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July 24, 2008 6:26 PM

Securities Class Action System Threatening Capital Markets

Posted by Brian Baxter

If you thought the plaintiffs bar was dead, then you probably didn't make it to a luncheon at the University Club of New York on Thursday cosponsored by the Manhattan Institute for Policy Research and the U.S. Chamber of Commerce's Institute for Legal Reform (ILR).

With nary a plaintiffs lawyer in sight--a dartboard bearing Bill Lerach's poofy visage might have made for a more appropriate backdrop to the dais instead of the portrait of former University Club president (and lawyer) Henry Anderson--the audience of lawyers, judges, journalists, and business executives listened to an all-star panel discuss the problems plaguing the current securities class action system.

Statistics from the ILR report, "Securities Class Action Litigation: The problem, its impact, and the path to reform," were released beforehand to rile up the generally staid crowd. Plaintiffs lawyers and their "middlemen" have raked in nearly $17 billion in fees over the past decade. Total class action payouts in the same timeframe amounted to approximately $51.8 billion. New filings in the first half of this year have increased 60 percent over the same time period last year. And on it went...

"Most businesses decide to settle even the most baseless of claims," said former Akin Gump Strauss Hauer & Feld partner and current ILR president Lisa Rickard in her opening presentation. "Plaintiffs lawyers know this. Why take even a 5 percent chance on [getting hit with] a $2 billion class action award, if you can pay $100 million to make it all go away?"

Public enemy number one was Bill Lerach himself. Rickard repeatedly invoked Lerach's own words from a July 2008 Portfolio magazine essay, especially his claim that paying plaintiffs was "industry practice." Rickard wants Congress to investigate Lerach's claims, noting that the changes instituted with the Private Securities Litigation Reform Act (PLSRA) of 1995 haven't gone far enough.

"[Plaintiffs lawyers] are very entrepreneurial people and [most of us] probably wish they were doing something else that benefits our economy," said panelist Andrew Pincus, a litigation partner at Mayer Brown. While the PLSRA was able to give more power back to institutional investors rather than individual plaintiffs, says Pincus, plaintiffs lawyers have used this to their advantage by co-opting the big public pension funds.

"Why are New York [plaintiffs] lawyers donating money to state senate races in Ohio?" asked Pincus. The answer: so those politicians--like former New York State Comptroller Alan Hevesi--can make appointments to the boards of public pension funds that will keep those firms in mind when it comes to lead counsel appointments.

Panelist Alyssa Kelman, assistant general counsel of JPMorgan Chase, said the situation is so bad for companies that whenever JPMorgan makes an acquisition, she thinks the bank will be sued for either paying too much or too little. "Then we just wait for the ERISA suit and the shareholder derivative suits," said Kelman, adding that the company "got slammed" by a wave of new suits in January stemming from the downturn in the capital markets.

In Kelman's view, whenever a company's stock price goes down, it opens the way for a "plaintiffs fishing expedition" for possible fraud. "There needs to be a way to test these cases for sufficiency instead of them being filed whenever there's a bad news report," she said. "Every dollar we spend on litigation is one dollar we don't spend on increasing shareholder value."

Kelman offers one possible solution: take a page from New York State courts, which allow interlocutory appeals to stay a case before it enters costly discovery.

The panel--moderated by Manhattan Institute Center for Legal Policy director James Copeland--also included University of Michigan Law School professor Adam Pritchard and ILR special counsel Cheryl Evans.

They offered up a few other solutions, which were on the whole embraced by the audience, but would probably make the hair on Lerach's neck stand up at his new home in Lompoc, Calif.

-Make plaintiffs lawyers invest in their own cases by implementing cost-sharing. Since plaintiffs lawyers can reap enormous benefits by just filing cases, they currently have no incentive to be rational. Making plaintiffs counsel share in the costs of discovery will reduce the amount of frivolous cases and any out-of-pocket costs can always be recouped if certain cases are successful.

-Ensure that costly discovery doesn't proceed--a tactic used by plaintiffs to enact settlements--if there are motions to dismiss pending.

-Increase scrutiny on political contributions made by lawyers that are seeking lead counsel appointments in class action cases and bring transparency to the process for those appointments.

"We need to implement common sense reforms to clean up trial lawyer abuses," Rickard said. "Only that way can we fix the broken, wasteful, and duplicitous securities class action system that harms our capital markets."

But Roger Moak, a certified class action arbitrator in New York, raised an interesting point during a brief Q&A period towards the end of the discussion. What about the "incompetence, greed, and sheer stupidity" demonstrated by companies that have lost billions for their shareholders?

Doesn't the fact that relatively few underperforming or outright incompetent CEO's get fired at least partially contribute to the increase in securities class actions?

Absolutely, said the University of Michigan's Pritchard. "Often the cleanest and most effective remedy for bad management is a good firing," he said, noting that he was reassured by a trend showing that more CEO's are getting fired today than ever before.

But securities class action plaintiffs lawyers can’t take those numbers to the bank.

Download the ILR Securities Class Action Litigation Report.

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