Tag Archives: Reform Act

Fixing the Economics of Securities Defense

In my last D&O Discourse post, “The Future of Securities Class Action Litigation,” I discussed why changes to the securities litigation defense bar are inevitable: In a nutshell, the economic structures of the typical securities defense firms — mostly national law firms — result in defense costs that significantly exceed what is rational to spend in a typical securities class action. As I explained, the solution needs to come from outside the biglaw paradigm; when biglaw firms try to reduce the cost of one case without changing their fundamental billing and staffing structure, they end up cutting corners by foregoing important tasks or settling prematurely for an unnecessarily high amount. That is obviously unacceptable.

The solution thus requires us to approach securities class action defense in a new way, by creating a specialized bar of securities defense lawyers from two groups: lawyers from national firms who change their staffing structure and lower their billing rates and from experienced securities litigators from regional firms with economic structures that are naturally more rational.

See Also: Future of Securities Class Actions

But litigation venues are regional. We have state and federal courts organized by states and areas within states. Because lawyers need to go to the courthouse to file pleadings, attend court hearings and meet with clients in that location, the lawyer handling a case needs to live where the judge and clients live.

Right?

Not anymore.

Although the belief that a case needs a local lawyer persists, that is no longer how litigation works. We don’t file pleadings at the courthouse; we file them on the Internet from anywhere (even from an airplane). These days, in most cases, there are just a handful of in-person court hearings. And the reality is that most clients don’t want their lawyers hanging around in-person at their offices because email, phone calls and Skype suffice. Even document collection can be done mostly electronically and remotely. And with increasingly strict deposition limits and witnesses located around the country and the world, depositions don’t require much time in the forum city, either.

In a typical Reform Act case, where discovery is stayed through the motion-to-dismiss process, the amount of time a lawyer needs to spend in the forum city is especially modest. If a case is dismissed, the case activities in the forum city (in a typical case) amount only to (1) a short visit to the client’s offices to learn the facts necessary to assess the case and prepare the motion to dismiss and (2) the motion-to-dismiss argument, if there is one. Indeed, assuming a typical securities case requires 1,000 hours of lawyer time through an initial motion to dismiss, fewer than 50 of those hours — one-half of 1% — need to be spent in the forum city.  The other 99.5% can be spent anywhere.

Discovery doesn’t change these percentages much.  Assume it takes another 10,000 hours of attorney time to litigate a case through a summary judgment motion (so 11,000 total hours). Four lawyers/paralegals spending four weeks in the forum city for document collection and depositions (a generous allotment) yields only another 640 hours. So, in my hypothetical, only 0.63% of the defense of the case requires a lawyer to be in the forum city. The other 99.37% of the work can be done anywhere. Because a biglaw firm would litigate a securities class action with a larger team, the total number of hours in a typical biglaw case would be much higher (both the total defense hours and the total number of hours spent in the forum city), but the percentages would be similar.

And the cost of travel does not move the economic needle. Of course, if a firm is willing not to charge for travel time and travel costs to the forum city, there is no economic issue. My firm is willing to make this concession, and I would bet others are, as well. Even if a firm does charge for travel cost and travel time, the cost is minuscule in relationship to total defense costs. For example, my total travel costs (airfare and lodging) for a five-night trip to New York City are typically less than the cost of two biglaw partner hours.

Of course, there are some purposes for which local counsel is necessary, or at least ideal: someone who knows the local rules, is familiar with the local judges and is admitted in the forum state. But the need to use local counsel for a limited number of tasks doesn’t present any economic or strategic issue, either — if the lawyers’ roles are clearly defined. Depending on the circumstances, I like to work either with a local lawyer in a litigation boutique that was formed by former large-firm lawyers with strong local connections or with a lawyer from a strong regional firm. I just finished a case where the local firm was a boutique and a case where the local firm was another regional firm. In both cases, the local firms charged de minimis amounts. In some cases, the local firm can, and should, play a larger role, but whatever the type of firm and its role, the lead and local lawyers can develop the right staffing for the case and work together essentially as one firm — if they want to.

