Toward a Mission Statement for Mutual Funds in Shareholder Litigation

67 Pages Posted: 22 Jul 2019 Last revised: 23 Sep 2019

See all articles by Sean J. Griffith

Sean J. Griffith

Fordham University School of Law; European Corporate Governance Institute (ECGI)

Dorothy S. Lund

University of Southern California Gould School of Law

Date Written: July 19, 2019

Abstract

This paper analyzes the conduct of mutual funds in shareholder litigation. We begin by reviewing the basic forms of shareholder litigation and the benefits such claims might offer mutual fund investors. We then investigate, through an in-depth docket review, whether and how the ten largest mutual funds participate in shareholder litigation. We find that although shareholder suits offer potential benefits, the largest mutual funds have essentially forfeited their use of litigation. This finding is particularly striking given that index funds and other long-term oriented mutual funds generally cannot sell their shares when they are dissatisfied with company performance, leaving them with only two levers in corporate governance — voting and suing. Mutual funds vote, but they do not sue.

We analyze potential explanations for the failure of mutual funds to litigate on behalf of their investors. Collective action problems and conflicts of interest raise significant obstacles to mutual fund participation in shareholder litigation. Yet, we argue, there are situations in which shareholder litigation could create value for mutual fund investors. We therefore turn to the normative question: how should mutual funds litigate on behalf of their investors? Answering this question allows us to articulate a mission statement for mutual funds in shareholder litigation.

Our mission statement is grounded on the perspective of the broadly diversified “market investor.” The repeat-play incentives and broad diversification of many mutual funds, index funds in particular, suggests that they could create value by focusing principally on deterrence objectives. Mutual funds should bring shareholder suits against portfolio companies when doing so would meaningfully enhance deterrence. They should also scrutinize the litigation brought by other shareholders, objecting to outcomes that fail to promote meaningful deterrence. At the same time, mutual funds should focus on compensatory goals in litigation against non-portfolio defendants because extra-portfolio claims do not raise circularity concerns. In addition, mutual funds should consider whether litigation can be used to implement corporate governance reforms. Finally, in all cases, mutual funds should closely monitor litigation agency costs. We close by suggesting ways in which the incentives of mutual funds might be restructured to bring these changes about.

Keywords: mutual funds, index funds, institutional investors, corporate governance, stewardship, litigation, shareholder, engagement, monitoring, agency problems, activism, hedge fund, pension fund, market investor

JEL Classification: G23, G34, K22

Suggested Citation

Griffith, Sean J. and Lund, Dorothy S., Toward a Mission Statement for Mutual Funds in Shareholder Litigation (July 19, 2019). University of Chicago Law Review, Forthcoming; European Corporate Governance Institute - Law Working Paper No. 468/2019; USC CLASS Research Paper No. CLASS19-23; USC Law Legal Studies Paper No. 19-23. Available at SSRN: https://ssrn.com/abstract=3422910

Sean J. Griffith (Contact Author)

Fordham University School of Law ( email )

150 West 62nd Street
New York, NY 10023
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Dorothy S. Lund

University of Southern California Gould School of Law ( email )

699 Exposition Boulevard
Los Angeles, CA 90089
United States

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