Coyote Blog

The general utility of shareholder lawsuits has confused me for quite some time.  Way back in the blogging stone age of 2006 I wrote a guest post at Overlawyered that said in part:

But from a philosophical standpoint, shareholder suits have never made much sense to me. While I can understand the shareholders of the company suing a minority shareholder who might be enriching themselves disproportionately (e.g. Rigas family at Adelphia), suits by shareholders against the company they own seem… crazy.

Any successful verdict for shareholders against the company would effectively come out of the pockets of the company’s owners who are.. the shareholders. So in effect, shareholders are suing themselves, and, win or lose, they as a group end up with less than if the suit had never been started, since a good chunk of the payout goes to the lawyers. The only way these suits make financial sense (except to the lawyers, like Bill Lerach) is if only a small subset of the shareholders participate, and then these are just vehicles for transferring money from half the shareholders to the other half, or in other words from one wronged party that does not engage in litigation to another wronged party who is aggressively litigious. Is there really justice here?

OK, you could argue that many of these shareholders are not suing themselves, because they are past shareholders that dumped their stock at a loss. But given these facts, these suits are even less fair. If these suits are made by past shareholders who held stock (ie, were the owners) at the time certain wrongs were committed, they are in fact paid by current and future shareholders who may well have not even owned the company at the time of the abuses, and who may in fact be participating in cleaning the company up. So these litigants are in effect making the argument that because the company was run unethically when they owned it, they are going to sue the people who bought it from them and cleaned it up? Shouldn’t the payment be the other way around, with past owners paying current owners for the mess they left?

So I found this decision in a case at Sears refreshing:

A federal appeals court on Wednesday put the kibosh on a shareholder antitrust suit against the board members of Sears Holding Corp, finding that the suit only served to enrich the plaintiffs' lawyers.

The ruling from the Chicago-based U.S. Court of Appeals for the 7th Circuit marks the latest victory for Ted Frank, of the Center for Class Action Fairness, who argued that the suit was an abuse of the legal system and conferred no benefit on Sears shareholders at large. The 7th Circuit agreed.

"The only goal of this suit appears to be fees for the plaintiffs' lawyers," Judge Frank Easterbrook wrote for a unanimous three-judge panel.

Several law firms, including Vianale & Vianale, filed the proposed class action on behalf of two named investors in 2009. The derivative suit accused two Sears directors of holding positions on the boards of several competing companies, in violation of federal antitrust law.

Given the high cost of litigating an antitrust suit, Sears reached a settlement with the investor plaintiffs, agreeing to get rid of one of the directors and pay $925,000 to the investors' attorneys.

Frank, who specializes in challenging class action settlements, argued that the resolution was a raw deal for Sears shareholders, costing them legal fees and a director they had recently re-elected. The deal also would not prevent someone else from filing a copycat suit, given that one of the two targeted directors would remain on the Sears board. What's more, the problem of interlocking boards is usually resolved when the Department of Justice or the Federal Trade Commission asks a company to fix the violation.

Frank, himself a Sears shareholder, asked to intervene in the case to block the settlement, but the Illinois district court refused, finding that the plaintiff investors adequately represented the interests of Frank and the other shareholders.

On appeal, the 7th Circuit panel reached the opposite conclusion, finding the interests to be "entirely incompatible." The panel sent the case back to the district court, with instructions to allow Frank to intervene and to rule in favor of the Sears defendants.

"The suit serves no goal other than to move money from the corporate treasury to the attorneys' coffers, while depriving Sears of directors whom its investors freely elected," Easterbrook wrote.

Ted Frank at Overlawyered is posting links to his favorite Overlawyered stories of 2006, month by month .  Don't miss the link to yours truly in March.  update:  Hey, I'm in February too.

I have written on this before on the context of Vioxx, but is it really rational public policy to have juries be allowed to effectively ban products, products that both legislatures and regulatory bodies have explicitly or implicitly deemed as legal?  Ted Frank takes this on at Overlawyered in a nice follow-up post on a $31 million jury verdict against Ford:

SUVs are designed to have high clearance to traverse rugged terrain.
This raises the center of gravity and affects the handling: it's a
known tradeoff of the laws of physics. There are a wide variety of
tests of varying degrees of scientific merit one can use to suggest a
vehicle is "too prone" to roll over, and plaintiffs have the benefit of
cherry-picking which tests to apply to which vehicles. You'll find lots
of lawyers complaining that the Bronco II allegedly responded poorly in
"J-turn tests", where the steering wheel is turned 330 degrees in one
third of a second and held there for another 4.67 seconds. Ford
designed the Explorer to pass the J-turn test to take away this claim,
and the trial lawyers started using different methodologies to claim
that the Explorer was too prone to roll over.

