The Class Action Racket

Have you ever received a notice in the mail informing you that you might be a member of a class action lawsuit? You probably have. Did you even bother to read it?  Probably not. Did you ever file a claim for compensation?  Probably not. Did you ever file an objection to the settlement? Certainly not. Did you know that the lawyers bringing these suits get paid regardless of how many people file claims and regardless of how many class members actually get anything out of the settlement?  In what could be the poster child for the dysfunctional class action system, plaintiffs' lawyers in the Ford Explorer SUV class action settlement were awarded $25 million in attorneys' fees by claiming that the class members were receiving a benefit of $500 million. However, what class members actually received were $500 coupons towards the purchase of a new Ford vehicle, and only 148 were redeemed for a total value of $74,000. That's right. $25 million for the lawyers although the class members actually received $74,000.

But it gets worse. Take the infamous Bank of Boston class action. In that case, class members had their accounts credited between $2.19 and $8.76 as a result of the settlement, but also had their accounts debited with a "miscellaneous deduction" of up to $91 -- to cover the costs of the settlement, i.e. plaintiffs' and defendants' attorneys' fees and litigation costs. For this so-called "benefit" to class members, class counsel received $8.5 million in attorneys' fees. It is all about focus. Class action lawyers never want the public to focus on the negative aspects of class action settlements -- the $91 the lawsuit is costing you. They want you to focus on the $2.19 you're getting. Like the Bank of Boston case, all class action settlements focus on the benefits, however meager, but never disclose the costs to class members and consumers generally.

Why do the lawyers get so much when their clients get so little?  In the words of Federal Judge William G. Young, "simply put, the class action vehicle is broken."  Unfortunately, it's broken in a way that the people who run it -- lawyers -- and the people who are in a position to fix it -- judges and legislators -- are benefitting from the status quo. The injured class members who are supposed to be the primary focus of these cases have become its primary victims. The plaintiffs' lawyers are happy because they are getting overpaid -- massively; the defendants' lawyers and the experts (hired by both sides and an important part of the class action scheme) are happy because they're getting well paid (if not overpaid); the defendants are happy because they are avoiding further costly legal proceedings with unknown outcomes. And, last but not least, the judges are happy because they are getting a case cleared off their dockets. Unfortunately, the criterion for good judging these days is how quickly cases are processed to conclusion, not how well reasoned the outcomes. The judge gets the additional satisfaction of having made an important decision in a big case, thereby enhancing his or her self-importance and reputation. Some class members may even be happy -- at least those few who actually read the notice and redeemed their coupons. (Although is getting a $500 coupon towards the purchase of a $25,000 car really something to gloat about?)  Even some class members who didn't redeem their coupons may be happy because they assume that a bad corporation has been punished for some actual or alleged misdeed. But we as a society should not be happy because money (we're talking hundreds of millions if not billions of dollars) that could be going to a better use becomes nothing more than slop for thousands of lawyers feeding at the class

action trough. What's wrong with the class action system? Why does it put lawyers' interests first and class members' interests last?

Statistics

Unfortunately, the Ford Explorer SUV case is the tip of the iceberg of deceit of what class actions are really about. The overall cost of the U.S. tort liability system, of which class actions are a significant portion, is $865 billion per year according to the Pacific Research Institute (an admittedly biased pro-defendant source). This works out to be an annual "tort tax" for a family of four of $9,827!  It means that in a given year corporations and the companies that insure them are passing on the costs of these lawsuits to us in the form of increased premiums, higher prices, fewer products, and less service to the tune of nearly $10,000 annually. We already knew we were paying at least $10,000 a year in health insurance premiums, but I bet you didn't realize your family was losing another $10,000 because of our out-of-control legal system.

In an objection filed in the Enron class action settlement, a shareholder complained about her lawyer's request for over $700 million in attorneys' fees. It would pay one of the attorneys nearly $3000 an hour -- five times his already extravagant "normal" rate of $650 an hour. She was upset that she would be receiving $6.79 for each share which she originally purchased for $70 -- a staggering loss of 90 percent.  But that's not unusual in securities class actions where lawyers typically recover pennies for each dollar of claimed shareholder damages. Take for example one of the largest securities class actions in history, In Re Initial Public Offering Securities Litigation, which consisted of over 300 class actions in which hundreds, if not thousands, of lawyers and their staffs represented the same class of plaintiffs. The lawyers requested $202 million in attorneys' fees for their efforts and the judge awarded them $170 million, while the best this legal talent could do for their clients was settle the case for 1¢ for every $1 of damages claimed!  Should class action lawyers really be getting over a hundred million dollars in fees when their clients receive such puny recoveries?

Statistics on class action payouts to class members are typically secret because the players involved don't want the public to know how dysfunctional the system really is. And along with hidden statistics come the hidden harms. Harms that, as in health care, don't appear on the surface. We are led to believe that class actions punish bad corporate behavior, but those responsible for the alleged wrongdoings don't pay. This is most apparent in securities class actions where the shareholders are made to sue the corporation they own (themselves!), and the corporation pays for any settlement through insurance -- insurance that the shareholders pay for. The injustice of these suits was confirmed by U.S. District Court Judge Jed S. Rakoff. In refusing to approve a $33 million class action settlement with Bank of America, he called the settlement "not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality. [The settlement] proposes that the shareholders who were the victims of the Bank's alleged misconduct now pay the penalty for that misconduct."  A legal outcome that "does not comport with the most elementary notions of justice and morality"! That's pretty strong language. One would be hard pressed to have devised a worse system.

