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August 9, 1993


The opinion of the court was delivered by: VAUGHN R. WALKER

 The settlement of these consolidated class and derivative actions must be disapproved because, although plaintiffs' claims appear to be weak and the consideration offered by Oracle to settle the class action is relatively large, the court is unable to conclude that the Oracle directors who approved the derivative settlement acted with the independence required under Delaware law.


 The first complaint in this securities class action litigation arrived in the clerk's office on March 29, 1990, two days after Oracle Systems Corporation, a Delaware corporation with its principal place of business in California, announced what many analysts considered to be lower-than-expected earnings, and a day after the price of Oracle's stock fell by thirty-one per cent. In the ensuing weeks, law firms from around the country filed eighteen more class action complaints, all of which alleged that Oracle and certain of its officers and directors ("the individual defendants") *fn1" had violated the federal securities laws by failing promptly to disclose unfavorable information about Oracle's financial health. A later amendment added Oracle's auditor, Arthur Andersen & Co, as a defendant in the class action. Various lawyers also filed two derivative actions on behalf of Oracle against the individual defendants, alleging that they breached their fiduciary duties to the corporation and its shareholders by engaging in insider trading and mismanaging Oracle in a manner that reduced Oracle's profitability and subjected it to litigation expenses and potential liability from the class action. The derivative plaintiffs never named Arthur Andersen as a defendant in their action, but entered into a tolling agreement with Arthur Andersen on October 23, 1992. The court consolidated the derivative and class actions on May 15, 1990.

 Not surprisingly, in December 1992, the parties notified the court that they had reached settlements for the class and derivative actions. See J. Cooper Alexander, Do the Merits Matter?: A Study of Settlements in Securities Class Actions, 43 Stan L Rev 497, 526 (1991) ("Indeed, no securities class action has [ever] gone through trial in the Northern District of California, where many such cases are filed"). At a status conference on February 1, 1993, the parties outlined the terms of the proposed settlements and the court scheduled a settlement approval hearing for April 22, 1993. The salient terms of the proposed settlements are as follows:

 - In exchange for dismissal of the class claims and entry of final judgment, Oracle will pay $ 23.25 million (in five installments to run through April 15, 1994) and Arthur Andersen will pay $ 1.75 million to a class settlement fund.

 - Up to $ 200,000 of the class settlement fund may be used by class counsel to pay various expenses incurred in notifying class members and administering distribution of the fund. *fn2"

 - Up to $ 4.8 million of the class settlement fund may be used to pay class counsel's fees, and $ 825,000 for its expenses, in accordance with the fee plans previously approved by the court.

 - The derivative plaintiffs agree to dismiss their claims against the Oracle defendants and any prospective claims against Arthur Andersen without receiving any concrete, present consideration. The derivative settlement agreement notes that dropping the derivative action will reduce Oracle's future litigation expenses and that, as a result of the prosecution of the derivative action, Oracle has made certain changes in its insider trading and revenue recognition policies.

 - Oracle will pay up to $ 750,000 to derivative counsel for fees and costs expended in prosecuting the derivative action.

 - The derivative plaintiffs agree to release the individual defendants from liability for settling the class or derivative actions.

 - The class settlement agreement and the derivative settlement agreement are contingent upon one another. That is, the class settlement agreement and the derivative settlement agreement become effective only after the court has entered final judgment dismissing both the class and derivative actions.

 It is this last provision which precludes court approval of either of the settlements. Although the class settlement alone appears to be reasonable, the court is not in a position to sanction the derivative settlement. Because of the interrelation of the settlements, however, the court cannot approve either one. This order will assess the class and derivative settlements in turn.



 It is well known that counsel for the class who decide to settle a class action may not necessarily have the interests of their putative clients, the class members, at heart. See generally J. Macey and G. 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). As in all lawsuits, the interests of lawyers and their clients conflict; plaintiffs' lawyers have an interest in maximizing their own fees, while their clients hope to minimize fees and maximize the recovery. In a normal lawsuit, the court rarely gets involved in this conflict since the client presumably has the final say on all major steps in the litigation. In class actions, however, class counsel run the litigation with little or, more realistically, no input from their clients since the class members generally have relatively small individual claims which give them insufficient incentive to supervise their lawyers. When the prospect of settlement arises, the unique dynamics of the lawyer/client relationship in class actions raise particular problems: an attractive attorney fee provision in the settlement agreement may induce class counsel to settle regardless of the likelihood that further pursuit of the litigation might substantially increase the total class recovery. In recognition of this problem, FRCP 23(e) provides that "A class action shall not be dismissed or compromised without the approval of the court * * *."

 In order to protect the interests of the class members, before approving a settlement proposal, the court must determine that the proposal is "fair, reasonable and adequate." Galdi Securities Corp v Propp, 87 F.R.D. 6, 10 (SDNY 1979). Courts have identified a number of factors which are relevant in making this assessment: (1) the complexity, expense and likely duration of the litigation, (2) the reaction of the class to the settlement, (3) the stage of the proceedings and the amount of discovery completed, (4) the risks of establishing liability, (5) the risks of establishing damages, (6) the risks of maintaining the class action throughout the trial, (7) the ability of the defendants to withstand a greater judgment, (8) the range of the reasonableness of the settlement in light of the best possible recovery, (9) the range of the reasonableness of the settlement fund to a possible recovery in light of all the attendant risks of litigation. Girsh v Jepson, 521 F.2d 153 (3d Cir 1975); City of Detroit v Grinnell Corporation, 495 F.2d 448, 463 (2d Cir 1974).

