Uncovering Hidden Conflicts in Stockholder Class Action Litigation

Stockholder representatives in class and derivative actions are supposed to share in any recovery on the same terms as other stockholders.[1]  Absent court approval, class counsel typically cannot share fee awards with their clients.[2]  Indeed, class-action litigator William Lerach famously served time in federal prison after pleading guilty to a conspiracy charge related to the payment of kickbacks to class plaintiffs.[3]

Direct payments between class counsel and their clients are the most obvious means of encouraging plaintiffs to bring cases, but there are others.  For instance, in a recent federal securities class action involving State Street Bank and Trust Company, a court-appointed special master discovered that class counsel shared over $4 million of their fee award with an attorney who had done no work in the case for having introduced class counsel to their plaintiff, the Arkansas Teacher Retirement System. [4]  Key to the report is an email from the referring attorney to class counsel that reads like something from a John Grisham novel:

We got you ATRS as a client after considerable favors, political activity, money spent and time dedicated in Arkansas, and Labaton would use ATRS to seek lead counsel appointments in institutional investor fraud and misrepresentation cases.  Where Labaton is successful in getting appointed lead counsel and obtains a settlement or judgment award, we split Labaton’s attorney fee award 80/20 period.[5]

Based on this case, Professor Coffee has raised the possibility of “an active market” in which politically connected attorneys receive fees for introducing prominent plaintiffs’ law firms to public pension funds that can serve as stockholder litigants.

Such a market, if it exists, survives because current class action procedures fail to uncover potential conflicts of interest between stockholder plaintiffs and their counsel.  William Lerach’s misdeeds remained undiscovered for years, until one of his firm’s clients – facing charges for insurance fraud in a different case – agreed to testify against the firm in the hopes of receiving a lighter sentence.[6]  Similarly, the problems in the State Street litigation came to light only after a Boston Globe investigation into billing practices prompted the federal court to appoint a special master.[7]  Neither emerged through the normal judicial process.

In a recent paper, we describe how potential conflicts of interest may emerge from a complex ecosystem that includes not only institutional stockholders and national class action law firms, but also local attorneys, political appointees, and pension fund beneficiaries.   Previous scholarship has focused on so-called “pay to play:” donations from class counsel to politicians with influence over institutional stockholders.[8]  We describe other, less direct ways that class counsel may share the benefits that they derive from stockholder litigation with their clients, based on a review of the State Street case and other publicly-available documents.  For instance, local counsel who receive class action fees may agree to charge lower rates on other matters, or forego fee increases, for clients who serve as representative plaintiffs.[9]  Counsel may set up scholarship funds for pension fund beneficiaries or offer to pay for holiday dinners for pension fund board members.[10]

The frequency or scale of these indirect benefits is impossible to estimate because they rarely receive judicial attention.  Plaintiffs have not disclosed these relationships in class certification or settlement proceedings.  Even where the relevant information is publicly available, the non-adversarial nature of the class-action settlement process means that no party has an interest in bringing these facts to a court’s attention.

Our article suggests a number of reforms that courts or legislatures could use to uncover hidden conflicts of interest between class plaintiffs and their counsel.  First, we suggest that representative plaintiffs should be required to disclose all law firms engaged on their behalf, and who might benefit from a fee award, at the outset of a case.  Second, because disclosure regimes work best when participants expect that nondisclosures will be caught, we recommend that courts appoint class guardians or independent monitors to investigate, and potentially challenge, settlements in class and derivative actions.  Third, we suggest that candor to the court concerning these disclosure requirements should be made an explicit element of adequate representation under Federal Rule of Civil Procedure 23, such that counsel who fail to disclose potential conflicts of interest would be considered inadequate to serve in future class actions.

In describing the State Street litigation, Professor Coffee notes the risk that “[m]any on both sides of the Bar may wish that this episode gets swept under the judicial rug, because it tends to embarrass the Bar.”  So long as class action procedures remain insufficient to detect and evaluate relationships between representative plaintiffs and their counsel, however, future embarrassing incidents are inevitable.  Reform is necessary so that improper influence is deterred by the judicial process itself rather than uncovered by investigative journalists long after the troubling conduct has already occurred.


[1] See, e.g., 15 U.S.C. § 78-u4(a)(4) (“The share of any final judgment or of any settlement that is awarded to a representative party serving on behalf of a class shall be equal, on a per share basis, to the portion of the final judgment or settlement awarded to all other members of the class.”); Ct. Ch. R. 23(aa) (requiring affidavit stating that class plaintiff “has not received, been promised or offered and will not accept any form of compensation, directly or indirectly, for prosecuting or serving as a representative party in the class action” apart from court-approved amounts or “actual and reasonable out of pocket expenses”).

[2] See, e.g., Raider v. Sunderland, 2006 WL 75310, at *2 (Del. Ch. Jan 4, 2006) (setting forth standards for the award of “incentive payments” to class and derivative plaintiffs).

[3] See Dealbook, Lerach is Sentenced to 2 Years in Prison, N.Y. Times, Feb. 11, 2008,; John Nocera, Serving Time, but Lacking Remorse, N.Y. Times, June 7, 2008.

[4] See Ark. Teacher Retirement Sys. v. State Street Bank and Trust Company, 2018 WL 3216012, at *2 (D. Mass. June 28, 2018).

[5] Id. at *2-3.

[6] See Peter Elkind, The fall of America’s meanest law firm, Fortune (Nov. 3, 2006).

[7] See Ark. Teacher Retirement Sys. v. State Street Bank and Trust Company, 232 F.Supp.3d 189, 192 (2017).

[8] See, e.g., Stephen J. Choi, et al., The Price of Pay to Play in Securities Class Actions, 8 J. Empirical Legal Stud. 650, 651 (2011) (“The available anecdotal evidence raises suspicion that class action law firms are buying lead counsel status with campaign contributions, that is, lawyers are paying to play”); David H. Webber, Is “Pay-to-Play” Driving Public Pension Fund Activism in Securities Class Actions? An Empirical Study, 90 B.U. L. Rev. 2031, 2080–81 (2010) (studying correlation between political donations and lead plaintiffs and concluding that “pay-to-play does not drive public pension activism in securities litigation”).

[9] See, e.g., City of Sarasota Firefighters Pension Board, Video of Firefighters’ Pension Board Meeting, Granicus.com (Mar. 27. 2013) (discussion at 2:29–2:32); Minutes, Pompano Beach Police and Firefighters’ Ret. Sys. at 3 (Dec. 12, 2011).

[10] See, e.g., City of Sarasota Firefighters’ Pension Board, Minutes of the Regular Meeting of the Firefighters’ Pension Board of Trustees of April 24, 2013 at 3, (discussing scholarship fund); Minutes, Pompano Beach Police and Firefighters’ Ret. Sys. at 4 (Jan. 22, 2019), (describing to-be-filed gift disclosure form from national securities counsel relating to hosting a holiday dinner).

This post comes to us from Professor Benjamin Edwards at the University of Nevada’s William S. Boyd School of law and Anthony Rickey of Margrave Law. It is based on their recent article, “Uncovering the Hidden Conflicts in Securities Class Action Litigation,” available here.