Fundamental Causes

This is not meant to be an article about greedy plaintiffs' lawyers, judges who don't care about justice, or evil defendants. This is about a dysfunctional system where everyone involved is incentivized to act against the best interests of the people for whom the system was designed to help -- consumers and the general public. In theory, the class action system was meant to protect us from life's little harms. But, as is often the case with theories, reality presents a different picture. Even the model of the lawyer as servant for the client breaks down in class actions because the lawyers are incentivized to serve themselves first. Class members merely provide a fig leaf of legitimacy for the lawyers to engage in what amounts to a shakedown. Why do I say shakedown?  Because all too often these cases, if brought to trial, would lose on their merits. However, because they are settled, the lawyers obtain millions, tens of millions, if not hundreds of millions of dollars in fees. For example, in an airline antitrust case, the judge's opinion noted that had the parties not agreed to the settlement that included $14 million in attorneys' fees, he likely would have dismissed the case against the defendant.

Another problem is that the system is rigged so that lawyers' fees are not tied to whether the clients are better or worse off as a result of the lawsuit; fees are tied to the theoretical size of a settlement. This is unlike a typical personal injury contingency case where the lawyer gets one-third of what the client actually recovers. Thus it is in the plaintiffs' lawyers' and defendants' interest to create a fictitious value for the settlement, and the court is encouraged to go along with this ruse because it gives the judge cover to approve a substantial class settlement and a handsome fee. It is not in any of the key players' interest to care about what class members are actually receiving, nor who is really paying for the litigation.

History

The foundation for our modem class action system was laid in the tumultuous '60s with a little appreciated change in the 1966 Federal Rules of Civil Procedure, wherein Congress expanded the ability of attorneys to prosecute class action lawsuits. Previously, the law had required that each plaintiff in a class action lawsuit be identified and demonstrate a willingness to participate in their case. This had been the law since Roman times and continues to be the law in most Western democracies. But in 1966, at the suggestion of law professors seeking to ensure the participation of the poor and disadvantaged, the law changed to allow attorneys, through the use of a token plaintiff, to sue on behalf of limitless numbers of unknown persons. The result has been an explosion in class action lawsuits, which, unfortunately, like our healthcare system, ignores the collateral damage.

Why the change occurred is a matter of opinion. Here's mine. During the 1960s, the legal profession and the judiciary played a leading role in eliminating institutional racial segregation in America. Legal academia promoted the notion that giving lawyers and judges greater power in American society generally would allow them to reform other domestic social ills. In fact, class actions were originally created solely for civil rights cases, not the tort actions for which they are now infamous. They were meant to allow individuals with separate but similar claims to be joined in one representative suit filed on behalf of many plaintiffs. Another justification for the class action was that it solved the problem that compensation for the little injuries of life would be more than offset by the high cost of litigation. Reformers never contemplated that class actions, rather than reducing the little injuries of life, would allow lawyers to make those little injuries a little bigger by adding on their fees.

          The ability to sue on behalf of groups of unknown individuals revolutionized the dynamics of litigation with many negative consequences. To justify their new wealth and power, class action lawyers and their apologists have fostered the exaggerated claims that:

1)  they are standing up for the "little guy" consumer against the big, bad corporation;

2)  class actions punish the guilty and compensate the innocent; and

3)  class actions deter bad corporate behavior.

The modem class action system elevates lawyers and judges to levels of power unknown in our nation's history.

Wrong Incentives

A major flaw in our country's healthcare system is that insurance companies profit by denying healthcare, not by providing it. Similarly, in the class action system, no one is incentivized to enrich the class members; indeed, they are incentivized to do the very opposite.

Plaintiffs' lawyers are incentivized to focus on their own compensation, not on what their clients will recover for their losses. Indeed, the fewer benefits the defendant provides to the class (think coupons), the more money there is available to pay the lawyers to stop litigating. And again, unlike a typical personal injury case where you and your lawyer negotiate what the fee is going to be, in a class action the lawyer negotiates his fee with the defendant -- the person you're suing! To legitimate this scheme, the judiciary has adopted a number of legal fictions including that plaintiffs' and defendants' lawyers who negotiate settlements first, separate from attorney's fee payments, do so without any thought of legal fees.

Assume you were injured in a car accident and had hired a lawyer. At the time of settlement, the lawyer comes to you and offers you a check. When you ask about his fee, he tells you not to worry, that you won't have to pay him because he has negotiated his fee with the other driver's insurance company. Hmmm, let's think about this. Can a lawyer really get the most for your claim if he is going to be negotiating his fee with the insurance company after your settlement? Probably not. Did the insurance company really offer you everything they had to settle your claim if they were going to negotiate your lawyer's fee after your settlement? Probably not. Yet, this separate payment structure is one way in which the class action lawyers have gamed the system. They structure settlements so that, rather than having the payment to the class and the payment to the lawyers be part of one recovery, there are purported separate payments. Is it any surprise then that defendants are incentivized to withhold benefits from the class (i.e., offer coupons) in order to pay off the plaintiffs' lawyers since the discussion of attorneys' fees comes later?

