Should mutual funds take a more active role in securities litigation? Data appears to suggest that they should.
According to Sean J. Griffith[1] and Dorothy S. Lund[2], authors of “Toward a Mission Statement for Mutual Funds in Shareholder Litigation”[3], mutual funds can improve returns for investors by taking on a greater role in enforcing shareholder and investor rights in court. Griffith and Lund survey participation in derivative suits, direct and class claims under state law, appraisal claims, and private securities litigation, and develop a recommendation for “a few simple changes [by which] mutual funds will be able to reap litigation benefits without substantially increasing their costs.”[4]
Amy Roy and Robert Skinner[5] offered a counterpoint in their piece “Mutual Funds Should Stay Out Of Shareholder Litigation,” asserting that “[l]itigation opportunities–like investment opportunities–come with opportunity costs, which the authors fail to acknowledge.” Focusing primarily on burdens of private securities litigation, such as serving as a lead plaintiff and what they view as the “myth” of improved opt-out recovery, Roy and Skinner concluded, “Notable exceptions aside, fund shareholders are generally better served by allowing their advisers to remain focused on what it is they were hired to do–investing their money and outperforming the market.”
Griffith and Lund responded to this critique in “Mutual Funds Should Use Litigation For Shareholders’ Benefit.” They wrote that the “notable exceptions” that Roy and Skinner brush aside are, in fact, “specific evidence . . . showing that shareholder litigation can benefit mutual funds and their investors–directly, by securing compensation, or indirectly, by deterring misconduct, among other things.” Looking at securities class actions and finding an active participation rate of only 0.6 percent–i.e., 10 cases out of 1,500 over a 10-year period–Griffith and Lund wonder (and rightly so) whether the true “rate of good cases to bad ones” could be so low.
Griffith and Lund’s conclusion that mutual funds’ “dismal litigation record . . . raises serious questions of whether mutual funds are acting as faithful governance intermediaries for their investors” presents an issue that both mutual fund managers and investors need to address, due in part to the rising prevalence of mutual funds.
By one recent measure, if mutual funds chose to functionally self-exclude from securities litigation, this would sideline nearly a quarter of all equity ownership:
Source: https://awealthofcommonsense.com/2019/01/who-owns-all-the-stocks-bonds/
As Congress noted when drafting the Private Securities Litigation Reform Act of 1995:
Private securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers, and others properly perform their jobs.[6]
This sentiment was echoed more recently by then-SEC Commissioner Luis Aguilar in his 2012 statement in the wake of the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd.:
It is unrealistic to expect that the Commission will have the resources to police all securities frauds on its own, and as a result, it is essential that investors be given private rights of action to complement and complete the Commission’s efforts.[7]
Relegating the largest single group of institutional investors to the role of onlookers in the face of securities fraud is not the path to maintaining a robust and trustworthy capital market. Mutual funds would often do well to adopt a more active role in protecting their investors.
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[1] T.J. Maloney Chair and Professor of Law at Fordham University School of Law.
[2] Assistant Professor of Law, University of Southern California Gould School of Law.
[3] Griffith, Sean J., and Lund, Dorothy S., Toward a Mission Statement for Mutual Funds in Shareholder Litigation (July 19, 2019), Univ. of Chicago L. Rev., Forthcoming; European Corporate Governance Institute–Law Working Paper No. 468/2019; USC CLASS Research Paper No. CLASS19-23; USC Law Legal Studies Paper No. 19-23. Available at SSRN: https://ssrn.com/abstract=3422910.
[4] Id. at 48.
[5] Roy and Skinner are partners at Ropes & Gray LLP.
[6] H.R. Rep No. 104-369, at 31 (1995).
[7] Aguilar, Luis A., Statement by Commissioner: Defrauded Investors Deserve Their Day in Court, Secs. & Exchange Comm., Apr. 11, 2012, available at https://www.sec.gov/news/public-statement/2012-spch041112laahtm.