It’s a belief many law-school graduates cling to fiercely, in the face of all contrary evidence: That the tort system is a mechanism for discovering the truth, disciplining wrongdoers, and compensating victims for their losses.
A new study in the Financial Analysts Journal casts serious doubt on the premise, at least when it comes to shareholder class actions. In most cases, the authors found, the litigation mainly serves to punish shareholders who have already suffered from a downturn in their stock. Only suits targeting illegal insider trading, and to a lesser extent, accounting fraud were associated with subsequent higher long-term returns.
The study, “Misdeeds Matter: Long-Term Stock Performance after the Filing of Class-Action Lawsuits” is by Rob Bauer and Robin Braun of Maastricht University in the Netherlands. They review a large body of research on securities class actions that is trying to answer the question of what, exactly, this expensive and highly lucrative — for the lawyers, anyway — legal enterprise is actually trying to accomplish.
If it’s to punish wrongdoers, that’s mostly a fiction. All but a handful of cases settle for a fraction of the claimed damages, and usually for a number suspiciously close to the limits of the company’s director and officer liability insurance policies. Since Delaware law indemnifies company officers from paying most civil damages, they are rarely exposed to the direct cost of shareholder litigation anyway. And previous studies have found most lawsuits are against larger companies, perhaps indicating a desire to empty deep pockets rather than ferret out financial fraud, which one might suspect would be more common at smaller, more loosely governed companies. In the end, most shareholder lawsuits result in a court-ordered, retroactive cash dividend to former shareholders, paid by the unlucky current owners of the firm.
The report is particularly timely given the Janus case pending before the Supreme Court:
One week from today, the Supreme Court will take another dip in the parlous waters of securities class actions when it hears oral argument in Janus v. First Derivative Traders. Two years ago, the Court launched a thousand law review articles on this topic with its decision in Stoneridge v. Scientific-Atlanta, when the justices firmly squelched liability for secondary actors in cases of securities fraud. The question in Janus concerns who precisely are these aiders and abetters (impervious to suit) and who are primary violators (susceptible to suit). In conceptually dividing these two populations, the Court could with one drawing of a line immunize almost all public corporations from private suit and virtually eliminate the securities class-action lawsuit. ...
