(I’m recovering from a cold, and on deadline for a book, so my apologies that this post is a little late and a little short.)
Today’s piece of "classic scholarship" was published in Public Choice in 2003. The authors, Jeffrey Haymond and James E. West, took a public-choice perspective on the class action, arguing that class actions are basically a wealth-transfer from corporations to plaintiffs’ lawyers. (In this case, it’s not something that class-action lawyers should take personally. Public choice theory tends to treat any movement of money as a "wealth transfer." Taxes are a wealth transfer. So are campaign donations.) As they put it:
[A]n examination of class action lawsuits leads to a similar model of extortion, not political but legal extortion. In this theory, trial lawyers have obtained a conditional property right to impose costs via the class action lawsuit. They have obtained this right bypassing the bar (whereby government restricts competition from others).
This was hardly the first article to argue that class actions were a form of "legal extortion" (by threatening costly litigation), but it was one of the first to actually describe the mechanisms by which the economic pressure occurs before certification. The lawyers also offered an argument for why a legislature (the usual subject of public-choice analysis) would delegate the collection of this wealth transfer to private lawyers rather than hold onto it themselves:
Trial lawyers have contributed handsomely to politicians, especially those supportive of plaintiff’s right to sue.
In addition, when private parties pay for the right to extract private rents, the extraction is one step removed from the political realm, making it easier for politicians to avoid blame in the aftermath of egregious verdicts.
These arguments have been well-rehearsed over the years. (And, to some degree, they have been ameliorated by legal reforms such as the enactment of CAFA, which reduced the potential problems from some elected state-court judges who might favor–consciously or unconsciously–plaintiffs who had contributed to their campaigns.) Nonetheless, the article is still worth a read, if only for its empirical work on what happens when a company is "threatened" (by press release or complaint) with a class action.
[T]he change in daily rate of return when the threat of a class action lawsuit was issued is negative and highly significant across both model specifications and all three event window durations, all well above the 99% level of significance. We found that most of the individual firms had a negative return when the threat of a class action lawsuit was issued, with around 70% of the cases in each treatment being negative. In short, we find the data consistent with Hypothesis 1 as described above.
Given the strong results … it appears that on average a statistically significant reduction in return is observed when the threat of a class action lawsuit is issued. Whether our data is more consistent with legal rent extraction or a public interest hypothesis is determined by whether or not a significant increase in return of sufficient size is observed when the threat is retracted.
It is this research that keeps the article relevant even today. Among other things, it suggests that class counsel in securities cases who engage in publicity when filing their lawsuits may in fact be harming the interests of the same investors that they claim to protect.
Important disclaimer (which I may not include often enough): just as every population has a little rogue in it, so does every population have conscientious and hardworking folk. I met many of these among the state judge population recently at the annual meeting of the American College of State Court Business Judges. I have also been lucky to correspond with a number of conscientious, hardworking, and honest plaintiffs’ lawyers in the past year.