An academic paper published in June 2021 highlights the important role of private stockholder litigation and plaintiff lawyers in protecting the rights of shareholders and regulating the financial markets.
Indirect Investor Protections
Holger Spamann, a Harvard Law School professor, questions in a recent paper the “mechanisms [that] ensure that investors’ money is not squandered on bad investments or, once invested, lost to bad management,” and finds that the “standard answer”—that investors are directly protected by disclosure obligations and investment professionals, like fund managers—isn’t accurate. In many cases, the information overload provided to investors by public companies is difficult to digest and, as to fund managers, even those running active strategies have “weak incentives” to protect investors and have “been mostly inactive in governance and notoriously underperformed the market.” Passive managers have even less incentive to police corporate misconduct given that they do not make investment selections and compete on price rather than performance. Rather, Professor Spamann finds that the most meaningful investor protections are provided indirectly by sophisticated market participants and plaintiff attorneys: the professor writes that “plaintiff attorneys police collusion between activists, buyers, and management; prices informed by speculators constrain activists to value enhancing interventions; buyers compete with each other for target firms; and speculators constrain each other by competing to eliminate pricing inaccuracies.” Without these indirect protections, the financial markets would be nowhere near as safe and efficient as they are today.
The paper’s nuanced viewpoint is consistent with our anecdotal observations as attorneys representing stockholders. Traditional fund managers are generally deferential to company management, despite superior access to executives in comparison to retail investors, which is reflected by the fact that fund managers almost never expose corporate misconduct and vote their shares with management 93% of the time. Only a narrow group of hedge funds and activists apply meaningful pressure on management to advance the interests of stockholders, as do plaintiff attorneys by way of the cases they advance on behalf of investors. Indeed, Professor Spamann acknowledges that “[w]hile some shareholder litigation is controversial, some is very likely essential, in particular corporate fiduciary duty litigation against self-dealing by corporate insiders, especially controlling stockholders, at the expense of outside investors.”
A Few Points of Disagreement
While we agree with the thesis, we take issue with some of the finer points. Professor Spamann writes that “plaintiff lawyers . . . are not motivated by a concern for the investors,” “[n]or are the legally mandated to have such a concern,” but nonetheless are incentivized to help regulate the market by contingent attorneys’ fees. These points are wrong in our view. We wouldn’t be in the business of advancing shareholder rights if we did not philosophically believe in the social and economic value of efficient markets, fair dealing, and investor protection. Some of the highest paid attorneys in America have earned their fortunes solely by representing the interests of company management, notwithstanding the merits of the cases against them. Graduating from law school, the top defense firms pay the highest attorney salaries available in the market. In any event, the attorney ethics laws do “legally mandate” us to faithfully advance the interests of our stockholder clients (which we would do in any event), and courts require the same of us when we apply to lead class action or derivative litigation and when we seek approval of a settlement of the same. Attorneys who lose sight of these principles do so at their own peril.
Professor Spamann also refers to plaintiffs in stockholder litigation as mere “figureheads.” We find this to be inaccurate as well, or at least unnecessarily disparaging in light of the typical role played by lay litigants who retain expert attorneys to advance their cases. Stockholders who serve as named plaintiffs assume the risks and burdens of filing lawsuits against the largest and most powerful companies in America, and take on the obligations to provide personal information, documents relating to their investments, trial and deposition testimony, and to stay abreast of the status of the case. Indeed, despite a lack of probative value in many instances, defense firms routinely insist on burdening plaintiffs with the maximum amount of written discovery, document discovery and deposition testimony in an effort to discourage them from continuing to advance their cases on behalf of other investors.
We appreciate Professor Spamann’s scholarship, which we think rightfully brings awareness to the critical importance of indirect investor protections, including plaintiff lawyers and private stockholder litigation, in maintaining the fairness and efficiency of the public markets.