Second Circuit Holds Federal District Court that Approved Settlement of Class Action had Supplemental Jurisdiction Over Subsequent Class Action Against Class Counsel Alleging Malpractice and Properly Granted Defense Motion to Dismiss
Class members in a securities fraud class action against Bennett Funding Group (BFG) filed a putative class action against the attorneys who served as class counsel in the BFG action alleging negligence in failing to name Arthur Andersen as a defendant. Defense attorneys moved to dismiss the lawsuit. The district court granted the motion and plaintiffs appealed. The Second Circuit remanded the matter to allow the district to explain the basis of federal court jurisdiction, and then affirmed both the existence of jurisdiction and the judgment of dismissal. Achtman v. Kirby, McInerney & Squire, 464 F.3d 328, 330-31 (2d Cir. 2006). The 1996 class action against BFG alleged a Ponzi scheme that cheated investors out of $500 million. Two law firms were appointed as lead counsel, Kirby, McInerney & Squire, and Bernstein, Litowitz, Berger & Grossman. While counsel named several co-defendants, they did not name Arthur Andersen “which had audited BFG’s allegedly misleading 1989 and 1990 financial statements.” Id., at 331. The district court ultimately approved a $139 million settlement of that class action, which included a $14 million settlement with the accounting firm that succeeded Arthur Andersen as BFG’s auditor. Id. Some individual BFG investors “met some success” in suing Arthur Andersen, but when efforts were made in 1999 to bring a class action against the company, the federal court dismissed the complaint as time-barred. The malpractice class action against Kirby and Bernstein followed premised upon (1) the failure to name Arthur Andersen as a defendant, (2) the failure to name Arthur Andersen in the Notice of Pendency as a party who could be sued but had not been sued, and (3) the failure to advise class members of the statute of limitations for claims against Arthur Andersen. As noted above, the federal courts agreed with defense attorneys that the complaint failed to state a claim. Id., at 331-32.
Preliminarily, the Circuit Court held that the federal courts had supplemental jurisdiction over the malpractice action. Achtman, at 334-36. In the Second Circuit, “disputes are part of the ‘same case or controversy’ within § 1367 when they ‘derive from a common nucleus of operative fact.’” Id., at 335 (citations omitted). The Court found itself “compelled” to find such a common nucleus in this case, explaining at page 336:
The district court has managed the consolidated BFG securities class actions since 1996 and has approved a series of settlements totaling more than $166 million since that time. In the course of approving those settlements and the resulting fee awards, the court found defendants’ representation reasonable and adequate several times. [¶] The district court was thus well-placed to consider the issues that would arise in the malpractice action, including questions as to whether Kirby and Bernstein asserted all appropriate claims. In addition, the district court was intimately familiar with Kirby and Bernstein’s overall strategy and the time they spent pursuing their clients’ interests.
Turning to the merits, the Circuit Court held that the malpractice complaint “failed to allege negligent conduct by Kirby and Bernstein.” Achtman, at 337. The failure to name Arthur Andersen as a defendant was made for “legitimate reasons” and “there was serious doubt as to auditor securities liability” at that time. Further, damages were problematic because “the BFG securities issued on Andersen’s watch had been largely paid down by the time of the BFG suits.” Id. Finally, while some individual claimants secured settlements from Arthur Andersen, other individual claimants had been threatened with Rule 11 sanctions by the district court and “none of the twenty-five class action suits filed by twenty-five different law firms in the BFG securities litigation named Andersen as a defendant.” Id., at 338.
The allegation that class counsel failed to list Arthur Andersen in the Notice of Pendency as a party who could be sued but had not been sued also failed: “Plaintiffs can point to no authority requiring class counsel to describe potential claims against parties not being sued” and the fact that Arthur Andersen was not a party-defendant “sufficiently alerted class members that any relief against the firm would have to be pursued independently.” Achtman, at 338. Similarly, class counsel was not required to advise class members of the statute of limitations for claims against Arthur Andersen. Id. Accordingly, the Second Circuit affirmed the judgment dismissing the malpractice class action.
NOTE: The Circuit Court rejected the district court’s conclusion that it also had jurisdiction because it had issued an injunction under the All Writs Act thereby acquiring subject matter jurisdiction over the malpractice action, and the conclusion that diversity jurisdiction exists. Achtman, at 333-34.