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’ feesby claiming that the class members were receiving a benefit of $500 million.  However, what class members actually received was a $500 coupon towards the purchase of a new Ford vehicle.  Only 148 of those were ever 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's all about focus.  Class action lawyers don't want the public to focus on the negative aspects of class action settlements -- the $91 the lawsuit is costing you.  All class action settlements focus on the benefits, however meager, but never disclose the true 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, the vehicle works well for the people who run it -- lawyers -- and the people who could fix it -- judges and legislators.  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, the public's interest last, and class members’ interests next to last?

Statistics

Unfortunately, the Ford Explorer SUV case is the tip of the iceberg of class action deceit.  The overall cost of the U.S.  tort liability system, of which class actions are a significant part, is, needless to say, difficult to estimate.  The Pacific Research Institute, an admittedly biased pro-defendant source, has put forth an estimate of $865 billion per year.  This works out to be an annual “tort tax” for a family of four of $9,827!  If it were accurate, this would mean 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. 

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 $3,000 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 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 paid nearly two hundred million dollars in fees for getting their clients 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.  We are led to believe that class actions punish bad corporate behavior, but the corporate officials who commit alleged wrongdoing almost never have to pay any damages or suffer any consequence.  How can class actions serve as a deterrent to corporate misbehavior if the alleged perpetrators get off scot free?  This is most important 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 more dysfunctional 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 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.  The court is encouraged to go along with this ruse because it gives the judge cover to approve a so-called "substantial" class recovery and what is politely referred as a "handsome" attorneys' fee.  It is not in any of the players’ interest to care about what class members are actually receiving or the cumulative cost to society of all this type of litigation.

History

The foundation for our modern 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, with great 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 of getting consumers compensation for the little injuries of life by sharing the high cost of litigation among a large group of plaintiffs.  Reformers never contemplated that rather than reducing the little injuries of life, class actions 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.  The modern class action system elevates lawyers and judges to levels of power unknown in our nation's history.  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.

Putting Lawyers' Interests First

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 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 less valuable the benefits the defendant provides to the class (think coupons), the more actual money 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 before filing the lawsuit, in a class action the lawyer negotiates his fee with the defendant -- the person you’re suing – after the class's recovery has been informally agreed to!  To legitimate this scheme, the judiciary has adopted a legal fiction that plaintiffs’ and defendants' lawyers who negotiate the class's settlement first, 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.  Do you really think the lawyer got you all he could when he is getting separately paid by the defendant's insurance company?  In fact, shouldn't you be legitimately concerned that your lawyer got a higher fee that was paid for by your lower settlement?  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 hold back real benefits to the class (i.e., offer coupons) in order to have sufficient cash to pay off the plaintiffs' lawyers.

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 attorneys' fee payment scheme, judges are further incentivized not to reduce excessive fee requests because the way the payment scheme is structured, any reductions remain with the defendant and do not benefit class members.

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.  Each of the players is incentivized to further abuse class members.  Only this second rip-off is more sordid because it is done under the guise of helping consumers.  The judiciary, having turned a blind eye, is an accomplice to what amounts to a vast conspiracy against consumers' interests.

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-on-the-dollar 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 million 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 was cut to $250 million, so while our nation’s ports may be left more vulnerable, class action lawyers continue receiving multimillion-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 lawyers' bank accounts.  Indeed, William Lerach (dubbed the "King of Torts" by The New York Times) pled guilty and went to prison for committing fraud on the court in class actions.  Lerach is reported to have amassed a personal fortune of $900 million.  His former partner, Melvin Weiss, also convicted of abusing the class action process for personal gain, amassed a collection of Picasso paintings that may be even more valuable.  Mr. Lerach claimed that the secret payments[1] for which he was prosecuted were a common practice in the class action field.  However, neither Congress nor any bar association has chosen to follow up on this indication of systemic illegality by the plaintiffs' class action bar.

Ineffective Judiciary

One would assume that the judges who approve these settlements would accept their responsibility to protect class members.  After all, isn't that their job?  Apparently not.  One judge let the cat out of the bag when he said “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)   Judges have enormous caseloads.  It's less work to simply sign the settlement.  Lawyers come in telling the judge he or she doesn’t have to do anything because "We lawyers have a deal.  Your Honor, just sign here.

2)   There is bias in favor of plaintiffs’ lawyers due to their portrayal by the media as “white knights,” protecting the “little guy” against the “evil” corporation.

