Reforming the Securities Class Action: An Essay on Deterrence and its Implementation

Abstract:     
The securities class action cannot be justified in terms of compensation, but only in terms of deterrence. Currently, the damages recovered through private enforcement dwarf the financial penalties levied by public enforcement. Yet, the evidence is clear that corporate officers and insiders rarely contribute to securities class action settlements, with the settlement funds coming instead from the corporation and its insurers. As a result, the cost of such actions in the aggregate falls on largely diversified shareholders. Such a system is akin to punishing the victims of burglary for their negligence in suffering a burglary and does little to deter corporate officials who have private motives for engaging in securities fraud. The present structure of securities class actions benefits a trio of interest groups - corporate officials, plaintiff's attorneys, and insurers - but not shareholders.

To reform the securities class action and give it a true deterrent orientation, this article proposes a variety of steps - none requiring legislation or the reversal of well-established precedents - to shift the costs of the securities class action to the culpable. These steps proceed from the twin premises that (1) the settlement of a securities class action is a conflict of interest transaction requiring independent directors to exercise oversight over the allocation process, and (2) enterprise liability is an ineffective approach for misconduct that is privately motivated and easily concealed. To incentivize private enforcers, a basic change in the judicial approach to attorney's fees is proposed.

Working Paper Series