Plaintiff's lawyers said to lack accountability

Large institutional investors are 'opting out' of securities class actions, legal experts say

By Bruce Kelly

Feb 25, 2008 @ 12:01 am (Updated 3:35 am) EST

Plaintiff’s attorneys in securities class actions often lack “accountability,” according to a prominent law professor.

“Accountability is lacking in class and representative litigation — largely because clients cannot control their agent, the plaintiff’s attorney,” John C. Coffee, a law professor at Columbia University Law School in New York and director of its Center on Corporate Governance, wrote in a paper presented Feb. 8 at a conference on securities fraud litigation.

As a result, large institutional investors, including public-pension funds, increasingly are opting out of securities class actions. If that continues, such lawsuits “may be abandoned by its most sophisticated users,” wrote Mr. Coffee.

“Instead, a two-tier system of securities litigation will emerge in its place, under which the largest investors will opt out and sue in state court individual actions, with the class action becoming the residual vehicle for smaller investors,” he wrote.

CHANGE IN ATTITUDE

That, in turn, has lead to a shift in the mind-set of attorneys who represent plaintiffs, according to Mr. Coffee.

<b>John C. Coffee:</b>
John C. Coffee: "The plaintiff's attorney behaves less as an agent serving a principal and more as an independent entrepreneur." Bloomberg

“The plaintiff’s attorney behaves less as an agent serving a principal and more as an independent entrepreneur — one who in fact often hires the client,” he wrote. “When the attorney is able to hire the client, the normal principal-agent relationship has been reversed, and this evidences that the attorney possesses unaccountable power.”

Mr. Coffee’s primary observation is “the conflict of interest between the class action attorneys and the members of the class,” said Bradford Cornell, a Sacramento, Calif.-based senior consultant with CRA International Inc. of Boston. “That’s an important problem.”

Greater accountability by securities class action attorneys is needed, Mr. Coffee’s paper concluded.

The paper was presented at Claremont (Calif.) McKenna College at a conference, “The Future of Securities Fraud Litigation.”

Mr. Coffee said there is a chance that large institutions opting out of class actions could ultimately benefit investors. If plaintiff’s attorneys face greater accountability, they could also face increased competition.

“Opting out is not a panacea for all the problems of the securities class action, but it should at least force the attorney to behave more as an agent and less as an opportunistic entrepreneur,” Mr. Coffee wrote.

In comments to the conference attendees, he said that large institutional investors will continue to abandon securities class actions to the detriment of defendant corporations and individual plaintiffs.

The large investors will sue in state court, leaving individual investors to sue corporations as a class, Mr. Coffee said.

Defendant corporations “have much to fear” from such a trend, he said.

For example, they could face more lawsuits in state court.

And individual investors could suffer if large institutions — which are often lead plaintiffs in class actions — opt out.

The first such case, Mr. Coffee said, occurred in 2005, when a group of state and local retirement funds, and insurance companies, withdrew from a class action and recovered $651 million from WorldCom Inc.’s investment banks.

Together, the individual plaintiffs in a class action against the Clinton, Miss., company received a $6.1 billion settlement, but attorneys at the time said the institutional investors had a rate of recovery of up to 83% more than the amount they would have gained as part of the class action.

One reason that opt-outs fare better is that the Private Securities Litigation Reform Act of 1995, which raised legal standards for filing securities class actions, does not apply in state courts, Mr. Coffee said.

Also, local courts — where judges are elected — can prove a more favorable forum for such claims, he said.

Bruce Kelly can be reached at bkelly@crain.com.