Lead Plaintiffs and Their Lawyers: Mission Accomplished, or More to Be Done?

In our chapter for the forthcoming Research Handbook on Shareholder Litigation, Lead Plaintiffs and Their Lawyers: Mission Accomplished, or More to Be Done? (to be published by Elgar Publishing) we survey the literature relating to the lead plaintiff provision under the Private Securities Litigation Reform Act (PSLRA). Prior to the enactment of the PSLRA in 1995, individual investors served as largely figurehead class representatives. Because class action lawyers typically had a much greater interest in the class recovery than the named class representatives, plaintiffs lacked the incentive to monitor class counsel.

The goal of the lead plaintiff provision of the PSLRA was to shift the balance of power between shareholders and class action lawyers by allowing investors with the most substantial losses to take control over securities fraud class actions. The hope was that lead plaintiffs with greater “skin in the game” would have appropriate incentives to monitor class counsel to ensure that settlements served shareholder interests, and in particular, negotiate lower attorneys’ fees on behalf of the class.

The empirical studies of the lead plaintiff provision to date demonstrate a substantial impact on securities fraud class actions. The provision has encouraged institutional investors to participate in securities class actions. There is evidence that institutional investors are more likely to volunteer as lead plaintiffs in the strongest cases, and that they may play a role in ensuring greater recovery for investors in those cases. In addition, institutional investors seem to have reduced the share of recovery that goes to pay lawyers post-PSLRA. In sum, the PSLRA has changed the game for securities class action lawyers, who now must compete to be selected as counsel.

The benefits from increased competition facilitated by the lead plaintiff provision are undercut, however, by political contributions made by plaintiffs’ lawyers. The larger institutional investors that have most frequently agreed to serve as lead plaintiffs in securities class actions have been government-sponsored pension funds. Many of these funds are managed directly by politicians, such as state comptrollers, who must campaign to retain their current positions, or may have designs on higher offices. Alternatively, these funds are managed by political appointees, who typically owe their position to the state’s governor. The political influence over these funds raises the question whether law firms are making campaign contributions to politicians to enhance their chances of being selected to represent the funds. The available evidence raises suspicion that at least some class action law firms are buying lead counsel status with campaign contributions, i.e., lawyers are paying to play. Not surprisingly, government officials receiving campaign contributions appear to be less vigorous overseers of class action counsel, with fees significantly higher in these cases.

We suggest additional reforms to promote transparency and competition among lawyers for lead plaintiffs. Specifically, courts appointing lead plaintiffs should inquire whether campaign contributions have been made to politicians controlling or affiliated with the institution. Disclosure of such contributions at the time that the lead plaintiff was being selected would allow for disqualification of funds that have received pay-to-play at the outset. In addition, the limits on repeat plaintiff status should be tightened to recognize that government officials may have decision-making authority over multiple pension funds. Institutions seeking lead plaintiff status should be required to disclose not only their own involvement in prior cases, but also that of affiliated funds. Finally, competition would be further enhanced if investors seeking lead plaintiff status were required to publicly disclose their fee arrangements with their proposed lead counsel. Disclosure of fee agreements at the time that investors were seeking to be appointed lead plaintiff would provide tangible evidence that a prospective lead plaintiff was interested in promoting the interests of the investor class members, rather than the lawyers. Moreover, insofar as the PSLRA seeks to promote competition amongst lawyers for work in securities class actions, market forces cannot work effectively unless the market is transparent. Forcing proposed fee agreements out in the open will make prices clear for courts that do not see a high volume of these cases.

We also suggest reforms to the lead plaintiff provision intended to enhance the screening effect of the PSLRA. Figurehead plaintiffs with nominal losses continue to appear in securities fraud class actions when there is little or no competition for lead plaintiff status. The suspicion is that many of these cases are brought with no expectation that the plaintiffs could prevail at trial, but rather with the hope that the defendants’ insurance carrier will pay a nominal settlement to make the case go away. That hope is not unrequited: with a median settlement of just over $6 million in securities fraud class actions, it is possible that nearly half of cases that are not dismissed are being settled for nuisance value. To discourage this abuse, we propose a standing requirement that would preclude shareholders with only nominal losses—perhaps less than $50,000 or $100,000—from serving as a class representative in a securities fraud class action. We suggest this standing requirement be bolstered fee-shifting applicable to shareholders with more substantial losses, but still below $1,000,000 in provable losses. Under this proposal, fees would be imposed on plaintiffs’ attorneys if their cases were dismissed on a motion to dismiss or summary judgment, and awarded to them if they prevailed on summary judgment or at trial. A fee-shifting provision for nominal plaintiffs would give defendants an incentive to resist cases that are lacking in merit, as it appears that many are, and to settle early in cases with merit. At the same time, a plaintiffs’ attorney who genuinely believes they have a strong case should not be dissuaded from bringing suit by the risk of a fee award. If they prevail, they get an additional award of fees. Even if they lose at trial, they would not be on the hook for the defendant’s fees. The upshot would be more efficient screening of potential securities fraud cases with less judicial time spent assessing them.

The full paper is available for download here.