Much of the literature related to large settlements seeks to improve how judges and private actors serve the large groups of people impacted by a massive settlement.¹  Settlement funds have reformed, in turn, by giving people more choices, such as more filing opportunities, different settlement outcomes, and extended deadlines. More opportunities to opt out of a large settlement theoretically assure that the fund’s administrators represent the interests of those who do not opt out. More choices of settlement awards means that more claimants can elect awards that fit their individual needs and circumstances. And more time to decide helps claimants to arrive at decisions that reflect their divergent interests. Few commentators have considered, however, how claimants to a large settlement fund make those choices.² Modern reform efforts, rather, assume that claimants make rational decisions about their options based on their own stable values and preferences.³

But is that correct? Studies have long shown that because of cognitive bias, people may buy things they do not want, save too little for retirement, or make risky choices about their health—based on their point of reference, the timing of the decision, and the presence of seemingly irrelevant choices.⁴ Behavioral economists have examined these ostensibly irrational decisions in many other legal contexts, but few commentators have explored these effects in the context of a large group settlement. Because claimants to large settlements are generally unassisted laypersons, large settlement funds may be particularly compelling settings to examine the adverse impact of cognitive bias.

To that end, I make three claims in this Essay. First, people may make irrational decisions about their settlement options in a large settlement fund because of cognitive bias. Second, cognitive bias may undermine some of the stated purposes of public and private settlement funds—to provide claimants with more access, efficiency, and fairness than in traditional litigation. Third, “fund designers”—judges, lawmakers, and agencies—should identify and, in some cases, capitalize on claimants’ cognitive bias by altering the context, timing, and sequence of settlement options. Fund designers, however, should avoid reforms that unduly eliminate settlement options or impose excessive administrative costs. Rather, the benefits of any reform—preventing avoidable harm to irrational claimants—must outweigh the potential costs, including the value of client autonomy, the chance of error, and the burden on the courts and public administrators.

I examine these three claims by describing how three cognitive biases are likely to affect claimants in large settlement funds. These biases are: (1) status quo bias, (2) contrast bias, and (3) time-inconsistency bias.

I.

Status Quo Bias

Status quo bias refers to a person’s tendency to stick to the status quo even when other options would increase well-being. In principle, a completely rational person will choose between alternatives based on his or her preferences and the potential costs of making an informed decision. In practice, however, simply characterizing an option as the status quo significantly increases the chances that a person will choose that option. Some speculate that this preference for the status quo derives from a general aversion to risks caused by one’s own actions, even when there are greater risks associated with inaction.⁵

For example, alternative investment and saving options are significantly more popular among college professors when designated as the status quo or the default choice.⁶ Because of the status quo effect, some commentators like Cass Sunstein and Richard Thaler have advocated “libertarian paternalistic” ways to encourage saving.⁷ They advocate changing the default rules to promote particular outcomes—like an employee’s decision to enroll in a 401(k) retirement plan—without limiting the employee’s opportunity to opt out of the plan at a later time.

Of course, switching costs also might explain adherence to default rules. A decisionmaker may rationally determine that it is not worth the time, money, or potential opportunity cost to deviate from the status quo. Moreover, people may be rationally indifferent to certain choices. Such explanations, however, do not fully account for how people make decisions. Although the subject of some criticism, many studies show that people irrationally overvalue either the default option or the costs associated with departing from the default option.⁸

In class action settlements and public settlement funds, status quo bias may be unavoidable. After all, there must be a default rule that asks people either to affirmatively join or affirmatively withdraw from a large settlement fund. But status quo effects complicate the long-held belief that opt-out rights (1) ensure fairer settlements and (2) provide an adequate opportunity to claim or reject awards through the fund. When few people affirmatively opt out or object to a settlement, courts and administrators have assumed that the fund successfully represents what claimants rationally want and therefore ensures a “fair, reasonable, and adequate” settlement.⁹ Status quo bias, however, provides a reason to be skeptical of these assumptions and the policies based on them, even when very large payouts are involved. Many people will join a large fund not because the overall settlement reflects their values and interests but simply because the default rule requires parties to affirmatively opt out of the fund.

The status quo bias also contributes to the phenomenon of underclaiming, in which parties refuse to opt out of a settlement but never claim an award. Many public and private settlements require parties to complete a new form to claim an award, to choose among substantive settlement options, or to select a settlement process. Commentators studying claim rates in class action settlements have found that the fraction of funds actually disbursed was very modest in these so-called claims-made settlements.¹⁰ This includes cases in which claimants were otherwise entitled to substantial awards.

Accordingly, settlement funds could automatically process claims, not unlike automatic 401(k) plan enrollment. Under such a system, a settlement fund would automatically distribute presumed awards to claimants who join the fund. Such a policy, however, would come at a cost. Among other things, funds would bear the administrative cost of precisely identifying eligible claimants in advance of payment.

In light of potential costs, automatic processing would be more justified in certain funds. In large-value cases, for example, automatically processing claims would not be worth the administrative cost, the burden on the courts, and the potential for error or fraud. Thus, automatic processing may be warranted in welfare benefit settlements or shareholder class action funds, in which fund designers typically have a great deal of information about claimants, the awards are modest, and claimants generally do not choose among multiple settlement options.¹¹ Such policies would be more problematic in large mass tort settlements, in which settlement trusts or public settlement funds have less information about potential claimants, the awards are large, and claimants may be offered various procedural and substantive options in the settlement.

II.

Contrast Bias

Contrast bias is the irrational tendency to weigh an option more or less favorably depending on the presence of other options. Theoretically, a rational decisionmaker should not rank options differently simply because the options are described in a particular way. Moreover, the introduction of an additional choice should not alter a decisionmaker’s relative valuation of the original options. But this is not always the case.

Take, for example, the uncanny effects of decoy options—options that no one ever chooses but that make another alternative more appealing—on physical attraction. In a survey of six hundred students, a behavioral economist asked subjects to rate the looks of two men.¹² When asked to choose between the photographs of two equally attractive candidates—call one “George Clooney” and the other “Brad Pitt”—subjects were equally divided. When another group of subjects was asked to choose between the two initial candidates and a third candidate, a photoshopped and deformed version of George Clooney, however, 75 percent chose the unspoiled version of George Clooney and 25 percent chose Brad Pitt. Although no one selected the third option, the seemingly irrelevant introduction of an ugly version of George Clooney led 50 percent more students to believe that the original George Clooney was better looking than Brad Pitt.

Psychologists and behavioral economists have found that contrast effects directly impact a wide array of decisions, including consumer purchases, employment decisions, elective medical procedures, and even presidential elections.¹³ There are many explanations for contrast bias. Some suggest that it is simply easier to compare similar options among a set of choices than to give an absolute or innate value to any particular option. ¹⁴

The presence of contrast bias may be relevant to laws designed to improve the oversight of large settlements. Many settlement funds ask claimants to choose from an array of options after joining a settlement, in part to maximize the benefit to claimants with different interests in settlement. But the interrelationship of various settlement options may unwittingly impact a choice between cash and nonpecuniary awards, like coupons and warranties. In my own classes, I distribute an altered Apple iPod Settlement Notice as an illustration. After litigation over reported battery problems in old Apple iPods models, Apple settled and offered customers a choice of a $50 store credit or $25 in cash. Half of my students receive the original version of the iPod settlement notice. The other half receives a modified notice that contains the same two options—a $50 store credit and $25 in cash—and a decoy option, a $35 store credit. The results show the addition of a seemingly irrelevant coupon dramatically affects the students’ willingness to take the coupon settlement. The original group chooses cash more than 61 percent of the time; the decoy group chooses the cash only 40 percent of the time.

