This is the second of a three-part post evaluating who is winning the securities class action war.
Part I explained that this war is not just a scorecard of wins and losses, but rather a fight for strategic positioning—about achieving a system of securities litigation that sets up plaintiffs or defendants to win more cases over the long term. Despite winning many of the battles, defendants are losing the war because of the defense side’s lack of a centralized command, which creates a mismatch in expertise, experience, and efficiency.
The plaintiffs’ bar is relatively small, with about a dozen firms in the core group. Their lead partners are full-time securities litigators who prosecute cases around the country. They don’t dabble in different kinds of cases—they aren’t securities litigators on some days and antitrust or IP lawyers on others. Because the bar is small and specialized, it has the practical ability to take common strategic, economic, and legal positions, even if they don’t always see eye-to-eye or get along personally.
Below, I contrast this small and specialized plaintiffs’ bar with the defense bar, and conclude that:
The splintered structure of the defense bar creates a fundamental mismatch between plaintiffs and defendants;
Defendants can only overcome this mismatch with greater centralized command; and
This organizing function can only come from D&O insurers—a proposition I’ll explain in depth next week in Part III of this post.
Part II: The Defense Bar
The Defense Bar is Splintered
In contrast to the small and specialized plaintiffs’ bar, there is an army of securities defense lawyers—but one with no coordinated set of strategic goals. Every firm in the AmLaw 200 has a securities class action defense group and conceivably could be hired to defend a securities class action. Each firm in the AmLaw 100 has a securities team they’d tout as a “leading” or otherwise strong practice—and among most of each of those firms, there are multiple partners who hold themselves out as securities litigation defense lawyers. The number of defense lawyers who called themselves “securities litigators” skyrocketed during the 2005-08 stock option backdating scandal, which drew in more defense lawyers for separate representations and investigations.
All in, I’d guess there are 300 white-shoe U.S. law-firm partners who would advertise themselves as securities litigators for purposes of a securities case pitch, though most of these work on other types of commercial litigation as well, such as antitrust and IP. The number of actual securities litigation senior partners on the defense side is a tiny fraction of this population—I’d bet around 30, or 10% of the so-called “securities defense bar.”
This small, specialized group comprises my mentors and my peers. Although it is hired in enough cases to allow it to continue to defend securities cases full-time, it doesn’t handle the number or range of cases the group’s skill and experience otherwise justify because of the jam-packed defense field overall. As a result, the average defense lawyer handles far fewer—and a narrower range of—cases than the average plaintiffs’ lawyer.
This is just one-half of a double-whammy for companies and their D&O insurers: the sub-optimal defense comes at an enormous cost to boot. At the same time that the number of securities class actions filed against smaller companies is increasing—indeed, a recent study said that the size of securities cases had fallen to a level last seen in 1997—the amounts that most defense firms charge to defend litigation have increased exponentially. This mismatch between 1997 case size and present-day law-firm economics creates the danger that a company’s D&O insurance program will be insufficient to cover the fees for a vigorous defense and the attendant price to resolve the case. Indeed, I am greatly concerned that inadequate policy proceeds due to skyrocketing defense costs is becoming the biggest risk directors and officers face from securities litigation.
The defense-cost problem is exacerbated by the scarcity of securities litigation work for the hordes of litigation partners who hold themselves out as securities litigators. Given the large group of lawyers competing for a limited number of cases, most of them are hired only sporadically—a case every year or two, at most—which creates pressure to maximize the billing revenue on each case. That is also a key reason why defense hourly rates have increased so dramatically—by almost 50%—in less than ten years.
To illustrate the economic squeeze in securities class actions, consider hypothetical securities class actions against two smaller companies: 1997 Co., which carries $15 million in D&O insurance limits, and 2017 Co., which carries limits of $25 million. (Smaller-company D&O insurance limits have increased since 1997, but not markedly.) Assume settlements of $7.5 million in 1997 and $12.5 million in 2017. Also assume that defense costs through summary judgment were $5 million in 1997 (cases against smaller companies are nevertheless often as labor-intensive as cases against larger companies) and $15 million in 2017, or triple the 1997 figure, corresponding to the tripling (or more) of the billing rates and partner profits of large law firms (“Big Law”).
