____________________________________ IN RE: CENDANT CORPORATION,       This Relates to All Actions ____________________________________

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Master File No. 98-CV-1664 (WHW) Hearing Date: August 19, 1998 Hearing time: 10:00 a.m. Courtroom of the Hon. William H. Walls

     I, JOHN C. COFFEE, JR., declare as follows:

     1.   I am the Adolf A. Berle Professor of Law at Columbia University Law School, where I have taught since 1980, and am a member of the Bars of the State of New York and the District of Columbia. I am also a Fellow of the American Academy of Arts and Sciences, a Fellow of the American Bar Foundation, and a member of, and former Reporter for, The American Law Institute. I have also taught law at the law schools of Stanford University, Georgetown University, University of Virginia, and the University of Michigan. Prior to entering academia, I practiced law with the firm of Cravath, Swaine & Moore in New York City from 1970 to 1976. I am a 1969 graduate of the Yale Law School.

     2.   As a law professor, one of my principal academic interests has been class action litigation (with a special focus on the management of the large class action and the incentive structure that the law creates to reward the successful plaintiff's attorney). In that capacity, I have testified on a number of occasions before Congressional committees on class action issues, served as a consultant to the Mass Torts Working Group recently appointed by Chief Justice Rehnquist, participated as the principal academic speaker at the last two ABA National Institutes on Class Actions, served as a special advisor to the White House's Office of General Counsel with respect to the consideration and passage of the Private Securities Litigation Reform Act of 1995, and testified before the Advisory Committee on the Civil Rules of the United States Judicial Conference.

     3.   I have authored a number of law review articles dealing with the performance of plaintiffs' attorneys and the techniques by which the law can best align their incentives with those of the class. These include: Coffee, Rescuing the Private Attorney General: Why the Model of the Lawyer as Bounty Hunter Is Not Working, 42 Md. L. Rev. 215 (1983); Coffee, The Unfaithful Champion: The Plaintiff as Monitor in Shareholder Litigation, 48 Law & Contemp. Problems 5 (Summer 1985); Coffee, Understanding the Plaintiffs' Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class Derivative Actions, 86 Colum. L. Rev. 669 (1986); Coffee, The Regulation of Entrepreneurial Litigation: Balancing Fairness and Efficiency in the Large Class Action, 54 U. Chi. L. Rev. 877 (1987); Coffee and Schwartz, The Survival of the Derivative Suit: An Evaluation and a Proposed Legislative Reform, 81 Colum. L. Rev. 261 (1981); Coffee, Rethinking the Class Action: A Policy Primer on Reform, 62 Ind. L. Rev. 625 (1987); Coffee, Class Wars: The Dilemma of the Mass Tort Class Action, 95 Colum. L. Rev. 1343 (1995); Coffee, The Future of the Private Securities Litigation Reform Act: or Why the Fat Lady Has Not Yet Sung, 51 Bus. Law. 975 (1996). Some of these articles have been cited and relied upon by other federal courts, including the U.S. Supreme Court, in well-known decisions dealing with class actions and attorney fee awards. See, e.g., Amchem Products, Inc. v. Windsor, 117 S. Ct. 2231 (1997); In re Asbestos Litig., 134 F.3d 668 (5th Cir. 1998), cert. granted, 117 S. Ct. 2503 (June 27, 1998); In Re General Motors Corp. Pick-up Truck Fuel Tank Prods. Liab. Litig. 55 F.3d 768, 801, 821 (3d Cir. 1995); Georgine v. Amchem Products, Inc., 83 F.3d 610, 618, 636 (3d Cir. 1995); BTZ, Inc. v. Great Northern Nekoosa Corp., 47 F.3d 463, 466 (1st Cir. 1995); In re Pacific Enterprises Secs Litig., 47 F.2d 373, 378 (9th Cir. 1995); Bell Atl. Corp. v. Bolger, 2 F.3d 1304 (3d Cir. 1993); Howes v. Atkins, 668 F. Supp. 1021 (E.D. Ky. 1987); Mashburn v. National Healthcare, Inc., 684 F. Supp. 679, 690 (M.D. 1988); In re Activision Securities Litigation, 723 Supp. 1373, 1376 (N.D. Cal. 1989); In re Oracle Systems Securities Litigation, 136 F.R.D. 639 (N.D. Cal., 1991); General Motors Corp. Bloyed, 916 S.W. 2d 949, at 953, 955 (Tex. 1996).