All of these considerations show securities litigation defense can and should be a nationwide practice. It is no longer local. We need to look no further than the other side of the “v” for a good example. Our adversaries in the plaintiffs’ bar have long litigated cases around the country, often teaming up with local lawyers from different firms. Like securities defense, plaintiffs’ securities work requires a full-time focus that has led to a relatively small number of qualified firms. The qualified firms litigate cases around the country, not just in their hometowns or where their firms have lawyers.

This all seems relatively simple, but it requires us all to abandon old assumptions about law practices that are no longer applicable and embrace a new mindset. Biglaw defense lawyers need to obtain more economic freedom within their firms to reduce their rates and staffing for typical securities cases, or they must face the reality that their firms perhaps are better-suited only for the largest cases. Regional firms must recruit more full-time securities litigation partners and be willing not to charge for travel time and costs. And companies and insurers must appreciate that securities litigation defense will improve — through better substantive and economic results in both individual cases and overall — if they recognize a good regional firm with dedicated securities litigators can defend a securities class action anywhere in the country and can usually do so more effectively and efficiently than a biglaw firm.

5 Changes Needed in Securities Litigation

I am committed to helping shape a system for securities litigation defense that helps directors and officers get through securities litigation safely and efficiently, without losing their serenity or dignity, or facing any real risk of paying any personal funds.

But we are actually moving in the opposite direction of this goal, and, unless some changes are made, securities litigation will pose greater and greater risk to individual directors and officers. It is time for the “repeat players” in securities litigation defense – D&O insurers and brokers, defense lawyers and economists – to make some fundamental changes to how we do things.

Although most cases still seem to turn out fine for the individual defendants, resolved by a dismissal or a settlement that is fully funded by D&O insurance, the bigger picture is not pretty. The law firms that have defended most cases since securities class actions gained footing through Basic v. Levinson – primarily “biglaw” firms based in the country’s several largest cities – are no longer suitable for many, or even most, securities class actions. Fueled by high billing rates and profit-focused staffing, those firms’ skyrocketing defense costs threaten to exhaust most or all of the D&O insurance towers in cases that are not ended on a motion to dismiss. Rarely can such firms defend cases vigorously through summary judgment and toward trial anymore.

Worse, these high prices too often do not yield strategic benefits. A strong motion to dismiss focuses on the truth of what the defendants said, with support from the context of the statements, as directed by the U.S. Supreme Court in Tellabs and Omnicare. Yet, far too often, the motion-to-dismiss briefs that come out of these large firms are little more than cookie-cutter arguments based on the structure of the Reform Act. And if a motion is lost, settlements are higher than necessary because the defendants often have no option but to settle to avoid an avalanche of defense costs that would exhaust their D&O insurance limits. On the other hand, if settlement occurs later, it can be difficult to keep settlement within D&O insurance limits – and defense counsel’s analysis of a “reasonable” settlement can influenced by a desire to justify the amount it has billed.

At the same time that defense costs are continuing to soar, securities class actions are becoming smaller and smaller, with two-thirds of cases brought against companies with market caps less than $2 billion, and almost half less than $750 million. Although catawampus securities litigation economics is a systemic problem, affecting cases of all sizes, the problem is especially acute in the smaller half of cases. Some of those cases simply cannot be defended both well and economically by typical defense firms. Either defense costs become ridiculously large for the size of the case and the amount of the D&O insurance limits, or firms try to reduce costs by cutting corners on staffing and projects – or both. We see large law firms routinely chase smaller and smaller cases. From a market perspective, it makes no sense at all.