Judges, who according to the law owe a fiduciary duty to class members, are incentivized to accept inflated settlement figures as an excuse to approve settlements and clear their dockets instead of looking out for the class members' interests. Under the separate settlement payment structure, even if the court were inclined to reduce the attorneys' fees, the money goes back to the defendant rather than to the class's recovery. Thus, judges are further incentivized to approve excessive attorneys' fees because any fee reduction would only benefit the wealthy defendant company.

And last but not least, under the separate payment regime, just as patients have little incentive to care about how much their insurance company may be paying for their healthcare, there is little incentive for class members to object to the settlement or fees. By the time they are notified, the settlement and fee award have already been negotiated and preliminarily approved by the court. And, under the separate payment scheme, class members have nothing to gain by objecting to the fees since, as already mentioned, any reduced fee would only benefit the defendant!

The class action, in practice, functions as a second rip-off of the consumer. What started out as a system to protect consumers has been turned on its head. We have all the players incentivized to not look out for the class members. Only this second rip-off is more sordid because it is done under the guise of helping consumers, and the judiciary, having turned a blind eye, is an accomplice to this scheme.

Trade-offs

When lawyers in a class action settlement get millions, tens of millions, or even hundreds of millions of dollars in fees for getting class members coupons or one-cent recoveries for every dollar in damages, what else could have been done with that money?

The amount of money awarded to class action attorneys by our court system is truly staggering.

  • The lawyers in the Enron settlement got over $670 million in fees; that's more than the $650 million the federal government aims to spend on grants for educational entrepreneurship this year.
  • The plaintiffs' lawyers in the Fen-Phen diet drug class action were awarded $567 million in attorneys' fees, while in 2009, the federal government spent $550 on a Mexican/U.S. border security program designed to curb drug trafficking and other transnational crime.
  • Lawyers in the Tyco class action settlement received $464 million in attorneys' fees, while the federal government spent only $400 million in protecting our country's ports in 2009. In 2010, the budget for the port security program is scheduled to be cut to $250 million, so while our nation's ports may be left more vulnerable, class action lawyers continue receiving multi-million dollar paydays.

These are only three examples, yet the fees amounted to more than $1.5 billion! Imagine the amount of money class action lawyers have received from the hundreds of thousands of class actions over the past 40 years. It adds up to billions of dollars taken from consumers' pockets and put into theirs. Indeed, one of the most prominent class action lawyers in the country, William Lerach, who pled guilty and went to prison for committing fraud on the court in class actions, is reported to have amassed a personal fortune estimated at $900 million. His former partner, Melvin Weiss, also a convicted felon, may have amassed even more as a collector of Picasso paintings.

Ineffective Judiciary

One would assume that the judges who approve these settlements would accept their responsibility to protect class members. Why wouldn't they? Isn't that their job? But to sum up how judges see class actions, one judge let the cat out of the bag when he said that "a bad settlement is better than a good trial."

Unfortunately, there are a host of reasons why judges (even in the most egregious cases) are unwilling to deny approval to "bad settlements," unwilling to press the settling parties to provide actual benefits to class members, unwilling to grapple with the ethical breaches raised by collusive settlements, and unwilling to reduce excessive attorneys' fees requests:

1)  It's easier. Lawyers come in telling the judge he or she doesn't have to do anything because we (the plaintiffs' lawyers and the defendants' lawyers) have come to you with a settlement. "Your honor, just sign your approval right here."

2)  There is bias in favor of plaintiffs' lawyers who are seen as "white knights" doing good for the "little guy" against the "evil" corporation.

3)  Settlements can be structured to allow judges to feel good about themselves when the payments are sugarcoated with special relief directed to a charity or nonprofit.

4)  Judges are anxious to clear cases from their dockets and approving settlements furthers that goal. As one federal judge expressed it, "[f]or us, a good settlement in the typical case is one that first and foremost makes the lawsuit go away."

5)  Then there is "regulatory capture." This occurs in situations where a governmental agency regulating an industry, charged with acting in the public interest, instead acts in favor of the commercial or special interests that dominate that particular industry.

6)  A more sinister reason why some judges look the other way when it comes to protecting consumers is that they are looking ahead to personal career opportunities. You see, after judges leave the bench, they have the opportunity to take well-paying assignments as private judges (e.g., privately hired to mediate disputes between litigants). Because of the lure of private judging, the public system becomes like a judicial farm team. Judges use cases to show the plaintiffs' and defendants' lawyers how they would perform when handling cases privately. How judges are viewed by the plaintiffs' lawyers, particularly on the issue of attorneys' fees, affects their opportunity to be hired by those lawyers as a private judges after they leave the bench.

Finally, as if all of the self-serving reasons for approval weren't enough of an excuse, there are the standard-less standards, and self-serving judicial principles upon which class action approval rests:

1)  that a settlement should be approved if it is fair, adequate, and reasonable, and it is up to each judge based on the unique facts of each case to make that determination;

2)  that a small number of objectors to a settlement is indicative of overwhelming support by silent class members. (It's more likely indicative of a lack of notice, a lack of understanding, indifference, or a realization that objecting is irrational from a cost-benefit perspective because the stakes for an individual class member are so low.); and

3)  that if class counsel negotiate their fee after the negotiation of the class settlement benefits, there is no conflict of interest between lawyer and client. We've already explained why this is a legal fiction.

