IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_______________
m 00-20875
_______________
MARK BERGER, ETC., ET AL.,
Plaintiffs,
MARK BERGER,
ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED,
Plaintiff-Appellee,
VERSUS
COMPAQ COMPUTER CORPORATION, ET AL.,
Defendants,
COMPAQ COMPUTER CORPORATION; ECKHARD PFEIFFER; EARL L. MASON;
JOHN T. ROSE; JOHN W. WHITE; ROBERT W. STEARNS; MICHAEL WINKLER;
THOMAS J. PERKINS; J. DAVID CABELLO; MICHAEL HEIL; GREGORY E. PETSCH;
KENNETH L. LAY; BENJAMIN ROSEN; AND RODNEY SCHROCK,
Defendants-Appellants.
_________________________
Appeal from the United States District Court
for the Southern District of Texas
_________________________
July 25, 2001
Before SMITH, DUHÉ, and WIENER, appointed all movants as lead plaintiffs.2 The
Circuit Judges.
1
JERRY E. SMITH, Circuit Judge: (...continued)
(“PSLRA”), a plaintiff seeking to represent the
In this securities litigation, the district court class must file, together with the complaint, a
certified a plaintiff class and appointed class sworn certification stating, inter alia, that the
representatives. Because of legal error, we plaintiff (1) is not acting at the behest of counsel,
reverse and remand. (2) is familiar with the subject matter of the
complaint, and (3) has authorized initiation of the
action. 15 U.S.C. § 78u-4(a)(2)(A). The plaintiff
I.
then must give notice of the filing of the class
On March 6, 1998, Compaq Computer action, advising class members of their right to
Corporation announced that sales from one of move to serve as lead plaintiffs. Id. at § 78u-4(a)-
its North American commercial channels were (3)(A)(i). The court then must appoint a “lead
not meeting expectations and that there would plaintiff,” adopting the rebuttable presumption that
be price reductions and aggressive promotions the “most adequate plaintiff” (1) has either filed the
to reduce inventories. About a month later, complaint or made a motion to be appointed lead
Mark Berger, on behalf of all purchasers of plaintiff, (2) has the largest financial interest in the
Compaq stock between July 10, 1997, and relief sought by the putative class, and (3)
March 6, 1998 (the “Investors”), sued Com- otherwise satisfies FED. RULE CIV. P. 23. Id. at §
paq and its directors (collectively “Compaq”) 78u-4(a)(3)(B)(i)-(iii).
complaining of violations of §§ 10(b) and 2
Although the appointment of such a large
20(a) of the Securities and Exchange Act of
group to serve as lead plaintiff is not before this
1934, 15 U.S.C. §§ 78j(b) and 78t(a), and rule court, it is notable that the Securities and Exchange
10b-5 promulgated thereunder, 17 C.F.R. Commission has taken the position that a group of
§ 240.10b-5. The Investors allege, inter alia, investors appointed to serve as lead plaintiffs
that Compaq attempted to inflate the price of ordinarily should comprise no more than three to
its stock by fraudulently engaging in “channel five persons. See In re Baan Co. Sec. Litig., 186
stuffing,” i.e., “overselling” products to F.R.D. 214, 224 (D.D.C. 1999). In that case, the
distributors with the knowledge that they district court refused to appoint a twenty-member
would not be able to resell the products to group, citing the “particular concern [which] arises
end-users at rates consistent with the com- when lead plaintiff status is sought by a ‘group’ of
pany’s own sales. persons who were previously unaffiliated, each of
whom have [sic] suffered modest losses, and who
Thirty-nine members of the putative class thus have no demonstrated incentive or ability to
collectively moved for (1) appointment as lead work together to control the litigation.” Id.
Likewise, in In re Waste Mgmt., Inc. Sec. Litig.,
plaintiffs, (2) approval of their selection of lead
120 F. Supp.2d 401, 413 (S.D. Tex. 2000), the
counsel, and (3) consolidation of all related court concluded that “the strictest approach,
actions.1 The court granted the motion and requiring at maximum a small group with the
largest financial interest in the outcome of the
litigation and a pre-litigation relationship based on
1
Under the “lead plaintiff” provisions of the more than their losing investment, satisfies the
Private Securities Litigation Reform Act of 1995 terms of the [PSLRA] and serves the purpose
(continued...) (continued...)
