Class action and financial markets: Insights from law and economics

Abstract

According to the law and economics approach, pure economic loss is a private loss that is not socially relevant but simply implies a redistribution of wealth. Consequently, wrongful behavior that induces reallocation of costs and benefits with no consequences on social welfare is not considered socially harmful, so is not necessarily subject to compensation. Since pure economic loss is very often financial, the above reasoning also applies to financial markets. However, the same law and economics arguments suggest that in financial markets, the policy of internalizing pure economic loss by means of class actions can be more far-sighted than simply compensating the victims: the liability system has the particular feature of producing deterrence and driving the market towards an efficient outcome. In this vein, the paper argues that class action intended as a complementary ex-post regulatory device can play a significant role in addressing a failure that ex-ante regulation has not. This is coherent with the law and economics tradition that interprets tort law remedies as a solution for internalizing externality and providing the correct incentive to the markets.class action, pure economic loss, regulation, liability, deterrence