Although, judges have a responsibility to scrutinize fee awards and make sure that class members are benefitting from a settlement, the reality, expressed by one judge, is that, "[s]uddenly we're told that things are different in settling a class action, that ... judges are fiduciaries for the entire class. That's a catchy label but it's dangerously misleading as a description of what trial judges are able to."

Ineffective Legislature

The U.S. Congress passed the Private Securities Litigation Reform Act (PSLRA) in 1995, hoping to address abuses in the securities class action system. One of the goals of the legislation was to get rid of "professional plaintiffs" (people who assist plaintiffs' lawyers by purchasing a few shares of stock in a large number of companies for the purpose of having their names attached to class action lawsuits). Unfortunately, the PSLRA did not impact securities class actions as intended. The class action lawyers gamed the system once again by replacing the "professional plaintiff" with the "professional union" (institutional investors, often public or union pension funds, who now act as lead plaintiffs). Since lawyers can no longer keep a handful of individual plaintiffs on call, they now woo union pension funds with promises to monitor their large portfolios. Federal Judge Jed Rakoff of the Southern District of New York declined to appoint a law firm as lead counsel in a securities class action lawsuit due to his concerns over a potentially unethical relationship between the law firm and a union client. Under their arrangement, the law firm reviewed the union's portfolio and identified potential securities class action claims. In return, the union retains the law firm on a contingency basis to bring recommended class actions -- exactly the type of abusive, lawyer-driven litigation the PSLRA was designed to curtail. So much for the legislative goal of not having these cases managed by the plaintiffs' class action bar.

Ten years later, the U.S. Congress enacted the Class Action Fairness Act (CAFA), expanding the federal courts' jurisdiction over class action litigation. Congress's intent was, in part, to squelch frivolous class actions because the federal courts were believed to more rigorously supervise class actions than state courts. What Congress failed to anticipate, however, is the resilience of class action lawyers. Sure CAFA has shifted cases to federal courts, but there is little hard evidence that federal court judges are any better than state court judges at reining in class action abuse in other than the most blatant cases. Furthermore, plaintiffs' class action lawyers are adept at finding their favorite plaintiff-friendly federal court just as they had previously done within the state systems.

CAFA was also meant to address abusive coupon settlements by providing that attorney contingency fees be based on the value of coupons actually redeemed by class members. Remember the Ford Explorer case I mentioned at the beginning of the article? In that case, the lawyers' fees would have been based on the $74,000 worth of coupons that were actually claimed by class members, instead of the $25 million they received, which was based on the $500 million in coupons that were made available to the class. However, CAFA itself appears to allow plaintiffs' class action lawyers a way around this rule.  It permits class counsel to chose to be compensated based on their hourly rate plus a multiplier (a factor used by a judge to enhance the attorneys' fees, such as in the Enron fee award mentioned earlier), virtually nullifying this attempt at reforming coupon-fee abuse. The plaintiffs' class action lawyers find a way to wiggle around reforms as fast as the Congress can legislate them.

Solutions

Sometimes the simplest change can have immense positive impact. In the case of healthcare, one doctor's heroic effort to curb deadly hospital-borne infections showed that instituting simple protocols, such as physicians washing their hands, reduced infection rates by two-thirds. Yet hospitals refused to implement the reform because it was seen as needless and belittling. Similarly, there are simple solutions that could significantly improve the class action system.

First, change the class action from an "opt-out" procedure to an "opt-in" procedure. Prior to 1966, individuals had to choose affirmatively to be a party in such a lawsuit, and only parties could share in the recovery. However, the more permissive procedural changes, in the name of helping the poor and the disadvantaged, allowed lawyers to sue whenever they believed that a group of individuals was harmed, merely by suing on one individual's behalf. If class members had to affirmatively "opt-in" rather than affirmatively "opt-out," it would take away the current death grip plaintiffs' lawyers currently have over class actions. Instead of the "opt-out" rule allowing plaintiffs lawyers to sweep up thousands and even millions of unwitting consumers into class actions for the purpose of reaping enormous attorneys' fees, defendants would be able to raise meritorious defenses without risking a crippling judgment.

Second, the class action system could be working for rather than against the class members' interests if the settlements and the attorneys' fees were treated as part of one class recovery, regardless of whether there were separate payments to the lawyers and the class. That way when attorneys' fees were reduced, the class would benefit with an increased recovery.

But class action lawyers and judges refuse to alter a status quo that benefits them.

Lawrence W. Schonbrun is the executive director of Class Action Watch, a nonprofit organization, and is a nationally recognized spokesperson on the issue of abusive class action settlements and excessive attorneys' fee awards in class actions.  He has appeared on behalf of unnamed class members/objectors in approximately 150 class actions throughout the United States.  A New York City native, he received his undergraduate degree from the University of Vermont in 1966, and his law degree from Boston College Law School in 1969.  Mr. Schonbrun has been featured on John Stossel's ABC special, "The Trouble With Lawyers," as well as Morley Safer's 60 Minutes report, "The Disaster That Wasn't."  He has testified before a U.S. Congressional subcommittee on the issue of attorney contingency fees.  His work in the field of class actions has been chronicled in The Wall Street Journal, The New York Times, Forbes, The Washington Post, Barron's, BusinessWeek, and the Bloomberg Business News Service.

