The investment theory of class actions

• Author: Guy Halfteck
• Pages: 89-136

THE

INVESTMENT

THEORY

OF

CLASS

ACTIONS

Guy

Halfteck*

A.

INTRODUCTION

This

article builds

on

insights

developed

in the

economic theory

of

investment under conditions

of

uncertainty

to

advance

a

novel theory

of

class action

law

enforcement.

The

theory conceptualizes class action

law

enforcement

as a

financial

call option, namely,

as a

complex

form

of

investment opportunity that consists

of

multiple, sequential options

to

invest under conditions

of

uncertainty.

This

novel theory

is

both

conceptually inclusive

and

analytically rigorous, thereby building solid

intellectual foundations necessary

for

adopting welfare-enhancing social

policy

and

designing proper regulation

of

class action

law

enforcement.

Class actions,

as is

well recognized, provide

an

overwhelmingly pow-

erful

law

enforcement mechanism that

is

capable

of

imposing, unlike

any

other civil

law

enforcement mechanism,

a

threat

of

liability exposure

on

business

entities

for the

social consequences

of

systematic

wrongdoing.1

Lecturer,

Faculty

of

Law,

Tel-Aviv

University;

LL.B.,

Hebrew University

of

Jerusalem

(1998);

LL.M.,

Columbia University (2000);

S.J.D.,

Harvard (2003).

For

helpful

comments,

I

thank David Rosenberg, Steven Shavell,

and

partici-

pants

at the

John

M.

Olin

Seminar

on Law &

Economics

at

Harvard; partici-

pants

at the

Litigating Conspiracy symposium

at

Western Law;

and

participants

at

the

Israeli

Law &

Economics Association Annual Conference. Financial sup-

port

from

the

John

M.

Olin Center

at

Harvard

is

greatly appreciated.

An

economic analysis

of the

functional

capacity

of

class action

law

enforcement

to

impose

a

threat

of

liability

and

deter systematic, risk-producing activities

is

found

in Guy

Halfteck,

The

Class

Action

Enterprise:

A

General

Economic

Theory

of

Mass-produced

Law

Enforcement,

Parts

II-III

(2003) (unpublished, archived

at

Harvard

Law

School Library).

The

analysis shows that

this

capacity squarely

derives

from

integrating

two

economic properties

in the

design

of the

class

action

mechanism,

namely,

(i) law

enforcement

entrepreneurship,

which

is

necessary

to

bypass collective action problems;

and

(ii)

formal

aggregation

and

collectivization

of

numerous, similarly-situated victims into

a

single, cohesive

pool, thereby creating

an

opportunity

to

exploit economies

of

scale

of

effort

in

class action

law

enforcement.

For a

detailed

discussion

of

litigation scale econ-

89

1

Monetary

remedies,

including

billions

of

aggregate liability dollars that

corporations internalize under

the

aegis

of

class action litigation

and

settlement, evidence

the

intrinsic

capacity

of the

class action mechanism

to

enforce

the law and

serve

the

social objectives

of

deterrence

and

com-

pensation.2

Similarly, non-monetary remedies,

including

injunctions that

prevent repetition

of

systematic, harm-inflicting conduct

and

corporate

governance reforms

of

public companies,

are

also prevalent

in the

land-

scape

of

class action civil

justice.3

Remedies

obtained

in

class action

law

enforcement enhance social

welfare

inasmuch

as

they deter wrongdoing

and

induce corporations

to

closely align their conduct with

the

social interest

in

minimizing

risk

of

harm

or

injury

to

consumers, investors, employees, residents,

and

other

classes

of

similarly-situated

individuals.4

On a

more general level,

the

magnitude

and

far-reaching

effects

of

such

monetary

and

non-monetary

remedies demonstrate

the

intrinsic

capacity

of the

class action mecha-

nism

to

deter wrongful corporate conduct

and

practices and, ultimately,

bring

about desirable, welfare-enhancing social

change.5

The

prevalent

use of

class actions does

not

remain

free

of

criticism,

however.6

omies,

see

David Rosenberg, "Mass Tort Class Actions: What Defendants Have

and

Plaintiffs

Don't" (2000)

37

Harv.

J. on

Legis. 393, and, more recently, David

Rosenberg,

"Mandatory-Litigation Class Action:

The

Only Option

for

Mass Tort

Cases" (2002)

115

Harv.

L.

Rev. 831.

2 See

generally Kenneth

W.

Dam, "Class Actions:

Efficiency,

Compensation,

Deterrence,

and

Conflict

of

Interest" (1975)

4J.

Legal Stud.

47.

See,

for

example,

"$149M

Bridgestone-Firestone Class Action Settlement Approved"

Associated

Press

(15

March 2004), describing

the

$149M

class action settlement

reached

on

behalf

of

Bridgestone-Firestone tire owners

in

connection with

the

tires'

tread-separation

problems

and the

resulting

safety

concerns.

3

Class-wide settlements

of

securities

fraud

class actions

often

involve non-mon-

etary

remedies. These include corporate governance measures that

not

only

reduce

the

likelihood

of

future

violations

by the

defendant company

and its

directors

and

officers,

but

also increase

financial

transparency, increase corpo-

rate

accountability, and, ultimately, strengthen

the

legal protection

afforded

to

investors.

4 See

generally David Rosenberg, "The Regulatory Advantage

of

Class Action"

in

W.