2
Investors then filed a consolidated amended interlocutory appeal of the certification order
complaint, which Compaq moved to dismiss pursuant to FED. R. CIV. P. 23(f). We denied
on various grounds, including failure to meet mandamus but granted interlocutory review,
the pleading requirements of the PSLRA and and that appeal is before us now.
FED. R. CIV. P. 9(b);3 the court denied the
motion to dismiss and a motion for II.
reconsideration. “We review a district court’s class
certification decisions for abuse of discretion.”
While the motion to dismiss was pending, Pederson v. La. State Univ., 213 F.3d 858,
the Investors moved for class certification. 866 (5th Cir. 2000). “[T]he district court
Although they initially proposed that all thirty- maintains great discretion in certifying and
nine lead plaintiffs serve as class managing a class action. We will reverse a
representatives, that number eventually was district court’s decision to certify a class only
whittled to seven, only four of whom appeared upon a showing that the court abused its
at depositions. Compaq filed a motion discretion, or that it applied incorrect legal
opposing class certification on the ground that standards in reaching its decision.” Mullen v.
the Investors “had not satisfied their burden of Treasure Chest Casino, LLC, 186 F.3d 620,
showing that the proposed representatives 624 (5th Cir. 1999) (citations omitted), cert.
were directing and controlling this litigation as denied, 528 U.S. 1159 (2000). “Whether the
required by rule 23 and the Reform Act.” The district court applied the correct legal standard
district court granted the motion for class in reaching its decision on class certification,
certification and appointed as class however, is a legal question that we review de
representatives the four plaintiffs who had novo.” Allison v. Citgo Petroleum Corp., 151
appeared at depositions. F.3d 402, 408 (5th Cir. 1998).
Shortly after the certification, Compaq An action may proceed as a class action
sought a writ of mandamus from this court di- only if the party seeking certification4
recting the district court to dismiss the demonstrates that all four of the familiar
complaint on the ground that it did not satisfy requirements of rule 23(a) are satisfied:
the pleading requirements of the PSLRA.
Compaq also petitioned this court to permit an (1) the class be so numerous that joinder
of all members is impracticable;
2
(...continued) (2) there be questions of law or fact
behind its enactment[.]”
3
Under the PSLRA, plaintiffs no longer are
4
permitted to plead scienter generally; rather, they The party seeking certification bears the
must “with respect to each act or omission . . . burden of proof. Castano v. Am. Tobacco Co., 84
state with particularity facts giving rise to a strong F.3d 734, 740 (5th Cir. 1996); see also In re Am.
inference that the defendant acted with the required Medical Sys., 75 F.3d 1069, 1086 (6th Cir. 1996)
state of mind.” See 15 U.S.C. § 78u-4(b)(2). Rule (reversing the district court because “the practical
9(b) provides, “In all averments of fraud or effect of the proceeding below was to place the
mistake, the circumstances constituting fraud or burden on defendants to disprove plaintiffs’ ‘en-
mistake shall be stated with particularity.” titlement’ to class certification.”).
3
common to the class; and to protect the interests of absentees.”6
(3) the claims or defenses of the This court has determined that
representative parties be typical of the
claims or defenses of the class; and [t]he adequacy requirement mandates an
inquiry into [1] the zeal and competence
(4) the representative parties will fairly of the representative[s’] counsel and . . .
and adequately protect the interests of [2] the willingness and ability of the rep-
the class. resentative[s] to take an active role in
and control the litigation and to protect
FED. R. CIV. P. 23(a). The main issue in this the interests of absentees[.]
appeal is whether the Investors carried their
burden on the fourth requirement.5 See Horton v. Goose Creek Indep. Sch. Dist.,
690 F.2d 470, 484 (5th Cir. 1982) (citations
Rule 23(a)’s adequacy requirement omitted).7 The adequacy inquiry also “serves
encompasses class representatives, their to uncover conflicts of interest between the
counsel, and the relationship between the two. named plaintiffs and the class they seek to
See 7A CHARLES A. WRIGHT, ARTHUR R. represent.” See Amchem Prods., Inc. v.