Have you ever received a notice in the mail informing you that you might be a member of a class action lawsuit? You probably have. Did you even bother to read it?  Probably not. Did you ever file a claim for compensation?  Probably not. Did you ever file an objection to the settlement? Certainly not. Did you know that the lawyers bringing these suits get paid regardless of how many people file claims and regardless of how many class members actually get anything out of the settlement?  In what could be the poster child for the dysfunctional class action system, plaintiffs' lawyers in the Ford Explorer SUV class action settlement were awarded $25 million in attorneys' fees by claiming that the class members were receiving a benefit of $500 million. However, what class members actually received were $500 coupons towards the purchase of a new Ford vehicle, and only 148 were redeemed for a total value of $74,000. That's right. $25 million for the lawyers although the class members actually received $74,000.

But it gets worse. Take the infamous Bank of Boston class action. In that case, class members had their accounts credited between $2.19 and $8.76 as a result of the settlement, but also had their accounts debited with a "miscellaneous deduction" of up to $91 -- to cover the costs of the settlement, i.e. plaintiffs' and defendants' attorneys' fees and litigation costs. For this so-called "benefit" to class members, class counsel received $8.5 million in attorneys' fees. It is all about focus. Class action lawyers never want the public to focus on the negative aspects of class action settlements -- the $91 the lawsuit is costing you. They want you to focus on the $2.19 you're getting. Like the Bank of Boston case, all class action settlements focus on the benefits, however meager, but never disclose the costs to class members and consumers generally.

Why do the lawyers get so much when their clients get so little?  In the words of Federal Judge William G. Young, "simply put, the class action vehicle is broken."  Unfortunately, it's broken in a way that the people who run it -- lawyers -- and the people who are in a position to fix it -- judges and legislators -- are benefitting from the status quo. The injured class members who are supposed to be the primary focus of these cases have become its primary victims. The plaintiffs' lawyers are happy because they are getting overpaid -- massively; the defendants' lawyers and the experts (hired by both sides and an important part of the class action scheme) are happy because they're getting well paid (if not overpaid); the defendants are happy because they are avoiding further costly legal proceedings with unknown outcomes. And, last but not least, the judges are happy because they are getting a case cleared off their dockets. Unfortunately, the criterion for good judging these days is how quickly cases are processed to conclusion, not how well reasoned the outcomes. The judge gets the additional satisfaction of having made an important decision in a big case, thereby enhancing his or her self-importance and reputation. Some class members may even be happy -- at least those few who actually read the notice and redeemed their coupons. (Although is getting a $500 coupon towards the purchase of a $25,000 car really something to gloat about?)  Even some class members who didn't redeem their coupons may be happy because they assume that a bad corporation has been punished for some actual or alleged misdeed. But we as a society should not be happy because money (we're talking hundreds of millions if not billions of dollars) that could be going to a better use becomes nothing more than slop for thousands of lawyers feeding at the class

action trough. What's wrong with the class action system? Why does it put lawyers' interests first and class members' interests last?

Statistics

Unfortunately, the Ford Explorer SUV case is the tip of the iceberg of deceit of what class actions are really about. The overall cost of the U.S. tort liability system, of which class actions are a significant portion, is $865 billion per year according to the Pacific Research Institute (an admittedly biased pro-defendant source). This works out to be an annual "tort tax" for a family of four of $9,827!  It means that in a given year corporations and the companies that insure them are passing on the costs of these lawsuits to us in the form of increased premiums, higher prices, fewer products, and less service to the tune of nearly $10,000 annually. We already knew we were paying at least $10,000 a year in health insurance premiums, but I bet you didn't realize your family was losing another $10,000 because of our out-of-control legal system.

In an objection filed in the Enron class action settlement, a shareholder complained about her lawyer's request for over $700 million in attorneys' fees. It would pay one of the attorneys nearly $3000 an hour -- five times his already extravagant "normal" rate of $650 an hour. She was upset that she would be receiving $6.79 for each share which she originally purchased for $70 -- a staggering loss of 90 percent.  But that's not unusual in securities class actions where lawyers typically recover pennies for each dollar of claimed shareholder damages. Take for example one of the largest securities class actions in history, In Re Initial Public Offering Securities Litigation, which consisted of over 300 class actions in which hundreds, if not thousands, of lawyers and their staffs represented the same class of plaintiffs. The lawyers requested $202 million in attorneys' fees for their efforts and the judge awarded them $170 million, while the best this legal talent could do for their clients was settle the case for 1¢ for every $1 of damages claimed!  Should class action lawyers really be getting over a hundred million dollars in fees when their clients receive such puny recoveries?

Statistics on class action payouts to class members are typically secret because the players involved don't want the public to know how dysfunctional the system really is. And along with hidden statistics come the hidden harms. Harms that, as in health care, don't appear on the surface. We are led to believe that class actions punish bad corporate behavior, but those responsible for the alleged wrongdoings don't pay. This is most apparent in securities class actions where the shareholders are made to sue the corporation they own (themselves!), and the corporation pays for any settlement through insurance -- insurance that the shareholders pay for. The injustice of these suits was confirmed by U.S. District Court Judge Jed S. Rakoff. In refusing to approve a $33 million class action settlement with Bank of America, he called the settlement "not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality. [The settlement] proposes that the shareholders who were the victims of the Bank's alleged misconduct now pay the penalty for that misconduct."  A legal outcome that "does not comport with the most elementary notions of justice and morality"! That's pretty strong language. One would be hard pressed to have devised a worse system.