Kip

Viscusi, ed.,

Regulation

through

Litigation

(Washington, D.C.: American

Enterprise Institute Press, 2002)

at

244.

5 See

Greg Burns

&

Michael

J.

Berens, "Special Report:

The

Class Action Game"

Chicago

Tribune

(7

March

2004)

Cl,

writing

that

"class

actions

have

reshaped

the

nation's economic

and

social landscape

...

[an] analysis

of

more than

300

state

and

federal

class-action settlements over

the

past three years shows that

nearly one-third prompted

reforms

of

improper practices

—

from

forced

over-

time

to the use of

inferior auto parts

in

repairs."

6

Inevitably,

the

prevalent

use of

class actions

to

enforce

the law

across many

90

LITIGATING

CONSPIRACY:

AN

ANALYSIS

OF

COMPETITION

CLASS

ACTIONS

THE

INVESTMENT

THEORY

OF

CLASS

ACTIONS

91

That

being said,

and the

scholarly literature

notwithstanding,7

the

existing knowledge

of how

class actions

function

and how the use of

sectors

of the

economy

and

society and, especially,

the

far-reaching economic

effects

of

liability

on

corporate

America,

are the

target

of

harsh

criticism.

The

latter

is

repeatedly voiced

by

advocates

of

"tort reform" who,

in

addition

to

sponsoring

various studies, also invest resources

in

promoting legislative

measures

to

curb allegedly abusive class action practices.

The

basic tenets

of

the

Republican "tort reform" manifesto

are

contained

in Ed

Gillespie

& Bob

Schellhas, eds.,

Contract

with America:

The

Bold

Plan

by

Rep. Newt Gingrich,

Rep.

Dick

Armey,

and the

House

Republicans

to

Change

the

Nation (New

York:

Times Books,

1994).

Recent studies include, among others, "Excessive Legal

Fees: Protecting Unsophisticated Consumers, Class Action Members,

and

Taxpayers," online: Manhattan Institute Center

for

Legal Policy -

tan-institute.org/html/mics3a.htm>.

For

further

discussion,

see

Walter Olson,

The

Litigation

Explosion:

What

Happened

When

America

Unleashed

the

Lawsuit

(New

York:

Truman Talley Books, 1991) and, more recently,

Thomas

F

Burke,

Lawyers,

Lawsuits,

and

Legal

Rights:

The

Battle

over

Litigation

in

American

Society

(Berkeley: University

of

California Press, 2002).

In the

past decade,

the

efforts

of

"tort

reform"

advocates

to

constrain

the

class action

bar

have been

most influential

in the

context

of

securities class action litigation.

See

gener-

ally

David

J.

Bershad

et

al.,

eds.,

Securities

Class

Actions:

Abuses

and

Remedies

(Washington: National Legal Center

for the

Public Interest,

1994).

Their

effort

led to the

Private Securities Litigation

Reform

Act

of

1995,

15

U.S.C.

§

77u-4

Stat.

2641 (1996),

codified

as

amended

at 42

U.S.C.

§

1988(b).

More recently,

however,

the

contentious political debate over

the

proper role

of

class actions,

the

alleged abuses

by

plaintiffs'

lawyers,

and

"tort reform" more generally

underlie

the

recently-proposed Class

Action

Fairness

Act

of

2004,

a

legislative

measure that

seeks

to

impose severe limitations

on

consumers' access

to

justice

in

state courts

as

well

as

significant constraints

on the

ability

to use the

class

action

device

to

obtain redress

for

injured victims

and

deter systematic corpo-

rate

wrongdoing.

See

Class Action

Fairness

Act

of

2004,

S.

2062,

108th

Cong.

(2004)

and

Class

Action

Fairness

Act

of

2003, H.R. 1115,

108th

Cong. (2003).

Insightful

studies

include, among others,

John

C.

Coffee,

Jr., "Understanding

the

Plaintiff's

Attorney:

The

Implications

of

Economic Theory

for

Private

Enforcement

of Law

Through Class

and

Derivative Actions"

(1986)

86

Colum.

L.

Rev. 669;

John

C.

Coffee,

Jr., "The Regulation

of

Entrepreneurial Litigation:

Balancing

Fairness

and

Efficiency

in the

Large Class Action"

(1987)

54 U.

Chicago

L.

Rev. 877; Samuel

Issacharoff,

"Class Action Conflicts" (1997)

30

U.C.

Davis

L.

Rev. 805; Jonathan

R.

Macey

&

Geoffrey

P.

Miller, "The

Plaintiffs'

Attorney's

Role

in

Class Action

and

Derivative Litigation: Economic Analysis

and

Recommendations

for

Reform"

(1991)

58 U.

Chicago

L.

Rev.

1;

David

Rosenberg,

"The Causal Connection

in

Mass Exposure Cases:

A

'Public

Law'

Vision

of the

Tort System"

(1984)

97

Harv.

L.

Rev. 849; David Rosenberg,

"Individual Justice

and

Collectivizing Risk-Based Claims

in

Mass-Exposure

Cases" (1996)

71

N.Y.U.L.

Rev. 210;

and

David Rosenberg, "Mandatory-

Litigation Class Action:

The

Only Option

for

Mass Tort Cases" (2002)

115

Harv.

L.

Rev. 831.

7