Uncovering the Hidden Conflicts in Securities Class Action Litigation: Lessons from the State Street Case

Courts, Congress, and commentators have long worried that stockholder plaintiffs in securities and M&A litigation and their counsel may pursue suits that benefit themselves rather than absent stockholders or the corporations in which they invest. Following congressional reforms that encouraged the appointment of institutional stockholders as lead plaintiffs in securities actions, significant academic commentary has focused on the problem of “pay to play”—the possibility that class action law firms encourage litigation by making donations to politicians with influence over institutional stockholders, particularly public sector pension funds. A recent federal securities class action in the District of Massachusetts, however, suggests that the networks of influence between class plaintiffs and their counsel are much more complex and difficult to detect. After appointing a special master to look into fee issues, the court discovered that a large class action firm had paid over $4 million in “bare referral” fees to an attorney who did little work on the case but had recommended the larger firm to a public sector pension fund “after considerable favors, political activity, money spent and time dedicated in Arkansas.” This is only one of the less-visible ways that class counsel may route benefits to class plaintiffs. Current class action processes do not routinely identify these potential conflicts of interest. Instead, they tend to surface when nonlitigants bring them to public attention. Because neither the lead plaintiff nor the defendants have a strong incentive to voluntarily address these conflicts, we propose revisions to the class certification process that would require class plaintiffs to disclose more information regarding their relationships with class counsel. We also propose that courts routinely appoint special masters or class guardians as part of the settlement approval process to ensure that class plaintiffs’ statements are subject to discovery and adversarial review

Conflicts & Capital Allocation

The regulatory structure for financial advice now tolerates incentives motivating financial advisors to manipulate and deceive retail investors. While scholars thus far have argued for ways to improve investor protections, the literature has largely ignored how these flawed incentives affect the economy. This Article contends that these flawed incentives cause financial advisors to negatively affect capital allocation throughout the overall economy. This Article draws on literature about manipulation and deception in principal-agent relationships to show how conflicts of interest cause the market for financial advisor services to generate excessive intermediation, driving harms to the real economy. This Article uses case studies of non-traded real estate investment trusts and closed-end funds to illustrate how financial advisor conflicts of interest contribute to inefficient capital allocation and inefficiency in the market for institutional intermediation. To address this issue, this Article argues that an effective policy response will address compensation incentives and focus on limiting the ability of conflicts of interest to skew capital allocatio

Adversarial Failure

Investors, industry firms, and regulators all rely on vital public records to assess risk and evaluate securities industry personnel. Despite the information\u27s importance, an arbitration-facilitated expungement process now regularly deletes these public records. Often, these arbitrations recommend that public information be deleted without any true adversary ever providing any critical scrutiny to the requests. In essence, poorly informed arbitrators facilitate removing public information out of public databases. Interventions aimed at surfacing information may yield better informed decisions. Although similar problems have emerged in other contexts when adversarial systems break down, the expungement process to purge information about financial professionals provides a unique case study. Multiple interventions may combine to more effectively surface information and generate better informed decisions. In quasi-ex parte proceedings, traditional attorney ethics rules must yield to a higher duty of candor. Yet adjudicators should not rely on duty alone. Adversarial scrutiny may emerge by designating an advocate to independently and critically engage in circumstances where no party has any real incentive to oppose an outcome. Ultimately, addressing adversarial failures may require a shift away from adversarial adjudication to a more regulatory framework

Cybersecurity Oversight Liability

A changing cybersecurity environment now poses a significant corporate-governance challenge. Although some cybersecurity data breaches may be inevitable, courts now increasingly consider when a corporation\u27s officers and directors may be held liable on theories that they acted in bad faith and failed to adequately oversee the corporation\u27s affairs. This short essay reviews recent derivative decisions and encourages corporate boards to recognize that in an environment filled with increasing threats, a reasonable response will require devoting real resources and attention to cybersecurity issues

Supreme Risk

While many have discussed the social issues that might arise because of a majority-conservative Supreme Court, one critical consequence of the current Court has been overlooked: the role of the Court in generating or avoiding systemic risk. For some time, systemic financial risk has been regulated by a mix of self-regulatory organizations (SROs), such as the Depository Trust Corporation, and federal regulators such as the Financial Stability Oversight Council (FSOC). However, the Court\u27s recent jurisprudence now creates real risk that federal courts will declare keystone SROs unconstitutional because they do not fit neatly into an eighteenth-century constitutional framework. SROs are under-appreciated regulatory entities comprised of industry members regulating their own industries with deferential oversight from federal administrative agencies. While ordinary civics discussions entirely omit SROs, they play critical legal and economic roles and exercise expansive power delegated to them by the federal government. Yet, as nominally private entities, they enforce federal law and their own rules without abiding by the constitutional restrictions imposed on governmental entities, such as providing due process. This Article makes three contributions to the literatures in financial regulation and constitutional law-disciplines that rarely interact. First, it provides a detailed account of how SROs became functionally integrated into the federal government and serve as federal law enforcement and regulators. Second, it shows how four different constitutional doctrines, now resurging under a majority-conservative Supreme Court, pose existential threats to existing SRO models. Third, this Article explains how Supreme Court decisions declaring SROs unconstitutional or limiting their powers generate systemic risk and may trigger a financial crisis as well as how possible measures can mitigate this risk

The Fate of State Investor Protection

In June 2019, the Securities & Exchange Commission made significant changes to the regulation of investment advice, issuing regulations and new interpretations of the Investment Advisers Act of 1940. Industry advocates have argued that states lack power to enact their own regulations on the theory that various federal statutes and regulations combine to preempt and sharply limit state authority. This article examines the current state of reforms around the country and the policy and legal arguments for and against limiting state efforts to raise the standards for investment advice