Professor Stephen Choi recently presented his paper, Motions for Lead Plaintiff in Securities Class Actions, at the Law and Economics Workshop. This is a forum where academic working papers are presented and discussed among interested faculty and students.
In a recent class action settlement, the class counsel requested attorney's fees that would amount to $500/hr for time worked by temp lawyers, but the temp lawyers were only paid $35/hr by the class counsel—a whopping markup of over 1000% (Forbes "Nice Work If You Can Get It"). The lead plaintiff, the State of Louisiana, acquiesced and said it was the court's job to determine the fees. However, the lead plaintiff is in charge of choosing the class counsel and is in the best position to monitor the lawyers. Professor Choi's paper examines which lead plaintiffs are effective monitors.
The two measures of successful monitoring used by Professor Choi were (1) hours worked (as reported in settlement motions), and (2) the total fee. Professor Choi's paper shows two general results. Institutional investors are more effective at monitoring, both in terms of lowering attorney's fees and increasing the number of hours worked. This effect is more pronounced when their loss is large and if the institutional investor frequently serves as lead plaintiff. Also, when the motion for lead plaintiff is contested (a competitive process), the resulting lead plaintiff is a more effective monitor. However, if some of the movants abandon their motions (perhaps due to side deals), this effect disappears.
One of the most striking results from Professor Choi's study is that one provision of the Private Securities Litigation Reform Act (PRSLA) may be detrimental to the Act's goal of reducing agency costs. The PRSLA limits how often individuals can serve as lead plaintiff. However, the results show that agency costs would be lower if the largest institutional investors (like CalPERS) repeatedly served as the lead plaintiff.
One thing that cannot be determined from the study is whether, on an absolute scale, any of these lead plaintiffs are really effective at reducing agency costs. All it shows is that some are relatively better than others. This is an important question as it seems that in many cases the lead plaintiff will have no incentive to monitor the class counsel. A survey of institutional investors showed that monitoring is quite costly ($25,000 to $100,000 for an average case). The marginal increase in recovery for the lead plaintiff will often not outweigh this cost.
However, there is another less costly form of monitoring. A repeat lead plaintiff should select class counsel based on past performance. Then a large institutional investor, who serves as a lead plaintiff many times, does not have to monitor each individual case. All the institutional investor has to do is look at the results that the class counsel provided in previous cases. If they were subpar, then the institutional investor will use a different law firm. Plaintiff's law firms will try to keep costs down and work harder to ensure they are chosen again in the future. If lead plaintiffs cannot serve repeatedly, this may not occur. Again, this suggests the PRSLA may be misguided in limiting how often an individual can serve as lead plaintiff.
One potentially troubling result of the paper suggests reputation-based monitoring does not occur. Frequent institutional investors almost always (80%+ of the time) choose the same class counsel. This suggests frequent institutional investors may even fail to perform their most fundamental task of choosing effective class counsel. However, there may just be a dearth of plaintiff's law firms capable of handling these types of cases. Just three law firms served as lead counsel in over 57% of the 482 settlements examined.