Fundamental Causes

This is not meant to be an article about greedy plaintiffs' lawyers, judges who don't care about justice, or evil defendants. This is about a dysfunctional system where everyone involved is incentivized to act against the best interests of the people for whom the system was designed to help -- consumers and the general public. In theory, the class action system was meant to protect us from life's little harms. But, as is often the case with theories, reality presents a different picture. Even the model of the lawyer as servant for the client breaks down in class actions because the lawyers are incentivized to serve themselves first. Class members merely provide a fig leaf of legitimacy for the lawyers to engage in what amounts to a shakedown. Why do I say shakedown?  Because all too often these cases, if brought to trial, would lose on their merits. However, because they are settled, the lawyers obtain millions, tens of millions, if not hundreds of millions of dollars in fees. For example, in an airline antitrust case, the judge's opinion noted that had the parties not agreed to the settlement that included $14 million in attorneys' fees, he likely would have dismissed the case against the defendant.

Another problem is that the system is rigged so that lawyers' fees are not tied to whether the clients are better or worse off as a result of the lawsuit; fees are tied to the theoretical size of a settlement. This is unlike a typical personal injury contingency case where the lawyer gets one-third of what the client actually recovers. Thus it is in the plaintiffs' lawyers' and defendants' interest to create a fictitious value for the settlement, and the court is encouraged to go along with this ruse because it gives the judge cover to approve a substantial class settlement and a handsome fee. It is not in any of the key players' interest to care about what class members are actually receiving, nor who is really paying for the litigation.

History

The foundation for our modem class action system was laid in the tumultuous '60s with a little appreciated change in the 1966 Federal Rules of Civil Procedure, wherein Congress expanded the ability of attorneys to prosecute class action lawsuits. Previously, the law had required that each plaintiff in a class action lawsuit be identified and demonstrate a willingness to participate in their case. This had been the law since Roman times and continues to be the law in most Western democracies. But in 1966, at the suggestion of law professors seeking to ensure the participation of the poor and disadvantaged, the law changed to allow attorneys, through the use of a token plaintiff, to sue on behalf of limitless numbers of unknown persons. The result has been an explosion in class action lawsuits, which, unfortunately, like our healthcare system, ignores the collateral damage.

Why the change occurred is a matter of opinion. Here's mine. During the 1960s, the legal profession and the judiciary played a leading role in eliminating institutional racial segregation in America. Legal academia promoted the notion that giving lawyers and judges greater power in American society generally would allow them to reform other domestic social ills. In fact, class actions were originally created solely for civil rights cases, not the tort actions for which they are now infamous. They were meant to allow individuals with separate but similar claims to be joined in one representative suit filed on behalf of many plaintiffs. Another justification for the class action was that it solved the problem that compensation for the little injuries of life would be more than offset by the high cost of litigation. Reformers never contemplated that class actions, rather than reducing the little injuries of life, would allow lawyers to make those little injuries a little bigger by adding on their fees.

          The ability to sue on behalf of groups of unknown individuals revolutionized the dynamics of litigation with many negative consequences. To justify their new wealth and power, class action lawyers and their apologists have fostered the exaggerated claims that:

1)  they are standing up for the "little guy" consumer against the big, bad corporation;

2)  class actions punish the guilty and compensate the innocent; and

3)  class actions deter bad corporate behavior.

The modem class action system elevates lawyers and judges to levels of power unknown in our nation's history.

Wrong Incentives

A major flaw in our country's healthcare system is that insurance companies profit by denying healthcare, not by providing it. Similarly, in the class action system, no one is incentivized to enrich the class members; indeed, they are incentivized to do the very opposite.

Plaintiffs' lawyers are incentivized to focus on their own compensation, not on what their clients will recover for their losses. Indeed, the fewer benefits the defendant provides to the class (think coupons), the more money there is available to pay the lawyers to stop litigating. And again, unlike a typical personal injury case where you and your lawyer negotiate what the fee is going to be, in a class action the lawyer negotiates his fee with the defendant -- the person you're suing! To legitimate this scheme, the judiciary has adopted a number of legal fictions including that plaintiffs' and defendants' lawyers who negotiate settlements first, separate from attorney's fee payments, do so without any thought of legal fees.

Assume you were injured in a car accident and had hired a lawyer. At the time of settlement, the lawyer comes to you and offers you a check. When you ask about his fee, he tells you not to worry, that you won't have to pay him because he has negotiated his fee with the other driver's insurance company. Hmmm, let's think about this. Can a lawyer really get the most for your claim if he is going to be negotiating his fee with the insurance company after your settlement? Probably not. Did the insurance company really offer you everything they had to settle your claim if they were going to negotiate your lawyer's fee after your settlement? Probably not. Yet, this separate payment structure is one way in which the class action lawyers have gamed the system. They structure settlements so that, rather than having the payment to the class and the payment to the lawyers be part of one recovery, there are purported separate payments. Is it any surprise then that defendants are incentivized to withhold benefits from the class (i.e., offer coupons) in order to pay off the plaintiffs' lawyers since the discussion of attorneys' fees comes later?