Contrast bias has implications for laws like the Class Action Fairness Act (“CAFA”), which expressly requires courts to conduct “fairness hearings” in coupon-only settlements and to postpone decisions about the amount of attorneys’ fees until after the coupons have been redeemed.¹⁵ CAFA’s purpose is to ensure that the attorneys’ fees are closely connected to the actual value of the settlement to the class. But CAFA does not impose a similar requirement for settlements involving both coupons and other options. Rather, courts may award attorneys’ fees upfront, based on an estimate of the cash value of the settlement apart from the portion of the settlement involving coupons. Due to contrast bias, courts may also have reason to wait for claimants to redeem these kinds of settlement awards: the coupon may encourage claimants to accept another settlement option that, by comparison, seems to offer a better value or greater liquidity. Such delay imposes costs. Class action litigation is risky business, and delaying even a portion of attorneys’ fees may dampen some attorneys’ willingness to file in the first place. But delay may be justified if it ensures that the attorneys’ fees better reflect the actual value that class members derive from the settlement.

III.

Time-Inconsistency Bias

Rational models of choice assume that people have time-consistent preferences. That is, a person’s relative preference for gratification will be the same no matter when he or she is asked. Substantial evidence, however, demonstrates that people have time-inconsistent or present-biased preferences. Ask whether a person prefers to rent Schindler’s List or So I Married an Axe Murderer, and the answer should not depend upon whether the decisionmaker plans to watch the movie today or later next week. But the proportion of people who elect to watch Schlindler’s List in the near future may be thirteen times higher than those willing to watch it on the same day they are asked.¹⁶ Present-biased preferences explain the systematic tendency to seek out more immediately gratifying benefits today than the long term benefits called for by earlier plans.¹⁷ More often than not, people choose a bird in the hand—be it dessert, a little extra cash, or a silly movie¹⁸—over three or four in the bush.

Time-inconsistency is compounded by nonintegrated decisionmaking. Nonintegrated decisions are rational decisions about costs and benefits in irrationally short periods of time. If a person had to choose whether to spend the next five minutes writing a paper or watching a YouTube video, she would rationally choose YouTube, the more pleasurable activity. After five minutes, she would rationally make the same decision again. But when the decision is viewed under a more integrated time horizon—four hours of paper writing versus four hours watching YouTube—she would rationally choose to write her paper. Because people are susceptible to nonintegrated decisionmaking, even small tastes for immediate gratification, or small costs associated with a task, may cause a naïve person to continuously postpone making decisions.

The converse of nonintegrated decisionmaking is that procrastinators will be highly sensitive to very small short-term incentives or penalties. Policies that make the cost of a short delay loom larger thus make procrastination less likely.¹⁹

Time-inconsistency bias may prove costly to claimants filing with a fund and to the administrative operation of the fund. Although some settlement funds fix relatively short deadlines, requiring filing within three to six months of settlement, other more complicated mass tort funds may allow one to two years to file. In many cases, there is no overt penalty for failing to file at an earlier time. There is a very powerful hidden penalty, however, to claimants—the time value of money and potential lost interest. For example, as illustrated in the graph below, more than half of the families affected by the September 11 attacks waited two years to file with the September 11 Victim Compensation Fund; as a result, each gave up, on average, over $100,000 in lost interest per year.

September 11 Victim Compensation Fund Claims Filed²⁰

Note the large spike in claims that appears just before the filing deadline on December 22, 2003. Rational considerations certainly explain some of the late filings. Claimants may choose to gather more information before filing with a large settlement fund. Or, particularly in large funds involving personal injuries, parties may need additional psychological distance from the event that gave rise to the claim. These explanations, however, are insufficient to account for the concentration of claims that appear just at the filing deadline of many large settlement funds. It is more likely that many claim filings represent present-biased preferences.

One solution is that large settlements could adopt rolling deadlines to encourage earlier filings. Parties could be required to file in the first week of each month until the final deadline. Human resource departments often use such rolling window systems to encourage employees to enroll in benefit programs, but these systems have never been applied in large public or private settlement funds. Cognitive science, however, suggests that such short-term incentives will encourage claimants to file more often over the duration of the fund, saving both opportunity costs to claimants and administrative costs to the fund.

Any such solution must take costs into account. Undoubtedly, rolling deadlines impose a cost on individual actors, who would suffer the inconvenience of filing at the beginning of the month, as well as on the fund, which would have to expend additional resources making such a filing system easy and transparent. But it would impose comparably small costs to claimants’ autonomy. A party unable to file at the beginning of the first month would always retain the ability to file the following month. A party that wants to wait for other strategic, information-driven, or psychological reasons would still retain that right.

Because of such costs, rolling deadlines may be more justified in funds that award high-value claims, like mass torts and some antitrust settlements, but not necessarily low-value claims, like consumer class actions. For high-value claims, the additional savings to the individual and the fund justify taking measures to encourage parties who might otherwise suboptimally delay filing.²¹

***

By “funding irrationality,” I do not challenge efforts to increase choices and opportunities for claimants to large funds. I only question whether such efforts, by themselves, are enough to accomplish their objectives of greater fairness, efficiency, and equity. Although such measures help rational participants to monitor, object, and exclude themselves from such funds, few measures exist to protect claimants who will make decisions based upon cognitive error. As this Essay demonstrates, there will be cases in which, on balance, many subjects will make poor decisions—both for themselves and for the fund as a whole—when available settlement options are not adjusted to account for cognitive biases. This is, in part, because in many large funds parties lack individual access to third-party expertise, like lawyers. Given the tremendous economic, social, and institutional resources devoted to operating large funds, it is worth asking: Are there better ways to design large funds? Can their design accommodate both rational and irrational decisionmaking?

I answer both questions with a qualified “yes” by recommending policies that benefit those prone to make cognitive errors but impose minimal costs on those who otherwise choose rationally. In so doing, I recommend accounting for and sometimes exploiting the timing, structure, and combination of options in large settlements to increase the welfare of all potential participants.

But such solutions raise fundamental questions of fairness and efficiency themselves: Will fund designers suffer from their own biases? Will procedures that fund irrationality unfairly limit claimants’ rights to control their own litigation? Will funding irrationality risk replacing one set of claimant biases with new biases that lead to even less desirable outcomes? These are all valid concerns. The compensatory goals of large funds require, however, that fund designers understand how claimants make choices and, when possible, adjust rules so that funds better serve them.

Acknowledgments:

Copyright © 2010 Duke Law Journal.

Adam S. Zimmerman is an Acting Assistant Professor at the New York University School of Law.

This Legal Workshop Editorial is based on the following article: Adam S. Zimmerman, Funding Irrationality, 59 DUKE L.J. 1105 (2010)

Here, the concern is not over some deviation from the one-on-one lawsuit.  Rather, the basic suggestion is to circumscribe what an ostensible individual action may do, by way of litigation or settlement, in order to prevent that lawsuit from exerting some binding force upon nonparties who are broadly similar to the parties involved.  The idea, in other words, is to constrain what individual litigation may do, precisely because such a proceeding is not a de facto class action empowered to act upon nonparties.

