Oct. 10, 2012
Albert Lin, Matthew Fornshell
Private shareholder actions are an “essential supplement” to criminal and civil enforcement actions brought by government regulators. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007). Institutional investors, which hold more than half of the value of the public stock markets, play a leading role to ensure that those markets are fair and transparent. Accordingly, Congress implemented the Private Shareholder Litigation Reform Act (PSLRA) to encourage more institutional investor involvement in securities class action.
Since the enactment of the PSLRA, public pension funds have led some of the most important securities class actions in recent memory, including litigation against Worldcom, Enron and AIG. Prosecuting a private securities class action can greatly benefit the pension fund serving as lead plaintiff and the larger institutional investor community. Sophisticated public pension funds have aggressively sought greater compensation from companies that engage in misconduct, pushed for more meaningful corporate governance, negotiated lower contingency fees with class counsel and helped lessen the influence of professional plaintiffs who are not interested in market-wide reforms.
Though the benefits of such litigation are clear, the decision to initiate litigation is complicated and often time consuming, requiring a balance of legal, business and policy factors. Although not intended to be exhaustive, here is a list of factors to consider when assessing whether a fund should initiate a large securities class action.
First, has the public pension fund suffered a large loss? The primary purpose of any securities class action litigation is to seek recovery for damages caused by company misconduct. Without a sufficient loss, there is no reason to enter into litigation. A significant loss will ensure that the pension funds’ interests are aligned with the class members, and will incentivize aggressively seeking compensation for the loss.
Second, has the company engaged in apparent misconduct? Market losses are the inherent risk of investing, and a large stock drop, without more, cannot support a securities class action. By contrast, damages caused by company misconduct are recoverable. Public reporting in the business press will help distinguish companies whose financial performance is merely below expectations – an insufficient basis to initiate litigation – and a company that has engaged in apparent misconduct resulting in a stock drop – which is recoverable.
Third, does initiating the class action further the policy goals of the pension fund? Numerous securities class actions are asserted every year. Ideally, there is a specific reason – in addition to large losses and company misconduct – that initiating such litigation would be important. For example, pension funds that have a particular interest in corporate governance may seek to initiate litigation where there appeared to be inadequate controls over executive conduct. Similarly, funds with a focus on health care costs may seek to assert litigation relating to health care overcharges or drug pricing.
Fourth, does the fund, or a related office, have the resources to hire and manage the outside counsel that will litigate large-scale securities litigation? Though all out-of-pocket costs are typically paid out of the class settlement, litigation will impose some burdens on in-house counsel and investment staff for public pension funds. These may include the time devoted to management of outside counsel, collecting data to assess losses and possible depositions of investment staff. Some pension funds can delegate the litigation management to related offices, such as the state Attorney General, or City Attorney’s office. However, many funds may have to manage litigation without support.
Though balancing these factors is a challenge, pension funds can greatly benefit themselves, and the institutional investor community, by taking a leading role in securities class actions. Once the fund makes an internal assessment that litigation is supportable, the next step is choice of lead counsel, and the lead plaintiff process. The next article in this series will address that process.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.