How the merits matter: Directors' and officers' insurance and securities settlements

University of Pennsylvania Law Review

Volumn 157, Issue 3, 2009, Pages 755-832

  Baker, Tom ^a   Griffith, Sean J ^b  

^a UNIVERSITY OF PENNSYLVANIA LAW SCHOOL   (United States)

^b Fordham Law School ^*

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EID: 64649103367     PISSN: 00419907     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (449)

1. Nathan Koppel, Milberg Figure Lerach Retires Amid Plea Talks, WALL ST. J., Aug. 29, 2007, at B2.
2. Id. Others have suggested as much, often with less restraint.
3. See, e.g., Karen Donovan, Bloodsucking Scumbag WIRED, Nov. 1996, at 134, 136-37 (describing Lerach's role in securities class actions against high-technology companies).
4. Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions, 43 STAN. L. REV. 497 (1991).
5. See id. at 500 (noting that "a strong case . . . appears to have been worth no more than a weak one");
6. id. at 597 (concluding that "[s]ettlements that do not reflect the merits therefore may be typical of securities class actions generally").
7. See Pub. L. No. 104-67, 109 Stat. 737 (1995) (codified as amended in scattered sections of 15 & 18 U.S.C).
8. On the influence of Professor Alexander's article, see generally William S. Lerach, "The Private Securities Litigation Reform Act of 1995-27 Months Later": Securities Class Action Litigation Under the Private Securities Litigation Reform Act's Brave New World, 76 WASH. U. L.Q. 597, 598 (1998), which notes that Congress "relied heavily upon Professor Janet Cooper Alexander's article" in enacting the PSLRA.
9. See James D. Cox, Making Securities Fraud Class Actions Virtuous, 39 ARIZ. L. REV. 497, 503-04 (1997) (arguing that the damages estimates supporting Alexander's core thesis had been calculated incorrecdy);
10. Elliott J. Weiss &John S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 YALE L.J. 2053, 2083-84 (1995) (recalculating potential damages for the lawsuits in Alexander's sample and finding much more variation, thereby destroying the support of Alexander's core assertion);
11. see also Leonard B. Simon & William S. Dato, Legislating on a False Foundation: The Erroneous Academic Underpinnings of the Private Securities Litigation Reform Act of 1995, 33 SAN DIEGO L. REV. 959, 990-93 (1996) (critiquing Alexander's methodology and deeming her analysis "unconvincing").
12. Alexander's Do the Merits Matter?, supra note 3, was published in February 1991. Based on our February 27, 2008, Westlaw search, Alexander's article was cited in 11 court cases, 143 law review articles, and 23 appellate filings or briefs-or 177 times in total-from June 1992 to June 1997. Although the frequency of cites has declined over time, her article was still cited in 3 cases, 76 law reviews, and in 26 appellate filings or briefs-105 times in total-between 2003 and 2008.
13. We are a case in point. In a prior article, Griffith assumes that the merits matter to some degree in arguing for mandatory disclosure of D&O insurance information. See Sean J. Griffith, Uncovering a Gatekeeper: Why the SEC Should Mandate Disclosure of Details Concerning Directors' and Officers' Liability Insurance Policies, 154 U. PA. L. REV. 1147, 1161 (2006) ("[T]he total cost of shareholder litigation depends, at least in part, on corporate wrongdoing . . . .").
14. Similarly, after finding that D&O insurers do weigh merits-related factors in their underwriting decisions, we concluded that that "the merits somewhat matter." Tom Baker & Sean J. Griffith, Predicting Corporate Governance Risk: Evidence from the Directors' & Officers' Liability Insurance Market, 74 U. CHI, L. REV. 487, 538 (2007).
