Is “Pay-to-Play” Driving Public Pension Fund Activism in Securities Class Actions?

Public pension funds have played a prominent role in securities class actions, comprising nearly half of all institutional investor lead plaintiffs. Overall, prior research has shown that the funds perform admirably in the lead plaintiff role, increasing recoveries for the class of defrauded shareholders, improving corporate governance, enhancing the independence of the board, and lowering attorneys’ fees. Recently, several articles in the business press and a concerted lobbying effort have argued that the funds’ participation in these class actions is driven by “pay-to-play”. In this context, “pay-to-play” means that politicians on pension fund boards direct the funds to obtain lead plaintiff appointments in exchange for campaign contributions from plaintiffs’ law firms. In my paper recently posted on SSRN, Is ‘Pay-to-Play’ Driving Public Pension Fund Activism in Securities Class Actions? An Empirical Study, I conclude that “pay-to-play” is, at most, a marginal factor in the funds’ participation in securities class actions.

Campaign contribution data is effectively unavailable for almost all local public pension funds (and some state funds); local funds comprise nearly two-thirds of all public pension fund lead plaintiffs. What is universally available is the funds’ board structure. While the funds’ board structure is diverse, there are two primary types of board members: (1) politicians who serve on the boards (or appoint members to it) as part of their official duties (for example, city mayors frequently serve on the boards of city pension funds); and (2) beneficiary board members whose own pensions are invested in the funds and who are elected by their peer beneficiaries to represent them. I use board structure as a proxy for “pay-to-play”, hypothesizing that if “pay-to-play” were true, politicians and political control would positively correlate with lead plaintiff appointments; there would be little sense in plaintiffs’ lawyers offering “pay” to politicians who cannot deliver the “play”.

The paper analyzes the securities litigation activity of 111 public pension funds from the years 2003 through 2006. It contains three primary findings: (1) politicians and political control of pension fund boards negatively correlate with lead plaintiff appointments; (2) beneficiary board members—and outright beneficiary control of the board—positively correlate with such appointments; and (3) the degree of a pension fund’s underfunding positively correlates with lead plaintiff appointments, particularly when the fund is controlled by beneficiaries. This evidence suggests that beneficiary board members, not politicians, drive these cases for reasons having to do with the financial soundness of the fund. I analyze the substantial role played by these members in securities class actions in light of prior research comparing such board members to corporate managers with an equity stake in a corporation. I also find no support for the theory that unions drive beneficiary board members to obtain lead plaintiff appointments, and offer evidence that resistance by politicians to lead plaintiff appointments correlates with the degree of business influence in the politicians’ home states.

The full paper is available for download here.