Judges, who according to the law owe a fiduciary duty to class members, are incentivized to accept inflated settlement figures as an excuse to approve settlements and clear their dockets instead of looking out for the class members' interests. Under the separate settlement payment structure, even if the court were inclined to reduce the attorneys' fees, the money goes back to the defendant rather than to the class's recovery. Thus, judges are further incentivized to approve excessive attorneys' fees because any fee reduction would only benefit the wealthy defendant company.

And last but not least, under the separate payment regime, just as patients have little incentive to care about how much their insurance company may be paying for their healthcare, there is little incentive for class members to object to the settlement or fees. By the time they are notified, the settlement and fee award have already been negotiated and preliminarily approved by the court. And, under the separate payment scheme, class members have nothing to gain by objecting to the fees since, as already mentioned, any reduced fee would only benefit the defendant!

The class action, in practice, functions as a second rip-off of the consumer. What started out as a system to protect consumers has been turned on its head. We have all the players incentivized to not look out for the class members. Only this second rip-off is more sordid because it is done under the guise of helping consumers, and the judiciary, having turned a blind eye, is an accomplice to this scheme.

Trade-offs

When lawyers in a class action settlement get millions, tens of millions, or even hundreds of millions of dollars in fees for getting class members coupons or one-cent recoveries for every dollar in damages, what else could have been done with that money?

The amount of money awarded to class action attorneys by our court system is truly staggering.

  • The lawyers in the Enron settlement got over $670 million in fees; that's more than the $650 million the federal government aims to spend on grants for educational entrepreneurship this year.
  • The plaintiffs' lawyers in the Fen-Phen diet drug class action were awarded $567 million in attorneys' fees, while in 2009, the federal government spent $550 on a Mexican/U.S. border security program designed to curb drug trafficking and other transnational crime.
  • Lawyers in the Tyco class action settlement received $464 million in attorneys' fees, while the federal government spent only $400 million in protecting our country's ports in 2009. In 2010, the budget for the port security program is scheduled to be cut to $250 million, so while our nation's ports may be left more vulnerable, class action lawyers continue receiving multi-million dollar paydays.

These are only three examples, yet the fees amounted to more than $1.5 billion! Imagine the amount of money class action lawyers have received from the hundreds of thousands of class actions over the past 40 years. It adds up to billions of dollars taken from consumers' pockets and put into theirs. Indeed, one of the most prominent class action lawyers in the country, William Lerach, who pled guilty and went to prison for committing fraud on the court in class actions, is reported to have amassed a personal fortune estimated at $900 million. His former partner, Melvin Weiss, also a convicted felon, may have amassed even more as a collector of Picasso paintings.

Ineffective Judiciary

One would assume that the judges who approve these settlements would accept their responsibility to protect class members. Why wouldn't they? Isn't that their job? But to sum up how judges see class actions, one judge let the cat out of the bag when he said that "a bad settlement is better than a good trial."

Unfortunately, there are a host of reasons why judges (even in the most egregious cases) are unwilling to deny approval to "bad settlements," unwilling to press the settling parties to provide actual benefits to class members, unwilling to grapple with the ethical breaches raised by collusive settlements, and unwilling to reduce excessive attorneys' fees requests:

1)  It's easier. Lawyers come in telling the judge he or she doesn't have to do anything because we (the plaintiffs' lawyers and the defendants' lawyers) have come to you with a settlement. "Your honor, just sign your approval right here."

2)  There is bias in favor of plaintiffs' lawyers who are seen as "white knights" doing good for the "little guy" against the "evil" corporation.

3)  Settlements can be structured to allow judges to feel good about themselves when the payments are sugarcoated with special relief directed to a charity or nonprofit.

4)  Judges are anxious to clear cases from their dockets and approving settlements furthers that goal. As one federal judge expressed it, "[f]or us, a good settlement in the typical case is one that first and foremost makes the lawsuit go away."

5)  Then there is "regulatory capture." This occurs in situations where a governmental agency regulating an industry, charged with acting in the public interest, instead acts in favor of the commercial or special interests that dominate that particular industry.

6)  A more sinister reason why some judges look the other way when it comes to protecting consumers is that they are looking ahead to personal career opportunities. You see, after judges leave the bench, they have the opportunity to take well-paying assignments as private judges (e.g., privately hired to mediate disputes between litigants). Because of the lure of private judging, the public system becomes like a judicial farm team. Judges use cases to show the plaintiffs' and defendants' lawyers how they would perform when handling cases privately. How judges are viewed by the plaintiffs' lawyers, particularly on the issue of attorneys' fees, affects their opportunity to be hired by those lawyers as a private judges after they leave the bench.

Finally, as if all of the self-serving reasons for approval weren't enough of an excuse, there are the standard-less standards, and self-serving judicial principles upon which class action approval rests:

1)  that a settlement should be approved if it is fair, adequate, and reasonable, and it is up to each judge based on the unique facts of each case to make that determination;

2)  that a small number of objectors to a settlement is indicative of overwhelming support by silent class members. (It's more likely indicative of a lack of notice, a lack of understanding, indifference, or a realization that objecting is irrational from a cost-benefit perspective because the stakes for an individual class member are so low.); and

3)  that if class counsel negotiate their fee after the negotiation of the class settlement benefits, there is no conflict of interest between lawyer and client. We've already explained why this is a legal fiction.