MILLER & MARY KAY KANE, FEDERAL Windsor, 521 U.S. 591, 625 (1997).
PRACTICE AND PROCEDURE § 1769.1, at 375 Furthermore, because absent class members
(2d ed. 1986). Compaq neither challenges the are conclusively bound by the judgment in any
adequacy of class counsel nor contends that class action brought on their behalf, the court
any conflict between the representatives and must be especially vigilant to ensure that the
the class members precludes certification, so due process rights of all class members are
the question is whether the court applied the safeguarded through adequate representation
correct legal standard in determining the ade-
quacy of the class representatives under
rule 23, i.e., whether the putative class 6
The district court’s observation that Compaq’s
representatives are “willing” and “able” to decision not to challenge the adequacy of class
“take an active role in and control the litigation counsel “tends to undermine [Compaq’s] argument
that the class will be inadequately represented”
evinces a misunderstanding of the nature of the
adequacy inquiry and of Compaq’s contention that
5
Compaq does not challenge the rulings that the class representatives, not class counsel, must direct
Investors have satisfied the numerosity, com- the litigation.
monality, and typicality requirements of rule 23(a),
7
or that certification is appropriate under rule The task of defining the precise contours of
23(b)(3), which provides that an action may be rule 23(a)’s adequacy requirement was largely left
maintained as a class action if “the court finds that to the lower courts after Hansberry v. Lee, 311
the questions of law or fact common to the U.S. 32 (1940). See generally 7A CHARLES A.
members of the class predominate over any ques- WRIGHT, ARTHUR R. MILLER & MARY KAY KANE,
tions affecting only individual members, and that a FEDERAL PRACTICE AND PROCEDURE § 1765, at
class action is superior to other available methods 269 (2d ed. 1986). Consequently, there is a lack of
for the fair and efficient adjudication of the uniformity in the various formulations of the
controversy.” requirements for adequacy.
4
at all times.8 Differences between named
plaintiffs and class members render the named
10
plaintiffs inadequate representatives only (...continued)
where those differences create conflicts . . . [T]he [deposition] testimony of
between the named plaintiffs’ and the class these representatives shows indifference to
members’ interests.9 and ignorance of key facts, a willingness to
speculate without foundation, decisions
Although we do not know whether the based on misinformation and blind reference
on counsel. The proposed representatives
named plaintiffs could meet the adequacy stan-
could not give any basis for their conclusory
dard,10 we do know that the district court
“channel stuffing” allegations and could not
explain, except through speculation, why
they accused Compaq’s Chief Executive
8
See Phillips Petroleum Co. v. Shutts, 472 Officer and twelve other individuals of
U.S. 797, 812 (1985) (“[T]he Due Process Clause fraud. They could not articulate one fact to
of course requires that the named plaintiff at all suggest that excess channel inventory was
times adequately represent the interests of the ab- due to fraud rather than to an unforeseen
sent class members.”); see also Hervey v. City of change in market conditions or a mistake in
Little Rock, 787 F.2d 1223, 1227 (8th Cir. 1986) business judgment, and instead relied on
(noting that even if the parties stipulate to what they themselves admitted was pure
certification, the court still must conduct a supposition and hindsight reasoning.
thorough rule 23(a) inquiry: “While class
stipulations by the parties may be helpful, they are ...
not complete substitutes for ‘rigorous analysis.’
The purpose of this analysis is to protect unknown Their shortcomings include taking po-
or unnamed potential class members, and by sitions in conflict with the Complaint, bas-
definition those people do not and cannot ing allegations on misinformation, and spec-
participate in any stipulations concocted by the ulating without foundation about accu-
named parties.”). sations of fraud against individuals.
9 ...
See Jenkins v. Raymark Indus., Inc., 782 F.2d
468, 472 (5th Cir. 1986) (considering, in
evaluating the requirement of adequate [N]one could articulate a distinction
representation, whether named plaintiffs have “an between legitimate and fraudulent sales to
insufficient stake in the outcome or interests the channel or identify a single specific fact
antagonistic to the unnamed members”; see also supporting their allegation that excess chan-
Mullen, 186 F.3d at 626 (noting that although the nel inventory in this case was the result of
differences described by defendant might create channel “stuffing” rather than of a non-
variances in the ways that the named plaintiffs and fraudulent cause, such as demand or
class members prove causation and damages, this competition.
did not affect the alignment of their interests).
