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E-MailJessica Erickson is Professor of Law at the University of Richmond School of Law. This post is based on her recent article, published in the Vanderbilt Law Review.
Securities class actions, like nearly all class actions in the United States, are ostensibly opt-out lawsuits. Under the opt-out model, individuals who fall within the class definition are automatically members of the class unless they take affirmative steps to opt out. This model is meant to ensure that individuals who do not have the financial incentive to opt into a lawsuit nevertheless get their day in court. Yet the reality has never been this rosy. True, class members in securities class actions are automatically part of the litigation, but that does not mean that they will get any money as a result. Even if a securities class action ends with a multi-million dollar settlement, investors do not receive any money from the settlement unless they file a claim as part of a complex claims administration process.
A well-known empirical study found that investors often fail to participate in the claims process. This study, which was published in 2005 by Professors James Cox and Randall Thomas, revealed that less than one-third of large institutional investors actually filed claims in securities class actions. The percentage is likely even smaller for less sophisticated investors. This study sparked a number of changes in the claims administration process, including a burgeoning industry of third-party claim filers that assist larger institutional investors with filing their claims. As a result, the percentage of submitted claims is likely higher today. Still, however, no one thinks that all or nearly all shareholders receive their share of the settlement funds. Opt-out securities class actions are still opt-in, at least if investors want their money.
No one set out to create an opt-in requirement for securities class actions. The complexities of the claims administration process developed not out of malice, but because courts do not think they have another way to accurately distribute settlement funds. In a securities class action, damages are based in large part on the number of shares that each class member purchased in the defendant corporation during the class period, as well as the price they paid for those shares. There is no global database that tracks securities purchases down to the level of individual customers. As a result, the only way to identify class members has been to require them to identify themselves, typically by filing a claim and documenting their transactions. In short, the opt-in requirement at the settlement stage is a result of a critical gap in the available data.
The data now exists to automate this process. My article identifies two possible ways to automate the distribution of settlement funds in securities class actions. The first approach relies on market innovation. Right now, only individual banks and brokers have records that identify transactions by particular customers in a company’s securities. Each bank and broker has data that identifies their own customers’ transactions, but there is no centralized database that collects this data. Yet claims administrators could create an automated system that collected the relevant information from individual banks and brokers. This system could then calculate each class member’s pro rata share of the settlement and send them their money. This approach will require the cooperation of multiple players, including courts, banks, brokers, and plaintiffs’ attorneys, but it would not be technologically difficult to obtain the customer data and distribute the settlement funds.
The second solution relies on regulatory innovation. Right now, there is not a centralized database that tracks all transactions in a given corporation’s securities. Yet the Securities & Exchange Commission (“SEC”) is on the verge of creating exactly this database. Spurred by a desire to shed light into the dark web and catch insider trading, the SEC has authorized the creation of the consolidated audit trail, or CAT. Once the CAT is up and running, it will include a complete record of nearly all securities transactions, including approximately 58 billion records every day of orders, executions, and quote life-cycles for equities and options markets. In other words, the CAT will likely contain exactly the type of data that is needed to automate the distribution of settlement funds in securities class actions. The SEC currently places strict limitations on the use of this data, so the SEC will almost certainly need some convincing to use the CAT data in this way. Doing so, however, would help fulfill the SEC’s mission of investor protection and complement the agency’s own enforcement agenda.
My article argues that the legal system should explore both market and regulatory approaches to automating the distribution of settlement funds in securities class actions. The current claims administration process was developed at a time when the data needed for automation was not available. Today, however, this data is within reach, both through individual outreach to banks and brokers and through the SEC’s promised CAT database. Neither system is turnkey right now, but both have the potential to revolutionize the way that investors recover money lost to fraud.
Finally, although my article focuses on securities class actions, it has broader implications. Many other types of class actions face similar problems when it comes to distributing settlement funds. The problems in securities class actions are particularly well-documented, which makes these lawsuits an obvious starting point in any effort to reform the distribution of settlement funds. Yet, in a world of increasing data sophistication, it may be possible to use similar measures to automate the distribution of settlement funds in other types of aggregate litigation as well. The article is therefore intended to spur a broader conversation about modernizing this stage of the litigation process.
The complete article is available here.