     4.   My work in the area of class actions and representative litigation also includes service (for over a dozen years) as a Reporter for the American Law Institute in connection with its effort to codify the common law rules of corporate law and fiduciary duties in a Restatement-like volume. See A.L.I., PRINCIPLES OF CORPORATE GOVERNANCE: Analysis and Recommendations (1992). I served as the Reporter for litigation remedies, and this project specifically recommended standards for plaintiffs' attorney fee awards in direct and derivative shareholder actions. In connection with serving as Reporter for the American Law institute, I have interviewed and discussed fee award procedures with many of the leading attorneys in the class and derivative action field and have participated in numerous seminars, panels, and informal conferences with judges who have faced similar issues to those involved in this case.

     5.   I am also a specialist in the field of securities law and regulation, where I currently serve on the Legal Advisory Board of the National Association of Securities Dealers ("NASD") and am an emeritus (but continuing) member of the Legal Advisory Committee of the New York Stock Exchange ("NYSE'). I am also a member of the Market Regulation Committee of NASD Regulation ("NASDR"), the enforcement arm of the NASD. I am a co-author of Jennings, March, Coffee and Seligman, SECURITIES REGULATION: Cases and Materials (8th ed. 1998), which is the oldest and most widely used casebook on securities law in the United States and I am a member of the executive committee of the Securities Regulation Institute. Finally, I have testified on securities law issues (both related and unrelated to class actions) before several Congressional committees.

     6.   Based on experience in both the class action and securities law fields, I believe that I am very familiar with the Private Securities Litigation Reform Act of 1995 ("PSLRA"), its legislative history, and in particular the caselaw dealing with its "lead plaintiff" provision. I am also familiar with those decisions that have attempted to employ an "auction" or "competitive bidding" procedure for the selection of lead counsel. I have discussed and analyzed such procedures as a participant on several ALI-ABA and PLI panels (including with United States District Judge Vaughan Walker, who was the original designer of such a procedure).

     7.   I do not make this affidavit to tell this Court whom to select for the position of counsel to the lead plaintiff. Frankly, I do not believe that I (or any other professor) possess any special competence that entitles us to do so. Also, having read the transcript of the proceedings at this Court's hearing on August 4, 1998, I realize that a number of highly competent counsel have applied (although I believe it would be a serious overstatement to describe them all as equally qualified).

     8.   Instead, my intent is to offer advice and recommendations only with regard to how the selection process should be run. My review of the transcript of the August 4, 1998 hearing before this Court indicates to me that this Court has determined to use a competitive bidding procedure.¹ This procedure was first developed by Judge Vaughan Walker of the Northern District of California. I have discussed this topic with Judge Walker, and I frankly consider his efforts original, incisive and even pioneering. However, as with most innovations, the first efforts have also revealed flaws, which have seemingly resulted in a tendency for auctions to produce "cheap" and early settlements. In this affidavit, I will review the problems that have arisen in these early cases and suggest procedures and ground rules that can both minimize those problems in this case and also reduce the tension between such a procedure and the premises of the PSLRA.

     9.   The starting point for any such review is inevitably the complicated Oracle Systems litigation in which United States District Judge Vaughan Walker first implemented a competitive bidding procedure.² See In re Oracle Secs. Litig., 131 F.R.D. 688 (N.D. Cal. 1990). There, after more than twenty-five law firms filed proposed class actions and a dispute broke out between two camps, Judge Walker determined to use a competitive bidding process and ordered each law firm wishing to compete for the position of lead counsel to submit a sealed bid "specifying the percentage of any recovery such firm will charge as fees and costs...." See Oracle I, 131 F.R.D. 688, 698. Four law firms submitted very different bids, and the court selected Lowey, Dannenberg, Bemporad, Brachtl & Selinges, P.C. (the "Lowey firm") as the winning bidder. The Lowey firm's bid followed a "declining percentage of the recovery" formula and proposed the following schedule:
 

See Oracle II, 132 F.R.D. 538, 541. In addition, the Lowey bid imposed a "cap or limit of $325,000 on the amount of the litigation expenses to be charged the class." Id. Also, it included a 20% discount off the fee award if the case was settled in less than one year. Later, the fee formula was amended to permit additional expenses (of up to $500,000) to be charged in a parallel action against Oracle System's auditors, Arthur Andersen & Co.

