Tag Archives: securities class actions

Is the Big-Name Firm the Best Bet?

When I moved my securities litigation practice to a regional law firm from “biglaw,” I made a bet. I bet that public companies and their directors and officers would be willing to hire securities defense counsel on the basis of value, i.e., the right mix of experience, expertise, efficiency and price — just as they do with virtually all other corporate expenditures — and not simply default to a biglaw firm because it is “safer.”

My bet certainly was made less risky by the quality of my new law firm (a 135-year-old, renowned firm that has produced past and present federal judges and is full of superior lawyers); by discussions with public company directors, officers and in-house lawyers; by my observations and analyses about the evolving economics of securities litigation defense and settlement; and by my knowledge that I could recruit other talented full-time securities litigators to join me in my new practice.  But I was still making a bet.

Well, so far, so good — my experience has confirmed my belief. So, too, did a recent article titled, “Why Law Firm Pedigree May Be a Thing of the Past,” on the Harvard Business Review Blog Network, reporting on scholarship and survey results indicating that public companies are increasingly willing to hire firms outside of biglaw to handle high-stakes matters. The HBR article frames the issue in colorful terms:

“Have you ever heard the saying: ‘You never get fired for buying IBM?’ Every industry loves to co-opt it; for example, in consulting, you’ll hear: “You never get fired for hiring McKinsey.” In law, it’s often: “You never get fired for hiring Cravath.” But one general counsel we spoke with put a twist on the old saying, in a way that reflects the turmoil and change that the legal industry is undergoing. Here’s what he said: ‘I would absolutely fire anyone on my team who hired Cravath.’ While tongue in cheek, and surely subject to exceptions, it reflects the reality that there is a growing body of legal work that simply won’t be sent to the most pedigreed law firms, most typically because general counsel are laser-focused on value, namely quality and efficiency.”

The HBR article reports that a study of general counsels at 88 major companies found that “GCs are increasingly willing to move high-stakes work away from the most pedigreed law firms (think the Cravaths and Skaddens of the world) … if the value equation is right.  (Firms surveyed included companies like Lenovo, Vanguard, Shell, Google, Nike, Walgreens, Dell, eBay, RBC, Panasonic, Nestle, Progressive, Starwood, Intel and Deutsche Bank.)”

The article reports on two survey questions.

The first question asked, “Are you more or less likely to use a good lawyer at a pedigreed firm (e.g. AmLaw  20 or Magic Circle) or a good lawyer at a non-pedigreed firm for high stakes (though not necessarily bet-the-company) work, assuming a 30% difference in overall cost?”

The result: 74% of GCs answered that they are less likely to use a pedigreed firm, and 13% answered the “same.”  Only 13% responded that they are more likely to use a pedigreed firm than other firms.

The second question asked, “On average, and based on your experiences, are lawyers at the most pedigreed, ‘white shoe’ firms more or less responsive than at other firms?”

The result:  57% answered that pedigreed firms are less responsive than other firms, and 33% answered they are the “same.”  Only 11% responded that pedigreed firms are more responsive than other firms.

The survey results ring true and are reinforced by other recent scholarship and analysis on the issue, including a Wall Street Journal article titled “Smaller Law Firms Grab Big Slice of Corporate Legal Work” and an article featured on www.law.com’s Corporate Counsel blog titled “In-House Counsel Get Real About Outside Firm Value.” As all three articles emphasize, skyrocketing legal fees are a notorious problem. And corporate executives are increasingly becoming attuned to this issue. Indeed, during the in-house counsel panel discussed in the Corporate Counsel article, a general counsel noted that in explaining outside counsel costs to the CEO and CFO of his company, “it’s very, very difficult … to say why someone should [bill] over $1,000 per hour . . . It just doesn’t look good.” The problem is especially acute in securities class action defense, in which the defense is largely dominated by biglaw firms with high billing rates and a highly leveraged structure (i.e. a high associate-to-partner ratio), which tends to result in larger, less-efficient teams.

Now, as the economy has forced companies to be more aware of legal costs, including the fact that using a biglaw firm often results in prohibitively high legal fees, it is unsurprising that companies are increasingly turning to midsize firms. According to the WSJ article, midsize firms have increased their market share from 22% to 41% in the past three years for matters that generate more than $1 million in legal bills. Indeed, both Xerox’s general counsel and Blockbuster’s general counsel advocated that companies control legal costs by using counsel in cities with lower overhead costs.

