Uncovering the Hidden Conflicts in Securities Class Action Litigation: Lessons From the State Street Case

Abstract

In stockholder class actions, plaintiffs and their counsel purport to represent the interests of a class of corporate stockholders, and class counsel typically seek contingency fees based on the benefits provided to absent class members. This presents two related agency problems: class plaintiffs must serve as fiduciaries for absent stockholders and also monitor their counsel to ensure that a lawsuit is pursued for the benefit of the class, rather than its lawyers. Scholars have theorized that institutional stockholders may act as better monitors than small shareholders, a theory that Congress embraced with the Private Securities Litigation Reform Act of 1995 (PSLRA).

However, institutional stockholders also face structural and political pressures presenting potential conflicts of interest. A recent federal securities class action revealed one such arrangement, when a federal court discovered that a large class action firm had paid over $4 million in “bare referral” fees to an attorney who did little work on the case, but had recommended the larger firm to a public sector pension fund “after considerable favors, political activity, money spent and time dedicated in Arkansas.”

Current class action processes do not routinely identify these potential conflicts of interest, which tend to surface when non-litigants bring them to public attention. Class counsel may route benefits to class plaintiffs through less visible channels. If these benefits flow exclusively to lead plaintiffs and not to the class, it creates the potential for conflicts of interest.

Because neither the lead plaintiff’s nor the defendant’s counsel may have a strong incentive to voluntarily address these conflicts, we propose that class plaintiffs be required to disclose more information regarding their relationship with class counsel as part of the class certification process. We also propose that courts consider the routine appointment of special masters or class guardians as part of the settlement approval process to secure fair settlements by vetting proposals with adversarial scrutiny.