     10.  In retrospect, what happened under this fee formula was economically forseeable. The case settled for $25 million, and the court awarded a $4,800,000 fee, as the foregoing formula dictated. But the critical fact was that the case settled at exactly the point at which the Lowey firm hit the ceiling on its expense reimbursement proposal. Indeed, at the fee award hearing, the court found that the firm's actual expenses came to $320,065.95 in connection with the Oracle case and $472,342 with regard to the Arthur Andersen litigation (or just below the respective $325,000 and $500,000 ceilings). See Oracle V, 852 F. Supp. 1457 (N.D. Cal. 1993). In short, the winning bidder found that it could not afford to continue the case once its own self-imposed expense ceiling was reached.

     11.  In theory, it might be argued that the Lowey firm was simply very accurate in predicting its litigation expenses.³ But this ignores the obvious truth that defendants also knew about its self-imposed ceiling and had every incentive to exploit it. Defendants can exploit such a myopic formula by waging a costly war of attrition that takes the plaintiff's firm near its ceiling and signals that any failure to settle will be personally costly for the plaintiff s firm. To be sure, the defendants may have to spend considerably more than plaintiffs to do so, but in so doing they are economizing on their ultimate settlement costs.

     12.  The early settlement "discount" in the Lowey firm's bid also proved illusory, as the case did not settle in the first year. This again was predictable. Why should a firm rush to settle in less than a year if doing so only reduces its fees by 20%?

     13.  It is also evident from the early cases using auction procedures that many plaintiff's counsel seem to be dissuaded by the apparent complexity of bidding procedures. For example, in In re California Micro Devices Secs. Litig., 168 F.R.D. 257 (N.D. Cal. 1996), Judge Walker noted that only two of seventeen firms representing the plaintiff class in that case chose to submit bids, and only one of these bids was characterized by him as "serious." This limited response to the court's request for bids and the court's dissatisfaction with the outcome again underscores that auctions are not as easily implemented as they seem in theory. Law firms in fact often seem perplexed as to how to bid.

     14.  The leading example of how a poorly designed auction procedure can produce results that fail to maximize the recovery for the class is provided by a recent antitrust class action. In In re Amino Acid Lysine Antitrust Litig., 918 F. Supp. 1190 (N.D. Ill. 1996), the district court awarded the position of lead counsel in a price-fixing class action against Archer Daniels Midland Co. and certain other defendants to a well-known plaintiff's firm that had done pioneering work in the field of antitrust class litigation and that had submitted the following "capped" bid:
 

     15.  As rival firms and legal commentators hastened to point out, this formula left the law firm with no incentive to reach a settlement of over $25 million. However, because Archer Daniels Midland was already the target of a much publicized price-fixing probe by the FBI (which involved taping conversations among its senior management and their competitors), the court apparently believed that further incentive was not needed. What happened? The case settled immediately -- for $25 million (the ceiling under plaintiff's fee formula). Press accounts have pointed out that only minimal discovery was conducted and that the settlement was reached only two months after the cases were consolidated. See Scott Medintz, "Big Suits: Lysine Antitrust Settlement," American Lawyer, June 1996 at p. 114. Economically, this made sense for the plaintiff's law firm (although not its clients) because discovery would just cost it litigation expenses and delay its fee award. Yet, many class members were obviously dissatisfied. Some thirty-two large corporations, representing 9% of all lysine sales, opted out and sued separately. See "32 Firms Reject ADM's Lysine Settlement Offer," St. Louis Post-Dispatch, July 11, 1996 at p. 4c. Others objected to the settlement, and the court itself expressed its dismay at the lack of documentation provided to show the likely damages from the admitted price-fixing violations. See Millman, "ADM Settlement Approved," Chicago Tribune, July 20,1996 at p. 1; "Settlement Approved in Lysine Lawsuit," The Commercial Appeal (Memphis), July 20, 1996 (Associated Press) at p. 4B.