So how do we achieve a better securities litigation system?  Five changes would have a profound impact:

  1. Require an interview process for the selection of defense counsel, to allow the defendants to understand their options; to evaluate conflicts of interest and the advantages and disadvantages of using their corporate firm to defend the litigation; and to achieve cost concessions that only a competitive interview process can yield.
  2. Move damages expert reports and discovery ahead of fact discovery, to allow the defendants and their D&O insurers to understand the real economics of cases that survive a motion to dismiss, and to make more informed litigation and settlement decisions.
  3. Increase the involvement of D&O insurers in defense-counsel selection and in other strategic defense decisions, to put those that have the greatest overall experience and economic stake in securities class action defense in a position to provide meaningful input.
  4. Increase the involvement of boards of directors in decisions concerning D&O insurance and the defense of securities litigation, including counsel selection, to ensure their personal protection and good oversight of the defense of the company and themselves.
  5. Make the Supreme Court’s Omnicare decision a primary tool in the defense of securities class actions. Obviously, Omnicare should be used to defend against challenges to all forms of opinions, including statements regarded as “puffery” and forward-looking statements protected by the Reform Act’s Safe Harbor. But defense counsel should also take advantage of the Supreme Court’s direction in Omnicare that courts evaluate challenged statements in their full factual context. Omnicare supplements the court’s previous direction in Tellabs that courts evaluate scienter by considering not just the complaint’s allegations, but also documents incorporated by reference and documents subject to judicial notice.  Together, Omnicare and Tellabs allow defense counsel to defend their clients’ honesty with a robust factual record at the motion to dismiss stage.

These five changes are among the top wishes I have to improve securities litigation defense, and to preserve the protections of directors and officers who face securities litigation.

Future of Securities Class Actions

Securities litigation has a culture defined by multiple elements: the types of cases filed, the plaintiffs’ lawyers who file them, the defense counsel who defend them, the characteristics of the insurance that covers them, the way insurance representatives approach coverage, the government’s investigative policies – and, of course, the attitude of public companies and their directors and officers toward disclosure and governance.

This culture has been largely stable over the nearly 20 years I’ve defended securities litigation matters full time. The array of private securities litigation matters (in the way I define securities litigation) remains the same – in order of virulence: securities class actions, shareholder derivative litigation matters (derivative actions, board demands and books-and-records inspections) and shareholder challenges to mergers. The world of disclosure-related SEC enforcement and internal corporate investigations is basically unchanged, as well. And the art of managing a disclosure crisis, involving the convergence of shareholder litigation, SEC enforcement and an internal investigation involves the same basic skills and instincts.

But I’ve noted significant changes to other characteristics of securities-litigation culture recently, which portend a paradigm shift. Over the past few years, smaller plaintiffs’ firms have initiated more securities class actions on behalf of individual, retail investors, largely against smaller companies that have suffered what I call “lawsuit blueprint” problems such as auditor resignations and short-seller reports. This trend – which has now become ingrained into the securities-litigation culture – will significantly influence the way securities cases are defended and by whom, and change the way that D&O insurance coverage and claims need to be handled.

Changes in the Plaintiffs’ Bar

Discussion of the history of securities plaintiffs’ counsel usually focuses on the impact of the departures of former giants Bill Lerach and Mel Weiss. But although the two of them did indeed cut a wide swath, the plaintiffs’ bar survived their departures just fine. Lerach’s former firm is thriving, and there are strong leaders there and at other prominent plaintiffs’ firms.

The more fundamental shifts in the plaintiffs’ bar concern changes to filing trends. Securities class action filings are down significantly over the past several years, but, as I have written, I’m confident they will remain the mainstay of securities litigation and won’t be replaced by merger cases or derivative actions. There is a large group of plaintiffs’ lawyers who specialize in securities class actions, and there are plenty of stock drops that give them good opportunities to file cases. Securities class action filings tend to come in waves, both in the number of cases and type. Filings have been down over the last several years for multiple reasons, including the lack of plaintiff-firm resources to file new cases as they continue to litigate stubborn and labor-intensive credit-crisis cases, the rising stock market and the lack of significant financial restatements.