15. See Stephen J. Choi, The Evidence on Securities Class Actions, 57 VAND. L. REV. 1465, 1498 (2004) ("[T]he existing literature on filings and settlements in the post-PSLRA time period provide [s] evidence that frivolous suits existed prior to the PSLRA and that a shift occurred in the post-PSLRA period toward more meritorious claims.");
16. Jonathan C Dickey & Mareia Kramer Mayer, Effect on Rule 10b-5 Damages of the 1995 Private Securities Litigation Reform Act: A Forward-Looking Assessment, 51 BUS. LAW. 1203, 1219 (1996) (concluding that reduced damages after the PSLRA may deter the filing of suits "that would have been brought under the prior law").
17. See Denise N. Martin et al., Recent Trends IV: What Explains Filings and Settlements in Shareholder Class Actions, 5 STAN.J.L. BUS. & FIN. 121, 123 (1999) (acknowledging that "the timing of settlements may indeed be reflective of a case's merits" and that "only a portion of low-valued settlements are likely to be nuisance suit settlements").
18. See Marilyn F. Johnson et al., Do the Merits Matter More? The Impact of the Private Securities Litigation Reform Act, 23 J.L. ECON. & ORG. 627, 630 (2007) (finding "a significantly greater correlation between litigation and both earnings restatements and abnormal insider selling after the PSLRA").
19. As the studies' authors acknowledge, the correlation will not be perfect. Some meritorious claims will lack hard evidence, and some hard evidence may not point to actual fraud. See id. at 649 ("[L]awyers may be unable to prove some meritorious claims under the rigorous constraints imposed by the PSLRA.").
20. For a discussion on how the merits affect settlement amounts, see infra Part III A.
21. Throughout this Article, we are dealing with the "fat middle" of securities class actions-i.e., those that are not too big and not too small. Researchers have shown that extremely small claims-those settling in the $2 million to $3 million range-are more likely to be nuisance claims. See James D. Cox et al., There Are Plaintiffs and . . . There Are Plaintiffs: An Empirical Analysis of Securities Class Action Settlements, 61 VAND. L. REV. 355, 383 (finding that small settlements exhibit qualities associated with strike suits). Similarly, the largest cases-those resulting in "megasettlements" of $300 million or more-differ systematically from those that are settled within or close to D&O insurance limits. As one defense counsel put it, [I]n a case that is going to go for $5 million, . . . usually the parties get together and say, you know, "Look, we should wrap this case up. It's not that big a case. I know you think it is." And you know that kind of thing happens, but in the bigger cases, it is just more complicated. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Defense Counsel #5, at 12 (May 23, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Defense Counsel #5];
22. see also id., Interview with Claims Head #9, at 15-17 (July 10, 2007) [hereinafter D&O Interviews, Claims Head #9] (noting that large settlements "bring in a lot of profits to yourself and the firm, a lot of name recognition and high profile, and as a result there's a lot attached, and the defense counsel who can stand above that and settle early is overcoming a lot of pressures," and that "[t]here's both psychological and career motivational factors to do otherwise"). For our purposes, the paradigmatic securities class action is one that settles for more than $2 million but either less than or not much more than total D&O insurance limits.
23. Qualitative research employs field interviews and other sociological techniques to develop thick descriptions of a problem area. See, e.g., Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 MICH. L. REV. 1724, 1725 (2001) (relying "on a detailed case study of contractual relations in the cotton industry to examine the ways that the rules, norms, and institutions that constitute the industry's [private legal system] create value for transactors"). We are not critics of quantitative research, but the use of regressions to how whether a particular variable is relevant requires an a priori theory of how something works, which then determines what kinds of data ought to be tested. We are asking the how question, not the whether question.
24. Pursuant to research protocols approved by the Institutional Review Boards of the University of Connecticut and Fordham University, we interviewed the participants under a promise of confidentiality. The interviews were recorded and transcribed, and participant-identifying information was removed from the transcripts. Copies of the redacted transcripts have been provided to the editors of the University of Pennsylvania Law Review for verification.
