In the current political environment, class action lawsuits are under assault, particularly in conservative legal circles. As Joe Patrice put it in an August 30, 2017 Above the Law post (here) , with a somewhat tongue-in-cheek summary of the conservative perspective on class actions, “The only thing every good conservative legal thinker knows is that class actions are greedy money grabs perpetrated by slimy lawyers that help no one and only frustrate the hard-working capitalists making America great again.”
Given this general outlook among conservatives about class action lawsuits it is all the more surprising and interesting that a conservative legal scholar has come forward with a robust defense of class actions. Vanderbilt Law Professor Brian Fitzpatrick, who clerked for Reagan appointee Dairmuid O’Scannlain on the 9th Circuit and for conservative Supreme Court Justice Antonin Scalia, has published a paper entitled “Do Class Actions Deter Wrongdoing?” (here), as part of his forthcoming book, “The Conservative Case for Class Actions.” In Fitzpatrick’s view, class actions serve an important role because they deter corporate wrongdoing. Fitzpatrick’s analysis may not only be important for the ongoing debate about class actions in the U.S., but, as discussed further below, it may be even more important for the debate about class actions outside the U.S.
In summarizing his paper’s conclusions, Fitzpatrick states that the theory of deterrence remains just as strong today as when it was introduced 50 years ago by the ‘classical’ law and economics movement. Moreover, he adds, “although there is not a great deal of empirical evidence to support the theory for class actions, there is some, it is uncontroverted, and it is consistent with the reams and reams of empirical evidence in favor of deterrence for individual lawsuits.”
In reaching these conclusions, Fitzpatrick distinguishes between “specific deterrence” and “general deterrence.” With the former type of deterrence, a lawsuit deters a particular company from continuing wrongdoing, say, through injunctive relief. With general deterrence, companies in general are deterred from misconduct because of the general threat of litigation. Fitzpatrick acknowledges that “market feedback loops” also deter misbehavior; if a company misbehaves, the customers, employees and shareholders can tell others to go elsewhere. But, Fitzpatrick notes, lawsuits enhance market feedback loops by publicizing the wrongdoing in a way that word of mouth alone does not.
Among other reasons that critics have questioned class actions’ general deterrence benefits is the view that corporations cannot avoid the misconduct that leads to class actions because corporations cannot predict which of their activities will lead to class actions. In other words, under this theory, class actions target behavior at random; if you can’t predict beforehand why you will be sued, they you can’t change your behavior to avoid the lawsuit.
Fitzpatrick reviews this class-actions-are-random theory at length, but his ultimate response is that the research shows that the threat of class actions does in fact affect behavior and deter misconduct. As he puts it, “it is not reams and reams of evidence, but there now are several studies, and they span different time periods and involve different types of class actions, and they all say the same thing: class actions deter misconduct.”
Readers of this blog will be interested to know that three of the studies Fitzpatrick cites relate to the deterrent effect of securities class action lawsuits. The first study examined what happened to after the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank insulated foreign companies from American securities class action lawsuits. The study’s authors found that when the threat of class action lawsuits went away, companies disclosed less information to their shareholders than they had before. The study’s authors concluded that the threat of a class action lawsuit had induced the companies to be more forthcoming to their shareholders. (Readers interested in this study’s conclusions can find the paper here.)
The second securities litigation study examined corporate disclosures for a larger set of companies over the period 1996-2010. The study’s authors compared disclosures by companies with a higher securities class action risk to those with lower risk. The authors identified companies with higher risk using a variety of factors including size, industry, and “a host of other variables.” The authors found that the companies at higher risk of being sued disclosed more information to shareholders, updated their disclosures more often, and rendered those disclosures in more readable language. (Readers interested in seeing this study and learning more about the factors the authors used in identifying companies a higher risk of securities litigation can found the authors’ paper here. )
The third study looked at what influenced corporate decisions to misrepresent corporate earnings during the period 1997 to 2008. The study’s authors found that the fact that a company got sued in a securities class action lawsuit for earnings manipulation discouraged other companies in the same industry or geographic region from manipulating their own earnings, and concluded that class actions deter behavior. (Readers can find this report of this research study here.)
