Private Securities Litigation: Important Deterrent or Wasteful Churn?
Professor Joseph A. Grundfest was a member of a panel discussion of professors on October 23, 2008 covering the question: Do private securities lawsuits play an important role in deterring fraud and compensating defrauded investors, or are they simply wasteful and ineffective? Kevin LaCroix of D&O Diary quotes Professor Grundfest:
Professor Grundfest: Professor Grundfest addressed the issues first. He characterized private securities litigation as a process "for moving money around for the benefit of the people moving the money around." Professor Grundfest was particularly emphatic in arguing that private securities litigation is a poor deterrent of misconduct. He pointed to the many allegations of wrongdoing that have accompanied the current financial crisis as evidence that private securities litigation is not a deterrent to misconduct.
Professor Grundfest argued that because the vast preponderance of private securities litigation is settled with insurance proceeds or company money, there is no "individual responsibility," because the "wrongdoers" are not "hit in the pocketbook."
In order for the system to provide deterrence, Professor Grundfest suggested, the process should be changed so that rather than having as its objective simply to be to produce "the largest pot of money" from whatever source derived, the objective should be geared toward settlements funded directly out of individuals’ pockets, even if it results in a much smaller settlement.
Professor Grundfest described the current system as a "drug induced fantasy," as it essentially involves institutional lead plaintiffs suing companies in which institutional investors are the primary shareholders. Professor Grundfest asserted that this system produced nothing more than a very elaborate and costly pocket shifting, as a result of which it is mathematically impossible for a fully diversified investor to come out ahead. The only effective deterrent, Professor Grundfest argued, would be to require individual settlement contributions as a regular part of private securities litigation settlements.
Professor Grundfest closed by commenting that individual responsibility is "the message that needs to go out" and he asked rhetorically, "why is it so rare?" He also asked "isn’t it what really works?" -- adding that motivating behavior is a more important goal than moving money around.