In the early 2000s, Pfizer Inc. was flying high on the booming sales of its blockbuster arthritis drugs Celebrex and Bextra. But things began crashing down when an independent study published in 2004 showed that patients who took the drugs had a high risk of blood clots and other cardiovascular problems. Bextra was pulled from the market; Celebrex stayed on shelves but only with a host of grim new warnings about the drug's dangers.

An avalanche of litigation ensued. For a class action lawsuit, plaintiffs firms set up websites to gather patients who took the drugs. The Department of Justice launched a probe into off-label marketing of Bextra that led to the largest-ever health fraud settlement up to that point. And investors sued. Their 2004 securities class action lawsuit is still pending today. In it, investors claim that Pfizer misled shareholders about its knowledge of the risks the drugs posed, leading to huge losses. According to the lawsuit, Pfizer lost $68.4 billion in market value between October 2004 and October 2005 as a result of the Celebrex and Bextra fallout.

But that suit isn't the only investor litigation Pfizer has to manage. On Nov. 16, 2012, a group of large institutional investors including the California Public Employees' Retirement System (CalPERS) and several mutual funds filed their own securities fraud lawsuit, opting out of the long-running class action.    

The Pfizer opt-out suit is the latest example of a growing trend in securities litigation. Large, sophisticated investors in growing numbers are choosing to go solo, taking their chances in individual lawsuits outside of massive securities class actions.   

“There's no question that large funds, insurance companies and money managers are increasingly considering pursuing direct claims for recovery outside of class actions,” says Blair Nicholas, a partner at Bernstein Litowitz Berger & Grossmann. Nicholas should know—he represents plaintiffs in pending opt-out suits against Pfizer, Countrywide Financial Corp. and several others currently in the pipeline.

Going Solo

The trend of opt-outs first gained traction a decade ago when investors were looking to recoup losses from the era of corporate scandals involving WorldCom, Tyco International Ltd. and Enron Corp. For example, New York public pension funds opted out of the WorldCom litigation and resolved their claims for $78.9 million—three times what they would have recovered as part of the investor class action. Likewise, investors who opted out of the AOL Time Warner securities class action reported results several orders of magnitude better than they would have achieved as class members—Alaskan government funds that opted out claimed recovery of 50 times what they would have received as class members and CalPERS reported receiving 17 times its estimated class recovery. 

Such results are fueling a growing perception that large investors with the wherewithal to litigate on their own can get bigger recoveries by doing so. While individual investors' claims may only involve hundreds or thousands of dollars—not enough to justify an individual lawsuit—a large investor such as a pension fund or mutual fund often has enough at stake on its own. Now large investors are using the examples from the era of corporate scandal as the model for a flurry of new opt-out litigation seeking greater control and higher recovery. 

“Class members are effectively given a take-it-or-leave-it offer to participate in the class settlement or go home,” says Neal Troum, a lawyer at Stradley Ronon Stevens & Young. “This may suit many institutional investors just fine, as they need not devote resources to assist the attorneys litigating the case. The trade-off to such a lack of involvement, however, is that pennies on the dollar are not uncommon in a class recovery.”  

Driver's Seat

In addition to the possibility of recouping more of their losses, large investors who choose to opt out of securities class actions are reaping other important litigation advantages.

One such advantage is that opt-out plaintiffs can pursue broader legal theories and remedies. Under the Securities Litigation Uniform Standards Act, federal securities laws preemept claims arising under state common law or statutory schemes in any class action involving more than 50 plaintiffs. Likewise, certain federal theories—such as claims premised on the plaintiff's actual reliance on the defendant's alleged misrepresentation—cannot be litigated in a class action. 

“Those claims are nearly impossible to litigate on a class basis because it's an individual question of fact regarding each plaintiff's reliance,” Nicholas says. “In a class, you can't take advantage of those claims. In the Countrywide case, we filed a state law case on behalf of CalPERS under the California Corporations Code.”

Individual claims also permit sophisticated plaintiffs to direct and manage the litigation and to hire counsel of their choice. Finally, opt-out plaintiffs achieve a significant strategic advantage by being able to piggyback on the work already done in the class action. Typically, significant discovery has already been completed before any opt-out deadline. Plaintiffs can use that information to make litigation of the opt-out case more efficient and economical. Achieving a speedier resolution may be the key consideration for the growing number of investors choosing to opt out.

“Class settlements are laborious processes, requiring court approval, a fairness hearing and public input on whether the class is getting a fair shake,” Troum says. “Enter into your own bilateral settlement with a securities fraudster, however, and the terms of the settlement, including the timing of the recovery, are up to you.”

Risky Endeavors

For public companies, the growing number of opt-out claims is shifting their risk-management equation and raising the expense of both litigation and settlement of securities cases.

“Companies can end up in very expensive, multifront wars—a shareholder derivative action, a class action and government enforcement,” says Kevin LaCroix, an attorney and executive vice president of D&O insurance intermediary RT ProExec. “Add to that the cost of opt-out litigation, [and] you need to take the possibility of a serious opt-out action into account when looking at your 'worser case scenarios' for determining how much insurance is needed. A well-advised board needs to be aware of this risk and involved with the decision-making.”