In recent years, variations of this concern have surfaced across seemingly unrelated contexts:  in the Supreme Court’s 2008 decision in Taylor v. Sturgell,¹ concerning preclusion principles and the procedural doctrine of “virtual representation”; in the Court’s 2007 decision in Philip Morris USA v. Williams,² regarding the constitutional due-process limits on punitive damages; and with respect to the widely-reported $4.85 billion deal in 2007 to resolve mass tort litigation over the prescription pain reliever Vioxx.³  Each of these situations merits scholarly attention in its own right.  My suggestion is that something deeper is going on here, but that its nature and implications remain undertheorized.

Each instance involves a situation of “embedded aggregation.”  In each, a doctrinal feature of what is ostensibly individual litigation—the scope of the right of action the plaintiff asserts, the nature of the remedy that the plaintiff seeks, or the character of the alleged wrong—gives rise to demands for the suit to bind nonparties in some fashion, beyond the ordinary kind of stare decisis effect that any case might exert.  An aggregate dimension, in short, is embedded doctrinally within what appears to be an individual lawsuit; and that aggregate dimension, in turn, gives rise to demands for a binding effect of a commensurately aggregate scope.

Taylor v. Sturgell provides the perfect backdrop for this set of issues.  Taylor involved the Freedom of Information Act (FOIA), which confers an undifferentiated right upon “any person” to request the disclosure of “records” that the federal government holds.⁴  The difficulty that this undifferentiated right presents is that, as to any given record, the universe of potential claimants who might assert a right to disclosure is without legal limits.

The Taylor Court held that constitutional due process forbids the judgment in one FOIA requester’s losing effort to compel disclosure from exerting preclusive effect upon a subsequent requester of the identical record, at least absent agreement or collusion between the two requesters.⁵  To hold otherwise—as some lower courts had attempted to do by developing a doctrine of virtual representation—would be to enable courts to “create de facto class actions at will.”⁶

The concern over nonparties in individual actions, however, extends well beyond FOIA litigation.  Under current doctrine, the limits on punitive damages as a matter of federal constitutional due process bespeak a similar concern.  In Philip Morris USA v. Williams, the Supreme Court held that the “Due Process Clause forbids a State to use a punitive damages award to punish a defendant for injury that it inflicts upon nonparties.”⁷  To do so, the Court reasoned, would be to punish the defendant “for injuring a nonparty victim”—in Williams, the many other Oregon smokers of the defendant’s cigarettes—without an “opportunity to defend against the charge” based upon the particulars of those nonparties.⁸  The Oregon court had never certified Williams to proceed as a class action.

On its face, the discussion of nonparties in Williams seems to dwell on the inputs to a punitive damages award in individual litigation rather than on the outputs in terms of nonparty effects.  With respect to allegations of extreme market-wide misconduct, however, the two cannot be so cleanly separated.  Prior to Williams, serious concern had emerged that punitive damages awards in seriatim individual lawsuits over the same course of extreme market-wide misconduct might amount, in the aggregate, to multiple punishment, such as to warrant a clampdown on the availability or application of punitive damages for later plaintiffs.

Williams holds that punitive damages are, at least in theory, exclusively about punishment of the defendant for the extremity of its wrong as to the particular plaintiff at hand, not as to nonparties.⁹  The Court nonetheless added that the jury still may consider harm to nonparties to assess the reprehensibility of the defendant’s misconduct vis-à-vis the plaintiff.¹⁰  As a result, after Williams, an ostensible individual action for punitive damages as to market-wide misconduct will continue to have at least some nonparty dimension—again, even though nonparties have not been brought into the suit.  The important point remains that Williams, too, grapples with how to regulate a kind of embedded nonparty dimension in individual litigation—here, under the Court’s due-process jurisprudence for punitive damages.

The concern that the disposition of ostensibly individual cases might gravitate over to a kind of class action in disguise is not limited to adversarial litigation.  The Vioxx settlement took the form not of a class action settlement but, rather, of a contract between the defendant manufacturer Merck & Company, Inc., and the small number of law firms within the plaintiffs’ bar with large inventories of Vioxx clients.  The contract described a grid-like compensation framework, but Vioxx claimants themselves literally were nonparties to that contract.  The enforcement mechanism for the deal consisted not of preclusion but, rather, of contractual terms whereby each signatory law firm obligated itself to do two things:  to recommend the deal to each of its Vioxx clients and—to the extent permitted by applicable ethical strictures—to disengage from the representation of any client who might decline the firm’s advice to take the deal.  Absent a signatory law firm’s commitment of its entire Vioxx client inventory to the deal, Merck would have the discretion to reject the firm’s enrollment, meaning that none of the firm’s clients would be eligible to participate.

The Vioxx settlement garnered (by a comfortable margin) the overall rate of participation from Vioxx claimants that Merck had specified as a precondition for its funding obligations.  In a public speech, one of the key dealmakers on the plaintiffs’ side explicitly touted the arrangement as a form of “mass settlement without class actions.”¹¹  Along similar lines, the federal district judge who shepherded the Vioxx litigation toward settlement went on to describe the proceedings as a “quasi-class action.”¹²  The terminology here is revealing.  The reference to a “quasi-class action” is the counterpart in the Vioxx setting to the Taylor Court’s concern over the creation of a de facto class action.  This is precisely the problem for critics of the Vioxx deal.

Absent a judgment capable of yielding class-wide preclusion, the glue to hold the Vioxx deal together ultimately consisted of individualized consent from each Vioxx claimant when the time came to accept (or reject) her signatory lawyer’s advice to enroll in the deal.  For critics of the deal, this individualized client consent is illusory—a kind of consent obtained only through the leveraging of mass client representation against itself.  On this account, the deal effectively pitted the economic interest of the signatory firms against their obligation to render advice that they tailored to their individual clients’ particular situations.  Further, the deal threatened dissenting clients with the prospect of having to start anew with alternate counsel, if the client could find any.  For all its details, however, the central thrust of this criticism should sound curiously familiar.  The insistence upon individualized client consent, unburdened by the strictures of Vioxx settlement contracts, is the counterpart in the world of mass-tort settlements today to the insistence upon individualized procedure in Taylor and Williams.

The doctrine of virtual representation, the constitutional law of punitive damages, and the settlement of mass torts via contracts with plaintiffs’ law firms clearly are not the same thing.  Still, cohesive consideration of these situations brings into focus the notion of embedded aggregation as an underexplored category within our modern civil-justice landscape.  I seek to initiate such a conversation by understanding embedded aggregation in terms of the right of action that a plaintiff asserts, the remedy a plaintiff seeks, and the wrong on the merits that the litigation concerns.  A situation of embedded aggregation arises whenever any of these features extends beyond the plaintiff in an individual lawsuit.  If so, then demands will tend to arise to bind, in some fashion, nonparties who are similarly situated, so as to bring the scope of resolution into line with the doctrinal feature that has an aggregate dimension.

The most revealing aspect of the concern that individual litigation somehow is verging into a quasi or de facto class action is this:  The features of Taylor, Williams, and the Vioxx litigation that make them situations of embedded aggregation—ironically enough—also, in all likelihood, would defeat efforts to aggregate them overtly as class actions.  The result is to leave the law today in a kind of procedural Catch-22, whereby embedded aggregation seemingly invites class action treatment, but such treatment is unavailable due to the very features that make the situation one of embedded aggregation.

