Putting Stockholders First, Not the First-Filed Complaint

The following post comes to us from Leo E. Strine, Jr., Senior Fellow for the Harvard Program on Corporate Governance and Austin Wakeman Scott Lecturer at Harvard Law School, Lawrence A. Hamermesh, Ruby R. Vale Professor of Corporate and Business Law at Widener University School of Law, and Matthew Jennejohn, an associate at Shearman & Sterling, LLP.

The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction, and the historical development of doctrines limiting parallel state court litigation — the doctrine of forum non conveniens and the “first-filed” doctrine — this paper suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.

Putting Stockholders First responds to the observation that in 2011, only 5% of settlements of shareholder litigation challenging mergers and acquisitions involved an additional payout to stockholders, 84% of such settlements were based on additional disclosure only, but all of such settlements involved payment of fees for plaintiffs’ attorneys. These figures reflect a significant change from 1999 to 2000, when 52% of suits filed on behalf of shareholders produced a financial benefit for the class, and only 10% of settlements were “disclosure-only.”

This change suggests a systemic failure endangering the ability of representative shareholder litigation to produce net benefits to investors. Coinciding with this change has been an increase in the incidence of deal litigation brought more or less simultaneously in multiple forums. The paper suggests that these two changes may be related: in a variety of ways, litigation in multiple forums, combined with suboptimal rules governing where parallel litigation should proceed, results in “race to the bottom” behaviors in which rational participants — plaintiffs’ lawyers, directors, directors’ lawyers, and judges — are constrained to engage in activities that adversely affect the interests of issuers and stockholders. Those activities include unnecessary expedited proceedings in weak cases, quick settlements that reward bringing weak cases but sometimes shut off meritorious claims, hasty preparation of derivative complaints that fail to survive motions to dismiss, and improvident lead counsel determinations or even class certification.

Putting Stockholders First proposes that these suboptimal activities can be ameliorated by refining forum selection doctrine to create a presumption that shareholder class and derivative litigation should proceed in the forum that provides the governing law: the state of incorporation. The proposal to adopt that presumption stems from an analysis of the interests at stake in shareholder class and derivative action: as the paper explains, the most compelling interest at stake is the investors’ interest in promoting the orderly, consistent, and full development of the law governing the corporation’s internal affairs. The proposed presumption, moreover, follows the historical trend in the evolution of forum selection (forum non conveniens) doctrine away from geographical considerations to reference to the important interests at stake, including the public interest in promoting efficient capital markets based on predictable development and enforcement of governing law.

The full paper is available for download here.

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