     16.  The lessons of the ADM lysine case are depressingly simple: even in a case where the plaintiffs' attorneys are essentially "shooting fish in a barrel" because the litigation risks are minimal (as ADM's then publicly impending indictment indicated), plaintiff's attorneys may still reach a cheap and early settlement if the wrong fee formula gives them an incentive to do so.

     17.  Fee and expense formulas are not the only problem the court must face in using an auction procedure. A single firm will face greater financial pressures in carrying the case forward than will the larger aggregation of firms that typically results under more traditional procedures. A financially strained firm has a greater incentive to reach a cheap settlement than does a collection of firms (who can more easily finance the case internally). Thus, Judge Walker has required a performance bond or other proof that the case will not be abandoned because of financial exigencies. See In re Wells Fargo Securities Litigation, 157 F.R.D. 467 (N.D. Cal. 1994). As discussed below, alternative arrangements (namely, a mandatory escrow fund to qualify as a bidder) probably more satisfactorily address this need to assure financial capability.

     18.  The foregoing discussion has focused on what can go wrong. However, I do not suggest that mistakes or failures are inevitable (although they have often resulted). As with any innovation, the first experiments can be improved upon and learned from. How can mistakes best be avoided? I would respectfully suggest that the following ground rules be observed:

          A.   No "Caps" or Ceilings Should Be Placed on Either Fees or Expenses. The clear lesson of both the ADM and the Oracle experiences is that, in the absence of any incentive to do otherwise, plaintiffs attorneys will often settle at or near the point where any ceilings is reached. After all, how can a plaintiff's attorney credibly threaten to go to trial unless defendants offer $30 million if defendants know that such a settlement does not benefit the plaintiff's attorney (whose fee is capped after the $20 million level) but does expose the attorney to the inevitable risks and delays of litigation. Any threat to go to trial in this context will likely be regarded by informed defendants as a bluff.

          B.   If Ceilings or Caps Produce Perverse Results, Sharply Declining Percentage Formulas Will Have Substantially Similar Results. Almost every commentator who has looked at the fee formula in the ADM lysine case has recognized that the plaintiff's attorneys had no incentive to go seek a recovery beyond $25 million. That such a formula makes little sense is obvious. But, suppose the formula gives the attorneys 5% of any amounts over $25 million. This might well prove to be a difference without a distinction. Consider a case where there was even a small risk of loss (either by jury verdict or dismissal) if the case did not settle (hypothetically, a 25% risk of loss). Assume also that the fee formula gave the attorney 25% of any amount up to $20 million but only 5% of any additional recovery. Lastly, assume that in the disinterested judgment of all attorneys, the case had a settlement value of $30 million and the defendants have made a final offer of only $20 million. The class here would want this case to proceed to trial, but the plaintiff's attorney is faced with a choice between a riskless recovery (by settlement) that will yield it $5 million (i.e., 25% of $20 million) and a risky recovery of $5.5 million (i.e., 25% of $20 million plus 5% of the additional $10 million). Because the latter recovery must be discounted by the 25% chance of loss, its expected value is truly only $4,125,000 to a risk neutral plaintiff's lawyer (and even less to a risk-averse one). Hence, the attorney will rationally want to settle when the class equally rationally does not.

          C.   In Cases Where Liability Seems Likely, the Court Should Consider an Increasing Percentage of the Recovery Formula. The great fear about the "percentage of the recovery" formula has long been both that it overcompensates and that it leads to early, premature settlements. Macey and Miller, The Plaintiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. Chi. L. Rev. 1 (1991). In a case where liability seems clear (for example where the government is also proceeding against the defendant or the defendant has acknowledged responsibility), a flat percentage of the recovery may well overcompensate. In these cases, an ascending percentage makes greater sense, at least when it starts very low. For example, in the ADM lysine case, it would have made more sense to reward plaintiff's counsel as follows:
 

This formula never exceeds the 30% benchmark that is now standard in securities class actions,⁴ but it also does not overcompensate lawyers for "shooting the proverbial fish in the barrel." In the instant case, although there are many technical complexities in litigating this case (particularly against the accountant, underwriter and individual defendants), Cendant does appear to be a wounded duck that will prefer to settle than fight. Thus, it over-rewards plaintiffs' attorneys to give them 20% (or any similar figure) of the first $25 million when, as a practical matter, even semi-competent attorneys could obtain that level of settlement.