Although I don’t think the downturn in filings is, in and of itself, very meaningful, it has created the opportunity for smaller plaintiffs’ firms to file more securities class actions. The Reform Act’s lead plaintiff process gives plaintiffs’ firms incentives to recruit institutional investors to serve as plaintiffs. For the most part, institutional investors, whether smaller unions or large funds, have retained the more prominent plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role. At the same time, securities class action economics tightened in all but the largest cases. Dismissal rates under the Reform Act are pretty high, and defeating a motion to dismiss often requires significant investigative costs and intensive legal work. And the median settlement amount of cases that survive dismissal motions is fairly low. These dynamics placed a premium on experience, efficiency and scale. Larger firms filed most of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role or make much money on their litigation investments.

This started to change with the wave of cases against Chinese issuers in 2010. Smaller plaintiffs’ firms initiated most of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs and uncertain insurance and company financial resources. Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss. The dismissal rate has indeed been low, and limited insurance and company resources have prompted early settlements in amounts that, while on the low side, appear to have yielded good outcomes for the smaller plaintiffs’ firms.

The smaller plaintiffs’ firms thus built up a head of steam that has kept them going, even after the wave of China cases subsided. For the last year or two, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and smaller firms have initiated an increasing number of cases. Like the China cases, these tend to be against smaller companies. Thus, smaller plaintiffs’ firms have discovered a class of cases – cases against smaller companies that have suffered well-publicized problems that reduce the plaintiffs’ firms’ investigative costs – for which they can win the lead plaintiff role and that they can prosecute at a sufficient profit margin.

To be sure, the larger firms still mostly can and will beat out the smaller firms for the cases they want. But it increasingly seems clear that the larger firms don’t want to take the lead in initiating many of the cases against smaller companies and are content to focus on larger cases on behalf of their institutional investor clients.

These dynamics are confirmed by recent securities litigation filing statistics. Cornerstone Research’s “Securities Class Action Filings: 2014 Year in Review” concludes that (1) aggregate market capitalization loss of sued companies was at its lowest level since 1997 and (2) the percentage of S&P 500 companies sued in securities class actions “was the lowest on record.” Cornerstone’s “Securities Class Action Filings: 2015 Midyear Assessment” reports that two key measures of the size of cases filed in the first half of 2015 were 43% and 65% lower than the 1997-2014 semiannual historical averages. NERA Economic Consulting’s “Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review” reports that 2013 and 2014 “aggregate investor losses” were far lower than in any of the prior eight years. And PricewaterhouseCoopers’ “Coming into Focus: 2014 Securities Litigation Study” reflects that, in 2013 and 2014, two-thirds of securities class actions were against small-cap companies (market capitalization less than $2 billion) and that one-quarter were against micro-cap companies (market capitalization less than $300 million). These numbers confirm the trend toward filing smaller cases against smaller companies, so that now, most securities class actions are relatively small cases.

Consequences for Securities Litigation Defense

Securities litigation defense must adjust to this change. Smaller securities class actions are still important and labor-intensive matters – a “small” securities class action is still a big deal for a small company and the individuals accused of fraud, and the number of hours of legal work to defend a small case is still significant. This is especially so for the “lawsuit blueprint” cases, which typically involve a difficult set of facts.

Yet most securities defense practices are in firms with high billing rates and high associate-to-partner ratios, which make it uneconomical for them to defend smaller litigation matters. It obviously makes no sense for a firm to charge $6 million to defend a case that can settle for $6 million. It is even worse for that same firm to attempt to defend the case for $3 million instead of $6 million by cutting corners – whether by under-staffing, over-delegation to junior lawyers or avoiding important tasks. It is worse still for a firm to charge $2 million through the motion to dismiss briefing and then, if it loses, to settle for more than $6 million just because it can’t defend the case economically past that point. And it is a strategic and ethical minefield for a firm to charge $6 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case.