In decades past, much debate centered upon the aspiration for the class action more or less to occupy the field of aggregate procedure.  The elaboration of a distinctive body of procedural doctrine on what the class action realistically may and may not do in the decades since the adoption of Rule 23 in its modern form have brought the remaining gaps in the world of aggregation into sharper focus.  I contend that the constraints on class certification that courts have elaborated over decades of real-world experience with the device are not hypertechnical bugaboos.  Rather, they stem from a well-taken notion of preclusive symmetry—an insistence that the plaintiff class ought not to be positioned to wield the bargaining leverage of a class-wide trial without, at the same time, affording to the defendant the assurance of a commensurately binding victory, were the defendant, rather than the plaintiff class, to prevail on the merits.

Drawing on the FOIA, punitive damages, and Vioxx examples, the law may frame an emerging prescription for situations of embedded aggregation in a world in which the modern class action does not, and will not, realistically shoulder the entire regulatory load.  The way out of the procedural Catch-22 in which the law finds itself consists of hybridization—the combination of individual actions with some manner of centralizing mechanism, just not always or inevitably the unity of litigation that the class action device generates.

For FOIA, the law might make such a move to specify what one might call a unity of forum for litigation that involves an undifferentiated right of action.  The practical goal would be largely to disable seriatim lawsuits over the same government-held record in courts spread across the country by specifying a single forum for such actions.  For punitive damages, developments in tobacco litigation contemporaneous with Williams embody a nascent and underdeveloped aspiration toward what one might call a unity of party—the notion that situating as plaintiff the government itself (with the aid of private whistleblowers empowered to litigate on its behalf) might best accomplish supra-compensatory relief.

The Vioxx deal underscores that the drive to identify some manner of centralizing or unifying mechanism in situations of embedded aggregation is not just the stuff of academic pipedreams.  In seeking to deploy mass client representation in mass tort litigation as a mechanism for closure, the Vioxx deal effectively crafts a near-unity of representation—if not of all Vioxx claimants by a single law firm (ala class representation), then in substantial part, due to the concentration of large Vioxx client inventories in the hands of a small number of signatory firms.  Further reform in the ethical strictures for what are known as aggregate settlements can refine and better regulate the use of this approach.

In sum, moving outside the parameters of the class action—to quasi, de facto versions that one cannot realistically fold into the class action device—means shifting into new settings a similar need for a centralizing mechanism and, crucially, for legal regulation of the manner in which that mechanism may exercise coercive power.  By bringing into sharper view situations of embedded aggregation in which the class action cannot shoulder the regulatory load, I seek to break down the prevalent supposition of a neat division between the perceived need for legal regulation of class actions and the supposedly benighted world of autonomous individual lawsuits.

For situations of embedded aggregation, the answer does not lie in a roving, undifferentiated mandate for class actions.  But neither does the answer lie uniformly in undifferentiated insistence upon notions of individual autonomy from the ancestral past of one-on-one litigation.  The elaboration in decades past of what is now a distinctive law of class actions has opened up a welcome conceptual space for experimentation with hybrid forms of rights, remedies, and wrongs that call for a commensurately hybrid approach on the part of the civil justice system.  The time has come, in short, to move the conversation about aggregation beyond the class action device—to broaden the menu of approaches available for our modern world of mass civil claims.

Acknowledgments:

Richard A. Nagareda is a Professor of Law and Director of the Cecil D. Branstetter Litigation & Dispute Resolution Program at Vanderbilt University Law School.

This Legal Workshop Editorial is based on Mr. Nagareda’s Article: Richard A. Nagareda, Embedded Aggregation in Civil Litigation, 95 CORNELL L. REV. ___ (forthcoming 2010).

Copyright © 2010 Cornell Law Review.

Federal securities laws are currently silent as to their extraterritorial application, leaving a growing mess of lower-court precedent addressing how to apply a pair of judicially created jurisdictional tests: the “effects test” and the “conduct test.”  Under the effects test, courts focus their attention on the impact of foreign conduct on U.S. investors and markets.  By contrast, courts applying the conduct test focus their attention on the extent and nature of the defendant’s U.S.-based conduct and whether such conduct was part of a fraudulent scheme resulting in losses to investors abroad.  Although the circuits differ on precisely how to apply the conduct test, the Second Circuit’s approach provides that the U.S.-based conduct must (1) be more than merely preparatory to the fraud and (2) directly cause the plaintiff’s loss.

Although articulating the effects and conduct tests is easy, recent cases demonstrate that their application is anything but straightforward. Another possibility, however, is that courts bungle what would otherwise be a straightforward application of the tests by focusing on the wrong factors, a digression that easily leads to counterintuitive outcomes.  A comparison of two recent F-cubed cases, In re National Australia Bank Securities Litigation¹ (NAB) and In re Alstom SA Securities Litigation,² illustrates the unpredictability with which courts apply the tests.  In NAB, plaintiffs alleged a fraudulent scheme whereby the defendant’s Florida-based subsidiary falsified the value of its future cash flow and then sent the data to the defendant-bank in Australia, where personnel incorporated the information into statements and filings disseminated to the public.  Likewise, in Alstom, the plaintiffs alleged a fraudulent scheme whereby the defendant incorporated into its financial statements fraudulent results that were based on the underreporting of costs on railcar construction projects at a wholly owned subsidiary located in New York.  Despite these nearly identical facts, the NAB court and the Alstom court reached divergent outcomes.  In NAB, the district court dismissed for lack of subject-matter jurisdiction the claims of non-U.S. residents who purchased their NAB shares abroad.  The district court held, and the Second Circuit agreed, that the domestic conduct was merely a link in the chain of an alleged overall securities fraud scheme that culminated abroad.  Treating the effects test and conduct test as two parts of the same test, the Second Circuit allowed the place of compilation of the public statements (Australia), rather than the place of improper conduct (Florida), to determine jurisdiction.  On the other hand, the Alstom court held the effects test to be wholly inapplicable as a source of subject-matter jurisdiction over the claims of F-cubed plaintiffs, a holding that stands in contrast to the Second Circuit’s characterization in NAB of the subject-matter inquiry as “binary.”³  As for the conduct test, the Alstom court retained subject-matter jurisdiction over F-cubed claims as to the railcar-construction fraud.  The Alstom court  reasoned that the fraudulent underreporting of costs occurred in the United States—specifically, in the New York office of the defendant’s subsidiary: “The false documents may have been sent to Alstom headquarters in France and incorporated into the Company’s financial reports, but[] . . . the mailing of the fraudulent documents for publication outside of the United States does not render the conduct in the United States any less of a cause of plaintiffs’ losses.”⁴  Thus, although the Second Circuit in NAB allowed the place of compilation of the public statements to determine jurisdiction, the Alstom court focused on the place of improper conduct.  As NAB and Alstom illustrate, courts do not apply the effects and conduct tests predictably.  Rather, courts manage to reach opposite outcomes, even in cases involving comparable claims and facts.

