Interview with Stanford Law Professor Joseph Grundfest About the State of Securities Class Action Litigation
Every year, the Stanford Law School Securities Class Action Clearinghouse, in conjunction with Cornerstone Research, releases its annual overview of securities class action lawsuit flings. As I noted in a post last week, this year’s version introduced a number of innovations and reflected a host in interesting observations. (The full 2010 Stanford/Cornerstone report can be found here.)
Because the securities class action litigation environment clearly is going through a significant transition, I thought it would be worthwhile to check in with the Stanford Law Professor Joseph Grundfest, who oversees the Stanford website. Professor Grundfest was gracious enough to agree to participate in an interview for this site. The interview, in the form of a Q&A, is reproduced below. My questions appear in italics, followed by Professor Grundfest’s responses.
Q. What do you think were the most important securities class action litigation trends during 2010?
A: The dramatic increase in merger related federal class securities fraud litigation. These cases were traditionally filed only in state court, but the decline in traditional securities fraud litigation appears to have generated a demand in the securities fraud plaintiff bar to find new cases to fill the litigation pipeline. Also, plaintiffs may discover that it is easier to control this litigation if they can bring cognizable federal claims, even if those claims are quite weak.
Q. What do you think were the most important judicial trends concerning securities litigation in 2010?
A: The implications of the Supreme Court’s Morrison decision continues to reverberate in the lower courts, and many observers are surprised by the vigor with which the lower courts are dismissing actions related to foreign market activity. Morrison is not being interpreted narrowly.
Q. What impact do you think that the Dodd Frank Act will have on securities litigation? Do you think the Dodd Frank whistleblower provisions will lead to significantly increased SEC enforcement activity? Are there other provisions of the Act that you think are particularly important from a litigation or enforcement activity standpoint?
A: Dodd-Frank’s bounty provisions are the joker in the deck here. If the presence of the bounty causes a material increase in SEC enforcement actions, it is reasonable to expect an increase in parallel private actions. After all, that’s the way the market works now: if the SEC files a claim that plaintiffs haven’t yet pursued, it’s only a short matter of time before a very similar private complaint is on file in federal court. There’s no reason that the market won’t work that way in response to SEC actions instituted in response to whistleblower information.
Q. You are in regular contact with directors at some the leading companies in the country. What are directors most concerned about these days? Are there particular liability exposures that you think directors are worried about?
A: Thoughtful, honest directors are most concerned with the implications of Dodd-Frank’s bounty provisions. In an ideal world, these directors would want all employees with information about potential violations to report those concerns to the appropriate authorities within the company, including the audit committee, so that prompt remedial activity (including potential self-reporting to the SEC) could take place as quickly as possible. Now, however, these directors find themselves in competition with the SEC which stands ready to offer significant financial rewards for the provision of information that might otherwise go to compliance authorities within the corporation. Honest directors, standing ready to remedy all violations brought to their attention, will now be frozen out of the information market because they simply can’t compete with the significant bounties available under Dodd Frank.
Q. You have been systematically observing securities class action litigation now for many years. What do you think are the most important securities class action trends and developments in recent years, and why?
A: It’s a business. The business responds to the forces of supply and demand, and reacts to exogenous shocks in the form of financial crises and revelations of backdating. If you analyze the securities litigation process from a purely economic perspective, otherwise mysterious behavior becomes far more transparent.
Q. Several years ago you suggested that there had been a “permanent shift” to lower securities class action litigation activity levels. I wonder what you think of that suggestion now with the benefit of the passage of time and of the opportunity to review intervening events.
A: To formally test this hypothesis, we still need several more years’ worth of data. With that caveat firmly in mind, I would like to suggest that this years’ data are consistent with that observation. The “core rate” of litigation, i.e., the number of companies named as defendants in traditional securities fraud actions, is well below the pre-Sarbanes Oxley level, once we net out the merger disclosure cases that inflate this year’s census. This observation suggests that fewer issuers are engaged in the sorts of conduct that would have stimulated litigation prior to Sarbanes Oxley. To be sure, plaintiff counsel can point to a variety of legal developments that arguably raise the bar for plaintiff recovery, but the cases likely precluded either reflect attempts to expand the scope of liability beyond the contours set by the Supreme Court, or involve weaker, more remote claims. The strong cases alleging clear frauds are, in my view, being prosecuted as strongly as ever.
Q. Are there pending cases or ongoing issues that you are watching that you think will be particularly important in the months ahead?
A: There are three securities cases pending before the Supreme Court this term and any or all of them could lead to decisions that would have significant implications for the securities fraud litigation market. Also, the Supreme Court has a busy class action procedure docket, and decisions in those non-securities cases could have profound implications for the prosecution of class action securities fraud litigation.
Q. Do you have any predictions about 2011 securities litigation activity, as far as anticipated levels or trends?
A: I would expect the core rate to remain constant, and from there I would expect a bump up as even more merger disclosure litigation finds its way to federal court and a bump down as Morrison reduces the incidence of claims targeting foreign trading activity. Farther down the road, I would not preclude an increase in litigation activity attributable to whistleblower “tag along” cases that will be filed shortly after the Commission announces litigation or settlements arising from Dodd Frank bounty hunter disclosures.
Q. If you were to be called upon to serve as a D&O insurance underwriter, what are the most important things you would want to consider when reviewing a particular company, and why?
A: I would only insure issuers who promise not to file any claims :)
I would like to thank Professor Grundfest for his willingness to participate in this dialog. I know there are many D&O insurance underwriters who earnestly wish they could implement his proposed D&O insurance underwriting philosophy.