07/15/2010 07:01 pm ET | Updated May 25, 2011

A Luxury America Can No Longer Afford

One Penny For You, 84 Cents For Your Lawyer

The Securities Class Action: A System That Drains Billions of Dollars of Shareholder Value Based on Perverse Notions of Justice and Morality

We have tried to explain why securities class actions are fundamentally flawed; how these lawsuits punish (for a second time) the shareholders who are already the victims of the companies' misconduct; and how billions (that's right, billions) of dollars of shareholder equity are drained from the pensions and 401Ks of working Americans every year in order to make class action lawyers filthy rich. Our warnings to Americans -- "The class action lawyers are coming! The class action lawyers are coming!" -- have finally been been confirmed by U.S. District Court Judge Jed S. Rakoff, who, in a recent securities class action against Bank of America, refused, in the most unequivocal judicial condemnation of the securities class action system to date, to approve a proposed settlement, "because it does not comport with the most elementary notions of justice and morality." That's right, unjust and immoral because although it was the corporation's executives that caused the harm, the same shareholders who suffered the harm were being required to foot the bill. Sad to say these unjust and immoral securities class action settlements are regular fare in our nation's courts, and have been for decades. (Hopefully, President Obama will address this problem.)

And yet, as if it couldn't get any worse, comes In Re: Initial Public Offering Securities Litigation. One of the largest securities class actions in history, the IPO litigation consisted of over 300 class actions, in which hundreds, if not thousands, of lawyers and their staffs represented the same class of plaintiffs. Yet with hordes of plaintiff's lawyers in the case, the best they could do was a settlement in which class members got 1¢ for every $1 of damages claimed! The lawyers requested $202 million in attorney's fees for their efforts and the judge awarded them $170 million. That's right, for every dollar the lawyers alleged the shareholders lost, their clients received one penny while for every dollar of fees the lawyers requested for themselves, they got 84 cents.

How did the judge defend this one-cent-for-class members-84-cents-for-the-lawyers class action system? Here is what the judge had to say:

JUDGE: We need to incentivize lawyers to risk their time and money to take these cases.

But why encourage lawyers to file cases where their clients receive next to nothing and the lawyers themselves are the only beneficiaries? Remember how the financial crisis was hastened by the bankers system of compensation which encouraged them to take risks from which they were the big winners and society was the big loser? It is a heads-I-win-tails-you-lose lawyers' scam. Yet another compensation system that rewards failure.

JUDGE: Disapproving this settlement would have a significant chilling effect on future class actions...

That sounds exactly right, shouldn't we "chill" lawsuits that get clients a penny for every dollar lost? How weak must these claims have been if a penny per share was best settlement the lawyers could get?

JUDGE: The lawyers worked hard on behalf of class members.

But aren't there better things for lawyers to work hard on where they'll get something for their clients? Did we really need 300 law firms working so hard for so little return for their clients? Isn't this the lawyers' version of the "Bridge to Nowhere" - the proposed bridge to connect the town of Ketchikan, Alaska with Gravina Island, population 50, at a cost of $398 million? Wouldn't the architects and construction workers have worked hard on the bridge? However, hard work isn't the issue, it's the benefit to the clients and society that should matter.

JUDGE: Securities class actions serve the important function of policing securities transactions. Awarding counsel a fee that is too low would be detrimental to the system of private enforcement.

Lawyers are not police officers, and our legal system is not a police department. Lawyers should not be awarded hundreds of millions of dollars in fees for lawsuit-to-nowhere litigation. With community after community laying off policemen who are protecting us from robbery, rape, and murder, these $750 an hour lawyer-police are simply too expensive; we can no longer afford them.

JUDGE: Forcing this case to go to trial will not benefit anyone.

Really? It wouldn't benefit class members to take to trial a case in which the settlement is providing them with one penny for every dollar lost? How much worse off would the shareholders have been if their lawyers took the case to trial? Is nothing that much worse than next to nothing?

JUDGE: The fact that defendants agreed to settle at all indicates that plaintiff's claims were not entirely meritless.

Does the simple fact that defendants settle mean that the suit is "not entirely meritless"? Really? In the JDS Uniphase case, after five years of litigation, the company was exonerated by a jury verdict. The company won, but paid a reported $50 million in legal fees. Even if JDS had been certain that it would prevail at trial, would their shareholders have preferred that they settle for $49 million? (And, to get really perverse, couldn't the company's failure to settle become grounds for yet another class action lawsuit for breach of duty to the shareholders?) The math on settlement is straightforward: for many companies facing a securities class action, the choice is settle or risk the possibility of bankruptcy. This is why even innocent defendants are forced to settle. If you are defending multi-billion dollar claims, isn't it cheaper and smarter to settle with the insurance companies' millions regardless of the merits?

And what is this "not entirely meritless" standard anyway? Has our legal system degenerated to a point where lawyers are entitled to $170 million because their lawsuit was "not entirely meritless"?

JUDGE: The fees are reasonable ($170 million) because they are lower than what the lawyers were asking for ($202 million), therefore, there is no real danger of overcompensation, and the fee request reflects a discount because of the small recovery.

A discount? Really? Awarding the lawyers $170 million instead of $202 million means the lawyers haven't been overcompensated? Class members were getting a bargain! To paraphrase the Roman general, "With discounts like these, the shareholders eventually won't have any equity left!"

JUDGE: Reducing class counsel's fees will not put more money in class members' pockets.

If that's the judicial philosophy in class actions than no lawyer's fee request should ever be reduced when hundreds, thousands and millions of class members have been brought into the case by class counsel.

Securities class actions -- unjust, immoral, and a luxury we can no longer afford.