Today, there are new fears that plaintiffs’ lawyers have co-opted securities class actions by paying-to-play. “Paying-to-play” describes the practice of lawyers giving campaign contributions to public pension funds’ political leadership in order to gain favorable consideration by the funds for appointment as class counsel. Many reforms have been proposed and enacted in response to paying-to-play fears. Aside from a few anecdotal reports, however, no examination of campaign contributions from plaintiffs’ lawyers to elected officials exists in the legal literature. This Editorial returns to the first stage of analyzing paying-to-play that many commentators have skipped: whether law firms are contributing to investment funds’ leadership at all. If law firms are not contributing, there can be no rational fear of paying-to-play. My study finds that law firms do indeed contribute to the investment funds that select them as lead counsel.

 
I.
The PSLRA and Paying-To-Play Fears

The PSLRA established a rebuttable presumption that the lead plaintiff is the plaintiff with the largest financial interest in the relief sought by the class. Congress’s theory was that the plaintiff with the largest financial stake would have the greatest incentive to manage the case competently and achieve the highest possible settlement. The PSLRA also guaranteed the lead plaintiff the power to select and control class counsel.

Congress explicitly targeted institutional investors to be the new lead plaintiffs in securities class actions because of their large financial interests and their experience as investors. While from 1997 to 2000, only between ten and twenty institutional investors were named as lead plaintiffs each year,¹ the number grew to thirty-one in 2001 and then to fifty-six institutions in 2002.² In the period covered in my study, 2002 to 2006, 41% of cases had an institutional investor as lead plaintiff.

The first fears over paying-to-play surfaced in media reports in 1998. The legal academy became concerned shortly thereafter, announcing the practice as a problem and then proposing solutions. However, my research revealed only two empirical studies of paying-to-play in the legal literature. Neither study examined lawyers’ campaign contributions; rather, they both used indirect means of investigating paying-to-play.

The lack of empirical evidence of paying-to-play, however, did not stop courts, the American Bar Association, pension funds, Congress, and state legislatures from discussing and implementing reform proposals. Reform may be necessary if paying-to-play indeed negatively affects securities class actions. However, reforms are not without cost; all efforts at reform make tradeoffs in an attempt to insulate pension fund officials from lawyers’ campaign contributions. Generally, there have been four proposals to combat the perceived paying-to-play problem. The first proposal calls for the lead plaintiff fund and the filing law firm to disclose to the court any payments made by the lawyers to the fund, enabling the court to decide whether the fund or firm are fit to serve. The second proposal is merely a bright-line version of the first: A lawyer is barred from representing a fund if the lawyer made a campaign contribution to the fund’s officials. The third proposal requires that elected officials be removed from pension funds’ governing boards and be replaced with unelected leadership. The final proposal is that courts, rather than the lead plaintiff, should select lead counsel through an auction.

The first two proposals would limit lawyers’ participation in the political process. Even if courts had discretion to allow lawyers to continue to serve, the threat of losing a client may be enough to silence lawyers’ political voices. Restructuring pension funds’ leadership—as required by the third proposal—also has costs. Public pension funds likely have elected officials in leadership positions to allow for state government control of the funds. This provides for democratic accountability with regard to the funds’ successes and failures, including their litigation decisions. Finally, as others have noted, a court-run auction to determine lead counsel “is inconsistent with the language of the PSLRA.”³ The PSLRA instructs the court to appoint the “most adequate plaintiff,” not the most adequate law firm, and then allows that plaintiff to choose the lead counsel. Replacing the lead plaintiff’s selection of counsel with that of the court undermines the PSLRA’s intent to empower the lead plaintiff to select and monitor class counsel.

 
II.
Data and Findings: Law Firms’ Contributions to Lead Plaintiff Funds

I examined the 1076 securities class actions filed in the United States from 2002 to 2006. I identified the 445 cases where an institutional investor was at least one of the plaintiffs filing to be lead plaintiff and then narrowed my dataset to the seventy-five cases where the lead plaintiff was an institutional investor with at least one state-level elected official, or person appointed by such an official, on its controlling board. I then identified the membership of the controlling boards of the institutional investors at the time the case was filed. Next, I identified the law firm or firms that each fund selected as counsel in each case. Finally, I used state-level campaign-finance filings to find campaign contributions from the plaintiffs’ law firm (or its lawyers) to any elected official affiliated with the pension fund that selected the firm as counsel. My campaign contribution dataset spanned both before and after the filing of the cases—from 1998 to 2008—in order to capture contributions that could come before law-firm selection as an enticement, or after as a reward. I included contributions made to the relevant candidates directly and also contributions to their political parties’ campaign committees under the theory that candidates may look favorably on contributions to their parties, and donors may seek to exploit such contributions.

I found that in a majority of cases where paying-to-play was possible, at least one law firm made a political contribution to an elected official affiliated with a lead plaintiff pension fund in the case. Of the seventy-four cases in my dataset, a law firm affiliated with a case made a political contribution to a pension fund in forty-eight cases, or 64% of the time.

