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Letting Billions Slip Through Your Fingers: Empirical Evidence and Legal Implications of the Failure of Financial Institutions to Participate in Securities Class Action Settlements


James D. Cox


Duke University School of Law

Randall S. Thomas


Vanderbilt University - Law School; European Corporate Governance Institute (ECGI)

December 2004

Stanford Law Review, Vol. 58, p. 411, 2005
Vanderbilt Law and Economics Research Paper No. 06-09
Duke Law School Public Law & Legal Theory Paper No. 107

Abstract:     
This article presents the results of an empirical investigation of the frequency with which financial institutions submit claims in settled securities class actions. We combine an empirical study of a large set of settlements with the results of a survey of institutional investors about their claims filing practices. Our sample for the first part of the analysis contains 118 settlements that were not included in our earlier study. We find that less than 30% of institutional investors with provable losses perfect their claims in these settlements.

We then explore the possible explanations for this widespread failure. We suggest a wide range of potential problems from mechanical failures in the notification and recordkeeping processes to more subtle issues such as portfolio managers' beliefs that only investment activities produce significant returns for their clients.

In order to determine which of these problems were the main culprits, we surveyed institutional investors about their claims filing practices, asking them who was responsible for this task, how they performed it, and what, if any, performance monitoring was done. We learned that most institutions relied on their custodian banks to file claims for them in securities fraud class action settlements, that many of these institutions did little monitoring of whether the custodian actually performed these services, and that custodians had financial disincentives to file claims on behalf of their clients.

We argue that any such failures should be evaluated as potential breaches of the duty of care consistent with the monitoring obligations embraced in Delaware's Caremark decision. Applying this standard to our problem, we believe that the trustees of institutional investors must, in good faith, insure that their fund has an adequate system in place to identify and process the fund's claims. Furthermore, they should create a monitoring mechanism to insure that this system is adequate, and if they learn it is inadequate they should take measures to fix the problem. Custodians that file claims on behalf of their institutional clients should perform the various aspects of this job with due care, too, or face potential liability for negligence. We then identify several discrete problems with the claims filing system that can be addressed to help remedy the current situation.

We conclude our article with two observations about the implications of our results for the goals of securities fraud litigation. Our survey results show a serious mismatch between the beneficiaries of the settlement and those that have been harmed by the securities violation that gave rise to the settlement. Simply stated, many defrauded beneficiaries are not compensated for their losses, while others are unjustly enriched. Given the enormous importance of institutional investors in the market, this mismatch raises serious doubts about whether securities fraud class actions can be justified as compensatory mechanisms. Moreover, the poor claims filing records of institutional investors exacerbates this mismatch, as many investors are systematically deprived of any benefits from these settlements. This raises more doubts about the compensatory function of securities fraud cases.

Rather we believe the more persuasive rational for these cases is the deterrence of fraud. But in order to accomplish that purpose, we think that the current process needs to undergo some changes. We therefore suggest targeting securities fraud litigation at the individual wrongdoers, and invoking vicarious liability only when the company benefits from the fraud.

Note: Previously titled: An Empirical Analysis of Institutional Investors' Impact as Lead Plaintiffs in Securities Fraud Class Actions

Number of Pages in PDF File: 45

Keywords: Institutional Investors, securities class action settlements, Caremark decision

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Date posted: January 27, 2005  

Suggested Citation

Cox, James D. and Thomas, Randall S., Letting Billions Slip Through Your Fingers: Empirical Evidence and Legal Implications of the Failure of Financial Institutions to Participate in Securities Class Action Settlements (December 2004). Stanford Law Review, Vol. 58, p. 411, 2005; Vanderbilt Law and Economics Research Paper No. 06-09; Duke Law School Public Law & Legal Theory Paper No. 107. Available at SSRN: http://ssrn.com/abstract=655181 or http://dx.doi.org/10.2139/ssrn.655181

Contact Information

James D. Cox
Duke University School of Law ( email )
Box 90360
Duke School of Law
Durham, NC 27708
United States
919-613-7056 (Phone)
919-613-7231 (Fax)
Randall S. Thomas (Contact Author)
Vanderbilt University - Law School ( email )
131 21st Avenue South
Nashville, TN 37203-1181
United States
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
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