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Cornyn Takes on Class Action Malfeasance

12:30 PM, Jul 16, 2008 • By ERIN SHELEY
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It was delicious poetic justice when famed plaintiffs' attorney William Lerach, formerly of the firm Milberg Weiss, was sentenced to two years in federal prison for paying shareholders of large corporations millions of dollars in kickbacks in exchange for their cooperation as name plaintiffs in Milberg's class actions. On the same day Lerach began his prison term, Senator John Cornyn (R-TX) introduced the Securities Litigation Attorney Accountability and Transparency Act (SLAATA), aimed to thwart future malfeasance in private securities litigation. Cornyn's bill recognizes that the problem with shareholder class actions transcends flatly illegal misconduct, such as Lerach's famous armoire full of cash, and is better captured by his 1993 boast to Fortune magazine: "I have the greatest practice of law in the world. I have no clients."

A securities class action works as follows: A company's stock price drops substantially (sometimes due to actual executive misconduct, frequently to any number of market forces). Plaintiff firms like Milberg Weiss find a shareholder--the more pliant and less engaged the better--who lost value in the transaction and use him as the name plaintiff in a class action against the corporation. Months and years of litigation ensue, draining the pockets of the corporation's current shareholders with the theoretical goal of compensating the "wronged" shareholders. (Meanwhile, in cases where actual corporate misconduct has occurred, the SEC and/or DOJ have already investigated and issued appropriate sanctions on the company and its executives). Eventually, the matter settles. The former shareholders receive some nominal compensation and the plaintiffs' attorneys cash in on enormous fees--which are calculated largely as a function of the sheer quantity of time spent on the matter.

The perversity of the incentives are clear. Plaintiffs' counsel will seek endless rounds of marginally relevant depositions and discovery requests, geared not toward developing a true case against the company, but to justify large fees for all of their "hard work." The only shareholders even theoretically compensated are those who sold their stock at its low point after the initial drop before it tanked further--drained in part by the very litigation purported to vindicate shareholders rights. Meanwhile, the threat of government prosecution has already much better deterred executive misconduct than the private litigation ever could. The plaintiffs' attorneys, quite literally, have "no client" but themselves.

SLAATA, of course, would not eliminate this structure entirely but calls for three alterations. The first would mandate broad disclosure of fee arrangements, contributions, and payments between counsel and plaintiffs. It is unclear, however, that this would actually prevent the worst conduct, such as Lerach's bribery (which was, of course, already illegal) and--since plaintiffs would file these disclosures with the presiding court as attachments to the complaint--the practice would almost certainly result in further protracting the litigation, as the sides squabbled over the disclosures themselves. SLAATA's second and third provisions, however, make a great deal of sense: one would require the court to exercise discretion over selection of plaintiff's counsel, implementing a competitive bidding process such as that used to select government contractors. The other would mandate a five-year study to determine the effective average hourly rate for counsel in such actions. These two features could serve to place at least some sort of reality check on the spoils gleaned by counsel, thereby disincentivizing the most wasteful and frivolous behavior. The bidding provision would also supplant the current ambulance chase joined by the plaintiff bar each time a big name stock price drops.