The securities class action war is about far more than the height of the pleading hurdles plaintiffs must clear, the scorecard of motions to dismiss won and lost, or median settlement amounts. It is a fight for strategic positioning—about achieving a system of securities litigation that sets up one side or the other to win more cases over the long term. How this war plays out has real-world consequences for the people sued in securities class actions.
Defendants win a lot of battles. The Private Securities Litigation Reform Act of 1995 was an enormous victory for the defense bar, imposing high pleading burdens on plaintiffs and establishing a safe harbor for forward-looking statements that, in Bill Lerach’s famous words, gives defendants “license to lie.” The rate of dismissal is markedly higher than the dismissal rate in other types of complex federal litigation. And cases that survive motions to dismiss typically settle for predictable amounts.
But despite their success in battle, defendants are losing the war. The root of the problem is the defense side’s lack of a centralized command, which creates a mismatch in expertise, experience, and efficiency.
While the plaintiffs’ bar is relatively small, with about a dozen firms that dominate, the defense bar is highly splintered, comprising many dozens of firms that can credibly pitch a case, with multiple possible lead partners within each firm—some qualified and some, frankly, not qualified. As a result, the average plaintiffs’ partner is many times more experienced than the average defense partner.
While the plaintiffs’ bar’s specialized composition and small size yield a unified approach, the splintered nature of the defense bar makes this impossible for defendants.
While the defense bar has achieved significant legislative and judicial success, it has come with costly collateral consequences.
While the plaintiffs’ bar’s contingent-fee structure incentivizes efficiency, the defense bar is wildly inefficient due to hourly billing and the view that D&O insurance reimbursement is “free money.” This penalizes the defense firms’ clients—both in individual cases and on the whole—by leaving less insurance money for a vigorous defense and settlement.
How can the defense bar approximate the plaintiffs’ bar’s advantages? Given the competitive legal environment and large-firm economics, the defense bar can’t achieve a centralized command on its own. The only way to do so is to give greater control to D&O insurers, the player with the greatest economic and strategic stake in both individual cases and on the whole.
Winning the securities litigation war isn’t an abstraction or a dispute about allocation of money between law firms and insurance companies. It’s about the safety and comfort of real people who face securities litigation. At the core of every securities case are people accused of doing something wrong—not just directors and officers, but also hard-working company employees who find themselves at the center of a securities suit. Just the idea of securities class actions makes businesspeople uncomfortable.
So the most fundamental question we on the defense side must ask ourselves is: how does the system of securities litigation defense position directors and officers to withstand securities litigation safely and comfortably?
To state the obvious, defendants are entitled to a system that allows them a fair fight with sufficient insurance resources.
I have divided this analysis into two blog posts. In this post (Part I), I explain how and why the plaintiffs’ bar is stronger than ever. In my next post (Part II), I’ll analyze the current state of the defense bar, explain why defendants are losing the war despite winning many battles, and propose a solution to the current mismatch between counsel for plaintiffs and defendants.
Part I: The Plaintiffs’ Bar Is Back—and Better than Ever
When I was a young lawyer, most of my cases were against Milberg Weiss Bershad Hynes & Lerach. I still remember the San Diego office’s phone number by heart (619-231-1058)—remember when we had to call people to communicate with them? Of course, there were several other strong plaintiffs’ firms and prominent lawyers, including some of my favorite lawyers in the plaintiffs’ bar—though from my vantage point, Lerach and Weiss loomed large.
The downfall of Lerach and Weiss is well-known, so I won’t recount it here. Many defense lawyers still discuss it with odd glee. To me, it was sad and unfortunate. My direct contacts with them made huge impressions on me. For example, one of Bill Lerach’s oral arguments remains the most impressive advocacy I’ve ever witnessed. And I’ll always remember the throng of defense lawyers at the first IPO Securities Litigation hearing turning to watch Mel Weiss enter the Daniel Patrick Moynihan U.S. Courthouse Ceremonial Courtroom, on September 7, 2001.
Lerach and Weiss helped shape and police our system of disclosure and governance, and our markets, corporate governance, and retirement savings are better off for it. I believe that most public company disclosure deciders see the image of Bill Lerach when they decide whether or not to disclose something.