When asked to give a basis for their al-
10
Compaq argues that the four named class legations regarding what supposedly
representatives fall far short of meeting the stan- motivated the Company’s chief executive,
dard. Set forth below are excerpts from Compaq’s Eckhard Pfeiffer, to commit fraud, the rep-
brief in this regard: resentatives were not able to identify any
(continued...) (continued...)
5
erred in two respects. First, it improperly and of plaintiffs’ counsel is presumed in the
shifted the burden of proof to the defendants absence of specific proof to the contrary.”
by adopting a presumption that the class rep- This is error; the party seeking certification
resentatives and their counsel are adequate in bears the burden of establishing that all
the absence of specific proof to the contrary. requirements of rule 23(a) have been satisfied.
Second, it applied an impermissibly lax See Castano, 84 F.3d at 740. Falcon v.
standard for adequacy that ignores the General Telephone Co., 626 F.2d 369 (5th
PSLRA’s mandate that class representatives, Cir. 1980), vacated on other grounds, 450
and not lawyers, must direct and control the U.S. 1036 (1981), cited by the district court, is
litigation. The Investors’ arguments to salvage not to the contrary.
both rulings are unpersuasive.11
In Falcon, id. at 376 n.8, this court merely
A. approved the practice of taking judicial notice
The district court unquestionably adopted of the competence of class counsel.12 Taking
an incorrect legal standard by stating that judicial notice of the fact that counsel is
“[t]he adequacy of the putative representatives competent, however, is not the same as
holding that class representatives therefore are
presumed to be adequate under rule 23(a)(4).
10
(...continued) Indeed, the district court’s presumption inverts
supporting facts, and simply resorted the well-established rule that the party seeking
to speculation, irrelevant personal certification bears the burden of establishing all
experiences, and undifferentiated elements of rule 23(a). Even more unsettling
citation to the Complaint. is that the district court’s presumption ignores
the constitutional dimensions of the adequacy
One representative not only had no
requirement, which implicates the due process
knowledge regarding why Pfeiffer allegedly
committed fraud, but disavowed the al- rights of all members who will be bound by the
legations in the Complaint that Pfeiffer judgment.
committed fraud in order to receive higher
bonus compensation. The Investors’ words belie the error. They
characterize the district court’s action not as
. . . Such conflicts between what the shifting the burden of proof, but rather as a full
proposed class representatives believe and consideration of “defendants’ objections to the
what the Complaint and class counsel allege certified representatives’ adequacy as well as
indicate that the lawyers . . ., and not the evidence to the contrary presented by
plaintiffs themselves, are driving this litiga- plaintiffs.” The argument’s structure confesses
tion.
11
First, they claim that the court merely
12
concluded that “the skill and experience of See also 7A CHARLES A. WRIGHT, ARTHUR
plaintiffs’ counsel is more important” in assessing R. MILLER & MARY KAY KANE, FEDERAL
adequacy than are “the personal qualifications of PRACTICE AND PROCEDURE § 1765, at 277-78 (2d
the named parties.” Second, they aver that the ed. 1986) (“Moreover, a few courts have indicated
court properly rejected Compaq’s argument that if the opposing party fails to challenge the
regarding the PSLRA’s effect on the stringency of ability of representatives’ counsel to conduct the
rule 23(a)’s adequacy requirements. action, his competence will be assumed.”).
6
the error: Adequacy is for the plaintiffs to abdicatesSSto a self-interested partySSthe
demonstrate; it is not up to defendants to dis- court’s duty to ensure that the due process
prove the presumption of adequacy. rights of the absent class members are
safeguarded.