Empirically, however, the Bronco doesn't roll over more than several
other SUVs on the market, which is why NHTSA, in both the Bush I and
Clinton administrations, refused to recall the Bronco when the
plaintiffs' bar asked it to. When I say Ford was held liable for
producing an SUV, I'm not spinning: it was because it was held liable
for producing an SUV.

Moreover, a vehicle should be viewed in totality: an auto that is
more likely to roll over may be safer in other particulars that more
than compensate for that increased propensity. So I question the
premise. One can't change the rollover propensity without creating a
different vehicle entirely. The vehicle should be viewed holistically,
and holistically, the Bronco is a safe car when used as designed.

Perhaps we as a society would be better off taking the nanny-state
step of banning SUVs, forbidding people from wildnerness driving
because too many drivers don't know how to drive SUVs in highway
conditions, but that's a decision that not only would end the American
auto industry, but should be made other than by a 12-person jury of
laypeople. This vehicle rolled over because the driver drove off the
road.

I had similar thoughts about the Vioxx cases:

Anyway, the point of this post is that this verdict represents a very dangerous assault on individual choice.  Recognize that there are many, many activities in life where individuals are presented with the following choice:

If I choose to do X, my life will be improved in some way but I may statiscally increase my chance of an early death.

You
may react at first to say that "I would never risk death to improve my
life", but likely you make this choice every day.  For example, if you
drive a car, you are certainly increasing your chance of early death
via a auto accident, but you accept this risk because driving allows
you to get so much more done in your life (vs. walking).  If you ride a
bike, swim, snow ski, roller blade, etc. you are making this choice.
Heck, everyone on the California coast is playing Russian Roulette with
an earthquake in exchange for a great climate, beautiful scenery, and
plentiful jobs.

The vast majority of drugs and medical therapies carry this same
value proposition:  A drug will likely improve or extend your life in
some way but carries a statistical chance of inducing a side effect
that is worse than the original problem, up to and including death.
The problem is that we have structured a liability system in this
country such that the few people who evince the side effects can claim
more money in damages than the drug was worth to all the people it
helped.  For example, if a drug helps 999 people, but kills the
thousandth, and that thousandth person's family is awarded $253 million
in damages (as in this case), the drug is never going to be put on the
market again.  Even if the next 1000 people sign a paper saying we are
willing to take the one-in-a-thousand risk to relieve the pain that is
ruining our lives, they still are not going to get the drug because the
drug companies know that some Oprah-loving jury will buy the argument
that they did not understand the risk they were taking and award the
next death another quarter of a billion dollars....

By the way, have you noticed the odd irony here?  Robert Ernst (the
gentleman who died in the Vioxx case) is assumed, both by the FDA and
the litigation system, to be unable to make informed decisions about
risk and his own health.  But a jury of 12 random people who never
experienced his pain can make such decisions for him?  And us?

Alex Tabarrok at Marginal Revolution said it even more succinctly:

How did we arrive at a system in which 12 random Texans are assigned
responsibility for evaluating the scientific merits of statistical evidence of
this type, weighing the costs and benefits, and potentially
sending a productive blue-chip American company into bankruptcy protection?

Ted Frank has this update on Vioxx litigation, and it couldn't possibly be more depressing:

Take, for example, the last
case Merck lost, that of Leonel Garza in south Texas. Mr. Garza, who
was said by plaintiffs to have taken Vioxx for three weeks, was a
71-year-old overweight smoker, with high cholesterol, decades of heart
disease, and a history of a heart attack and a quadruple bypass, yet a
jury awarded his survivors $7 million in "compensatory" damages, and
punitive damages to boot

He goes on to recount the very reasonable suspicion that Garza may not have even taken Vioxx at all, as he never had a prescription and his doctor has denied that he passed Garza a series of free samples in little brown bottles.

So out of eleven cases that
have gone to trial or almost gone to trial, there is a reasonable
suspicion that plaintiffs faked Vioxx usage in as many as five of them.
How many more of the tens of thousands of pending plaintiffs have
similar flaws?

He concludes with this excellent point:

Perhaps appellate courts
will get around to correcting these travesties, but the plaintiffs' bar
is counting on enough bad verdicts to slip through the cracks to make
these cases profitable.

The equation of expected returns is certainly helped by the fact
that no one is even suggesting that presenting this sort of
questionable evidence is unethical, much less illegal. Drug safety is
important, but so are the health costs from vaccines and drugs not
marketed because of liability risks. If the judicial system cannot
police itself adequately, the question then becomes why we want to
entrust national drug safety policy to an elected judge and a handful
of randomly selected jurors in Starr County, Texas?

Props to Merck for fighting each and every case so far and resisting the mass tort pressure to start offering settlements to anyone who asks for one.