So their exit naturally left a void in the plaintiffs’ bar. But a remarkable thing has happened: their protégés, who are my contemporaries and counterparts—as well as other senior plaintiffs’ lawyers and their protégés, plus some new entrants into the plaintiffs’ securities class action market, described below—have not only filled the gap, but have bolstered the bar. The plaintiffs’ bar is now back, and better than ever.
Looking back, several things converged to cause this. The first was the stock options backdating scandal, which began with a study by University of Iowa professor Eric Lie that showed an unusually large number of stock option grants to executives at stock price lows. Since few of the companies exposed in the scandal suffered stock-price drops, the vast majority of the dozens of options cases were filed as shareholder derivative claims, on behalf of the company, alleging breaches of fiduciary duty and proxy-statement misstatements.
At the time, the most prolific securities class action firm was Coughlin Stoia Geller Rudman & Robbins, the successor of Bill Lerach’s firm and the predecessor of Robbins Geller Rudman & Dowd. If they filed a derivative suit on behalf of a company, it meant they could not sue the company in a securities class action. For this simple reason, many people, including me, did not think they would file many options backdating derivative cases.
But they did—and they filed a lot of them. Not only did they file a lot of them, they defeated motions to dismiss and achieved settlements involving unprecedented types of corporate governance reforms and plaintiffs’ attorneys’ fee awards. Their large fee awards increased the fee awards of smaller plaintiffs’ firms. By the time they were finished, the plaintiffs’ firms that filed options backdating cases made a mint.
Then, toward the end of the options backdating scandal, the credit crisis happened and started a new wave of shareholder litigation, this time both securities class actions and shareholder derivative actions. The plaintiffs’ bar had a war chest and was ready for battle. The larger plaintiffs’ firms won lead plaintiff roles in the mega securities class actions and also represented plaintiffs in large individual actions.
While that was going on, the Chinese reverse-merger scandal happened. That created a new breed of securities class action plaintiffs’ firms. Historically, the Reform Act’s lead plaintiff provisions incentivized plaintiffs’ firms to recruit institutional investors to serve as plaintiffs. For the most part, institutional investors have retained the larger plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role. At the same time, securities class action economics tightened in all but the largest cases, placing a premium on experience, efficiency, and scale. As a result, larger firms filed the lion’s share of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role, or make much money on their litigation investments.
The China cases changed this dynamic. Smaller plaintiffs’ firms initiated the lion’s share of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs, and uncertain insurance and company financial resources. Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations and/or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss (and thus reducing the likelihood of dismissal and no recovery). The dismissal rate was indeed low, and limited insurance and company resources prompted early settlements in amounts that, while on the low side, yielded good outcomes for the smaller plaintiffs’ firms.
With these recoveries, these firms built up momentum that kept them going even after the wave of China cases subsided. For the last several years, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and they have initiated an increasing number of cases. Like the China cases, these cases tend to be against smaller companies. Thus, smaller plaintiffs’ firms have discovered a class of cases—cases against smaller companies that have suffered well-publicized problems (reducing the plaintiffs’ firms’ investigative costs) for which they can win the lead plaintiff role and that they can prosecute at a sufficient profit margin.
As smaller firms have gained further momentum, they have expanded the cases they initiate beyond “lawsuit blueprint” cases—and they continue to initiate and win lead-plaintiff contests primarily in cases against smaller companies brought by retail investors. The securities litigation landscape now clearly consists of a combination of two different types of cases: smaller cases brought by a set of smaller plaintiffs’ firms on behalf of retail investors, and larger cases pursued by the larger plaintiffs’ firms on behalf of institutional investors. This change is now more than five years old, and appears to be here to stay.
Plaintiffs firms thus have us surrounded—no public company can fly under the radar anymore. Plaintiffs’ firms of all types have made a lot of money over the past decade. They’re now filing a record number of cases, even subtracting out the federal-court merger cases. And on the whole, they’re strong lawyers, with some genuine superstars among them.
Yet, though expanded, the number of firms is small, with about a dozen in the core group. This gives them the practical ability to take common strategic, economic, and legal positions—even if they don’t always see eye-to-eye or get along.
In Part II, I’ll analyze the current state of the defense bar, explain why defendants are losing the war despite winning key legislative and judicial battles, and propose a solution to the mismatch between the plaintiffs’ bar and defense bar. Please stay tuned.