Big Law defense of 1997 Co. makes some economic sense: $5 million in defense costs plus $7.5 million to settle equals $12.5 million—or $2.5 million less than the D&O insurance limits.
Big Law defense of 2017 Co. does not make economic sense: $15 million in defense costs plus $12.5 million to settle equals $27.5 million—or $2.5 million more than the D&O insurance limits.
However, when large firms with high billing rates and high associate-to-partner ratios try to reduce the cost of one case without changing their fundamental billing and staffing structure, they end up cutting corners by forgoing important tasks, delegating important roles in the case to junior attorneys or settling prematurely for an unnecessarily high amount.
It obviously makes no sense for a firm to charge $15 million to defend a case that can settle for $15 million. It is even worse for that same firm to attempt to defend the case for $7 million instead of $15 million by cutting corners—whether by understaffing, overdelegating to junior lawyers, or avoiding important tasks.
It is worse still for law firms to charge $2 million through the motion-to-dismiss briefing and then, if they lose, to settle for more than $15 million just because they can’t defend the case economically past that point. And it is a strategic and ethical minefield for a defense firm to charge $15 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case.
Obviously, companies and their directors and officers should not be subjected to these hazards—which are created not by the securities class action itself, but by the incentives inherent in law firm economics.
So, to sum up, we have a defense bar that is both (1) under-experienced and (2) over-priced and/or that cuts corners. Quite obviously, on the defense side, the system is broken.
Nevertheless, the Defense Bar Wins a Lot of Battles
Yet a reasonable reader would ask, “if the defense bar is so over-matched, why do defendants win so many motions to dismiss?”
The defense bar obviously wins a lot of dismissals at the pleading stage. But those victories are short-lived if the court grants the dismissal without prejudice, allowing the plaintiffs an opportunity to more carefully replead—often with the benefit of the court’s roadmap identifying the various defects in the initial complaint. The skeptics need look no further than the liberal law of amendment, which courts often relax further to counterbalance the Reform Act’s pleading standards. One court put it this way: “The PSLRA requires a plaintiff to plead a complaint of securities fraud with an unprecedented degree of specificity and detail. … In this technical and demanding corner of the law, the drafting of a cognizable complaint can be a matter of trial and error.” Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1053 (9th Cir. 2002).
Cases that survive a motion to dismiss are increasingly settled before the cost of discovery mounts. In days gone by, if the court denied the motion to dismiss, defendants would oppose class certification and defend the litigation through a summary judgment motion—in other words, defendants would actually defend the case. Today, given skyrocketing defense costs, cases increasingly settle soon after the court denies a motion to dismiss, to avoid the danger that a company’s D&O insurance program will be insufficient to cover the fees for a vigorous defense and a settlement later in the case. The splintered defense bar plays a role too: because of the absence of a coordinated strategic approach to issues of class certification and summary judgment, there often appears to be little strategic benefit to using these potentially valuable mechanisms to defeat plaintiffs’ claims. Thus, in this era of ineffective and inefficient securities defense, securities class action defense involves use of only one of three pre-trial escape hatches—the motion to dismiss—and leaves class certification and summary judgment on the table.
So motions to dismiss are the whole ballgame these days. And while, again, defendants obviously win a lot, they would win a lot more if the defense bar were more specialized and took a better strategic approach more often. In keeping track of pending securities cases, I read a lot of motions to dismiss in cases around the country. Some of them are good, but a great many of them are not. Although some of the poor motions yield a dismissal anyway, too many cases aren’t dismissed that should be—and certainly the reason for many of those is a poorly constructed motion.
Whatever success defendants have under the Reform Act’s pleading standards, it comes at a high price. It almost always makes sense to give a motion to dismiss a shot, even if it’s a long one. And, whether the motion is an easy or difficult one, many defense firms take advantage of the Reform Act’s defense-friendly standards to do more work than is necessary at that point, rationalizing the extra work along these lines:
“If the motion is granted, no one will really mind if we’ve billed a lot. Plus, we’ll ‘lose’ the case before we get to bill a lot in discovery. If the motion is not granted, the extra work we did will give us a head start on the rest of the case.”
