When it comes to corporate litigation, is more necessarily better? The legal system has developed a broad array of litigation options to address corporate wrongdoing. Under state law, shareholders can file a derivative suit or class action alleging that directors and officers breached their fiduciary duty. Under federal law, shareholders can file a securities class actions alleging that the directors and officers misled the market. These private lawsuits are often filed alongside government enforcement actions brought by the Securities & Exchange Commission, the Department of Justice, or state regulators.
In our article, Piling On: An Empirical Study of Parallel Derivative Suits, we examine the relative effectiveness of state corporate lawsuits and securities class actions in targeting corporate wrongdoing. Starting with a sample of 582 public companies named as defendants in securities class actions between July 1, 2005 and December 31, 2008, we explore the interplay between these suits and parallel suits filed under state corporate law, both derivative and class action. This data offers several important findings.
First, parallel suits are extremely common. More than 45 percent of the securities class actions in our sample were accompanied a parallel state law action. Despite the focus on Delaware’s role in corporate law, a remarkably small percentage of parallel suits (1.5 percent) were filed in Delaware courts. Instead, a majority of the parallel suits were filed in federal court.
Second, parallel suits are typically filed after securities class actions, suggesting that the parallel suits are piggybacking on their federal law counterparts. Parallel suits are also more likely to be filed in the wake of highly salient allegations in the securities fraud class action, such as a government investigation or an accounting restatement. These observations support the hypothesis that attorneys in parallel suits cherry pick the most promising securities class actions when deciding which suits to file.
Third, parallel suits frequently result in settlements in which the defendants pay no money but the corporation promises to make modest corporate governance reforms. These settlements involved less work by the plaintiffs’ attorneys, as reflected by a lower amount of hours and lodestar. These settlements also correlate with lower fees for the plaintiffs’ attorneys, indicates that judges may not view these settlements very highly. Taken together, this data suggests that corporate governance reforms are often window dressing, allowing defendants to settle parallel suits cheaply while giving plaintiffs’ attorneys a basis to claim a fee.
Finally, parallel suits may be an area where experience is not necessarily a good thing. Attorneys who frequently file parallel suits are more likely to obtain lower monetary recoveries for their clients. They are also more likely to agree to settlements involving corporate governance reforms. At the same time, however, these attorneys receive higher attorneys’ fees and expenses as a ratio of the attorneys’ fees and expenses awarded in the accompanying securities class action. In short, these attorneys deliver less to shareholders, but get more for themselves.
These findings suggest several possible reforms. First, and most obviously, courts should exercise greater oversight over corporate governance settlements. Although these settlements have been criticized for decades, our study shows that they remain a staple of derivative litigation.
In addition, courts should take a hard look at frequent filing attorneys when choosing lead counsel. Many courts consider an attorney’s experience as one of the most important factors in selecting lead counsel. Our study suggests, however, that many attorneys view parallel suits as a volume business. Experience does not correlate with strong results for shareholders. Courts should play close attention to the firm’s record of achieving tangible benefits for shareholders, rather than simply tallying their participation in past cases.
Finally, the legal system should explore ways that state corporate lawsuits can offer greater value for shareholders. To the extent that many of these lawsuits simply piggyback on securities class actions, they may not do much to deter corporate wrongdoing. There are areas, however, where state corporate lawsuits can play a more meaningful role. Private companies, for example, seldom face securities class actions and therefore state corporate lawsuits may be more important in deterring corporate wrongdoing in these companies. State corporate lawsuits can also play a more meaningful role in situations where the underlying allegations relate to a fundamental governance problem, rather than a disclosure problem, as in the case of backdated stock options.
The preceding post comes to us from Stephen Choi, the Murray and Kathleen Bring Professor of Law and Director of the Pollack Center at NYU Law School, Jessica Erickson, Professor of Law at the University of Richmond School of Law and Adam C. Pritchard, the Frances and George Skestos Professor of Law at Michigan Law School. The post is based on their article, which is entitled “Piling On? An Empirical Study of Parallel Derivative Suits” and available here.