25. These interviews build upon an initial round of forty-eight interviews of directors' and officers' liability insurance professionals conducted in connection with our prior research. Baker & Griffith, supra note 8, at 493. We describe the interviews and their selection at the beginning of Part III of this Article.
26. Legal scholarship of this kind dates back to the Legal Realists, most notably Roscoe Pound and Karl Llewellyn. Cf. ROBERT C. ELLICKSON, ORDER WITHOUT LAW: HOW NEIGHBORS SETTLE DISPUTES (1991) (finding, primarily through field interviews, that neighbors in Shasta County, California, resolve most conflicts through the use of informal norms, rather than formal legal rules). Intensive qualitative research has long been the hallmark of anthropologists and much of sociology, and even of some scholars working within a law-and-economics framework, particularly in recent years.
27. See, e.g., RICHARD V. ERICSON ET AL., INSURANCE AS GOVERNANCE (2003) (offering a sociological investigation of the insurance industry);
28. SALLYENGLE MERRY, COLONIZING HAWAI'I: THE CULTURAL POWER OF LAW (2000) (presenting an anthropological investigation of the role of law in colonization);
29. H. LAURENCE ROSS, SETTLED OUT OF COURT: THE SOCIAL PROCESS OF INSURANCE CLAIMS ADJUSTMENTS (1970) (providing a sociological investigation of automobile law in action);
30. Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry, 21J. LEGAL STUD. 115 (1992) (describing the private legal system at work in the diamond industry);
31. Bernstein, supra note 15 (examining, through a detailed case study of the cotton industry, how private legal systems can reduce costs).
32. Policies cover not only losses incurred by individual directors and officers, but also losses incurred by the corporation itself in defending and settling securities claims. A typical policy excludes adjudication of "actual fraud," but pays for judgments where the defendants meet the lower standard of reasonableness. Policies typically cover amounts paid in settlement as well as defense costs. Because virtually all securities class actions settle without adjudication, the exclusion of "actual fraud" typically does not affect payment obligations, and it is not an overstatement to assert that D&O policies cover all losses typically incurred by corporations in connection with securities litigation. See Baker & Griffith, supra note 8, at 499-501 (describing important facets of the coverage offered by D&O policies).
33. See TOWERS PERRIN, DIRECTORS AND OFFICERS LIABILITY: 2006 SURVEY OF INSURANCE PURCHASING AND CLAIMS TRENDS 25 exhibit 29 (2006), available at http://www.towersperrin.com/tp/getwebcachedoc?webc=HRS/USA/ 2007/200704/ DO-Survey-Report2006-040507.pdf (reporting that 91% of public-company respondents in the United States purchased entity coverage). The annual Towers Perrin D&O survey is based on a nonrandom, self-selecting sample of companies. It is also the only systematic source of information on D&O insurance purchasing patterns in the United States. We therefore draw upon it as a source of aggregate data despite its methodological weaknesses.
34. According to the Towers Perrin data, the size of the average D&O policy ranges from approximately $20 million in limits for small-cap companies to over $195 million in limits for large-cap companies. Id. at 17 exhibit 13. At the same time, average D&O settlements range from less than $10 million for the majority of settlements to more than $100 million for the most expensive 11% of cases.
35. See STEPHANIE PLANCICH ET AL., NERA ECON. CONSULTING, RECENT TRENDS IN SHAREHOLDER CLASS ACTION LITIGATION 9-11 (2007), available at http://www.nera.com/image/BRO-Recent-Trends-Dec07- 0708-final.pdf (reporting that average settlements-excluding those over $1 billion-increased from $22.7 million in 2006 to $33.2 million in 2007, and noting that including settlements over $1 billion would raise the 2007 average to $40.2 million);
36. PRICEWATERHOUSECOOPERS, 2006 SECURITIES LITIGATION STUDY 33, 36-37 (2007), available at http://www.pwc.com/images/us/eng/about/svcs/advisory/pi/SecLitStudy -2006-Final.pdf (reporting that for cases that settled between $1 million and $50 million, the average setdement amount was $9.6 million, but the average for all cases settled in 2006 was $62.3 million, and that 11% settled for over $100 million);
37. LAURA E. SIMMONS & ELLEN M. RYAN, CORNERSTONE RESEARCH, SECURITIES CLASS ACTION SETTLEMENTS: 2006 REVIEW AND ANALYSIS 3 & fig.3 (2007), available at http://www.cornerstone.com/pdf/ practice-securities/2006Settlements.pdf (reporting that over 60% of all securities class action settlements in 2006 were for less than $10 million, consistent with past years). The average settlement is well within average limits.