The Investors’ offer of supporting
precedent also fails. Neither case they cite B.
supports their argument that once they Compaq also argues that the district court
establish (1) the lack of conflict between the applied an impermissibly lax adequacy stan-
representatives and the absent class members dard. We address this issue to guide the
and (2) the adequacy of class counsel, district court on remand.
adequacy of class representation is
“presumed.” In Kalodner v. Michaels Stores, Compaq’s basic contention is that when
Inc., 172 F.R.D. 200, 211 (N.D. Tex. 1997), assaying whether the named plaintiffs are ade-
for example, the court merely presumed the quate, a court must account for PSLRA’s sub-
adequacy of class counsel. Likewise, in stantive goals. In responding to this assertion,
Longden v. Sunderman,13 even though the we analyze the PSLRA and our precedent. Al-
court concluded that “the qualifications and though the extent of the PSLRA’s impact on
experience of class counsel is of greater the rule 23 inquiry is a matter of first im-
consequence than the knowledge of class rep- pression in this circuit, we are guided by anal-
resentatives,” there is no mention of any “pre- ogous precedent involving other statutes. Ad-
sumption” whereby evidence of a lack of con- ditionally, we consider the particular statutory
flict together with evidence of counsel’s com- change effected by the PSLRA.
petency, without more, conclusively
establishes the adequacy of class As an initial matter, we articulate the
representation. adequacy standard outside of any specific
statutory context. The district court cited
In sum, the district court’s “presumption” Surowitz v. Hilton Hotels Corp., 383 U.S. 363
of adequate class representation “in the (1966), for the notion that “[a]dequacy is a
absence of any specific proof to the contrary” low threshold.” This is a misapplication of
is reversible error on two grounds. First, it in- Surowitz.
verts the requirement that the party seeking
certification bears the burden of proving all Although “often cited inaccurately to sup-
elements of rule 23(a). Second, it effectively port arguments that plaintiffs with little
understanding of the facts or theories of their
claims and little incentive to monitor the lit-
13
igation can nonetheless be adequate class rep-
123 F.R.D. 547, 557-58 (N.D. Tex. 1988)
resentatives,”14 Surowitz did not address the
(“In order to satisfy the requirements of rule
23(a)(4) that the representative parties fairly and
adequately protect the interests of the class, the
14
interests of the class representative must not be See Elliot J. Weiss and John S. Beckerman,
antagonistic to those of the remaining class Let the Money Do the Monitoring: How
members, and the representative parties, through Institutional Investors Can Reduce Agency Costs
their attorneys, must be prepared to prosecute the in Securities Class Actions, 104 YALE L.J. 2053,
action vigorously.”). (continued...)
7
adequacy requirement, but concerned only the Once the generic standard is understood,
verification of a complaint. Just as Surowitz the indagation becomes whether, and to what
did not hold, this circuit has never read Suro- extent, the statute affects the standard. “[T]he
witz so broadly as to support the proposition class determination generally involves
that a class representative who does not considerations that are enmeshed in the factual
understand any of the legal relationships or and legal issues comprising the plaintiff’s cause
comprehend any of the business transactions of action.” See Castano, 84 F.3d at 744
described in the complaint nonetheless may be (citing Coopers & Lybrand v. Livesay, 437
“adequate” for purposes of class certification. U.S. 463, 468 (1978) (internal quotation
marks and citation omitted)).16 Likewise, we
To the contrary, we have described “[t]he have called for rule 23 to be interpreted to
adequacy requirement [as one that] mandates accommodate the substantive policies of the
an inquiry into . . . the willingness and ability governing statute.17
of the representatives to take an active role in
and control the litigation and to protect the Indeed, this court’s pre-Reform Act
interests of absentees.” Horton, 690 F.2d at precedent outside the context of securities
484. Likewise, even in Gonzales v. Cassidy, fraud litigation already has recognized the
474 F.2d 67 (5th Cir. 1973), which interpreted importance, when making the adequacy
rule 23(a)’s adequacy requirement somewhat determination, of assessing “the willingness
more loosely, we insisted that “it must appear and ability of the representatives to take an
that the representative[s] will vigorously pro- active role in and control the litigation.” See
secut e the interests of the class through Horton, 690 F.2d at 484. Although, certainly,
qualified counsel.” Id. at 72 (5th Cir. 1973). class representatives need not be legal scholars
Both understandingsSSeven accepting the and are entitled to rely on counsel, plaintiffs do
variance between themSSrequire the class
representatives to possess a sufficient level of
knowledge and understanding to be capable of 15
(...continued)
“controlling” or “prosecuting” the litigation.15 added).
