Class Actions

Exercise

Build an argument trying to explain the essence of the following story. Better if you expressed it in terms of a hypothesis and propose a way of testing it. (A bit of jargon: A “shareholder class action” is a legal complaint filed by a lawyer or group of lawyers for a group of shareholders with an identical grievance, often with an award proportionate to the number of shareholders involved. In a class action, different persons combine their lawsuits because the facts and the defendant are so similar. This is designed to save Court time and to allow one judge to hear all the cases at the same time and to make one decision binding on all parties).

Securities lawsuits: Classier actions (The Economist, February 15, 2007).

Shareholder class actions are fewer in number, but bigger and better led

AFTER years of lost sleep over Sarbanes-Oxley and other post-Enron clampdowns, can America's corporate chieftains finally stop fretting so much about the threat of shareholder litigation? Some of them will be soothed by news that the Securities and Exchange Commission, the main financial-markets watchdog, wants to make it harder for “professional plaintiffs” to win securities class actions (in which investors band together to sue listed firms over accounting irregularities or abrupt dips in the share price). Others will be lulled by the recent drop-off in filings of such suits.

Wake up. Alert executives will have noticed two things that should still keep them up at night: settlements are much bigger than they were, and payouts increasingly come with strings attached. Both developments reflect the rise of a more knowing and demanding kind of plaintiff.

Last year only 110 securities class actions were filed in America, well below the average of 193 for the previous ten years, according to Stanford Law School and Cornerstone Research. But the average settlement, at $65m, was much higher than in 2001-04 and only slightly below the peak of $71m reached in 2005.

Dan Dooley of PricewaterhouseCoopers, an accounting firm, links this to the growing power of institutional investors. Until a few years ago, the status of “lead plaintiff” was mostly awarded to the first shareholder to file suit, usually an individual. But in recent years pension funds have stepped into that role with increasing gusto, exploiting a law offering leadership to the investor who has lost the most, not the one who sues first. Big institutions, including retirement funds and unions, now front more than half of all cases, double their share of five years ago (see chart).

CalPERS, America's largest pension fund, has led several class actions over the past three years, the latest being a case against UnitedHealth over its stock-option practices. The New York City Employees' Retirement System, which manages $89 billion on behalf of municipal workers, agreed last month to lead an options-backdating lawsuit against Apple. Nowadays, when S&P 500 companies are sued, a respected investor will almost always step forward to lead the disgruntled masses.

And they lead them well. Cases fronted by unions, pension funds and mutual funds result in settlements that are around one-third larger than those led by small fry, according to a recent report by NERA, a consultancy.

One source of their success is the tight leash they keep on their lawyers. They often employ their own advisers and are thus less willing to accept whatever deal counsel recommends. Plaintiff lawyers are not above wrapping things up in a hurry when progress slows and they have other battles to fight. The institutions are also better at squeezing lawyers' fees and their share of settlements. As a result, some frustrated attorneys are going out of their way to avoid such switched-on clients.

The more generous settlements may also be owing to big investors choosing cases more carefully to start with. Unlike some small shareholders, they have better things to do than wage frivolous legal battles. “Fewer lawsuits are being brought, but they are better,” says Stuart Grant, managing partner of Grant & Eisenhofer, a law firm that specialises in securities cases.

Though CalPERS and its like are keen to punish corporate miscreants, they also have a higher purpose: to improve behaviour. On top of the usual payouts, pension-fund plaintiffs increasingly insist that companies reform their governance: bringing in more independent directors, reforming executive-pay schemes, splitting the roles of chairman and chief executive, and even—in the case of TXU, a utility—creating a chief governance officer. “They may want money, but they also want to send a message,” says Adam Savett of ISS, a shareholder-advisory firm. Plaintiffs want chief executives to take a good look in the mirror before they lie awake at night.