Class action reform could take a lesson from U.S. public company governance, I argue in a new working paper, available here.
Class actions and public companies have a lot in common. Class action scholars routinely explain problems in class action litigation, such as excessive attorneys’ fees and settlements that shortchange the class, as “agency costs.”[1] Corporate law scholars frame the problems that beset the governance of U.S. public companies in the same terms. It is also the case that the agency relationship between class counsel and class members looks similar to that between executives and shareholders in U.S. public companies. In both contexts, agents are tasked with maximizing the value of claims held by a large, dispersed collective of persons. This is important because collective action problems can render ineffective certain monitoring techniques useful for reducing agency costs in simpler relationships. These similarities are often noted in class action scholarship, but the importance of the public company analogy tends to be quickly dismissed. The reason given: Public companies are subject to market discipline and class actions are not.[2] In Cutting Class Action Agency Costs, I argue that this has it precisely backwards. The insulation of class counsel from market pressure relative to the managers of public companies is precisely why the public company analogy has the potential to offer valuable insights for class action reform. Because public companies are subject to market discipline, the tools they utilize to reduce agency costs are more likely to be efficient than the tools used to constrain class counsel from elevating its interests above those of the class.
With that idea in mind, it is useful to consider how class action governance and public company governance differ. Anatomy of Corporate Law, by Renier Kraakman et al., offers a useful taxonomy of agency-cost reduction strategies (the “ACL taxonomy”) that we can employ for purposes of this comparison. The ACL taxonomy groups agency-cost reduction strategies into three categories. First are incentive alignment strategies, which aim to align the interests of agents with those of principals through either a trusteeship or rewards approach. Trusteeship involves identifying parties who will be driven primarily by conscience, pride, or reputation (as opposed to monetary incentives) and placing them in a position to either manage the enterprise or monitor the financially-motivated agents tasked with managing the enterprise. A rewards approach, by contrast, seeks to improve agent incentives by promising agents a financial reward if they successfully advance the principals’ interests. Second are governance strategies, which give principals control over their agents’ behavior; they take the form of “appointment rights,” which refer to the power of principals to select and remove agents (or the trustees who oversee the agents), and “decision rights,” which refer to principals’ power to initiate or ratify agent decisions. Third are regulatory strategies, which seek to prescribe agent behavior during the course of the agency relationship or to regulate the terms upon which agents and principals enter and exit that relationship.
U.S. public companies meaningfully rely on each of these strategies. For example, they use incentive alignment strategies in the form of independent boards (an example of the trusteeship approach) and performance-based executive pay (an example of the rewards approach), governance strategies in the form of shareholder voting, and regulatory strategies in the form of judicially-enforced fiduciary duties, mandatory disclosure, appraisal, and the free transferability of shares (which in turn facilitates hostile takeovers and hedge fund activism). By using multiple strategies and approaches, public company governance offers layers of protection to shareholders: If one mechanism fails to operate as intended, another stands behind it. The mechanisms also offer cross-cutting support to one another. For example, disclosure (a regulatory strategy) assists in shareholder voting (a governance strategy), and shareholder voting in turn legitimatizes the board of directors (a trusteeship strategy). In addition, courts’ approach to fiduciary duty litigation (a regulatory strategy) is influenced by whether the challenged transaction was negotiated by an independent board (a trusteeship strategy) or approved by a disinterested shareholder vote (a governance strategy).
| Primary Strategies to Reduce Agency Costs: U.S. Public Companies | ||
| Incentive Alignment | Governance | Regulatory |
| Independent Boards
Gatekeepers (Auditors, Underwriters) Performance-Based Pay |
Shareholder Voting Rights
|
Fiduciary Duty
Mandatory Disclosure Appraisal Free Transferability |
A very different picture emerges when one assesses the techniques used to reduce agency costs in the class action context. Class actions rely almost exclusively on just two mechanisms to combat agency costs: the percentage-of-the-recovery method of compensating class counsel (a rewards-based incentive alignment strategy) and judicial control over class counsel’s appointment, case settlement, and fees (a regulatory strategy). Governance strategies play no role, and while the class representative and objectors may act as trustees in theory, in practice the class representative is no more than a figurehead chosen by class counsel, and objectors are rare and often lack credibility. Exit-based regulatory strategies are also absent: Opt-out rights mean nothing in small-claims class actions, because it is economically irrational for a class member to pursue individual litigation, and class members cannot practically transfer their class claims to third-party buyers.
| Primary Strategies to Reduce Agency Costs: Class Actions | ||
| Incentive Alignment | Governance | Regulatory |
| Class Representatives
Objectors Percentage-of-the-Recovery Fee Method |
None | Judicial Approval of Settlement/Fees
Judicial Appointment of Class counsel Notice & Opt-Out Rights |
Placing such heavy reliance on rewards and court-centered regulatory strategies, to the exclusion of other agency-cost-reduction strategies, is almost certainly suboptimal. Most scholars believe that judicial oversight of class actions is largely ineffective, and the percentage-of-the-recovery method of compensating class counsel, while helping to align class counsel’s interests with those of the class, has significant limitations. In Cutting Class Action Agency Costs, I therefore consider ways that the more varied techniques used by public companies to reduce agency costs might be translated, scaled, and imported into class action practice. Some of my ideas involve modest changes. Others are bolder.