          My point is that the first dollars in any settlement are easy, while the marginal dollars become progressively harder. An optimal fee formula should reward the attorney for working harder and gaining more for the class. This does not mean that the attorneys will necessarily receive more money. A fee formula that starts low (at 5% to 10% and ascends to 25%) may produce the same (or lesser) compensation as one that starts at 25% and then descends to 5% -- but it will clearly work better to discourage "cheap" early settlements (as in the ADM fiasco).

          Although an increasing percentage of the recovery may not be advisable in all cases (because it can over-encourage an attorney to take a long-shot gamble on highly speculative litigation), it seems better suited to cases of presumptive liability such as this one (which no one has yet to my knowledge dared to characterize as a long-shot gamble).

          D.   Plaintiffs' Bids Should Remain Secret So That Defendants Do Not Gain Any Strategic Advantage From Them. Defendants gain an unfair advantage when they learn that a plaintiff's lawyer's fee is capped or that it declines in percentage terms after some point. They can exploit this knowledge both by seeking to increase costs or by discounting negotiating counter-proposals as a bluff. Secrecy should require that all bidders keep their bids confidential -- at least until some post-settlement point.

          E.   Because a Single Counsel Is Financially Less Able to Continue the Litigation Than the Traditional Ad Hoc Firm, the Court Should Require All Bidders in an Auction to Demonstrate Their Financial Capability by Creating at the Outset an Adequate Escrow Fund. One major difference between an auction system and the classic appointment (or election) approach is that it tends to produce a much smaller plaintiff's team. This is both an advantage (in that a leaner team costs less) and a disadvantage (in that a small team is less able to afford the costs of litigation and this may be exploited by the defendants). Also, an auction procedure encourages very small firms to submit a low-ball bid even though they lack the financial capability to carry the litigation forward. Such firms have very limited overhead and hence can formulate very low bids, but their realistic ability to achieve settlement is also in serious doubt. It is particularly hard for the court to deal with this problem because even a small firm can be "qualified" in the sense of possessing the requisite legal competence. In truth, even a highly "qualified" attorney may be a financially disabled one. To solve this problem, the simplest answer in my judgment is to use a screening device: each bidder must commit to creating an escrow fund sufficient to carry the litigation forward for two years on the day its bid is accepted. In my judgment, this required escrow fund should not be less than $2,000,000 and withdrawals from this account could only be made for reimbursable litigation expenses (not partners' compensation). Announcing this requirement in advance would motivate smaller firms to band together to submit a joint bid and reduce the danger of the future de facto insolvency of a winning bidder.

          F.   All Bids Should Be Submitted to the Lead Plaintiff, and No Firm Should Be Appointed Counsel Without the Consent of the Lead Plaintiff. This Court noted at its August 4th hearing that the language of the PSLRA (now, Section 21D(a)(3)(B) of the Securities Exchange Act of 1934) states that the selection of counsel is "subject to the approval of the court." In my judgment, this cited language has a two-edged significance: the court can veto any counsel it considers unqualified, but it cannot mandate the choice of counsel. Rather, § 21D(a)(3)(B) also mandates that "the most adequate plaintiff shall... select and retain counsel to represent the class." The legislative history to the PSLRA clearly indicates a desire to increase client control, and minimize lawyer control, of securities class actions. In that light, although the court can clearly veto, any attempt to impose an attorney on an unwilling institutional client would amount to a forced "shotgun marriage" that the PSLRA simply does not authorize or contemplate.

          The forced imposition of an attorney on a client makes particularly bad sense when the client is a sophisticated institution. Sophisticated institutions (and individuals) understand that all attorneys are not equal (even if all are minimally qualified). An intelligent, informed client would prefer a superior attorney (or simply an attorney that it was more experienced or comfortable with) to an attorney that was $10,000 or 1% cheaper in its bid.