3)   Settlements can be structured to allow judges to feel good about themselves when excessive attorneys' fee requests 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., they are hired to mediate disputes between litigants).  Because of the lure of private judging, the public system acts 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 to approve the lawyers' proposed deal were not enough of an excuse, there are the standard-less standards, and self-interested judicial principles upon which class action approval rests:

1)   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)   a small number of objectors to a settlement is presumed to be 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)   if class counsel negotiate their fee after the negotiation of the class settlement benefits, it is presumed there is no conflict of interest between lawyer and the class.  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 benefit 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 do.”

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 institutions” (large 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.

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 file a class action -- 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 directed 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 action litigation.  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 as adept at finding plaintiff-friendly federal courts as they had previously done with state courts.

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 fee they received based on $500 million in coupons that were merely "made available" to the class.  By analogy, suppose you got some grocery discount coupons in the mail, which you toss in the garbage.  But when you file your federal taxes, the IRS says you should have included the value of the discarded coupons as income because that value “was made available to you.”  Nuts?  You bet, but that is exactly what courts are doing when they award fees on the basis of the alleged value of settlement coupons “made available,” irrespective of whether the class members have any use for them.  It remains to be seen how the plaintiffs' class action bar will find a way to wiggle around the rules imposed upon them under CAFA.   

Solutions

Sometimes even the simplest change can have an immense positive impact.  In the case of healthcare, one doctor’s effort to curb deadly hospital-borne infections by requiring physicians to wash their hands reduced infection rates by two-thirds.  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 to such a lawsuit, and only parties could share in the recovery.  If class members had to affirmatively “opt-in” rather than affirmatively “opt-out” of a class, it would take away the current death grip plaintiffs’ lawyers currently have over the class action mechanism.  Defendants would be able to raise meritorious defenses without risking a crippling judgment.  Instead, the "opt-out" rule allows plaintiffs lawyers to sweep up thousands and even millions of unwitting consumers into class actions for the purpose of reaping enormous attorneys’ fees. 

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

But class action lawyers, judges, and legislators refuse to meaningfully alter an entrenched status quo that benefits them.  So you and I must continue to pay for this scam that infects our halls of justice.

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.


[1] To individuals he put forward as representing the class.

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’ feesby claiming that the class members were receiving a benefit of $500 million.  However, what class members actually received was a $500 coupon towards the purchase of a new Ford vehicle.  Only 148 of those were ever 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's all about focus.  Class action lawyers don't want the public to focus on the negative aspects of class action settlements -- the $91 the lawsuit is costing you.  All class action settlements focus on the benefits, however meager, but never disclose the true 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, the vehicle works well for the people who run it -- lawyers -- and the people who could fix it -- judges and legislators.  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, the public's interest last, and class members’ interests next to last?

Statistics

Unfortunately, the Ford Explorer SUV case is the tip of the iceberg of class action deceit.  The overall cost of the U.S.  tort liability system, of which class actions are a significant part, is, needless to say, difficult to estimate.  The Pacific Research Institute, an admittedly biased pro-defendant source, has put forth an estimate of $865 billion per year.  This works out to be an annual “tort tax” for a family of four of $9,827!  If it were accurate, this would mean 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. 

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 $3,000 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 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 paid nearly two hundred million dollars in fees for getting their clients 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.  We are led to believe that class actions punish bad corporate behavior, but the corporate officials who commit alleged wrongdoing almost never have to pay any damages or suffer any consequence.  How can class actions serve as a deterrent to corporate misbehavior if the alleged perpetrators get off scot free?  This is most important 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 more dysfunctional 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 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.  The court is encouraged to go along with this ruse because it gives the judge cover to approve a so-called "substantial" class recovery and what is politely referred as a "handsome" attorneys' fee.  It is not in any of the players’ interest to care about what class members are actually receiving or the cumulative cost to society of all this type of litigation.

History

The foundation for our modern 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, with great 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 of getting consumers compensation for the little injuries of life by sharing the high cost of litigation among a large group of plaintiffs.  Reformers never contemplated that rather than reducing the little injuries of life, class actions 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.  The modern class action system elevates lawyers and judges to levels of power unknown in our nation's history.  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.

