November 02, 2009
The following article “A costly lesson in the rule of ‘loser pays’ by HLS Professor John Coates appeared in the Nov. 1, 2009, edition of The Financial Times. On September 3, Coates joined more than 20 other corporate law and finance professors in filing an amici curiae brief in the case of Jones et al. v. Harris Associates, now pending before the U.S. Supreme Court.
As Lord Justice Jackson reviews proposals to reform costs in the UK’s civil justice system by abolishing the “loser pays” rule in collective lawsuits, a current case before the US Supreme Court may provide a useful caution. Jones v. Harris Associates L.P., which will be argued this week, clearly demonstrates that lowering the “loser pays” barrier could have serious consequences.
In the US, each side in a collective action pays its own costs regardless of outcome. Plaintiffs – or, more accurately, plaintiffs’ attorneys – can often extract a settlement that covers their costs (plus a bit), even if the case would lose at trial. Settlement costs from class-action securities lawsuits in the US have exploded from $150m (£90.6m, €101m) to $3.5bn in less than a decade, from 1995 to 2004.
In Jones v. Harris, plaintiffs’ attorneys allege a financial adviser breached its duties by overcharging clients of its collective investment schemes (mutual funds) for services. In the trial court, they lost. The adviser, after all, had produced above-average returns over many years in return for fees well within industry norms – and well below typical advisory fees in the UK.
But the case has survived two rounds of appeal – despite independent trustees having negotiated the fees on behalf of investors, despite investors having approved the fees, and despite the fact that investors are free to liquidate at net asset value at any time and move their funds elsewhere in a highly competitive market. And plaintiffs’ lawyers have been able to tie up the courts with scores of cases like this. How can such cases make it to the highest court in the land? Plaintiffs’ lawyers are able to file these cases because of three features of the US legal system.
First, investors are dispersed, and cannot easily work together to protect their own interests. Collective action costs are often identified as a reason that investors cannot protect themselves from predatory institutions – and sometimes that is true. But those same costs also make it impossible for investors to control the lawyers who nominally represent them.
Investors angry at the recent financial meltdown should remember that trial lawyers profit whether they target the guilty or the innocent, as long as their targets settle.
In particular, investors cannot stop lawyers from using weak or even frivolous claims to extract rich legal fees. Nor need lawyers even listen to investors with the most at stake in a case.
Unlike the advisers, the lawyers are not required to negotiate with independent trustees, or to submit their lawsuit for approval to the investors. Once lawyers have appointed themselves as investor guardians, they face little competition – again, unlike the advisers, who compete with other advisers to attract new investments.
Second, relevant US law is vague. A federal statute imposes on advisers an undefined “fiduciary duty with respect to the receipt of compensation”. Without clear or uniform rules to guide courts, without clear direction that judges consider the effects of competition, cases can be brought and slip through the barriers that are supposed to limit frivolous claims and discipline plaintiffs’ lawyers.
Judges in the US are in theory empowered to knock out cases early if not backed up by credible specifics. But many judges are reluctant in practice to use that power when the relevant law is so vague. After all, they reason, maybe some fact to be revealed at trial will make an apparently weak claim turn out to be strong. Faced with legal uncertainty, risk-averse defendants would often rather settle than fight, even if they are right.
In these two respects, the UK and the US are much alike. UK investors (and consumers) are dispersed, and would have no easier time controlling lawyers who nominally represent them in collective actions. UK law is also full of vague standards – including fiduciary duties.
That leaves the third element of the US system – the one distinguishing the UK at the moment. In the US, plaintiffs’ lawyers face no deterrent other than their own time and costs – they never need worry about compensating the adviser even if the defendant prevails. Lord Justice Jackson should pause long before giving up that distinction.