Nor is the answer to hire general commercial litigators at lower rates. Securities class actions are specialized matters that demand expertise, consisting not just of knowledge of the law but of relationships with plaintiffs’ counsel, defense counsel, economists, mediators and D&O brokers and insurers.

Rather, what is necessary is genuine reform of the economics of securities litigation defense through the creation of a class of experienced securities litigators who charge lower rates and exhibit tighter economic control. Undoubtedly, that will be difficult to achieve for most securities defense lawyers, who practice at firms with supercharged economics. The lawyers who wish to remain securities litigation specialists will thus face a choice:

  1. Accept that the volume of their case load will be reduced, as they forego smaller matters and focus on the largest matters (which Biglaw firms are uniquely situated to handle well, on the whole);
  2. Rein in the economics of their practices, by lowering billing rates of all lawyers on securities litigation matters, and by reducing staffing and associate-to-partner ratios; or
  3. Move their practices to smaller, regional defense firms that naturally have more reasonable economics.

I’ve taken the third path, and I hope that a number of other securities litigation defense lawyers will also make that shift toward regional defense firms. A regional practice can handle cases around the country, because litigation matters can be effectively and efficiently handled by a firm based outside of the forum city. And they can be handled especially efficiently by regional firms outside of larger cities, which can offer a better quality of life for their associates and a more reasonable economic model for their clients.

Consequences for D&O Insurance

D&O insurance needs to change, as well. For public companies, D&O insurance is indemnity insurance, and the insurer doesn’t have the duty or right to defend the litigation. The insured selects counsel, and the insurer has a right to consent to the insured’s selection, but such consent can’t be unreasonably withheld. D&O insurers are in a bad spot in a great many cases. Because most experienced securities defense lawyers are from expensive firms, most insureds select an expensive firm. But in many cases that spells a highly uneconomical or prejudicial result, through higher than necessary defense costs or an early settlement that doesn’t reflect the merits but that is necessary to avoid using most or all of the policy limits on defense costs.

Given the economics, it certainly seems reasonable for an insurer to at least require an insured to look at less expensive (but just as experienced) defense counsel before consenting to the choice of counsel – if not outright withholding consent to a choice that does not make economic sense for a particular case. If that isn’t practical from an insurance law or commercial standpoint, insurers may well need to look at enhancing their contractual right to refuse consent or even to offer a set of experienced but lower-cost securities defense practices in exchange for a lower premium. It is my strong belief that a great many public company CFOs would choose a lower D&O insurance premium over an unfettered right to choose their own defense lawyers.

Because I’m not a D&O insurance lawyer, I obviously can’t say what is right for D&O insurers from a commercial or legal perspective. But it seems obvious to me that the economics of securities litigation must change, both in terms of defense costs and defense-counsel selection, to avoid increasingly irrational economic results.

Future of Securities Class Actions

Securities litigation has a culture defined by multiple elements: the types of cases filed, the plaintiffs’ lawyers who file them, the defense counsel who defend them, the characteristics of the insurance that covers them, the way insurance representatives approach coverage, the government’s investigative policies – and, of course, the attitude of public companies and their directors and officers toward disclosure and governance.

This culture has been largely stable over the nearly 20 years I’ve defended securities litigation matters full-time. The array of private securities litigation matters (in the way I define securities litigation) remains the same – in order of virulence: securities class actions, shareholder derivative litigation matters (derivative actions, board demands and books-and-records inspections) and shareholder challenges to mergers. The world of disclosure-related SEC enforcement and internal corporate investigations is basically unchanged, as well. And the art of managing a disclosure crisis, involving the convergence of shareholder litigation, SEC enforcement and an internal investigation, involves the same basic skills and instincts.

But I’ve noted significant changes to other characteristics of securities-litigation culture recently, which portend a paradigm shift. Over the past few years, smaller plaintiffs’ firms have initiated more securities class actions on behalf of individual, retail investors, largely against smaller companies that have suffered what I call “lawsuit blueprint” problems such as auditor resignations and short-seller reports. This trend – which has now become ingrained into the securities-litigation culture – will significantly influence the way securities cases are defended and by whom, and change the way that D&O insurance coverage and claims need to be handled.

