Last fall, the U.S. Chamber Institute for Legal Reform issued a paper detailing the ways in which the U.S. securities class action litigation system is “spinning out of control,” and calling for a renewed wave of securities litigation reform. In a new paper, entitled “Containing the Contagion: Proposals to Reform the Broken Securities Class Action System,” the Institute renews the call for reform and sets out a series of specific proposals intended address the “abuses” the paper identifies. The current securities class action litigation system, according to the paper, is “plainly broken, harming investors and our capital markets.” The Institute’s February 25, 2019 paper can be found here.
The Institute’s latest paper, discussed below, was prepared in conjunction with an event to take place on the morning of February 26, 2019 at the National Press Club in Washington, D.C. (as detailed here). The latest paper was prepared for the Institute by Andrew Pincus of the Mayer Brown law firm (as was the prior paper as well). An additional paper was also prepared in conjunction with the February 26 event by several academics, including Adam Pritchard of the University of Michigan Law School. I will review the academics’ paper separately in a future post. At the February 26 event, I will be moderating a panel in which Pincus and Pritchard will be discussing their papers, their findings, and their recommendations.
The new Institute paper to which I linked above begins by recapping and updating the prior paper’s observations about the current alarming trends concerning U.S. securities class action litigation. The paper reviews and further details two specific current securities litigation trends — the flood of federal court merger objection litigation and rise of event-driven securities litigation. The new paper also details what it calls “the Cyan effect” – that is, the rise of state court securities class action litigation under the ’33 Act in the wake of the U.S. Supreme Court’s March 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund.
In addition to these trends regarding securities class action litigation filings, the paper also details recent developments that the paper says “highlight the need to curb the plaintiffs’ bar’s ongoing abusive litigation practices.”
First, the paper notes the recent rise – contrary to the purposes and intent of the PSLRA – of the appointment of individuals rather than institutional investors as lead plaintiffs in securities class actions. The plaintiffs’ lawyers are turning to these individual “professional plaintiffs,” which the paper says results in “the very lawyer-driven litigation that the PSLRA sought to eliminate.”
Second, the paper details how three small plaintiffs’ firms increasingly are responsible for a flood of securities litigation. These firms (referred to elsewhere as “emerging” law firms) appear as counsel of record on more than half of the initially filed complaints in non-M&A cases. These firms’ increased filing activity has coincided with the increase in the appointment of individuals as lead plaintiffs. These three firms cases are dismissed at a “staggering” 51 percent rate, compared to the “already high” rate of 43 percent for all other firms. Because these three firms’ cases involve relatively small claimed damages, the firms are able to pressure defendant companies to settle on a discount of the costs of defense.
Among the other plaintiffs’ counsel practices the paper details is the set of circumstances surrounding the contested plaintiffs’ fee petition in the State Street foreign exchange settlement (discussed here). A special master assigned to investigate the plaintiffs’ fee request found a number of troubling issues, including the payment of a significant amount of money from class funds to a lawyer who never appeared in the case, did not work on the case, and whose identity was hidden from the clients, the class, co-counsel, and the courts. The existence of what amounted to a finders’ fee suggested what Columbia Law Professor John Coffee called a “rather sordid market of buying and selling plaintiffs in securities class actions.”
In light of these developments and perceived “abuses,” the paper argues that securities litigation reforms are “urgently needed.” The paper suggests that each of the three branches of government have roles to play in this reform process.
The SEC, with its core responsibility for protecting the capital markets and investors, should undertake to review the current class action system, identify abuses practical ways to address those abuses, including for example instituting a program of amicus brief filings to inform courts about the pervasiveness of the problem. The SEC, the paper suggests, could also suggest that courts assert authority to review and out-of-court resolutions of federal court M&A cases and order Rule 11 proceedings to sanction unwarranted litigation.
The paper also argues that the courts have a role to play in the reform process, in particular in adopting the successful approach of the Delaware Chancery Court in addressing the avalanche of litigation.
The paper suggests that Congress has a role to play, as well. The paper suggests a number of specific steps Congress can take, including overturning Cyan and requiring all federal securities class actions to be brought in federal court. The paper also suggests centralizing M&A litigation in federal courts in the defendant company’s state of incorporation; the suggestion is that by concentrating the cases it will accelerate the moves toward the kinds of reforms the Delaware courts adopted when faced with a flood of cases.
The paper also suggests that Congress should enact an “investors’ bill of rights” that would, among other things, give courts the information they need to curb abuses; among other things, the paper suggests that Congress should require disclosure of all relationships between the plaintiffs’ lawyers and the plaintiffs (including referral arrangements). The paper also suggests Congress should presumptively bar any individual or entity from serving as a plaintiff for more than five cases in 36 months, and required federal courts to more closely scrutinize fee requests, including through the appointment of an independent monitor in fee requests above a specified threshold.
The paper also suggests that Congress should adopt a number of measure to curb abusive practices, one of the most interesting of which is the suggestion that, because denials of motions to dismiss are so critical that Congress should provide for interlocutory appeals of denials of motions to dismiss, either as of right or based on a discretionary standard.
Finally, the paper suggests that Congress should consider adopting a cap on damages in non-IPO cases, in order to reduce the extent to which these cases simply represent the shifting of funds from one group (current shareholders) to another group (the plaintiff class), which among investors with a diversified portfolio may make the pocket-shifting exercise ultimately meaningless.
There have of course been prior securities litigation reform efforts in recent times (refer for example here), which ultimately ran aground. It remains to be seen whether in the current divided atmosphere in Washington and in light of the party division between the two houses of Congress any reform is possible now. However, there is no doubt that the statistics surrounding securities class action litigation have been growing at an alarming rate, which at least potentially be sufficient to galvanize even a divided Congress into action.
As a lower trajectory target, the suggestion that Congress address the Cyan problem seems like a modest goal to address what is an obvious and unintended problem in the wake of the PSRLA and SLUSA; it also seems like it might well be achievable even in the current political environment.