 Certain of these factors are quite easy to assess here. First of all, the court is aware of only one objection to the proposed settlement. The paucity of objections is of little moment, however, because agency costs often discourage meaningful objection in securities class actions. See J. Macey and G. Miller, 58 U Chi L Rev at 19. More importantly, it is clear that this litigation is complex and that its continuation would be time-consuming and expensive. On the other hand, it is unlikely that the magnitude of the proposed settlement approaches Oracle's maximum ability to pay. See Wall St J, Mar 24, 1993, at B4 ("Oracle Systems Corp says third quarter profit rose 74% to $ 29.2 million or 20 cents a share from $ 16.8 million or 12 cents a share a year ago despite a $ 24 million charge to settle certain shareholder lawsuits; revenue rose 28% to $ 370.1 million from $ 289.6 million"). The court's inquiry must focus, then, on the reasonableness of the settlement in light of the likelihood of reaching a larger or smaller recovery should the litigation proceed further. See, e.g., Barkan v Amsted Industries, Inc, 567 A.2d 1279, 1285 (Del 1989).


 Plaintiffs' theory of the class action is that during the period July 11, 1989, through September 26, 1990 ("the Class Period"), *fn3" Oracle and the individual defendants intentionally perpetrated a series of frauds which violated §§ 10(b) and 20(a) of the Securities Exchange Act of 1934. Generally, plaintiffs allege that the defendants fraudulently altered the financial picture of Oracle by improperly recognizing revenues for contingent receivables and by giving unreasonably optimistic projections of future results. These practices, plaintiffs allege, had the effect of inflating the price of Oracle stock throughout the Class Period. *fn4" Plaintiffs do not allege that they relied directly on these alleged misrepresentations, but instead premise liability on the "fraud-on-the-market theory." See Basic, Inc v Levinson, 485 U.S. 224, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988). Plaintiffs allege that Arthur Andersen contributed to the stock price inflation by issuing materially false audit reports for Oracle and by helping Oracle to issue its own materially false reports.

 Plaintiffs' attacks on Oracle's revenue recognition policy focus on its practice of immediately recognizing revenue on licensing contracts even when payment was due up to one year in the future. The policy also allowed Oracle to recognize revenue from contracts which were signed but not received at Oracle headquarters before the end of a quarter, so long as headquarters received the contract within four business days after the close of the quarter. According to plaintiffs, Oracle's revenue recognition policy facilitated defendants' manipulation of Oracle's financial reports. Moreover, plaintiffs' accounting expert, Robert Berliner, claims that Oracle's policy for recognition of long term licensing contracts violated Generally Accepted Accounting Principles ("GAAP") and that investors were unaware of Oracle's accounting practices.

 On July 11, 1989, Oracle announced revenue and income growth for the fourth quarter of its 1989 fiscal year ("4Q 1989"), which ended May 30, 1989. On July 12, 1989, Oracle held a teleconference with financial analysts. Plaintiffs allege that the information Oracle released on these two dates understated 4Q 1989 revenue by $ 21.5 million, which enabled defendants to overstate revenue projections for 1Q 1990 and artificially inflated the value of Oracle stock. According to plaintiffs' accounting expert, the stock was also inflated because Oracle had not disclosed to investors its aggressive revenue recognition practices for long term contracts. Oracle continued this alleged fraud on September 26, 1989, when it announced its 1Q 1990 earnings without disclosing that these figures were based in part on revenues that should have been recognized earlier and on contracts where payment was not actually due until much later. Plaintiffs allege that this inflation of 1Q 1990 revenue painted an unduly rosy portrait of Oracle's financial state, and enabled Oracle to inflate revenue reports for the remainder of the fiscal year.

 Oracle allegedly perpetrated a separate fraud on January 2, 1990, when it issued its 2Q 1990 financial report. Plaintiffs allege that the 2Q 1990 report overstated net income by 30 per cent because the announced revenues improperly included approximately $ 15 million in revenue from twelve contracts, which were either signed after the quarter ended or contained contingencies which should have precluded immediate recognition.

 Oracle's alleged series of frauds began to unravel on March 27, 1990, when Oracle announced that its 3Q 1990 revenues were substantially below what it had earlier projected and what analysts were expecting. According to plaintiffs, the fraud nonetheless continued, because on the same day Oracle announced an optimistic forecast of future revenues and earnings. Oracle made some disclosure of its true financial state on August 27, 1990, when it finally acknowledged that the original January 2, 1990, report for 2Q 1990 overstated revenues for that quarter by $ 15 million. According to plaintiffs, Oracle did not fully disclose all of its frauds until September 26, 1990, ...

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