Some companies, and many law firms, see securities class actions as a cost-insensitive type of litigation to defend: The theoretical damages can be very large; the lawsuits assert claims against the company’s directors and officers; and the defense costs are covered by D&O insurance.

But these considerations rarely, if ever, warrant a cost-insensitive defense. Securities class actions are typically defended and resolved with D&O insurance. D&O insurance limits of liability are depleted by defense costs, which means that each dollar spent on defense costs decreases the amount of policy proceeds available to resolve the case. At the end of a securities class action, a board will very rarely ask, “Why didn’t we hire a more expensive law firm?” Instead, the question will be, “Why did we have to write a $10 million check to settle the case?” Few GCs would want to have to answer:  “because we hired a more expensive law firm than we needed to.”

That takes us to the heart of the HBR article: “Do we need to hire an expensive law firm?” After all, in a securities class action, the theoretical damages can be very large, often characterized as “bet the company,” and the fortunes of the company’s directors and officers are theoretically implicated. Certainly, when directors and officers are individually named in a lawsuit, their initial gut reaction may be to turn to biglaw firms regardless of price, if they believe that the biglaw brand name will guarantee them a positive result.

Biglaw capitalizes on these fears. But, of course, hiring a biglaw firm does not guarantee a positive result. The vast majority of securities class actions are very manageable. They follow a predictable course of litigation and can be resolved for a fairly predictable amount, regardless of how high the theoretical damages are. And it is exceedingly rare for an individual director or officer to write a check to settle the litigation. Indeed, the biggest practical personal financial risk to an individual director or officer is exhaustion of D&O policy proceeds because defense costs are higher than necessary.

Lurking behind these considerations are two central questions: “Aren’t lawyers at biglaw firms better?” and “Don’t I need biglaw resources?”

“Aren’t lawyers at biglaw law firms better?”

Not necessarily. That’s the main point of the GC survey discussed in the HBR article.

To be sure, there are excellent securities litigators at many biglaw firms. But the blanket notion that biglaw securities litigators are more capable than their non-biglaw counterparts is false. And it’s not even a probative question when comparing biglaw lawyers to non-biglaw lawyers who came from biglaw. In the WSJ article, Blockbuster’s general counsel, in explaining why his company often seeks out attorneys from more economical areas of the country, pointed out that many of the attorneys in less expensive firms came from biglaw firms. Many top law school graduates and former biglaw attorneys practice at non-biglaw firms, not because they were not talented enough to succeed at a biglaw firm, but for personal reasons, including: a desire to live in a city other than New York, the Bay Area or Los Angeles; to find work-life balance; to have the freedom to design a better way of defending cases; or to develop legal skills at a faster pace than is usually available at a biglaw firm.

There obviously is a baseline amount of expertise and experience that is necessary to handle a case well, and there are a number of non-biglaw lawyers in the group of lawyers who meet that standard. One easy way to judge the quality of firms is by reading recently filed briefs of biglaw and midsize firms. While this type of analysis takes more time than simply looking up a lawyer or law firm ranking, it will be the best indicator of the type of work product to expect from a firm. As with all lawyer-hiring decisions, the individual lawyer’s actual abilities, strategic vision for the litigation and attention to efficiency are key considerations. A lawyer’s association with a biglaw firm name can be a proxy for quality, but it does not ensure quality.

Indeed, the opposite can be true — by paying for the biglaw expertise and experience of a particularly accomplished senior partner (the partner likely to pitch the business), companies often end up with the majority of the work being done by senior associates and junior partners. A company should consider the impact of the economic realities of biglaw vs. non-biglaw firms. Senior partners at biglaw firms, with higher associate-to-partner ratios, must have a lot of matters to keep their junior partners and associates busy, and thus necessarily spend less time on each matter — even if they have good intentions to devote personal time to a matter. Biglaw firms’ largest clients and cases, moreover, often demand much of a senior partner’s time, at the expense of other cases. And given the reality that partners practice less and less law the more senior they become, it is fair to question whether they are the right people for the job anyway. In contrast, senior partners at non-biglaw firms typically have fewer people to keep busy and have lower billing rates — which means that they can spend more time working on their cases, and they spend more time actually practicing law.