Changes in the Plaintiffs’ Bar

Discussion of the history of securities plaintiffs’ counsel usually focuses on the impact of the departures of giants Bill Lerach and Mel Weiss. But although the two of them did indeed cut a wide swath, the plaintiffs’ bar survived their departures just fine. Lerach’s former firm is thriving, and there are strong leaders there and at other prominent plaintiffs’ firms.

The more fundamental shifts in the plaintiffs’ bar concern changes to filing trends. Securities class action filings are down significantly over the past several years, but I’m confident they will remain the mainstay of securities litigation and won’t be replaced by merger cases or derivative actions. There is a large group of plaintiffs’ lawyers who specialize in securities class actions, and there are plenty of stock drops that give them good opportunities to file cases. Securities class action filings tend to come in waves, both in the number of cases and type. Filings have been down over the last several years for multiple reasons, including the lack of plaintiff-firm resources to file new cases as they continue to litigate stubborn and labor-intensive credit-crisis cases, the rising stock market and the lack of significant financial-statement restatements.

Although I don’t think the downturn in filings is, in and of itself, very meaningful, it has created the opportunity for smaller plaintiffs’ firms to file more securities class actions. The Reform Act gave plaintiffs’ firms incentives to recruit institutional investors to serve as plaintiffs. For the most part, institutional investors, whether smaller unions or large funds, have retained the more prominent plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role. At the same time, securities class action economics tightened in all but the largest cases. Dismissal rates under the Reform Act are pretty high, and defeating a motion to dismiss often requires significant investigative costs and intensive legal work. And the median settlement amount of cases that survive dismissal motions is fairly low. These dynamics placed a premium on experience, efficiency and scale. Larger firms filed most of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role, or make much money on their litigation investments.

This started to change with the wave of cases against Chinese issuers in 2010. Smaller plaintiffs’ firms initiated most of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs and uncertain insurance and company financial resources. Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss. The dismissal rate has indeed been low, and limited insurance and company resources have prompted early settlements in amounts that, while on the low side, appear to have yielded good outcomes for the smaller plaintiffs’ firms.

The smaller plaintiffs’ firms thus built up a head of steam that has kept them going, even after the wave of China cases subsided. For the last year or two, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and these firms have initiated an increasing number of cases. Like the China cases, these cases tend to be against smaller companies. Thus, smaller plaintiffs’ firms have discovered a class of cases – cases against smaller companies that have suffered well-publicized problems that reduce the plaintiffs’ firms’ investigative costs – for which they can win the lead plaintiff role and can prosecute at a sufficient profit margin.

To be sure, the larger firms still mostly will beat out the smaller firms for the cases they want. But it increasingly seems clear that the larger firms don’t want to take the lead in initiating many of the cases against smaller companies, and are content to focus on larger cases on behalf of their institutional investor clients.

These dynamics are confirmed by recent securities litigation filing statistics. Cornerstone Research’s “Securities Class Action Filings: 2014 Year in Review” concludes that (1) aggregate market capitalization loss of sued companies was at its lowest level since 1997, and (2) the percentage of S&P 500 companies sued in securities class actions “was the lowest on record.” Cornerstone’s “Securities Class Action Filings: 2015 Midyear Assessment” reports that two key measures of the size of cases filed in the first half of 2015 were 43% and 65% lower than the 1997-2014 semiannual historical averages. NERA Economic Consulting’s “Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review” reports that 2013 and 2014 “aggregate investor losses” were far lower than in any of the prior eight years. And PricewaterhouseCoopers’ “Coming into Focus: 2014 Securities Litigation Study” reflects that in 2013 and 2014, two-thirds of securities class actions were against small-cap companies (market capitalization less than $2 billion), and one-quarter were against micro-cap companies (market capitalization less than $300 million). These numbers confirm the trend toward filing smaller cases against smaller companies, so that now most securities class actions are relatively small cases.