In light of this unpredictability—and in light of their success in establishing jurisdiction under the conduct test relative to the effects test—F-cubed plaintiffs have sought new arguments to bolster their position in support of subject-matter jurisdiction.  Thus, F-cubed plaintiffs have proposed that a fraud-on-the-global-market theory ought to establish reliance and satisfy the conduct test in cases involving cross-border transactions in much the same way that the traditional fraud-on-the-market theory operates to create a rebuttable presumption of reliance, as established in Basic Inc. v. Levinson.⁵  No doubt, this argument draws on the efficient-market hypothesis, which the F-cubed plaintiffs have expanded into the global arena.  To link misrepresentations in the United States with effects on securities prices abroad, F-cubed plaintiffs argue that information publicly available in one country will affect the price of the issuer’s securities in other countries as well.  In re AstraZeneca Securities Litigation⁶ is a particularly illustrative case.  A typical F-cubed class action, AstraZeneca involved claims under section 10(b) of the Securities Exchange Act of 1934⁷ and Rule 10b-5⁸ promulgated thereunder against AstraZeneca, a U.K.-based pharmaceutical company, with the plaintiffs alleging that an anticoagulant drug developed by AstraZeneca was not as safe or effective as the company’s statements suggested and that AstraZeneca did not disclose certain risks associated with the drug to the public.  The plaintiffs argued that the court had subject-matter jurisdiction over the claims of F-cubed members of the class on the basis of the conduct test.  As to the first prong of the conduct test, the plaintiffs alleged that several misrepresentations and misstatements occurred in the United States.  To satisfy the second prong of the conduct test, the plaintiffs invoked the fraud-on-the-market doctrine with a global twist: they argued that AstraZeneca stock traded in an efficient global market, shown by allegations that the stock prices on all three exchanges tracked one another during the relevant period, and that, because analysts at major brokerage firms whose reports were publicly available followed AstraZeneca, the market for AstraZeneca’s securities promptly digested current information and reflected such information in AstraZeneca’s stock price on each exchange on which it traded.  Thus, even if foreign purchasers had not relied directly on AstraZeneca’s alleged misstatements, fraudulent misstatements or omissions made in the United States would necessarily affect the price of AstraZeneca stock on foreign exchanges and harm individuals who purchased their shares abroad.  The court rejected these arguments.  Despite finding that the plaintiffs had satisfied the first prong of the conduct test by adequately alleging that AstraZeneca’s U.S. conduct was more than merely preparatory to the fraud, the court rejected the plaintiffs’ suggestion that a fraud-on-the-global-market theory was sufficient to satisfy the second prong.  Accordingly, the court dismissed for lack of subject-matter jurisdiction the claims of foreigners who acquired AstraZeneca stock on foreign exchanges.  The court noted simply:

Courts that have rejected a global fraud-on-the-market theory have not done so because they believe the theory does not hold true on a global level, but rather because of a concern that allowing foreign purchasers on foreign exchanges to plead reliance in this manner would extend the jurisdictional reach of the United States securities laws too far.⁹

Thus, the court’s decision turned on its concern about jurisdictional overreach.  The question of how far U.S. securities laws ought to reach is no doubt a valid inquiry.  Nevertheless, the court misdirected this concern by expressing it in response to plaintiffs’ fraud-on-the-global-market argument, an argument the plaintiffs made to satisfy the second prong of the conduct test (the “direct causation” prong).  By finding that the plaintiffs satisfied the first prong (the “more than merely preparatory” prong), the court ought to have allayed any concern it had about jurisdictional overreach.  That is, after finding that the U.S. conduct was sufficient to satisfy the first prong, the court should have moved to the second prong and considered the fraud-on-the-global-market argument free of any worry about jurisdictional overreach.  By using jurisdictional overreach as a response to the plaintiffs’ fraud-on-the-global-market argument, the court simply permitted itself to dismiss the argument without considering it at all.

Given the interconnectedness of today’s securities markets, the fraud-on-the-global-market theory should be a viable argument.  The Basic Court, relying upon the traditional fraud-on-the-market theory, stated: “The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face transactions contemplated by early fraud cases, and our understanding of Rule 10b-5’s reliance requirement must encompass these differences.”¹⁰  Why, then, should our understanding of Rule 10b-5’s reliance requirement not take into account the fact that securities transactions now involve the cross-border exchange of millions of shares every day?  In fact, to assume that the reasoning in Basic does not extend to an efficient worldwide market for a particular issuer’s stock is illogical.  The current financial crisis proves that the market effect of information disseminated in the United States is not restricted to U.S. securities markets.  News that Lehman Brothers would fail leaked on a Sunday, a day when markets around the world were closed.  Global markets reacted to the news upon opening the very next morning, and Lehman’s demise turned out to be a trigger for a global financial crisis.  In today’s interconnected world, information travels rapidly and can affect securities prices around the globe, no matter where that information is disseminated.  Courts, however, by dismissing the claims of F-cubed plaintiffs for lack of subject-matter jurisdiction, ignore the global nature of the securities markets.

One problem with the almost systematic rejection of the fraud-on-the-global-market doctrine is that any rule restricting the doctrine to domestic markets creates a logical logjam.  Courts—and defendants, for that matter—in F-cubed actions routinely concede the courts’ subject-matter jurisdiction over the claims of three distinct investor groups: (1) U.S. residents who purchased their shares on a U.S. exchange; (2) non-U.S. residents who purchased their shares on a U.S. exchange; and (3) U.S. residents who purchased their shares on a foreign exchange.  Thus, courts accept that the fraud-on-the-market theory suffices to establish reliance for some investors whose claims arise from foreign transactions (for example, those in Group 3, U.S. residents purchasing abroad).  This reasoning puts courts in the illogical position of finding that the global market is efficient for U.S. purchasers but not for many foreign purchasers.  Yet, as one commentator points out, “if the market in the issuer’s securities is in fact an efficient, global market, then the jurisdiction plaintiffs seek to establish over only a subset of claims based on foreign transactions . . . should—under the conduct test—be established over all claims based on foreign transactions.”¹¹  The only way out of this seemingly illogical position would be for the court to cut off such claims by U.S. purchasers for failure to establish reliance, but this approach would no doubt fly in the face of Basic and would, moreover, ignore the realities of today’s efficient securities markets.  More troubling than the courts’ dismissal of a valid economic theory, though, is their tendency to do so because of concerns about jurisdictional overreach. Cases like AstraZeneca illustrate a common fear among U.S. courts that allowing foreign purchasers on foreign exchanges to plead reliance through the fraud-on-the-global-market theory would extend the jurisdictional reach of the federal securities laws too far.  As discussed above, this concern is properly addressed not by considering fraud-on-the-global-market, but by considering the defendant’s U.S.-based conduct.  Furthermore, the AstraZeneca court’s conclusion makes little sense for the F-cubed plaintiff who pleads direct reliance.  If pleading reliance through the fraud-on-the-global-market theory would extend the reach of the federal securities laws too far, then why is the same not true if the plaintiff pled reliance the old-fashioned way?  Why would the securities laws apply to a foreign purchaser on a foreign exchange who read and directly relied on a defendant’s statements but not to a foreign purchaser on a foreign exchange who took advantage of the presumption of reliance afforded to him by Basic?  U.S. courts have yet to address this question.

The recent decision of the Second Circuit in NAB¹² did not bring clarity to these questions.  In November 2009, the Supreme Court granted certiorari to review NAB.  Thus, the Supreme Court will finally address the arbitrariness with which U.S. courts apply the effects and conduct tests in F-cubed class actions.  Whether the Court adopts the approach of the Second Circuit or whether it announces an entirely different standard remains to be seen.  For example, the Court could choose to adopt a transaction-based approach, limiting subject-matter jurisdiction under the antifraud provisions to claims arising out of transactions on U.S. markets; but such an approach would exclude from a putative class any U.S. citizens who happened to purchase their shares abroad.  Arguably the globalization of securities markets has resulted in an increased need for investor protection.  Denying class membership to American investors, then, is not ideal.  Instead, the Court could adopt the approach of the NAB and AstraZeneca courts and require dismissal only of the claims of foreigners purchasing on foreign exchanges.  As discussed above, however, this approach completely ignores the global nature of today’s securities markets.  Furthermore, this approach fails to take seriously the premise of Basic v. Levinson.  In an efficient market—any efficient market—publicly available information determines securities prices.  If the market for a particular issuer’s securities is an efficient one, it does not stop being efficient simply because certain investors happen to be non-U.S. residents or happen to have purchased their shares on a non-U.S. exchange.