Indeed, a cynic would say that the system is a rigged game for defense firms. Win or lose, they “win.” If the case is dismissed, the defense firm has done a healthy amount of work and added a victory to its win-loss record. And if the case isn’t dismissed, the defense firm still “wins,” because the case goes into discovery, which is notoriously expensive and almost impossible for a client or insurer to capably oversee. The opaqueness of the system is exacerbated by the swashbuckling style of many defense lawyers, who set up a criticism-free moat around themselves by dint of being a prominent partner at a powerful law firm.
So, in a nutshell, (1) the defense bar’s lack of effectiveness squanders dismissal opportunities, while (2) their lack of efficiency (to put it politely) squanders insurance resources. The Reform Act’s high pleading standards tend to mask this problem—but a problem it is.
A reasonable reader would also ask, “if the defense bar is so over-matched, how have they accomplished so many Supreme Court and Legislative victories?”
This is more complex, but also supports my lament. The Private Securities Litigation Reform Act of 1995 was a huge victory for the defense bar. Although many people played a hand in its passage, a key group was the Silicon Valley securities defense bar—which in 1995 was a fairly small and experienced group of lawyers, including my former firm Wilson Sonsini, who defended a very high volume of securities litigation. Indeed, in many ways, what I am arguing for is a return to the Silicon Valley firm defense bar and economics of the 1995.
On the judicial front, I don’t think the 10-year run of Supreme Court securities decisions has been very helpful outside of Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), and Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 135 S. Ct. 1318 (2015). Most of the decisions have been neutral—though they all caused a huge stir, and competing claims of victory, because they were Supreme Court decisions.
Some of the decisions are an attractive nuisance. For example, in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014), the Court held that a defendant may rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence that the alleged misrepresentations did not impact the stock price. Although it is a rare case in which a price-impact class certification can make a real difference in a case, it takes a lot of impulse control for a defense lawyer to turn down the chance to take a shot. Others are examples of “be careful what you wish for.” For example, the jurisdictional limitations the Court set in Morrison v. National Australia Bank, 561 U.S. 247 (2010), have yielded enormously expensive multi-front international litigation that can’t easily be settled.
And despite the defense bar’s successes, such as they are, there is a complete inability for any coordination about the decision to seek Congressional or judicial change. This is in large part due to the lack of visibility by other lawyers into what is happening in cases and the lack of familiarity with each other in the defense bar. The plaintiffs’ bar, with its smaller size and greater specialization, doesn’t have those problems, at least to the same extent. The prominent plaintiffs’ lawyers know what’s happening across the cases and know each other, and thus can at least try to stop someone from taking a misguided strategy.
We defense lawyers don’t have the same visibility or capacity to coordinate. Even when defense counsel support an appeal on behalf of amici, they are forced to work within a trial and appellate strategy in which they weren’t involved, and which is sometimes shaped by a defense lawyer who isn’t a true specialist. Certainly, the nature of the clients that plaintiffs and defendants represent can come into play—for example, a large pension fund cares about the state of the law more than Acme, which might only care about the case against it. But the splintered structure of the defense bar prevents these discussions from even happening.
The Solution: Greater Insurer Control
These problems—a splintered, relatively inexperienced, and highly inefficient defense bar—are fundamental and structural. There is a simple solution: in every securities class action, there is a group of D&O insurer representatives associated with the defense of the litigation. As a group, D&O insurers see the big picture in securities class action in a way no defense lawyer ever could, and could easily provide input that would help solve these problems.
Although the number of D&O insurers may seem large to many, from my perspective it is a relatively small and close-knit group. Every major D&O insurer has highly experienced internal or external claims personnel who track securities litigation developments very closely, in individual cases and the big picture. There is a relatively small number of primary insurers who write the lion’s share of primary D&O policies. And there is a handful of professionals who drive thought leadership. Without question, the D&O insurance community is well-suited to be the glue that fixes the fractured defense bar.
Next week, I’ll explain in detail why and how the D&O insurance community can perform this critical function. Please stay tuned.