Consequences for Securities Litigation Defense

Securities litigation defense must adjust to this change. Smaller securities class actions are still important and labor-intensive matters – a “small” securities class action is still a big deal for a small company and the individuals accused of fraud, and the number of hours of legal work to defend a small case is still significant. This is especially so for the “lawsuit blueprint” cases, which typically involve a difficult set of facts.

Yet most securities defense practices are in firms with high billing rates and high associate-to-partner ratios, which make it uneconomical for them to defend smaller litigation matters. It obviously makes no sense for a firm to charge $6 million to defend a case that can settle for $6 million. It is even worse for that same firm to attempt to defend the case for $3 million instead of $6 million by cutting corners – whether by under-staffing, over-delegation to junior lawyers or avoiding important tasks. It is worse still for a firm to charge $2 million through the motion to dismiss briefing and then, if it loses, to settle for more than $6 million just because it can’t defend the case economically past that point. And it is a strategic and ethical minefield for a firm to charge $6 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case. .

Nor is the answer to hire general commercial litigators at lower rates. Securities class actions are specialized matters that demand expertise, consisting not just of knowledge of the law but of relationships with plaintiffs’ counsel, defense counsel, economists, mediators and D&O brokers and insurers.

Rather, what is necessary is genuine reform of the economics of securities litigation defense through the creation of a class of experienced securities litigators who charge lower rates and exhibit tighter economic control. Undoubtedly, that will be difficult to achieve for most securities defense lawyers, who practice at firms with supercharged economics. The lawyers who wish to remain securities litigation specialists will thus face a choice:

  1. Accept that the volume of their case load will be reduced, as they forego smaller matters and focus on the largest matters (which big law firms are uniquely situated to handle well, on the whole);
  2. Rein in the economics of their practices, by lowering billing rates of all lawyers on securities litigation matters and by reducing staffing and associate-to-partner ratios; or
  3. Move their practices to smaller, regional defense firms that naturally have more reasonable economics.

I’ve taken the third path, and I hope that a number of other securities litigation defense lawyers will also make that shift toward regional defense firms. A regional practice can handle cases around the country, because litigation matters can be effectively and efficiently handled by a firm based outside of the forum city. And they can be handled especially efficiently by regional firms outside of larger cities, which can offer a better quality of life for their associates and a more reasonable economic model for their clients.

Consequences for D&O Insurance

D&O insurance needs to change, as well. For public companies, D&O insurance is indemnity insurance, and the insurer doesn’t have the duty or right to defend the litigation. Thus, the insured selects counsel, and the insurer has a right to consent to the insured’s selection, but such consent can’t be unreasonably withheld. D&O insurers are in a bad spot in a great many cases. Because most experienced securities defense lawyers are from expensive firms, most insureds select an expensive firm. But in many cases, that spells a highly uneconomical or prejudicial result, through higher than necessary defense costs or an early settlement that doesn’t reflect the merits, but that is necessary to avoid using most or all of the policy limits on defense costs.

Given the economics, it certainly seems reasonable for an insurer to at least require an insured to look at less expensive (but just as experienced) defense counsel before consenting to the choice of counsel – if not outright withholding consent to a choice that does not make economic sense for a particular case. If that isn’t practical from an insurance law or commercial standpoint, insurers may well need to look at enhancing their contractual right to refuse consent, or even to offer a set of experienced but lower-cost securities defense practices in exchange for a lower premium. It is my strong belief that a great many public company CFOs would choose a lower D&O insurance premium over an unfettered right to choose their own defense lawyers.

Because I’m not a D&O insurance lawyer, I obviously can’t say what is right for D&O insurers from a commercial or legal perspective. But it seems obvious to me that the economics of securities litigation must change, both in terms of defense costs and defense-counsel selection, to avoid increasingly irrational economic results.