Ultimately, this editorial and the note on which this editorial is based attempt to show that the fraud-on-the-global-market doctrine is a logical extension of the traditional fraud-on-the-market theory and that, where  an efficient worldwide market for an issuer’s securities exists, the doctrine ought to satisfy the second prong of the conduct test.  Nevertheless, more than logic is at play, and when the Supreme Court tackles NAB, it will likely take a fresh look at the question of how far the securities laws should apply.  In doing so, it need not choose between extending the reach of the securities laws too far and denying the economic validity of the fraud-on-the-global-market doctrine.  If the Court retains the two-pronged conduct test, it ought to address any concerns about jurisdictional overreach as it considers the defendant’s U.S.-based conduct.  If the Court finds the U.S.-based conduct sufficient—using whatever standard it deems appropriate, whether that is the Second Circuit’s “more than merely preparatory” test or an alternative approach—this finding should appease any worry about extending the reach of the securities laws too far.  Free of any such concern, the Court should then consider the fraud-on-the-global-market argument in connection with the conduct test’s second prong.  As I have attempted to show, the fraud-on-the-global-market doctrine is a viable theory given the interconnectedness of today’s securities markets, and the Supreme Court ought to accept this doctrine as a way to satisfy the conduct test’s “direct causation” prong.

Acknowledgments:

Copyright © 2010 Cornell Law Review.

Julie B. Rubenstein is a 2010 J.D. candidate at Cornell Law School.

This Legal Workshop Editorial is based on Ms. Rubenstein’s Student Note: Julie B. Rubenstein, Note, Fraud on the Global Market: U.S. Courts Don’t Buy It; Subject-Matter Jurisdiction in F-Cubed Securities Class Actions, 95 CORNELL L. REV. 627 (2010).

Choice of law has proven to be one of the most consistent obstacles to damage class certification in recent years. Federal precedent has developed such that when multiple state laws would apply to a class, federal judges usually deny certification. To the extent that states rely on class actions to enforce their regulatory regimes, CAFA’s jurisdictional shift appears to be weakening enforcement, resulting in underdeterrence and perhaps greater corporate misbehavior. Academics have suggested various solutions to this choice-of-law problem, but each proposal has failed to comprehend the full scope of the problem.

In fact, there are two choice-of-law problems, stemming from choice of law’s two distinct roles in the class action context:  (1) choice of law as a procedural gatekeeper for certification, and (2) choice of law as the mechanism by which substantive regulatory authority is allocated between states. In the current federal judicial climate, these two roles are in frequent conflict. The choice-of-law rules that facilitate the most fair and efficient consumer protection (those applying different states’ laws to different class members) tend to cause denial of certification, while rules that facilitate certification (those applying a single state’s law to all class members) produce suboptimal regulation of corporate conduct.

To achieve a real solution, one must account for both sets of concerns. To this end, I propose a two-pronged approach that would remove choice of law from the Rule 23(b)(3)² analysis for CAFA cases and would prescribe a uniform federal choice-of-law rule directing courts to apply the law of the consumer’s home state.

I.
Background

A.     Choice of Law Allocates Regulatory Authority

Choice of law performs an essential function in our federal system, determining which sovereign authority will regulate conduct implicating several states’ interests. Each state has developed its own choice-of-law rules over time, guided primarily by federalism and substantive policy concerns. The earliest American choice-of-law rules looked to territoriality and nationality, strictly applying the law of the place in which some important event occurred or a particular party was domiciled. Most states now, however, employ “modern methods” that try to promote fairness to litigants and good federalism by applying the law of the state with the greatest regulatory interest in the controversy, as judged by the nature and extent of the state’s connections to the parties and the conduct.

B.     Damage Class Actions Perform an Essential Regulatory Function

Damage class certification is appropriate when the putative class meets the requirements of Federal Rule of Civil Procedure 23(a) and 23(b)(3)³—that is, when collective treatment would promote overall efficiency and fairness even when certification is not strictly necessary. Choice of law has proven to be one of the most consistent impediments to certification under Rule 23(b)(3). When the choice-of-law rule of the state in which the case is being heard points to the laws of different states for different class members, federal courts usually find “predominance” and/or “superiority” lacking and deny certification.

The certification decision has important implications for regulatory enforcement. Appropriately constituted damage classes promote efficiency by pooling plaintiff resources, avoiding duplicative discovery and litigation, and resolving large numbers of claims with minimal expenditure of judicial time and resources. They also promote the adjudication of meritorious claims, particularly when individual claim values are so small that the transaction costs of litigation would otherwise preclude plaintiffs from enforcing their rights. Without class actions as a claim-pooling mechanism, corporations would not fully internalize the costs of their conduct, causing inefficiencies, undercompensation, underdeterrence, and other social losses.

C.     Certification Trends Pre- and Post- CAFA

From the 1970s through the early 1990s, many judges—both state and federal—favored the damage class as a useful mechanism for resolving mass torts and consumer claims. Beginning in the mid-1990s, however, state and federal courts’ attitudes began to diverge in this respect, due in part to their different approaches to choice of law. Federal courts increasingly refused to certify nationwide damage classes, finding predominance lacking on choice-of-law grounds. Unsurprisingly, plaintiffs’ attorneys started filing more nationwide classes in state courts, which were more amenable to certification.

As part of the “tort reform” movement, certain business interests and politicians began calling for a congressional fix that would save corporate defendants from these “anomalous” state court certifications. CAFA did this by moving most nationwide class actions into federal courts, but it failed to address a more significant regulatory mismatch:  State rather than federal law continues to determine nationwide liability, regardless of forum. As a result, choice of law remains a significant obstacle to certification in federal courts, which now hear most large class action cases.

D.     Alternatives to Class Adjudication: What Happens When Certification Is Denied?

In theory, a variety of alternatives to the nationwide class exist; in practice, however, without nationwide certification, high value consumer claims usually settle in aggregate settlements, and low value claims generally go completely unredressed. Both are undesirable outcomes.

Contrary to many courts’ and commentators’ assumptions, high value claims rarely proceed to trial individually when class certification is denied; instead, they settle in the aggregate without judicial oversight mandated by the class form to protect claimants. Modern large scale litigation is dominated by plaintiffs’ firms that collect “inventories” of high value cases that are then typically disposed of in package deals, which create significant opportunities for collusion between plaintiffs’ attorneys and defendants, but offer none of Rule 23’s judicial safeguards.

Low value claims face even bleaker fates when denied certification. Most simply disappear. Individual representation is not an option, since by definition the claims are not sufficiently valuable for attorneys to pursue them individually, so these claims rarely settle—aggregately or individually—without certification.

II.
Why Proposed Solutions Fail to Address the Full Scope of the Problem

Choice of law creates two problems in the class action context. First, choice of law issues make certification difficult, which in turn leads to underdeterrence. Second, since state—not federal—law still determines defendants’ liability post-CAFA, choice-of-law rules as applied to these classes threaten to disrupt the balance of regulatory interests of the different states. Scholars have proposed a variety of solutions, each of which has failed to address both choice-of-law problems.