In summarizing the findings of these studies, Fitzpatrick noted that “although these studies of class actions and deterrence are not numerous, they are unanimous: class action lawsuits generate general deterrence.” Moreover, he noted these finding are consistent with what more extensive research has shown to be true with respect to lawsuits other than class action lawsuits, that is, that the threat of a lawsuit deters misconduct.
Fitzpatrick’s analysis is all the more interesting because of his impeccable conservative credentials. In discussing Fitzpatrick’s analysis and showing how it is in fact consistent with conservative principles, Alison Frankel, in an August 29, 2017 post on her On the Case blog about Fitzpatrick’s analysis (here), says the following: “Fitzpatrick argues that if you accept the proposition that corporations should not be allowed to extract even small amounts of money from hoodwinked customers, then class actions are actually a conservative way to make sure they don’t. The other options are to provide no vehicle to litigate small-dollar claims, thus allowing businesses to steal from customers, or to rely on the government to enforce corporate honesty. I suggested that perhaps we can rely on the market to punish deceptive businesses; Fitzpatrick said class actions act as a megaphone to amplify warnings to consumers.”
Fitzpatrick’s analysis is interesting in the context of the current and ongoing debate within the U.S. about the social value of class action lawsuits. The analysis may be even more interesting in the context of the emerging debate in countries outside the U.S., as a number of different countries move toward adopting class action or other collective action mechanisms. For example, in 2013, the EU promulgated a mandate directing member countries to adopt procedural mechanisms for collective redress, primarily focused on consumer claims (as discussed at length here). And as I have noted in numerous prior posts on this site (most recently here), a number of other countries are adopting mechanisms for collective investor actions.
As these other countries have wrestled with the issues surrounding the adoption of class action or other collective redress mechanisms, the justifications provided have primarily focused on the value for these kinds of mechanisms to produce litigation efficiency or to provide compensation for victims. Fitzpatrick is in fact disdainful of these justifications for class action remedies. As he puts it, “it is unlikely that any litigation efficiency is gained because there would be no individual litigation at all in the absence of class action.” He also put little weight on the value of class action mechanisms to provide compensation; he notes that “the class action is not known for its success at delivering compensation to class members; sometimes it does it well … but in the run-of-the-mill case, only a small percentage of victims are made whole.”
I am not sure I would be so quick to dismiss the litigation efficiency argument in support of class actions. In this regard, I would point to the Deutsche Telecom litigation in Germany. When the company was hit with an accounting scandal in the first decade of this century, investors filed over 13,000 lawsuits against the company, which overwhelmed the courts. As discussed here, the German legislature responded by adopting the Capital Market Investors’ Model Proceeding Act (or KapMuG), which provides for a representative proceeding to decide disputed issues affecting similar claims. The entire point of the KapMuG was to impose efficiency constraints on a set of proceedings that otherwise would be extraordinarily inefficient.
I am also not sure I would dismiss the compensation justification either. Here, I would point to the Satyam scandal, in which investors who bought Satyam securities in both New York and Mumbai were injured. The difference between these two sets of investors is that the investors who purchased their securities in New York were part of a class action lawsuit that resulted in a $125 million settlement. The investors who purchased their shares in Mumbai received nothing, an outcome that contributed to the Indian legislature’s adoption, in clause 245 of the Companies Act of 2013, of a class action mechanism.
But while I believe that the efficiency and compensation justifications for class action litigation arguably have greater merit than perhaps does Fitzpatrick, I am struck by his conclusion that the class action mechanism can be defended for its deterrent effects. The debate on these issues in the U.S. is likely to go on, and it is as likely to be a political debate as it is an economic or social justice debate. Fitzpatrick’s analysis may be even more informative for countries outside the U.S. as they struggle with the question about whether or not to adopt collective redress mechanisms. These other countries have tended to focus on the litigation efficiency and compensation justifications for class action litigation. Fitzpatrick’s analysis supporting the conclusion that class action litigation deters misconduct could be important for these other countries to consider as they debate these issues, and could provide additional justification for the adoption of class action mechanisms.