          To some extent, this court may have sought to address this problem by permitting the originally retained attorney to retain the position of counsel if it matches the "winning" bidder's low bid. Unfortunately, this gives the choice to the attorney and not the client.

          The real value of an auction where a lead plaintiff exists is that it gives the client valuable information and maximizes its choices. This is particularly true in the case of institutional investors (and especially public pension funds that effectively live in a fishbowl of public disclosure). One should not underestimate the pressure that a CalPERS (or any similar institution) would be under to accept the most attractive bid. Although an unknown law firm might be ignored, it is not likely in my opinion that a public pension fund could ignore a significantly lower bid by a recognized, qualified law firm. To focus this pressure, the court could place the burden on the client to justify its refusal to accept representation by the lowest qualified bidder. Of course, we can all understand some reasons for a refusal (for example, the law firm may have previously sued the client or may represent another conflicting client). Given the public pressures to which institutional investors are subject, there is no need for the court to impose counsel on the client. Rather, the court can more subtly influence the selection process by asking the lead plaintiff to explain and justify any choice that seems to deviate significantly from the results of its auction (and possibly to meet with the winning bidder). In this way, the court would avoid any direct conflict with the statutory language while also maximizing the pressure on the lead plaintiff to select for the class the lowest cost counsel (among those most qualified) for the class.

          G.   To Simplify Bidding Formulas and Prevent Manipulation, the Court Should Reduce the Elements in Its Proposed Grid and In Particular Minimize the Use of "Litigation Mileposts." As noted earlier, some bidders, beginning in Oracle, have proposed a differential in the fee award depending on when the case is settled or resolved. Experience teaches, however, that these factors are often in the law firm's control. For example, the 20% discount offered by the Lowey firm in Oracle for a first year settlement never materialized, probably because it was simply not in that firm's interest to settle in the first year. At the August 4th hearing, this court outlined a proposed grid, which calls for bids in terms of the case's progress through discovery and trial. In my judgment, this approach places excessive weight on factors within counsel's control (for example, if a higher percentage is to be awarded for a case that goes to trial and then settles, it now becomes in the law firm's interest to reject all settlements until after the trial commences). Another problem with this approach is that it makes it more difficult to compare bids, once each bid must have multiple elements. Some bids may be lower on one end; others lower on the other end. Thus, I would submit that no more than one (or at most two) litigation milepost(s) should be used.

          I declare under penalty of perjury that the foregoing is true and correct. Executed on this 17th day of August, 1998.
 

/s/ _______________________________ John C. Coffee, Jr.

¹I must acknowledge that I do not believe the PSLRA contemplates the use of auction procedures, but I will adopt as my starting point this Court's determination that it will use such a procedure. My suggestions can be regarded as an attempt to reconcile the PSLRA with auction procedures.

²The Oracle litigation involves the following decisions: In re Oracle Secs. Litig, 131 F.R.D. 668 (N.D. Cal. 1990) ("Oracle I"); In re Oracle Secs. Litig., 132 F.R.D. 538 (N.D. Cal. 1990) ("Oracle II"); In re Oracle Secs. Litig., 136 F.R.D. 639 (N.D. Cal. 1991) ("Oracle III"); In re Oracle Secs. Litig., 829 F. Supp. 1176 (N.D. Cal. 1993) ("Oracle IV"); In re Oracle Secs. Litig., 852 F. Supp. 1457 (N.D. Cal. 1994) ("Oracle V").

³In fact, however, the Lowey firm was forced to absorb an additional $188,761 in notice expenses and $174,176 in claims processing expenses, which it unsuccessfully argued were not included within its own ceiling. This tends to undercut the accuracy of its prediction.

⁴Actually, the fullest recent study shows that 32% is the now the prevailing benchmark. See Dunbar, Foster, Juneja, Martin, Recent Trends III: What Explains Settlements in Shareholder Class Actions (NERA June 1996) (using data from 656 shareholder class actions that settled, were dismissed or resolved by verdict between 1991 and 1994).
 
 

Source: Scanned paper copy of court-stamped document