TWO American law professors have helped the US Senate stop the legal race to the courthouse in shareholder class action suits.
Professors Elliott J Weiss and John S Beckerman outlined in the Yale Law Journal how institutional investors could reduce agency costs in security class actions by appointing a "most adequate plaintiff".
Their work was acknowledged in the recent passage of the Private Securities Litigation Reform Act, which attempted to halt the abuse by lawyers, who used professional plaintiffs to bring shareholder class action suits for their own benefit.
These lawyers recruit plaintiffs who own nominal shares in a wide variety of public companies, and use these figurehead plaintiffs to initiate legal actions when adverse publicity appears about the companies in the press.
"The courts created the problems by saying that whoever files first gets the case," said Weiss.
This allowed the fastest lawyers to the court to act as lead counsel.
He added: "The real problem is not the professional plaintiffs. Lawyers usually get 25 to 30 per cent of the total recovery. They have the biggest stake in the action. It is the lawyers who use the professional plaintiffs to get to the court doors."
In the role of lead counsel, unscrupulous lawyers could accrue huge legal costs and settle cases, maximising their own incomes rather than benefiting the shareholders. They could also demand bounty payments, which institutional investors had to pay for.
The effect of the new legislation is that the courts now appoint a most adequate representative.
This means that even if professional plaintiffs or their attorneys manage to be the first to the courthouse, they may not be entitled to direct the legal race to the finish.
Since institutions represent 51 per cent of the $9.1 trillion dollars in security assets, they will often be appointed as lead plaintiff.
The court will base its selection on which plaintiff makes the claim, or the one with the largest financial interest in the outcome of the case.
This, Weiss and Beckman believe, will promote the role of institutional investors as lead plaintiffs and it will provide better legal services for shareholders.
"They'll do a better job acting for the shareholders, rather than lawyers who act in their own interest," said Weiss.