Further, for smaller and less significant projects that should be handled by associates, and should not require the higher billing rates of partners, biglaw is similarly unable to offer a cost-effective solution for companies. Associates at biglaw firms typically have less hands-on experience than their counterparts at mid-sized firms. In litigation, for example, biglaw associates generally spend their first few years solely on discovery or discrete research projects. The result is that many projects that could be handled by a junior or mid-level associate at a mid-sized firm would have to be handled by a senior associate or junior partner at a biglaw firm. So, even putting aside differences in billing rates between a fifth-year biglaw associate and a fifth-year midsize firm associate, going with a biglaw firm typically means that projects are being assigned to attorneys too senior (and accordingly too costly) to be handling the assignments.

Don’t I need biglaw resources?

There are two primary answers. First, from both a quality and an efficiency standpoint, securities litigation defense is best handled by a small team through the motion–to-dismiss process. Before a court’s decision on the motion to dismiss, the only key tasks are a focused fact investigation and the briefing on the motion to dismiss. As to both, fewer lawyers means higher quality.

If a case survives a motion to dismiss, most firms with a strong litigation department will have sufficient resources to handle it capably. That, of course, is something a company can probe in the hiring process. There are cases that necessarily will require a larger team than some mid-size firms can provide. However, such cases are rare, and it is often the case that biglaw firms, in an effort to maintain associate hours at a certain level, will heavily staff associates on discovery projects such as document review. While the exceptional case will require a team of more than around five associates, for the most part discovery can and should be handled most efficiently by a team of contract attorneys supervised by a small team of associates — or by utilizing new technologies that allow smaller teams to review documents more efficiently and effectively.

Second, as reflected in the HBR article’s discussion of GCs’ answers to the second question, there isn’t a correlation between a firm’s pedigree and its responsiveness — which is a key facet of law firm resources. Indeed, responsiveness is a function of effort, and it stands to reason that non-biglaw firms will make the necessary effort to give excellent client service.

The bottom line of all this is simply common sense: Within the qualified group of lawyers, a company should look for value — the right mix of experience, expertise, efficiency and cost — as it does with any significant corporate expenditure.

Tips for Avoiding Securities Litigation

Here are tips on how public companies can better protect themselves against securities claims — practical steps companies can take to help them avoid suits, mitigate the risk if they are sued and defend themselves more effectively and efficiently.

Avoiding suits

Companies can avoid many suits with what I’ll call “better-feeling” disclosures. Nearly all public companies devote significant resources to accounting that conforms with GAAP, and non-accounting disclosures that comply with the labyrinth of disclosure rules. Despite tremendous efforts in these areas, events sometimes surprise officers and directors — and the market — and make a company’s previous accounting or non-accounting disclosures appear to have been inaccurate. But plaintiffs’ lawyers decide to sue only a subset of such companies — a smaller percentage than most people would assume. What makes them sue Company A, but not Company B, when both have suffered a stock price drop because of a development that relates to their earlier disclosures?  There are a number of factors, but I believe the driver is whether a company’s disclosures “feel” fair and honest. Without the benefit of discovery, plaintiffs’ lawyers have to draw inferences about whether litigation will reveal fraud or a sufficient degree of recklessness — or show that the discrepancies between the earlier disclosures and later revelations was due to mistake or an unanticipated development.

What can companies do to make their disclosures “feel “more honest? An easy way is to improve the quality of their Safe Harbor warnings. Although the Reform Act’s Safe Harbor was designed to protect companies from lawsuits over forward-looking statements, there are still an awful lot of such actions filed. The best way to avoid them is by crafting risk warnings that are current and candid. A plaintiffs’ lawyer who reads two years’ worth of risk factors can tell whether the risk factors are boilerplate or an honest attempt to describe the company’s risks. The latter deters suits. The former invites them.Another way for companies to improve their disclosures is through more precision and a greater feel of candor in the comments they make during investor conference calls. Companies sweat over every detail in their written disclosures but then send their CEO and CFO out to field questions on the very same subjects and improvise their responses. What executives say, and how they say it, often determines whether plaintiffs’ lawyers sue — and, if they do, how difficult the case will be to defend. A majority of the most difficult statements to defend in a securities class action are from investor calls, and plaintiffs’ lawyers listen to these calls and form impressions about officers’ fairness and honesty.

