Even casual observers of securities litigation trends know that in recent years case filings have increased. Using new data, a pair of recent empirical studies addressed questions of interest to institutional investors: is the number of opt-out cases going up and how involved are mutual funds in shareholder lawsuits?
The first study titled Opt-Out Cases in Securities Class Action Settlements: 2014-2018 Update from Cornerstone Research concluded that opt-out cases remain a “significant (although still relatively small) part of the securities class action landscape.” Cornerstone researchers found that at least one opt-out case filed in 82 of the 1,775 class actions settled in the 23 years between the beginning of 1996, when the Private Securities Litigation Reform Act (“PSLRA”) took effect, and the end of 2018. The 4.6% opt-out rate increased to 8.9% for cases settled from 2014 through 2018, during which opt-outs were filed in 34 of the 382 settled class actions. The opt-out rate rose significantly for large cases, especially in the most recent time period. Overall in the post-PSLRA era, 28% of cases that settled for more than $20 million drew opt-outs, while two-thirds of “mega-settlements” over $500 million had opt-outs associated with them. All four cases that settled for over $500 million in 2014-2018 attracted opt-out plaintiffs.
The Cornerstone study theorized that the apparent increase in opt-out cases since 2014 may be due to a succession of court decisions that found that investors could not rely on the existence of a class action to extend, or “toll,” the three-year statute of repose contained in the Securities Act of 1933; the only way to guarantee that a court won’t dismiss their claims as untimely is to file their own lawsuit less than three years after the allegedly unlawful behavior at issue took place. The same logic applies to the five-year statute of repose found in the Securities Exchange Act of 1934 (“Exchange Act”).
One area where the Cornerstone researchers were unable to shed new light was on whether more recent opt-out plaintiffs were able to continue to achieve higher settlements than their class-action counterparts. Settlement data for the 26% of opt-outs filed in the post-PSLRA era, showed opt-out plaintiffs getting a 13% premium over other class members. But most of it corresponded to cases settled prior to 2014.
Finally, the Cornerstone study looked at the type of plaintiffs filing direct actions and noted the “significant role” played by mutual funds, hedge funds, and other investment firms, which participated in 15 of the 34 opt-outs in 2014-2018. Individuals, trusts, and other companies were involved in 30 of the 34 opt-outs.
The involvement of mutual funds in securities litigation—or, more accurately, the lack thereof—is precisely the subject of the second study, a University of Chicago Law Review working paper entitled “Toward a Mission Statement for Mutual Funds in Shareholder Litigation.” The empirical study by Sean Griffith, a professor at Fordham University School of Law, and Dorothy Lund, an assistant professor at USC’s Gould School of Law, shows that the ten largest mutual fund companies “very rarely” participate in securities litigation despite their highly vocal claims that they are actively engaged to improve corporate governance.
“Traditionally, there are three levers of power in corporate governance: voting, selling, and suing,” the authors wrote in an article posted on Columbia Law School’s Blue Sky Blog. “Selling is not an option for many mutual funds—especially index funds, EFTs, and other passive funds that are effectively long-only—leaving them with only two remaining levers of power: voting and suing. Yet mutual funds use only one: They vote, but do not sue.”
Griffith and Lund looked at ten years of data on the major types of securities litigation and found that the ten largest U.S. mutual fund companies were involved in just ten traditional shareholder lawsuits involving five instances of managerial misconduct—all of them opt-outs. Over the same ten years, the major mutual fund companies filed just one appraisal-rights action and no derivative cases. None of the funds had served as lead plaintiff. In contrast, for example, Griffith and Lund found that large hedge funds sued more frequently than their mutual fund counterparts, most often bringing derivative or other fiduciary cases that lined up with their activist positions.
The authors urge mutual fund companies to more closely monitor “agency costs and conflicts of interest” that discourage them from undertaking litigation. Such conflicts include the desire not to sue corporate clients that are the source of 401(k) and other advisory business and an unwillingness to serve as lead plaintiff because it benefits all investment companies, including competitors.
Whatever the causes, the impact of large mutual fund companies’ decision to sit on the sidelines in most types of securities litigation is enormous because of the vast size of their public equity holdings, the authors argue, and greater involvement would benefit mutual fund investors by increasing overall returns, providing effective deterrence to corporate wrongdoing, implementing meaningful corporate governance reform, and intervening in non-meritorious cases.
The working paper concludes that mutual fund companies’ decision to sit on the sidelines in most types of securities litigation has a negative impact on investors and may not be in the companies’ best interests. “Our empirical study of the largest mutual funds’ conduct in shareholder litigation leaves little doubt that mutual funds are not using litigation as a tool to create value for investors. Mutual funds’ abysmal litigation record sheds light on the broader debate over mutual funds’ stewardship incentives,” they write. “To the extent that mutual funds take governance seriously, as some, including the funds themselves, claim they do, they must reform their approach to shareholder litigation.”