Because there was sometimes more than one law firm or pension fund filing in each case, and my data grouped these firms and funds together, there were 184 total opportunities for pension funds and law firms to be matched through political contributions. Firms made contributions in seventy-eight of those 184 opportunities, or 42% of the time. Of all the total contributions from a particular firm to officials associated with a particular fund, the mean was $58,942 and the median was $9,300.

 
III.
Discussion and Future Areas of Research

My data confirms that plaintiffs’ law firms are contributing to the pension funds that hire them. These contributions form the baseline of the paying-to-play theory. My study thus provides the first set of paying-to-play data on which future scholarship can build. Some may argue that these contributions themselves create an appearance of impropriety that should be avoided. Others suggest that the focus should be on the actual performance of class counsel, no matter how selected.⁴ The resolution of this question is beyond the scope of this Editorial.

The debate over paying-to-play involves more than a concern over political contributions. The paying-to-play theory has three basic elements: (1) law firms are giving political contributions to officials affiliated with pension funds’ boards; (2) the firms are doing so with the intention of earning favors from the funds; and (3) pension funds are in fact giving those favors by selecting contributing firms as lead counsel in class action cases.

While this Editorial has provided some evidence of the presence of element one, we must examine elements two and three to understand fully the paying-to-play problem and to formulate an appropriate policy response. The factors listed below are not meant to be an exhaustive list of all important matters but rather a helpful guide for future researchers of what I consider to be the most interesting quantifiable factors surrounding the paying-to-play problem.

 
A.     Geography

Pension funds might be likely to select local law firms with whom they are familiar and with whom they can meet frequently. This may be especially true if pension funds plan to, or have been, working with firms for a long period of time, such as funds hiring a firm to provide litigation monitoring services. Geography may also be important for researchers seeking to understand law firms’ political contributions. Contributions from lawyers to politicians in their own states may seem less suspicious than donations to those in distant states.

 
B.     Experience

Based on my data, from 2002 to 2006, pension funds selected the same few law firms repeatedly. Bernstein Litowitz Berger & Grossman was affiliated with an institutional plaintiff in thirty of the seventy-five cases in my dataset, or 40% of the cases. On the other hand, pension funds selected twenty-nine of the thirty-six total firms each three or fewer times. Future research could quantify indicators of a law firm’s experience, such as the number of previous securities fraud class action cases handled, in an effort to discover whether experience is an independently significant variable in funds’ selection decisions.

 
C.     Previous Relationships

Funds may also be more likely to select firms with which they have had a particular former relationship. This might mean a firm representing the fund in a previous class action, but it could also include a law firm providing other services for a fund. According to one securities class action expert, funds increasingly are relying on law firms to monitor their investments and to provide advice on possible suits to file or join.⁵ Funds typically do not pay the law firms for these litigation and investment monitoring services, but the firms instead hope to be rewarded by being selected as lead counsel if the fund decides to file suit and is named lead plaintiff. In a recent case, Judge Jed S. Rakoff raised concerns at a hearing that a proposed plaintiff law firm had a “blatant, shocking conflict of interest” stemming from free monitoring services provided for a union pension fund client.⁶ Additionally, pension funds have been reported to keep “short lists” of firms that have been prescreened to use when the fund decides to file suit. In these cases, the law firm that provides investment monitoring services competes with other firms on the fund’s list. Pension funds without exclusive lists rely on “requests for proposals” sent to law firms, inviting them to bid for the pension fund’s legal work. All of these arrangements may shed light on law firms’ decisions to contribute to funds, or may impact funds’ lead counsel selection decisions.

 
Conclusion

Past fears, and even reforms, of the paying-to-play practice have been based on anecdotal evidence in the media and scholarly literature. This Editorial provides empirical evidence for the first time showing that plaintiffs’ law firms do contribute to officials affiliated with the public pension funds that select them as lead counsel in securities fraud class actions. Given this prima facie evidence, it is still important to explore other factors that may explain why law firms contribute to funds and how funds choose which law firms to hire. Moreover, even if the worst paying-to-play fears are true and pension funds are selecting law firms based on political contributions, does paying-to-play actually have a negative effect on lawyer-client agency costs in securities fraud class actions? In other words, even if paying-to-play is happening, does it matter? This is a question Stephen J. Choi, Adam C. Pritchard, and I examine in an upcoming paper, The Price of Paying to Play in Securities Class Actions.⁷

Acknowledgments:

Copyright © 2010 New York University Law Review.

Drew T. Johnson-Skinner received his J.D. from New York University School of Law in 2009. He is currently a Law Clerk for Judge John G. Koeltl.

This Legal Workshop Editorial is based on the following Student Note: Drew T. Johnson-Skinner, Paying-To-Play in Securities Class Actions: A Look at Lawyers’ Campaign Contributions, 84 N.Y.U. L. REV. 1725 (2009).

Click here to access the raw data analyzed in this Editorial.

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.