Although, judges have a responsibility to scrutinize fee awards and make sure that class members are benefitting from a settlement, the reality, expressed by one judge, is that, "[s]uddenly we're told that things are different in settling a class action, that ... judges are fiduciaries for the entire class. That's a catchy label but it's dangerously misleading as a description of what trial judges are able to."

Ineffective Legislature

The U.S. Congress passed the Private Securities Litigation Reform Act (PSLRA) in 1995, hoping to address abuses in the securities class action system. One of the goals of the legislation was to get rid of "professional plaintiffs" (people who assist plaintiffs' lawyers by purchasing a few shares of stock in a large number of companies for the purpose of having their names attached to class action lawsuits). Unfortunately, the PSLRA did not impact securities class actions as intended. The class action lawyers gamed the system once again by replacing the "professional plaintiff" with the "professional union" (institutional investors, often public or union pension funds, who now act as lead plaintiffs). Since lawyers can no longer keep a handful of individual plaintiffs on call, they now woo union pension funds with promises to monitor their large portfolios. Federal Judge Jed Rakoff of the Southern District of New York declined to appoint a law firm as lead counsel in a securities class action lawsuit due to his concerns over a potentially unethical relationship between the law firm and a union client. Under their arrangement, the law firm reviewed the union's portfolio and identified potential securities class action claims. In return, the union retains the law firm on a contingency basis to bring recommended class actions -- exactly the type of abusive, lawyer-driven litigation the PSLRA was designed to curtail. So much for the legislative goal of not having these cases managed by the plaintiffs' class action bar.

Ten years later, the U.S. Congress enacted the Class Action Fairness Act (CAFA), expanding the federal courts' jurisdiction over class action litigation. Congress's intent was, in part, to squelch frivolous class actions because the federal courts were believed to more rigorously supervise class actions than state courts. What Congress failed to anticipate, however, is the resilience of class action lawyers. Sure CAFA has shifted cases to federal courts, but there is little hard evidence that federal court judges are any better than state court judges at reining in class action abuse in other than the most blatant cases. Furthermore, plaintiffs' class action lawyers are adept at finding their favorite plaintiff-friendly federal court just as they had previously done within the state systems.

CAFA was also meant to address abusive coupon settlements by providing that attorney contingency fees be based on the value of coupons actually redeemed by class members. Remember the Ford Explorer case I mentioned at the beginning of the article? In that case, the lawyers' fees would have been based on the $74,000 worth of coupons that were actually claimed by class members, instead of the $25 million they received, which was based on the $500 million in coupons that were made available to the class. However, CAFA itself appears to allow plaintiffs' class action lawyers a way around this rule.  It permits class counsel to chose to be compensated based on their hourly rate plus a multiplier (a factor used by a judge to enhance the attorneys' fees, such as in the Enron fee award mentioned earlier), virtually nullifying this attempt at reforming coupon-fee abuse. The plaintiffs' class action lawyers find a way to wiggle around reforms as fast as the Congress can legislate them.

Solutions

Sometimes the simplest change can have immense positive impact. In the case of healthcare, one doctor's heroic effort to curb deadly hospital-borne infections showed that instituting simple protocols, such as physicians washing their hands, reduced infection rates by two-thirds. Yet hospitals refused to implement the reform because it was seen as needless and belittling. Similarly, there are simple solutions that could significantly improve the class action system.

First, change the class action from an "opt-out" procedure to an "opt-in" procedure. Prior to 1966, individuals had to choose affirmatively to be a party in such a lawsuit, and only parties could share in the recovery. However, the more permissive procedural changes, in the name of helping the poor and the disadvantaged, allowed lawyers to sue whenever they believed that a group of individuals was harmed, merely by suing on one individual's behalf. If class members had to affirmatively "opt-in" rather than affirmatively "opt-out," it would take away the current death grip plaintiffs' lawyers currently have over class actions. Instead of the "opt-out" rule allowing plaintiffs lawyers to sweep up thousands and even millions of unwitting consumers into class actions for the purpose of reaping enormous attorneys' fees, defendants would be able to raise meritorious defenses without risking a crippling judgment.

Second, the class action system could be working for rather than against the class members' interests if the settlements and the attorneys' fees were treated as part of one class recovery, regardless of whether there were separate payments to the lawyers and the class. That way when attorneys' fees were reduced, the class would benefit with an increased recovery.

But class action lawyers and judges refuse to alter a status quo that benefits them.

Lawrence W. Schonbrun is the executive director of Class Action Watch, a nonprofit organization, and is a nationally recognized spokesperson on the issue of abusive class action settlements and excessive attorneys' fee awards in class actions.  He has appeared on behalf of unnamed class members/objectors in approximately 150 class actions throughout the United States.  A New York City native, he received his undergraduate degree from the University of Vermont in 1966, and his law degree from Boston College Law School in 1969.  Mr. Schonbrun has been featured on John Stossel's ABC special, "The Trouble With Lawyers," as well as Morley Safer's 60 Minutes report, "The Disaster That Wasn't."  He has testified before a U.S. Congressional subcommittee on the issue of attorney contingency fees.  His work in the field of class actions has been chronicled in The Wall Street Journal, The New York Times, Forbes, The Washington Post, Barron's, BusinessWeek, and the Bloomberg Business News Service.