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 that law.

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 unintended ways."

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 said.

'TROUBLESOME' QUESTIONS

Plaintiffs' lawyers have an "incentive to settle and thereby earn a sure fee rather than try a case and take that risk," he said.

Besides looking at how plaintiffs' lawyers are paid, Kaplan also said that there should be an examination of how they get their clients.

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 field.

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 funds.

"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 to dismiss.

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 taken.

"You have to wonder if too many healthy babies are being thrown out with the bath water," he said.

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