Companies looking to minimize the risks of litigation should also take steps to prevent their officers and directors from making suspicious-looking stock sales — for obvious reasons, plaintiffs’ lawyers like to file suits that include stock sales. If a company’s officers and directors don’t have 10b5-1 plans, companies should establish and follow an insider trading policy and, when in doubt, seek guidance from outside counsel on issues such as trading windows and the propriety of individual stock sales, both as to the legal ability to sell, and how the sales will appear to plaintiffs’ lawyers. Even if officers and directors have 10b5-1 plans, companies aren’t immune to scrutiny of their stock sales — plaintiffs’ lawyers usually aren’t deterred by 10b5-1 plans, contrary to conventional wisdom. So companies should consult with their counsel about establishing and maintaining the plans, to avoid traps for the unwary.

Defending suits

Whether a securities class action is a difficult experience or a fairly routine corporate legal matter usually turns on the company’s decisions about directors’ and officers’ indemnification and insurance, choice of defense counsel and management of the defense of the litigation.

Deciding on the right director and officer protections and defense counsel require an understanding of the seriousness of securities class actions. Although they are a public company’s primary D&O litigation exposure, most companies don’t understand the degree of risk they pose. Some companies seem to take securities class actions too seriously, while others might not take them seriously enough.

The right level of concern is almost always in the middle. A securities class action is a significant lawsuit. It alleges large theoretical damages and wrongdoing by senior management and often the board. But the risk presented by a securities action is usually very manageable, if the company hires experienced, non-conflicted and efficient counsel and devotes sufficient time and energy to the litigation. Cases can be settled for a predictable amount, and it is exceedingly rare for directors and officers to write a personal check to defend or settle the case. On the other hand, it can be a costly mistake for a company to take a securities class action too lightly; even meritless cases can go wrong.

The right approach involves several practical steps that are within every company’s control.

Companies should hire the right D&O insurance broker and treat the broker as a trusted adviser.

There is a talented and highly specialized community of D&O insurance brokers. Companies should evaluate which is the right broker for them — they should conduct an interview process to decide on the right broker and seek guidance from knowledgeable sources, including securities litigation defense counsel. Companies should heavily utilize the broker in deciding on the right structure for their D&O insurance program and in selecting the right insurers. And, because D&O insurance is ultimately about protecting officers and directors, companies should have the broker speak directly to the board about the D&O insurance program.

Boards should learn more about their D&O insurers.

Boards should know their D&O insurers’ financial strength and other objective characteristics. But boards should also consider speaking with the primary insurer’s underwriting executives from time to time, especially if the relationship with the carrier is, or may be, long-term. The quality of any insurance turns on the insurer’s response to a claim. D&O insurance is a relationship business. Insurers want to cover D&O claims, and it is important to them to have a good reputation for doing so. The more the insurer knows the company, the more comfortable the insurer will be about covering even a difficult claim. And the more a board knows the insurer, the more comfortable the board will be that the insurer will cover even a difficult claim.

Boards should oversee the defense-counsel selection process, and make sure the company conducts an interview process and chooses counsel based on value.

The most important step for a company to take in defending a securities class action is to conduct an audition process through which the company selects conflict-free defense counsel who can provide a quality defense — at a cost that leaves the company enough room to defend and resolve the litigation within policy limits. Put differently, the biggest threats to an effective defense of a securities class action are the use of either a conflicted defense counsel, defense counsel who will charge an irrational fee for the litigation or counsel who will cut corners to make the economics appear reasonable.

Errors in counsel-selection most often occur when a company fails to conduct an interview process, or fails to consult with its D&O insurers and brokers, who are “repeat players” in D&O litigation and thus have good insights on the best counsel for a particular case. Although the Reform Act’s 90-day lead plaintiff selection process gives companies plenty of time to evaluate, interview, and select the right defense counsel for the case, many companies quickly hire their corporate counsel’s litigation colleagues, without consulting with brokers and insurers or interviewing other firms.

The right counsel may end up being the company’s normal corporate firm, but a quick hiring decision rarely makes sense under a cost-benefit analysis. The cost of hiring the wrong firm can substantial — the harm includes millions of dollars of unnecessary fees; hundreds of hours of wasted time by the board, officers and employees; an outcome that is unnecessarily uncertain; and an unnecessarily high settlement — and there’s very little or no upside to the company.

On the other hand, it costs very little to interview several firms for an hour or two each, and the benefit can be substantial – free and specialized strategic advice by several of the handful of lawyers who defend securities litigation full time, and potentially substantial price and other concessions from the firm that is ultimately chosen.  The auditioning lawyers can also provide guidance to the company on whether its corporate counsel faces conflicts and, if so, the potential harm to the company and the officers and directors from hiring corporate counsel anyway.