 
A.     Proposals that Would Remedy the Difficulty of Certification

Many scholars advocate for a federal rule that would mandate the application of a single state’s law to the entire class, eliminating choice-of-law-based predominance and manageability concerns. Professor Samuel Issacharoff recently proposed a federal choice-of-law rule for CAFA cases under which courts would apply the law of the defendant’s state of incorporation to all class claims.⁴

This proposal offers definite benefits. Ex ante, it would promote uniformity and predictability, helping defendants plan their conduct according to more accurate estimates of potential liability. Ex post, it would discourage forum shopping (since all federal fora would apply the same rule), and it would facilitate both certification and settlement (since a single, predictable law would apply). However, the proposal carries a serious risk of “capture”:  It creates strong incentives for a corporation to manipulate the political process in its home state to secure favorable laws that would shelter its wrongdoing. Issacharoff’s proposed rule would further the regulatory function of class actions by facilitating certification, yet it would undermine this function by applying defendant-friendly laws to corporate conduct. Further, it would impede choice of law’s other fundamental function, the proper allocation of regulatory authority among the states.

 
B.     Proposals that Focus on Federalism Concerns

Unfortunately, scholars who take choice of law’s allocation-of-authority role seriously tend to go too far in the opposite direction. They prioritize choice of law’s traditional concern for federalism and individual rights over any practical interest in achieving collective resolutions. These scholars would sacrifice certification in order to uphold the existing choice-of-law regime.

Professor Larry Kramer asserts that choice of law is substantive rather than procedural and that applying a single state’s law to all class claims impermissibly abridges class members’ and defendants’ rights when individual treatment would apply different laws.⁵ Along similar lines, Professor Richard Nagareda argues that federal courts should not be “bootstrapping”—applying a single state’s law to facilitate certification.⁶ In light of class actions’ significant regulatory effects, bootstrapping amounts to inappropriate law reform, supplanting existing state governance regimes and altering individuals’ rights. Professor Linda Silberman has focused particularly on federalism concerns in arguing against the application of a single state’s law.⁷ These scholars are right to highlight choice-of-law’s important federalism function, but they do not sufficiently account for the practical significance of the certification decision and its regulatory implications.

III.
A Two-Pronged Proposal for Amending CAFA

How then can reform address both the practical procedural problem of securing certification for meritorious cases and the substantive problem of properly allocating regulatory authority between states?  Below I introduce a two-pronged solution.

A.     Prong: One: The Feinstein Amendment

First, Congress should remove choice of law from the predominance analysis under Rule 23(b)(3). Senator Diane Feinstein’s proposed amendment to CAFA, rejected in the floor debates, provides a useful model:  “[T]he district court shall not deny class certification, in whole or in part, on the ground that the law of more than [one] State will be applied.”⁸

As explained in Part I, the regulatory function of most class actions cannot be realized without certification. This is not to say that all putative classes should be certified:  Sometimes differences between plaintiffs’ claims reveal inadequacies in representation, or factual dissimilarities indicate that class adjudication will over- or undercompensate or over- or underdeter. But when class treatment is otherwise warranted, the necessity of applying multiple states’ laws should not in and of itself result in a denial of certification.

Absent certification, meritorious negative value claims tend to disappear entirely, along with the deterrent and compensatory effects they were intended to achieve, while positive value claims settle aggregately in lump sums that advantage plaintiffs’ counsel without the procedural safeguards and judicial oversight afforded by Rule 23. Collective treatment has become a near inevitability, and for all its shortcomings, the class action mechanism effectuates more fair and efficient deterrence and compensation than the alternatives. Adopting the Feinstein amendment would facilitate class treatment of meritorious claims that CAFA and federal certification precedent currently have rendered unenforceable.

B.     Prong Two: A Federal Choice-of-Law Rule that Looks to the Home State of the Consumer

The Feinstein amendment alone would improve upon the status quo, but it attends to only half of the choice-of-law problem. I further propose a uniform federal choice-of-law rule for consumer cases that would apply the law of each plaintiff’s residence to his or her claim.

A federal rule is desirable because it would promote predictability and uniformity while discouraging forum shopping. Not only would this allow defendants to plan their conduct around known liability standards, but it would also facilitate more efficient settlements since parties’ claim valuations are more likely to converge when the applicable law is known. The more difficult question is which federal rule Congress should adopt.

Each option has downsides. A “modern method” would mirror the majority approach among states, but modern methods are famously indeterminate. In order to provide the predictability and uniformity justifying its adoption, the federal rule must clearly indicate which law will govern in any given situation. The other likely contender, Professor Issacharoff’s home-state-of-defendant rule, is similarly unsatisfying. This rule would be highly predictable but would likely lead to underregulation:  It is too open to capture by corporate interests and could easily create a race to the bottom, hindering effective deterrence and compensation.

My proposal—applying the law of the consumer’s home state—strikes a better balance between predictability and uniformity of results on the one hand and fair and appropriate allocation of authority on the other. A home-state-of-consumer rule would provide clear guidance to courts:  Parties could reasonably expect federal courts across the country to apply the rule with similar results. Defendants’ conduct would still be subject to varied state standards, but defendants would know ex ante that they faced each state’s particular standard of liability in fairly direct proportion to the amount of business they did in that state, allowing them to plan accordingly.

My proposal would also allocate regulatory authority more fairly and efficiently than the alternatives. Professor Silberman has noted that “justice” assumes definite meaning only in light of a particular political community’s values and principles.⁹ The fifty states remain the relevant politically accountable communities with respect to consumer class actions, defining consumer rights and justice through state law. Principles of federalism and political accountability therefore counsel that any federal choice-of-law rule should honor the respective states’ interests by compensating state citizens and deterring corporate wrongdoing in a manner and to a degree determined by each state’s democratic process.

Ultimately, my proposal offers a predictable, neutral rule that would foster greater political accountability. It would generate more effective regulation through settlement pricing and damage recoveries that more closely track the differentiated values of class members’ claims.

Conclusion

Society appears ready to embrace a new culture of corporate responsibility, yet the existing rules and doctrine make it nearly impossible for the class action mechanism to perform its intended regulatory function. It is time for Congress to address the full scope of the “choice-of-law” problem by telling courts to make meritorious nationwide class actions work and to do so in a manner that respects the regulatory interests of the different states. Only by attending to both aspects of the choice-of-law problem in this manner can Congress effectively revitalize the class action as a meaningful regulatory mechanism and ensure effective consumer protection.

Acknowledgments:

Copyright © 2010 New York University Law Review.

Genevieve G. York-Erwin received her J.D. in 2009 from the New York University School of Law. She is now clerking for Judge Lewis A. Kaplan of the Southern District of New York.

This Legal Workshop Editorial is based on the following Student Note: Genevieve G. York-Erwin, The Choice-of-Law Problem(s) in the Class Action Context, 84 N.Y.U. L. REV. 1793 (2009).

Although the Duke Law Journal’s article, Milberg’s Monopoly: Restoring Honesty and Competition to the Plaintiffs’ Bar,¹ reflects a lot of effort by student author James McDonald, it is a very disappointing article in terms of analysis and reliability of information. Mr. McDonald and the Duke Law Journal are entitled to express their opinions on the important issues raised by class actions, but the article misapprehends many of the realities of class action law and practice, and repeats highly pejorative rumors and speculation about class actions as though they were fact.

