Berger v. Compaq Computer Corp.

• Decision Date: 25 July 2001
• Docket Number: No. 00-20875,00-20875
• Citation: 257 F.3d 475
• Parties: (5th Cir. 2001) Mark Berger, etc., et al., Plaintiffs, Mark Berger, on Behalf of Himself and All Others Similarly Situated, Plaintiff-Appellee, v. 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
• Court: U.S. Court of Appeals — Fifth Circuit

Page 475

257 F.3d 475 (5th Cir. 2001)

Mark Berger, etc., et al., Plaintiffs, Mark Berger, on Behalf of Himself and All Others Similarly Situated, Plaintiff-Appellee, v. 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.

No. 00-20875

IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

July 25, 2001

[Copyrighted Material Omitted] Appeal from the United States District Court for the Southern District of Texas

Before SMITH, DUHE, and WIENER, Circuit Judges.

JERRY E. SMITH, Circuit Judge:

In this securities litigation, the district court certified a plaintiff class and appointed class representatives. Because of legal error, we reverse and remand.

I.

On March 6, 1998, Compaq Computer Corporation announced that sales from one of its North American commercial channels were not meeting expectations and that there would be price reductions and aggressive promotions to reduce inventories. About a month later, Mark Berger, on behalf of all purchasers of Compaq stock between July 10, 1997, and March 6, 1998 (the "Investors"), sued Compaq and its directors (collectively "Compaq") complaining of violations of §§ 10(b) and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t(a), and rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. The Investors allege, inter alia, that Compaq attempted to inflate the price of its stock by fraudulently engaging in "channel stuffing," i.e., "overselling" products to distributors with the knowledge that they would not be able to resell the products to end-users at rates consistent with the company's own sales.

Thirty-nine members of the putative class collectively moved for (1) appointment as lead plaintiffs, (2) approval of their selection of lead counsel, and (3) consolidation of all related actions.¹ The court granted the motion and appointed all movants as lead plaintiffs.² The Investors then filed a consolidated amended complaint, which Compaq moved to dismiss on various grounds, including failure to meet the pleading requirements of the PSLRA and Fed. R. Civ. P. 9(b);³ the court denied the motion to dismiss and a motion for reconsideration.

While the motion to dismiss was pending, the Investors moved for class certification. Although they initially proposed that all thirty-nine lead plaintiffs serve as class representatives, that number eventually was whittled to seven, only four of whom appeared at depositions. Compaq filed a motion opposing class certification on the ground that the Investors "had not satisfied their burden of showing that the proposed representatives were directing and controlling this litigation as required by rule 23 and the Reform Act." The district court granted the motion for class certification and appointed as class representatives the four plaintiffs who had appeared at depositions.

Shortly after the certification, Compaq sought a writ of mandamus from this court directing the district court to dismiss the complaint on the ground that it did not satisfy the pleading requirements of the PSLRA. Compaq also petitioned this court to permit an interlocutory appeal of the certification order pursuant to Fed. R. Civ. P. 23(f). We denied mandamus but granted interlocutory review, and that appeal is before us now.

II.

"We review a district court's class certification decisions for abuse of discretion." Pederson v. La. State Univ., 213 F.3d 858, 866 (5th Cir. 2000). "[T]he district court maintains great discretion in certifying and managing a class action. We will reverse a district court's decision to certify a class only upon a showing that the court abused its discretion, or that it applied incorrect legal standards in reaching its decision." Mullen v. Treasure Chest Casino, LLC, 186 F.3d 620, 624 (5th Cir. 1999) (citations omitted), cert. denied, 528 U.S. 1159 (2000). "Whether the district court applied the correct legal standard in reaching its decision on class certification, however, is a legal question that we review de novo." Allison v. Citgo Petroleum Corp., 151 F.3d 402, 408 (5th Cir. 1998).

An action may proceed as a class action only if the party seeking certification⁴ demonstrates that all four of the familiar requirements of rule 23(a) are satisfied:

(1) the class be so numerous that joinder of all members is impracticable;

(2) there be questions of law or fact common to the class;

(3) the claims or defenses of the representative parties be typical of the claims or defenses of the class; and

(4) the representative parties will fairly and adequately protect the interests of the class.