Putting Lawyers' Interests First

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 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 less valuable the benefits the defendant provides to the class (think coupons), the more actual money 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 before filing the lawsuit, in a class action the lawyer negotiates his fee with the defendant -- the person you’re suing – after the class's recovery has been informally agreed to!  To legitimate this scheme, the judiciary has adopted a legal fiction that plaintiffs’ and defendants' lawyers who negotiate the class's settlement first, 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.  Do you really think the lawyer got you all he could when he is getting separately paid by the defendant's insurance company?  In fact, shouldn't you be legitimately concerned that your lawyer got a higher fee that was paid for by your lower settlement?  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 hold back real benefits to the class (i.e., offer coupons) in order to have sufficient cash to pay off the plaintiffs' lawyers.

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 attorneys' fee payment scheme, judges are further incentivized not to reduce excessive fee requests because the way the payment scheme is structured, any reductions remain with the defendant and do not benefit class members.

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.  Each of the players is incentivized to further abuse class members.  Only this second rip-off is more sordid because it is done under the guise of helping consumers.  The judiciary, having turned a blind eye, is an accomplice to what amounts to a vast conspiracy against consumers' interests.

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-on-the-dollar 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 million 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 was cut to $250 million, so while our nation’s ports may be left more vulnerable, class action lawyers continue receiving multimillion-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 lawyers' bank accounts.  Indeed, William Lerach (dubbed the "King of Torts" by The New York Times) pled guilty and went to prison for committing fraud on the court in class actions.  Lerach is reported to have amassed a personal fortune of $900 million.  His former partner, Melvin Weiss, also convicted of abusing the class action process for personal gain, amassed a collection of Picasso paintings that may be even more valuable.  Mr. Lerach claimed that the secret payments[1] for which he was prosecuted were a common practice in the class action field.  However, neither Congress nor any bar association has chosen to follow up on this indication of systemic illegality by the plaintiffs' class action bar.

Ineffective Judiciary

One would assume that the judges who approve these settlements would accept their responsibility to protect class members.  After all, isn't that their job?  Apparently not.  One judge let the cat out of the bag when he said “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)   Judges have enormous caseloads.  It's less work to simply sign the settlement.  Lawyers come in telling the judge he or she doesn’t have to do anything because "We lawyers have a deal.  Your Honor, just sign here.

2)   There is bias in favor of plaintiffs’ lawyers due to their portrayal by the media as “white knights,” protecting the “little guy” against the “evil” corporation.

3)   Settlements can be structured to allow judges to feel good about themselves when excessive attorneys' fee requests 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., they are hired to mediate disputes between litigants).  Because of the lure of private judging, the public system acts 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 to approve the lawyers' proposed deal were not enough of an excuse, there are the standard-less standards, and self-interested judicial principles upon which class action approval rests:

1)   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)   a small number of objectors to a settlement is presumed to be 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)   if class counsel negotiate their fee after the negotiation of the class settlement benefits, it is presumed there is no conflict of interest between lawyer and the class.  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 benefit 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 do.”

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 institutions” (large 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.

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 file a class action -- 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 directed 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 action litigation.  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 as adept at finding plaintiff-friendly federal courts as they had previously done with state courts.

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 fee they received based on $500 million in coupons that were merely "made available" to the class.  By analogy, suppose you got some grocery discount coupons in the mail, which you toss in the garbage.  But when you file your federal taxes, the IRS says you should have included the value of the discarded coupons as income because that value “was made available to you.”  Nuts?  You bet, but that is exactly what courts are doing when they award fees on the basis of the alleged value of settlement coupons “made available,” irrespective of whether the class members have any use for them.  It remains to be seen how the plaintiffs' class action bar will find a way to wiggle around the rules imposed upon them under CAFA.   

Solutions

Sometimes even the simplest change can have an immense positive impact.  In the case of healthcare, one doctor’s effort to curb deadly hospital-borne infections by requiring physicians to wash their hands reduced infection rates by two-thirds.  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 to such a lawsuit, and only parties could share in the recovery.  If class members had to affirmatively “opt-in” rather than affirmatively “opt-out” of a class, it would take away the current death grip plaintiffs’ lawyers currently have over the class action mechanism.  Defendants would be able to raise meritorious defenses without risking a crippling judgment.  Instead, the "opt-out" rule allows plaintiffs lawyers to sweep up thousands and even millions of unwitting consumers into class actions for the purpose of reaping enormous attorneys’ fees. 

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

But class action lawyers, judges, and legislators refuse to meaningfully alter an entrenched status quo that benefits them.  So you and I must continue to pay for this scam that infects our halls of justice.

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.


[1] To individuals he put forward as representing the class.

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