Shareholder Litigation Without Class Actions

Abstract

In this Article, I imagine a post-class action landscape for shareholder litigation. Assuming, for the sake of this exercise, an environment in which both securities-fraud and transactional class actions are hobbled by procedural or substantive reforms — most likely through the adoption of mandatory-arbitration provisions or fee-shifting provisions — I assess what shareholder litigation would disappear, what would remain, and what a post-class action landscape would look like. I argue that loss of the class action would remove a layer of legal insulation that prevents institutional investors from having to pursue positive value claims against companies. Currently, the class action effectively ratifies fund fiduciary passivity in the face of fraud, for example, as long as the institution files a claim form to collect its share of a class action settlement that has been judicially certified. But without the class action, monitoring and litigation costs for such institutions may increase because fund fiduciaries must monitor their portfolios for, and litigate, positive value claims. Failure to do so could expose them to liability to fund beneficiaries. I offer some suggestive, but incomplete, evidence about how many funds will have positive value claims. I also argue that bizarre gaps in liability coverage for public-pension fund fiduciaries — who serve the funds that have traditionally been the most active litigants — may have unpredictable effects on trustee behavior outside the class action, may tilt in favor of bringing claims, and may also lead to herding behavior in arbitration. I also assess how loss of the class action would affect plaintiff law firms, sketching out scenarios in which these firms disappear, or face new competition from traditional firms, or survive (in small numbers) and perhaps thrive representing institutional investors. I argue that the end of the class action means abandonment of the idea that all investors should be compensated for losses due to fraud or other corporate malfeasance, and I demonstrate that loss of the class action leaves investors in smaller firms with no remedy for wrongdoing.I argue that shareholder litigation without class actions creates a new distortion in the private enforcement regime, what I call the “semi-circularity problem.” Without class actions, negative value claimants would no longer be able to recover for their damages in shareholder litigation. But they would still be forced to subsidize the losses of positive-value claimants to the extent that the smaller investors own shares in defendant companies that must pay damages claims to large institutional investor plaintiffs. Loss of the class action device creates a two-tier legal system for investors: one in which large institutions recover while individuals and smaller institutions do not from the same fraud (or mispriced deal), and one in which smaller investors that still own defendant companies must reach further into their pockets to compensate large institutional investor losses for that fraud (or mispriced deal).