This article explains the basics of serving as a named plaintiff in a stockholder lawsuit. We believe that the deterrent effects of stockholder litigation—and the billions of dollars recovered for millions of investors over the preceding decades—are largely attributable to a small group of individual and institutional investors who were willing to assert their legal rights to remedy corporate misconduct.
Our firm specializes in recovering losses for stockholders harmed by corporate misconduct. Before bringing a case, we often counsel clients on the benefits and risks of serving as a named plaintiff in a lawsuit. Participating in litigation is a special privilege granted to stockholders under U.S. law, and we believe it is crucial to maintaining healthy and efficient financial markets. Nonetheless, serving as a plaintiff in a lawsuit is not for everyone. In this article, we discuss the benefits and potential drawbacks to consider.
Basics of Stockholder Litigation
Stockholders have a range of alternatives after incurring an investment loss attributable to misconduct. Depending on the facts and circumstances surrounding the loss, a stockholder lawsuit may take multiple forms.
In cases where a company has misled investors about its operations, financial results or prospects, stockholders may be entitled to assert claims under federal or state securities laws. These laws make it illegal to mislead investors regarding facts that are material (i.e., important) to their investments in the company. Because other investors are typically also harmed in the same way, these cases are often brought as class actions. A named plaintiff in a securities class action serves as a representative of all investors similarly harmed by the misconduct at issue. Class representatives owe a duty to the class to diligently pursue the litigation for the class’s benefit.
In cases where officers or directors are responsible for causing harm to a company (for example, by causing it to squander assets on illegal transactions, excessive compensation, regulatory penalties or litigation settlements), stockholders may be entitled to bring an action on behalf of the company, which is called a “derivative” action. This means that the stockholder steps into the shoes of the company for purposes of suing the officers and directors responsible for causing the harm. In derivative cases, the named plaintiff serves as a representative of the company and owes the company a duty to diligently pursue a recovery of the squandered assets.
Although these two categories of corporate misconduct cases are legally distinct, the practical differences for a named plaintiff are minor. In either case, plaintiff’s counsel will manage the litigation, make recommendations as to litigation strategy, and advise the named plaintiffs of their obligations in connection with the lawsuit.
One exception here is that a named plaintiff in a derivative action may not sell all of his or her shares during the pendency of the case. Representatives of a company in a derivative action must continuously hold at least some of their shares from the time of the misconduct through the resolution of the lawsuit. By contrast, an investor in a securities class action may bring an action to recover damages caused by the company’s misrepresentations regardless of whether he or she subsequently sells the shares held in the company.
Obligations of a Named Plaintiff
Stockholder litigation cannot proceed without the active participation of the named plaintiffs. As a general matter, plaintiffs must agree to communicate promptly with counsel, make themselves available for phone calls when needed, and make a limited number of in-person appearances pre-trial and, if necessary, at trial.
Before agreeing to the case, a plaintiff must decide whether he or she is comfortable with filing a public complaint against a company, which may draw news coverage and public comment. Because litigation is naturally an adversarial exercise, a plaintiff must be prepared for the company to vigorously defend itself and the officers and directors involved, including by publicly denying or discrediting the plaintiff’s allegations.
The specific obligations of a named plaintiff will vary based on the type of matter and procedural stage of the lawsuit.
At the beginning of a case, a plaintiff’s participation is typically limited to the functions required to draft and file the lawsuit. For example, plaintiffs may be asked to (i) provide identification information; (ii) provide proof of their stock ownership, including the initial date of purchase; (iii) sign attestations regarding their stock ownership and status as a stockholder; (iv) discuss the underlying allegations in the case and provide any information they may have; and (iv) review the complaint and its allegations before filing.
After a lawsuit is filed, a plaintiff’s participation may increase as the lawsuit progresses. For example, early motion practice in a case is typically handled by counsel. But, during the discovery stage, plaintiffs may be asked to (i) produce documents or emails regarding their stock purchases or knowledge of the misconduct at issue; (ii) answer written questions about the case and their stock purchases; and (iii) submit to a deposition, during which defense counsel may question the plaintiff about the basis for the lawsuit and their stock purchases. If the case proceeds to trial, a plaintiff may also have to appear in person to testify (although it is worth noting that few stockholder litigations proceed to trial).
These obligations may become burdensome from time to time, but they are necessary to advance the lawsuit. Indeed, if a plaintiff chooses to no longer participate after a lawsuit is filed, the lawsuit may be dismissed and other similarly situated investors may lose the chance to recover their losses. It is important for plaintiffs to fully understand the scope of commitment before agreeing to bring a representative action.
Benefits of Serving as a Named Plaintiff
Although there are obligations associated with serving as a named plaintiff, there are significant offsetting benefits to the individual plaintiff, other investors and society.
As an initial matter, a named plaintiff stands to make a recovery alongside other investors. In a securities class action, the named plaintiff and other class members share directly in the recovery proportionate to their losses. In a derivative action, only the company itself is entitled to the recovery, but the named plaintiff and other stockholders benefit indirectly as a result of the company’s recovery of lost assets. In many cases, these recoveries would not be made but for the participation of a small group of investors willing to serve as named plaintiffs.
Although a plaintiff’s individual recovery may be relatively small in some cases (especially where his or her losses are relatively small), the aggregate recovery for all investors may be tens of millions or hundreds of millions of dollars. Without the active participation of a named plaintiff, no recovery for investors would be possible and millions of dollars in losses would be left uncompensated, not to mention that the misconduct at issue would be left unaddressed.
In addition to recovering losses, in some cases, courts will approve an additional payment to named plaintiffs in recognition of their time, expense and burden committed to a matter. These payments are called “incentive awards” and are made by application to the presiding judge, which will approve or deny the payment in light of the circumstances at issue. It is impossible to predict the size of an incentive award in advance of the resolution of litigation. However, awards are typically not trivial amounts, and named plaintiffs are entitled to these awards on top of any recovery of their losses in the action.
In addition to these benefits, stockholder litigation serves an important societal function: regulation of our financial markets. While the Securities Exchange Commission (“SEC”) is the primary regulator of the financial markets, it cannot identify and pursue all cases of misconduct. There are over 4000 public companies in the U.S., and the SEC simply lacks the time and resources to police every instance of misconduct. For decades, significant corporate misconduct has been outed and remedied by private litigants—i.e., named plaintiffs in stockholder litigation—who have chosen to assert their rights as stockholders to hold company officers and directors accountable. In the aggregate, these individuals and their counsel have recovered billions in losses for investors in the past decade alone. Although the vast majority of companies do not engage in misconduct (and are not subject to stockholder lawsuits), a small minority of companies, led by unfaithful officers and directors, cause significant losses every year. Stockholder litigation provides both (1) a disincentive for companies to commit fraud and (2) a mechanism for stockholders to recover their losses when companies veer off course. The laws providing meaningful investor protections make the U.S. legal system unique, and provide assurance that our financial markets operate efficiently and that wrongdoers are held to account.
We respect the role of private litigants in helping to regulate the financial markets, and take our role as plaintiffs’ counsel seriously. We understand that investors have jobs, families and other obligations that must be prioritized, and we make every effort to limit the time and burden required of a plaintiff to pursue a matter. The deterrent effects of stockholder litigation—and billions of dollars recovered for millions of investors over the preceding decades—are largely attributable to a small group of individual and institutional investors who were willing to assert their legal rights to remedy corporate misconduct. Litigation isn’t for everyone, but if you’ve been harmed by corporate misconduct and are interested in pursuing the accountable parties, Morris Kandinov LLP stands ready to provide you with the representation and resources necessary to prevail in your case.