By way of introduction and disclaimer, I was a partner in the Milberg Weiss firm for several years, and was an editor of the Duke Law Journal many years before that. I now practice and teach law.

The following are my principal concerns with the article:

1. Milberg Weiss did not suffer an “Enron-like collapse,” (p. 506), and is alive and well.

2. The federal prosecutors never charged, nor could they ever prove, that class members were harmed by the wrongdoing (p. 506). The best they could do when the trial judge asked them whether this was a “victimless crime” was to suggest that competing class action firms might have lost business to Milberg Weiss. The underlying cases were real fraud cases, prosecuted to judgments or court-approved settlements, yielding court-awarded attorneys fees. No client or defendant was disadvantaged by the wrongdoing, which affected only internal issues among class counsel as to leadership of the cases.

3. For the reasons stated in the prior paragraph, it is a gross overstatement to say that the tactics at Milberg Weiss were “as fraudulent and unethical as any action taken at Enron, WorldCom or Tyco.” (p. 507). Stockholders lost billions in those frauds, and the wrongdoing was central to the issuers’ businesses and was widespread. The vast majority of Milberg Weiss’s lawyers were uninvolved in the wrongdoing, and continue to represent investors and others, with court approval. Indeed, the Coughlin Stoia Robbins Geller & Rudman firm, partial successor to Milberg, was appointed to represent the investors in Enron despite ad hominem attacks like those in this article made by competing class action firms seeking competitive advantage from the indictment.

4. The term “strike suit,” (p. 507), is both pejorative and highly ambiguous in meaning. Contrary to the Note’s suggestion, it is most often used to refer to cases that have little merit but are filed to obtain a quick “cost of defense” settlement. That does not seem to be what the author means because few (if any) of the cases the author refers to were settled at that low level. It does not advance understanding of class actions to use such undefined (but highly charged) terms.

5. At page 508, Mr. McDonald says that Milberg Weiss breached its fiduciary duty to clients, but again, the Note provides no backup for that statement, and the prosecutors declined to state a theory for proving it.

6. Securities fraud cases do not pit stockholders against their own company. (p. 511). Rather, they pit stock purchasers during a period of alleged fraud (often far less than all stockholders, and including many ex-stockholders) against those who made false statements (officers, directors, accounting firms, investment bankers, et cetera, plus the company). The fact that business interests attack class actions by misdescribing them this way is not a good reason for the author to parrot this language. (Derivative cases do meet the author’s description, but derivative cases and class actions are different, and a serious legal journal should be able to keep them straight.)

7. To say that “many suits settled quickly for only a fraction of their potential worth” (p. 512) is the kind of vague attack we often hear on Capitol Hill. Nearly every civil case settles for a “fraction of its worth,” the only question being whether the fraction is three-fourths, or one-hundredth. Again, the author is repeating pejorative and empty phraseology employed by those unhappy with the fact that investors can band together and try to recover their fraud losses. Professor Janet Cooper Alexander’s article suggesting that all cases settle for the same fraction of their worth reached that conclusion by extrapolating from a grand total of three cases! It is rebutted in a piece I coauthored in the San Diego Law Review. Possibly the author’s research did not find it.

8. Mr. McDonald says that Mr. Lerach and his colleagues in California (I guess that would include me) “dreamed up” new types of claims and defendants, and went so far as to sue accountants, lawyers and bankers! There is nothing exotic about suing accountants for securities fraud, and lawyers (White & Case) were defendants in the first securities case I ever worked on, years before I joined Milberg Weiss. Bankers paid most of the billions recovered in Enron, so if we dreamed it up, it was a good thing.

9. The Note says that unidentified sources with whom the author has not spoken call Mr. Lerach a “Godfather-like . . . ruthless don” who demanded “tribute” from other law firms. (p. 514 n.60). This seems like a rather reckless statement to make without sources, and seems more appropriate to the pages of People Magazine than of the Duke Law Journal.

10. As the author points out, the 1995 Private Securities Litigation Reform Act (written by people who didn’t like class actions) placed large investors in a favored position as class action plaintiffs on the theory that large investors would know whom to sue, whom to hire as counsel, and when to settle. Thereafter, Milberg Weiss was retained by many large investors—public and union pension funds. Unable to accept a positive point that does not fit into his thesis, the author adds that “rumor suggests that Milberg Weiss paid a share of its attorneys’ fees to labor pension funds it represented.” (p. 532). I do not believe this to be true, nor have I ever read it anywhere else, and in any event, this type of rumor-mongering is really quite outrageous for an academic publication.

11. Mr. McDonald concludes, based on who knows what, that even after the 1995 Act, and separate and apart from the Milberg Weiss wrongdoing, “law firms continue to be chosen [for class actions] using suboptimal criteria such as personal relationships, as opposed to quality of representation.” (p. 533). How did he conclude this? Institutional plaintiffs choose law firms the same way corporate defendants do—location, reputation, prior relationships, price, et cetera. If institutional plaintiffs are choosing the largest, best funded, best staffed plaintiffs’ firms, and often using the same firm more than once, (p. 535) what exactly is wrong with that?

12. Even when the author trips over useful information, he misapprehends it. The reason securities lawyers were puzzled over the Milberg Weiss investigation and dubious about serious charges resulting therefrom (p. 533 n.188) is that they understood that what was being investigated was basically beside the point to securities litigators focused on the merits of their cases. (See next point.)

13. More generally, defense lawyers and other sophisticated players in this field (including judges) understand that the individual plaintiff does not run a class action, his lawyer does (with court oversight), and class action law recognizes this in many ways, for example, permitting counsel to settle a case even if the class representative does not support the settlement. Picayune disputes over who the plaintiff is, and whether he will “supervise” counsel bore serious litigators to death, because they are phony issues entirely collateral to the merits.

14. The author bemoans the lack of small firms obtaining lead counsel status (p. 535), but small firms do not get the defense side of class actions either, probably because these are not small cases.

15. Why should a pension fund that litigates one class action successfully be presumed less qualified to litigate another one (p. 541)? The author believes that constantly changing plaintiffs and constantly changing plaintiffs’ counsel somehow provides a public benefit, but it would appear more of a detriment to investors. Experience counts, and certainly is not a negative.

16. The author suggests that the class action market is dominated by “a few large firms seeking fast settlements.” There is no support cited for the latter half of this assertion, and it is simply wrong. The largest and best firms in this business settle some cases fast, settle some cases on the courthouse steps, and take some cases to trial. It is the smaller firms, and the neophytes, the very firms the author wishes to elevate, who often settle fast before they bankrupt their small law firms with a case that is more challenging than they suspected when they read breezy articles about the riches of class action lawyers.

I am sorry to sound so harsh toward a student piece, but Mr. McDonald chose a controversial topic, and having waded into deep water, he should have known how to swim better than this. I have spent thirty-five years in this field defending, prosecuting, and teaching class actions, and it is sad to read some of these misunderstood points, inaccurate allegations, and outlandish rumors in a publication I once served on, which is published at an institution I care about very much.

Acknowledgments:

Copyright © 2009 Duke Law Journal.

Len Simon is a former Partner at Milberg Weiss and a former Editor of the Duke Law Journal.

This Editorial is a response to the following full-length Note:  James McDonald, Milberg’s Monopoly: Restoring Honesty and Competition to the Plaintiffs’ Bar, 58 DUKE L. J. 505 (2008). Click here for the full version.