Consumer Protection Settlements: Theory and Policy

Abstract

Lawsuits have a deterrent effect, but this is mitigated if settlements are routine. Regulators and judges should consider that a firm contemplating predatory activity directed at financially unsophisticated individuals might have built an estimate of settlement costs into their analysis of the net present value of the “project.” This suggests that choosing not to settle to establish a precedent would be an appropriate regulatory policy, especially in cases involving egregious behavior. Hence, while private settlements may be Pareto optimal, this notion does not apply to public consumer protection class action settlements. Asymmetric information is a major factor in consumer protection litigation, but the consumer protection regulator has an information advantage; this can allow regulators to represent the class effectively. We develop these issues by considering theories of the settlement process in the context of a pivotal case. We provide suggestions for theoretical research on consumer protection class actions, an underdeveloped area of the literature.