Fed. R. Civ. P. 23(a). The main issue in this appeal is whether the Investors carried their burden on the fourth requirement.⁵

Rule 23(a)'s adequacy requirement encompasses class representatives, their counsel, and the relationship between the two. See 7A Charles A. Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice and Procedure § 1769.1, at 375 (2d ed. 1986). Compaq neither challenges the adequacy of class counsel nor contends that any conflict between the representatives and the class members precludes certification, so the question is whether the court applied the correct legal standard in determining the adequacy of the class representatives under rule 23, i.e., whether the putative class representatives are "willing" and "able" to "take an active role in and control the litigation and to protect the interests of absentees."⁶

This court has determined that

[t]he adequacy requirement mandates an inquiry into [1] the zeal and competence of the representative[s'] counsel and . . . [2] the willingness and ability of the representative[s] to take an active role in and control the litigation and to protect the interests of absentees[.]

See Horton v. Goose Creek Indep. Sch. Dist., 690 F.2d 470, 484 (5th Cir. 1982) (citations omitted).⁷ The adequacy inquiry also "serves to uncover conflicts of interest between the named plaintiffs and the class they seek to represent." See Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 625 (1997). Furthermore, because absent class members are conclusively bound by the judgment in any class action brought on their behalf, the court must be especially vigilant to ensure that the due process rights of all class members are safeguarded through adequate representation at all times.⁸ Differences between named plaintiffs and class members render the named plaintiffs inadequate representatives only where those differences create conflicts between the named plaintiffs' and the class members' interests.⁹

Although we do not know whether the named plaintiffs could meet the adequacy standard,¹⁰ we do know that the district court erred in two respects. First, it improperly shifted the burden of proof to the defendants by adopting a presumption that the class representatives and their counsel are adequate in the absence of specific proof to the contrary. Second, it applied an impermissibly lax standard for adequacy that ignores the PSLRA's mandate that class representatives, and not lawyers, must direct and control the litigation. The Investors' arguments to salvage both rulings are unpersuasive.¹¹

A.

The district court unquestionably adopted an incorrect legal standard by stating that "[t]he adequacy of the putative representatives and of plaintiffs' counsel is presumed in the absence of specific proof to the contrary." This is error; the party seeking certification bears the burden of establishing that all requirements of rule 23(a) have been satisfied. See Castano, 84 F.3d at 740. Falcon v. General Telephone Co., 626 F.2d 369 (5th Cir. 1980), vacated on other grounds, 450 U.S. 1036 (1981), cited by the district court, is not to the contrary.

In Falcon, id. at 376 n.8, this court merely approved the practice of taking judicial notice of the competence of class counsel.¹² Taking judicial notice of the fact that counsel is competent, however, is not the same as holding that class representatives therefore are presumed to be adequate under rule 23(a)(4). Indeed, the district court's presumption inverts the well-established rule that the party seeking certification bears the burden of establishing all elements of rule 23(a). Even more unsettling is that the district court's presumption ignores the constitutional dimensions of the adequacy requirement, which implicates the due process rights of all members who will be bound by the judgment.

The Investors' words belie the error. They characterize the district court's action not as shifting the burden of proof, but rather as a full consideration of "defendants' objections to the certified representatives' adequacy as well as evidence to the contrary presented by plaintiffs." The argument's structure confesses the error: Adequacy is for the plaintiffs to demonstrate; it is not up to defendants to disprove the presumption of adequacy.

The Investors' offer of supporting precedent also fails. Neither case they cite supports their argument that once they establish (1) the lack of conflict between the representatives and the absent class members and (2) the adequacy of class counsel, adequacy of class representation is "presumed." In Kalodner v. Michaels Stores, Inc., 172 F.R.D. 200, 211 (N.D. Tex. 1997), for example, the court merely presumed the adequacy of class counsel. Likewise, in Longden v. Sunderman,¹³ even though the court concluded that "the qualifications and experience of class counsel is of greater consequence than the knowledge of class representatives," there is no mention of any "presumption" whereby evidence of a lack of conflict together with evidence of counsel's competency, without more, conclusively establishes the adequacy of class representation.

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