16
Coopers & Lybrand involved securities
fraud, albeit in the context of pre-Reform Act law.
14
(...continued) Whether the case was pre- or post-Reform Act
2127 n.254 (1995). does not affect the principle at issue here: When
making a class certification determination, courts
15
The Investors’ proffered cases undermine should consider the applicable legal landscape. It
their claim. Even those opinions that privilege the would be somewhat inconsistent for us to rely on
counsel’s qualifications over the class Coopers & Lybrand when creating precedent such
representatives’ knowledge admit that the as Castano and then not applySSor at least not
representatives’ level of knowledge remains a inquire as to the applicability ofSSCoopers & Ly-
relevant factor. See, e.g., Longden, 123 F.R.D. at brand in a securities fraud case such as this one.
558 (“In analyzing the ‘vigorous prosecution’
17
element of the adequacy requirement, the Court See Redditt v. Miss. Extended Care Ctrs.,
concludes that the qualifications and experience of 718 F.2d 1381, 1388 (5th Cir. 1983) (stating that
class counsel is of greater consequence than the courts must interpret rule 23 to accommodate the
knowledge of class representatives.”) (emphasis substantive policies of title VII) (citations omitted).
8
need to know more than that they were defendants are not entitled to challenge the
“involved in a bad business deal.” Kelley v. appointment of lead plaintiffs, this reference
Mid-America Stables Racing, Inc., 139 F.R.D. merely reflects recognition by Congress that its
405, 410 (W.D. Okla. 1990). 18 Unoccupied overlay of the lead plaintiff provisions in class
space exists between these positions for the actions should not be interpreted to limit
purpose of preserving meaningful defendants’ ability to challenge the adequacy
consideration of the class representatives’ or typicality of the proposed class
knowledge about, or control of, the litigation. representatives in the context of class
certification. The district court erred in failing
Any lingering uncertainty, with respect to to consider the adequacy requirement through
the adequacy standard in securities fraud class the lens of Congress’s activity in this area.
actions, has been conclusively resolved by the
PSLRA’s requirement that securities class ac- III.
tions be managed by active, able class In summary, it follows that in complex class
representatives who are informed and can action securities cases governed by the
demonstrate they are directing the litigation. PSLRA, the adequacy standard must reflect
In this way, the PSLRA raises the standard the governing principles of the Act and,
adequacy threshold. particularly, Congress’s emphatic command
that competent plaintiffs, rather than lawyers,
The Investors, in response, rely on direct such cases. Accordingly, to the extent
legislative history: “The provisions of the bill that the district court’s adequacy analysis
relating to the appointment of a lead plaintiff failed to assess the representatives’ own
are not intended to affect current law with qualifications “to take an active role in and
regard to challenges to the adequacy of the control the litigation,” the court departed from
class representative or typicality of the claims the correct legal standard.
among the class.” H.R. Conf. Rep. No. 104-
67, at 34-35 (1995). Assuming, arguendo, We reverse for the above error and for the
that we should even look to such legislative improper shift, from plaintiff to defendant, of
history here, it appears that because the burden of proof regarding an element of
rule 23. Precedent and due process concerns
require that courts protect potential class
18
Kelley provides a useful example for this members by ensuring that the named plaintiffs
circuit. There the court noted, and we agree, that demonstrate their adequacy. Class action law-
it is not enough that plaintiff’s counsel are suits are intended to serve as a vehicle for cap-
competent if the plaintiffs themselves almost totally able, committed advocates to pursue the goals
lack familiarity with the facts of the case. See Kel- of the class members through counsel, not for
ley, 139 F.R.D. at 409-11. The Kelley court was
capable, committed counsel to pursue their
concerned not only that the plaintiffs lacked
familiarity with the facts, but also that counsel
own goals through those class members.
apparently was the source of plaintiffs’
information. We see these as two separate re- VACATED and REMANDED.
quirements: Plaintiffs should understand the
actions in which they are involved, and that
understanding should not be limited to derivative
knowledge acquired solely from counsel.
9