result of this press release, purchasers of securities during the class period will contact the law firm filing the class action complaint, and sometimes provide the firm with their purchase information and a certification. However, since the aggregation of several class members by one law firm or group of law firms is no longer permitted to secure the coveted position of lead counsel, typically reserved for the large institution that will negotiate their fees, those persons responding to the press release, otherwise consulting with class counsel, are largely ignored.

The question becomes to what extent, if any, does class counsel have an ethical duty to inform prospective or actual clients in the class action that they may have claims sounding in negligence or the failure to perform due diligence against the individual broker or brokerage firm that sold them these securities, and that if they do not bring these claims in a timely manner that these claims will be eventually time barred by the statute of limitations. Moreover, what duty does class counsel have to inform these “clients” should the underlying class claims not survive a motion to dismiss or a motion for summary judgment.

Claimants with individual claims against their stockbrokers, particularly claims for oral misrepresentations, do not make for suitable class representatives. Counsel for the class certainly is not serving the interest of the class by advising clients to opt out of any class, thereby undermining the integrity of the class and the prospect of any substantial settlement. In fact, recently opt outs in the Charles Schwab YieldPlus class and the Countywide Class, permitted defendants in both cases from initially withdrawing from these settlements.

1 Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 617 (1997) (quoting Mace v. Van Ru Credit Corp., 109 F.3d 388, 344 (7th Cir. 1997)). “A class action solves this problem by aggregating the relatively paltry potential recoveries into something worth someone’s (usually an attorney’s) labor.” Amchem Prods., Inc., 521 U.S. at 617 (quoting Mace, 109 F.3d at 344).

Guiliano Law Group

The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise.

We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.