On the more modest end, I suggest that courts presiding over class actions adjust the level of scrutiny they apply to proposed settlements and fee petitions, depending on whether positive input has been received by the government agency required to be notified under CAFA. Courts hearing fiduciary duty claims brought under corporate law similarly adjust the level of scrutiny applied to conflicted transactions depending on whether those transactions were approved by independent directors, thereby encouraging reliance on trusteeship. Courts could also improve the way they set attorneys’ fees by taking cues from executive compensation. For example, stock options are an important component of executive pay at public companies, encouraging executives to take risks they might otherwise avoid – and that shareholders would want them to take – because options pay off only on the upside. In class actions, by contrast, there is no option component to class counsel pay that would help to align class counsel’s risk preferences with those of the class. This means that, when confronted with the choice of taking a sure thing settlement or threatening trial unless the defendant pays more, class counsel will be more inclined to take the settlement than class members would prefer. Awarding rising marginal contingency fees would mimic the incentive-alignment effect of stock options. Courts could replicate the executive pay practices of public companies in others ways as well, such as by setting fee terms at the outset of the litigation.
On the bolder end of the spectrum, I suggest the creation of an independent class overseer position that would ideally be staffed by a government entity or non-profit organization (consumer-advocacy groups might, for example, serve this role in consumer class actions). The class overseer would play a trusteeship role more akin to that played by the independent board in public companies, with authority over counsel selection, fees, and (with certain caveats) settlement. Governance rights could be granted to class members for the limited purpose of electing the class overseer, affording it a legitimacy the class representative lacks under current practice. In addition, I suggest that the regulatory strategy of free transferability be imported into class action practice by allowing class members to sell their class claims to third parties any time after certification. This would allow class members with larger stakes to emerge, and they – like institutional and hedge fund investors in public companies – might take a greater interest in monitoring the enterprise. These larger-stakes class members would also make good class overseer candidates and credible objectors. Moreover, the possibility that they might choose to opt out and pursue litigation separately would help to discipline class counsel.[3]
My bolder proposals may sound unrealistic. Class member voting rights, for example, have long been considered a non-starter, as rational apathy and collective action problems render it unlikely that class members would cast an informed vote. And the transaction costs associated with selling claims in small-stakes class actions seem prohibitive. Under current practice, this assessment is most certainly correct. But another reform has the potential to radically reduce the impediments to successful implementation of these proposals, as well as to revolutionize class action practice in other important respects. This reform also finds inspiration in the public company analogy.
Public company governance does not exist in a vacuum. A variety of external institutions exist that, together, create a capital market infrastructure of sorts. This infrastructure is not captured in the ACL taxonomy, but it greatly reduces the cost, and increases the effectiveness, of public company governance. The SEC’s Edgar database, for example, provides free and easy access to all public company filings, making mandatory disclosure meaningful. Shareholder voting is aided by the existence of share depository institutions, which maintain ownership records for public company stockholders, as well as by firms specializing in proxy administration. Stock exchanges and clearinghouses facilitate low-cost share transfer, which is critical to hostile takeovers and hedge fund activism. Class action governance lacks any comparable supporting infrastructure. Identifying class members, communicating with them, and distributing settlement funds are incredibly cumbersome and expensive tasks. While specialist companies exist to assist counsel with these tasks for a fee, considerable efforts must be replicated on a case-by-case basis, and the fruits of these efforts are unimpressive—in a recent FTC empirical study, the median percentage of direct class action notice recipients who made claims in the class actions studied was less than 10%.
