A famous law review article by Janet Cooper Alexander found that that settlements in securities fraud litigation have little to do with the merits of the litigation. Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions, 43 Stan. L. Rev. 497 (1991). Did the enactment of the Private Securities Litigation Reform Act back in 1995 change that result? Boalt law professor Steve Choi has just published a paper with some very interesting empirical findings:
The paper provides evidence on the impact of the Private Securities Litigation Reform Act of 1995 (PSLRA) by examining a sample of initial public offerings from 1990 to 1999 facing a mix of Section 11 and Rule 10b-5 antifraud claims. Others have provided evidence that the PSLRA increased the significance of merit-related factors in determining the incidence and outcomes of securities fraud class actions. The increase in the importance of merit-related factors, however, is consistent with two possible hypotheses. First, the PSLRA may have reduced solely the incidence of nuisance litigation. Second, the PSLRA may have reduced the incidence of both nuisance litigation as well as a subset of the pre-PSLRA meritorious claims where the additional costs imposed by the PSLRA made such claims unprofitable from the perspective of plaintiffs' attorneys. This paper tests between these hypotheses and provides evidence that meritorious claims lacking obvious hard evidence indicia of fraud (an accounting restatement or SEC action) (a) are less likely to be filed post-PSLRA and (b) face a greater likelihood of receiving a dismissal or low-value settlement in the post-PSLRA period. In determining the welfare implications of blocking frivolous suits, policymakers should therefore consider the negative impact of the PSLRA in also discouraging a significant fraction of meritorious litigation.
I like this paper a lot, even though I would quibble with a few points (such as how you measure merit). As a policy matter, moreover, I would argue that it is very difficult to imagine a regulatory scheme that can (a) eliminate strike suits, while (b) leaving meritorious suits unaffected, (c) at a very early stage of the litigation before defendants to strike suits have been put to any significant expense, and (d) do so at a reasonable level of administrability. In other words, we may have to accept the loss of some meritorious suits in order to crack down on strike suits. The unresolved question is whether the social benefits of eliminating strike suits is outweighed by the social costs associated with meritorious litigation going unpursued.
