The Business of Securities Class Action Lawyering

Stephen Choi is the Murray and Kathleen Bring Professor of Law at the New York University School of Law, Jessica M. Erickson is the Nancy Litchfield Hicks Professor of Law at the University of Richmond School of Law, and Adam C. Pritchard is the Frances and George Skestos Professor of Law at the University of Michigan Law School.  This post is based on their recent paper. Related research from the Program on Corporate Governance includes Rethinking Basic (discussed on the Forum here) by Lucian Bebchuk and Allen Ferrell.

Plaintiffs’ lawyers in the United States play a key role in combating corporate fraud. Shareholders who lose money due to fraud can file securities class actions to recover their losses, but most shareholders do not have enough money at stake to justify overseeing the cases filed on their behalf. As a result, plaintiffs’ lawyers control these cases, deciding which cases to file and how to litigate them. Recognizing the agency costs inherent in this model, the legal system relies on lead plaintiffs and judges to monitor these lawyers and protect the best interests of absent class members. Yet there is remarkably little data on the business of securities class action lawyers, leaving lead plaintiffs and judges to oversee this area without the tools to understand how it works.

Our latest article, The Business of Securities Class Action Lawyering, is the largest academic study to date of the law firms that help shareholders recover money lost to corporate fraud. Our study is based on hand-collected data from the case records of all federal securities fraud class actions filed against public companies between 2005 and 2018—approximately 2500 lawsuits. This data allows in-depth analysis of the business behind securities class action lawyering.

Our data yields a number of significant insights into this area of practice. We first examine the specific business models of the law firms that participate in these cases as plaintiffs’ lawyers, finding the business of securities class action lawyering is far more complex than prior scholarship has recognized. Contrary to conventional wisdom, there are not two tiers of plaintiffs’ law firms; instead, there are multiple tiers of firms, each with its own client base, litigation patterns, and revenue model. We also find a previously unrecognized category of firms playing secondary roles in these cases, including many that appear to connect lead counsel firms with investors willing to serve as lead plaintiffs.

We start with the law firms at the top that have the largest average settlements. Firms in this top tier make more than 75% of the total estimated revenue, and most of this revenue is made by just two firms: Robbins Geller Rudman & Dowd, and Bernstein Litowitz Berger & Grossman. For cases filed during the period of our study, we estimate that each of these generated fees in excess of $1 billion. All the other firms in the market compete for a much smaller piece of the pie. This market concentration is the result of federal legislation that encourages large institutional investors to serve as lead plaintiffs in these lawsuits. The firms that succeed in recruiting these investors as clients are then able to secure the lead counsel role in the most lucrative cases, which are heavily skewed toward corporate defendants having the largest market capitalization.

Below this top tier of law firms are several other categories of law firms, each with its own client base, litigation strategy, and revenue model. Firms that we classify as middle tier and bottom tier produce substantially smaller average settlements: $13.3 million and $5.2 million, respectively, compared to $76.5 million for firms in the top tier. The firms in these bottom two tiers are much more likely to rely on individual lead plaintiffs, and these firms face substantially less competition when seeking lead counsel status. We also find significant differences in the suits that firms in the lower tiers bring with respect to objective characteristics commonly associated with fraud, including SEC and other government investigations, officer terminations, and restatements.

At the very bottom is a category of merger objection law firms. These firms rarely if ever produce monetary settlements for investors, but instead appear to making a living filing suits and then dismissing them in exchange for “mootness” fees not subject to court approval. These firms do very little litigating beyond the filing of mostly boilerplate complaints.

We also highlight a category of “Additional Counsel,” who are not formally appointed by the court. Although most of the firms in our study play this role in at least some cases, a surprising number of firms specialize in this role. Curiously, many do not submit hours as part of the fee application once the case gets settled. Instead, these firms appear to serve a match-making role connecting prospective lead plaintiffs with the firms seeking appointment as lead counsel.

After providing this overview of the market, we present data that may help prospective lead plaintiffs and judges select and compensate lead counsel. We first find that prospective lead plaintiffs do not have the information they need when selecting lead counsel. Prospective lead plaintiffs vary widely in their selection processes, and law firms often do not present representative data about their records in their pitches to shareholders and courts. Our data instead highlights specific metrics that prospective lead plaintiffs and judges can use to compare law firms going forward.

Second, we find that that judges’ fee awards consistently fail to account for firm performance or risk in any systematic way. Fee awards are supposed to reward law firms for the results they achieve, while also compensating them for the risk inherent in contingency fee litigation. Yet our analysis suggests that judges base their awards largely on the size of the settlement, rather than factors that reflect the law firms’ own contributions and risk. Judges are impressed by large settlements, but they are less inclined to look behind the settlements to figure out how much credit the law firms deserve for achieving them.

We build on these empirical observations by proposing reforms at two stages of the litigation process. At the front end, we provide a framework for the selection of lead counsel. Lead plaintiffs and judges are charged with selecting and approving lead counsel, but they are not experts in securities class actions and they have limited time to devote to oversight of these cases. We therefore offer a list of specific questions that lead plaintiffs and judges can use to evaluate competing law firms. These questions are based on our empirical findings and would allow lead plaintiffs to focus on firms’ relative performance, while giving judges the information they need to uncover potential conflicts of interest.

At the back end, we suggest changes that would bring more analytical rigor to the fee award process. When deciding on a fee award, judges should request standardized information from the law firms, including relevant data from comparable cases and details about the law firms’ own work on the cases. We explain how judges can use this information to set fee awards that reflect law firm performance and risk. Taken as a whole, these reforms would improve the ability of lead plaintiffs and judges to hire and compensate securities class action law firms.

The complete paper is available for download here.

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