By Nate Raymond
NEW YORK, Dec 11 (Reuters) - A prominent federal judge on
Tuesday called for a review of how securities class actions are
conducted, saying the current system was producing small
settlements that cost too much.
U.S. District Judge Lewis Kaplan said there should be an
examination of the way plaintiffs' lawyers are paid, the
standards allowing lawsuits to move forward, as well as a
decades-old premise underlying this kind of litigation.
"Its a jerry-rigged system never thought through from
beginning to end," he said.
Kaplan, who presided over securities litigation stemming
from the collapse of Lehman Brothers Holdings Inc, was speaking
at a conference on securities litigation hosted by the New York
City Bar Association.
He noted that securities litigation sprang from the
Securities Act of 1933 but was not explicitly provided for by
Instead, securities class actions evolved out of a series of
court decisions and, later, the Private Securities Litigation
Reform Act (PSLRA) of 1995. And that process, which was
"nobody's plan," has developed in some "unexpected and
The judge, who was nominated by former president Bill
Clinton, zeroed in on the small size of settlements, which he
suggested were a product of some of the current incentives.
The median ratio of settlements to investor losses has
declined from 7 percent in 1996 to an all-time low of 1 percent
in 2011, according to research firm NERA Economic Consulting. A
new report Tuesday by NERA found the median settlement so far in
2012 was $11.1 million, up from $7.5 million last year.
Those statistics are before taking into account the fees of
plaintiffs' lawyers, which can be up to a third of settlements,
Kaplan said. Adding in "comparable" costs on the defense side,
"we as a society are probably paying about a dollar for every
dollar recovered in securities class action settlements," Kaplan
Plaintiffs' lawyers have an "incentive to settle and thereby
earn a sure fee rather than try a case and take that risk," he
Besides looking at how plaintiffs' lawyers are paid, Kaplan
also said that there should be an examination of how they get
Under the PSLRA, the plaintiff with the largest losses
typically is named lead plaintiff. That has resulted in
institutional investors like public pension funds dominating the
But Kaplan cited a report by Columbia Law School professor
John Coffee that said plaintiffs' lawyers hire lobbyists and
contribute campaign funds to officials who oversee those pension
"It needs to be looked at, I suggest," he said.
Kaplan also said "troublesome" questions have arisen over
the basic premise underlying a seminal 1988 U.S. Supreme Court
case, Basic Inc v. Levinson, which enshrined the so-called
presumption of reliance in a fraud-on-the-market case underlying
all modern securities class actions.
Under that theory, stock prices are assumed to take into
account all available information to investors. Any misstatement
by a company can, under this theory, harm investors, whether
they personally knew of it or not, since a fraud on the entire
market is assumed to affect the price of the stock.
But Kaplan said recent research found that stock prices do
not incorporate all known information due to "structural
obstacles" in the sale of securities. Investors also don't
always rely on price to buy stocks, sometimes buying and selling
them on the assumption they always go up, he said.
Kaplan said that modern securities class actions depend on
the idea that plaintiffs are presumed to have relied on a
misstatement in a fraud-on-the-market case.
"If the foundations are on sand like the houses on the south
shore of Staten Island, they're not going to bear the weight
upon them," he said, referring to the effect of Superstorm Sandy
on parts of New York.
Kaplan also suggested that the current system for dismissing
lawsuits may be failing.
Under the PSLRA, plaintiffs cannot take depositions or
obtain evidence from defendants until after a court holds the
allegations in their complaint are plausible and deny a motion
But recent U.S. Supreme Court cases have heightened that
pleading standard. Kaplan estimated that as much as 30 percent
of class actions today are dismissed before discovery can be
"You have to wonder if too many healthy babies are being
thrown out with the bath water," he said.
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