Given technological advances, a more efficient class action infrastructure is within reach. In a companion piece, Classaction.gov, I lay out what such an infrastructure might look like. Imagine, for example, if federal law required persons to register on a website run by the federal government – Classaction.gov – in order to participate as class members in class actions. Not registering would serve, effectively, as a universal opt out to the class action regime. Registrants on Classaction.gov would be required to provide basic information about themselves, which would allow for the creation of a secure database that could be searched in certified class actions in order to identify potential class members. When the database could not be used to identify all potential class members, published notices could be posted on the website and emailed to registrants who have opted to receive such communications; class members could then self-identify via the website. Every case would have a dedicated page on Classaction.gov, where counsel would be obligated to post court filings and other important information would be conveyed, in a standardized format, and where opt-outs and (if necessary) claims forms could be submitted and objections lodged. All communications in a case would be emailed to class members from a trustworthy @classaction.gov email address and would appear in a standardized format. Settlement funds would be put in escrow with the federal government and then deposited electronically into the accounts specified by class members when they registered on Classaction.gov. Actual settlement distribution data would be made publicly available on the case’s webpage. Court filings and settlement distribution data would also be fed into a comprehensive, searchable Classaction.gov database and made available to researchers for free.[4]
This website would, inter alia: (1) render class actions more transparent, allowing researchers and the public to intelligently assess their value in our society; (2) dramatically increase the number of class members that actually receive notice and share in settlement funds; and (3) radically reduce the costs associated with notice and claims administration, leaving more money on the table for victims. In addition to producing these benefits, which are detailed in Classaction.gov, the envisioned website would also render feasible some of the bolder public-company inspired reform ideas I advance in Cutting Class Action Agency Costs. For example, voting for class overseer via a hyperlink contained in an email may be easy enough that class members would find it worthwhile to participate. Alternatively – and taking further inspiration from the public company analogy – registrants could select a proxy (perhaps a government official, trusted non-profit, or law school clinic) to vote on their behalf in any case they find themselves a class member in. The website could also render practical the free transferability of class claims by operating as an online exchange, providing a platform for the posting of bids and for effecting secure sales transactions. Because all claims sales would occur via the website, it would be easy to redirect communications in the case, as well as settlement payments, to the purchaser.
The reform ideas raised in Cutting Class Action Agency Costs necessarily raise many questions that I attempt to carefully address in the manuscript. Reasonable minds may differ as to whether specific reforms are wise. I hope I leave all readers certain of one thing, however: The public company analogy provides a richer source of inspiration for class action reform than scholars have previously recognized.
ENDNOTES
[1] This approach is traceable to the pioneering early work of Professor John Coffee.
[2] See, e.g., Kenneth W. Dam, Class Actions: Efficiency, Compensation, Deterrence, and Conflict of Interest, 4 J. Legal Stud. 47, 59-60 (1975) (distinguishing the relationship between shareholders and corporate managers from the relationship between class members and class counsel due to the absence of a market in legal claims); John C. Coffee, The Regulation of Entrepreneurial Litigation: Balancing Fairness and Efficiency in the Large Class Action, 54 U. Chi. L. Rev. 877, 882-83 (1987) (arguing that agency problems in class actions are distinguishable from those in public companies because, inter alia, “no informed and active market [] discipline[s] or motivate[s] the agents in the litigation context”); Alexandra Lahav, Fundamental Principles for Class Action Governance, 37 Ind. L. Rev. 65, 115 (2003) (observing that the corporate analogy is “not entirely appropriate” because “there is no market—efficient or otherwise—for class action settlements”); Samuel Issacharoff, The Governance Problem in Aggregate Litigation, 81 Fordham L. Rev. 3165, 3167 (2013) (“There is no telling act by class members that would look like the realized buy-in of the capital markets”). Professor Coffee goes furthest to develop the analogy in Class Action Accountability: Reconciling Exit, Voice, and Loyalty in Representative Litigation, 100 Colum. L. Rev. 370 (2000).
[3] As discussed in my paper, the proposal to make class claims freely transferable shares features with, but enjoys distinct advantages over, several notable market-based class action reform proposals that have been advanced by scholars in the past. See, e.g., Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs’ Attorney’s Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. Chi. L. Rev. 1 (1991); Charles R. Korsmo & Minor Meyers, Aggregation by Acquisition: Replacing Class Actions with a Market for Legal Claims, 101 Iowa L. Rev. 1323 (2016); Coffee, Class Action Accountability, supra, at 421-25; Charles Silver & Sam Dinkin, Incentivizing Institutional Investors to Serve as Lead Plaintiffs in Securities Fraud Class Actions, 57 DePaul L. Rev. 471 (2008); Alon Klement, Who Should Guard the Guardians? A New Approach for Monitoring Class Action Lawyers, 21 Rev. Litig. 25 (2002); Geoffrey P. Miller, Competing Bids in Class Action Settlements, 31 Hofstra L. Rev. 633 (2003).
[4] As I explain in Classaction.gov, a federal class action website could substantially improve class action practice even if it did not have all of the functionality described here. For example, it could significantly increase the claims rates even without a registration requirement by increasing class member trust in notices and claims processes. See also Amanda M. Rose, The Trust Barrier to Consumer Participation in Class Actions, Public Comments of Professor Amanda M. Rose, Consumers and Class Action Notices: An FTC Workshop (October 29, 2019), available here.
This post comes to us from Professor Amanda Rose at Vanderbilt University Law School. It is based on her recent paper, “Cutting Class Action Agency Costs: Lessons from the Public Company,” available here.