38. See Cox, supra note 6, at 512 ("[A}pproximately 96% of securities class action settlements are within the typical insurance coverage, with the insurance proceeds often being the sole source of settlement funds."). 22 We are not the first to address the role of insurance in settlement.
39. See, e.g., Bernard Black et al., Outside Director Liability, 58 STAN. L. REV. 1055, 1067 (2006) (focusing on the importance of D&O insurance in explaining why outside directors almost never pay their own money in corporate and securities litigation settlements). However we are the first to address it directly with extensive participant interviews, relating our empirical observations from those interviews to the question of merit in securities litigation.
40. See Baker & Griffith, supra note 8, at 516-17 (finding that in addition to employing a variety of financial risk factors similar to those used by investors, underwriters evaluate risk through a consideration of a corporation's "deep governance" structure, which includes an assessment of the firm's "culture" and management's "character"),
41. See Tom Baker & Sean J. Griffith, the Missing Monitor in Corporate Governance: The Directors' & Officers' Liability Insurer, 95 GEO. L.J. 1795, 1822-23 (2007) (arguing, furthermore, that the entity-protection aspects of D&O coverage are likely to be pure waste from a diversified shareholder's point of view).
42. See id. at 1817-18;
43. see also John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation, 106 COLUM. L. REV. 1534, 1536 (2006) (emphasizing the deterrence function of securities class actions over the compensation function).
44. This fact, of course, does not mean that bad acts are wholly undeterred. Civil litigation is but one of the misfortunes that can befall one engaged in securities fraud, to which job loss, regulatory fines, and jail time must be added. See, e.g., Jonathan M. Karpoff et al., The Legal Penalties for Financial Misrepresentation 3 (May 1, 2007) (unpublished manuscript), available at http://ssrn.com/abstract=933333 (comparing regulatory and private penalties for misrepresentation claims). Our focus is solely on the component of deterrence against which would-be defrauders can be insured-i.e., civil litigation-and to which our conclusions are limited.
45. In our first article, we concluded mat risk-based pricing by D&O insurers is likely to have very little impact on the behavior of corporate executives-both because of the difficulty of predicting securities litigation risk and because D&O insurance prices and other contract terms are not disclosed to investors. Baker & Griffith, supra note 8, at 536, 538-40.
46. We concluded in our second article that D&O insurers do not engage in any significant monitoring and that, as a result, D&O insurance poses a significant moral hazard. Baker & Griffith, supra note 24, at 1817.
47. See generally 2 WILLIAM E. KNEPPER & DAN A. BAILEY, LIABILITY OF CORPORATE OFFICERS AND DIRECTORS §17.02 (7th ed. 2003) (listing 170 possible grounds for liability in shareholder litigation).
48. One study found that 77% of shareholder class actions from 1993 to 2002 were securities class actions, although the authors admit that this is likely overstated. Theodore Eisenberg & Geoffrey P. Miller, Attorney Fees in Class Action Settlements: An Empirical Study, 1J. EMPIRICAL LEGAL STUD. 27, 46 (2004) ;
49. see also TOWERS PERRIN, supra note 20, at 60 exhibit 83 (reporting that more than 80% of claims made against public companies dealt with securities issues).
50. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Monitoring Counsel #9, at 11 (Aug. 4, 2005) (unpublished interviews, on file with authors) ("The big exposure to D&O, .. . head and shoulders above everything else, is securities class actions ... .");
51. see also id., Interview with Policyholder #3, at 5 (Oct. 12, 2004) [hereinafter D&O Interviews, Policyholder #3] (claiming that "[s}ecurities litigation outweighs derivative litigation by far"). In the last two years there has been an unusually large number of derivative actions, many of which have arisen out of the recent revelations regarding options backdating. It is too soon to tell whether this increase indicates a trend or a unique event. In 2006, 22 of 131 securities cases filed were options backdating cases; in 2007-a year in which 38 subprime cases were filed-there were projected to be about 4.
52. See PLANCICH ET AL., supra note 21, at 2 (breaking down the types of federal shareholder class action suits for false registration statements).
53. See 15 U.S.C. §77k(a) (2006) (codifying the Securities Act's provision for civil liability for false registration statements).
54. See id. §78j (codifying the Exchange Act's prohibition of manipulative and deceptive devices).
55. See id. §77k (detailing the persons liable, the persons exempt, and the nature of the liability for misrepresentations and omissions).
56. See JAMES D. COX ET AL., SECURITIES REGULATION: CASES AND MATERIALS 481 (5th ed. 2006) (noting that the "essence" of a section 11 claim begins with "[a] material misrepresentation or omission in a registration statement").
57. 17 C.F.R. §240.10b-5 (2006).
58. STEPHEN J. CHOI & A.C. PRITCHARD, SECURITIES REGULATION: CASES AND ANALYSIS 252 (2005).
59. See, e.g., Coffee, Jr., supra note 25, at 1545 ("[A]lthough it would be an overstatement to say that the securities class action exclusively polices fraud in financial reporting, this seems to be its primary role.").
60. See CORNERSTONE RESEARCH, SECURITIES CLASS ACTION CASE FILINGS, 2007: A YEAR IN REVIEW 1 (2007) (reporting 2218 class actions, excluding IPO-allocation, analyst, and mutual-fund actions, filed between 1996 and 2007). In 2007, only 10% of securities class actions alleged a claim under section 12(2) of the Securities Act, which provides a remedy for securities sold by the issuer to the public pursuant to a false or misleading prospectus or oral communication.
61. Id. at 21 exhibit 19;
62. cf. 15 U.S.C. § 771(a)(2);
63. Gustafson v. Alloyd Co., 513 U.S. 561, 573 (1995) (limiting the applicability of section 12(2) to issuer communications in public offerings). We note that these are cumulative remedies and that the percentages need not add to one hundred.
64. The proper standard for scienter has not been elucidated fully by the Supreme Court. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 & n.12 (1976) (rejecting a negligence standard and holding that private plaintiffs must show scienter, but reserving the question of whether recklessness satisfies the standard). As a result, courts of appeals have fashioned their own standards, with most accepting that the standard has been met when a defendant, unaware of the true state of affairs, can foresee the likelihood that a statement will mislead.
65. See, e.g., AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 234 (2d Cir. 2000) ("In securities law, however, the critical issue is what a reasonable investor would have considered significant, and foreseeability is generally fromthe plaintiff's point of view. . . .");
66. SEC v. Falstaff Brewing Corp., 629 F.2d 62, 76 (D.C.Cir. 1980) (holding that information is material if "there is a substantial likelihood that a reasonable shareholder would consider [it] important in deciding how to vote" (internal quotation marks omitted) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438,449(1976))).
67. PSLRA sec. 101(b), §27(b)(1), 15 U.S.C. §77z-l (b)(1) (2006).
68. Id. §21D(b)(2), 15U.S.C§78u-4(b)(2).
69. 127 S. Ct. 2499 (2007).
70. Id. at 2504-05 (emphasis added).
71. Plaintiffs' lawyers commented that "sometimes .. . cases that don't look very good turn out to be great, and sometimes cases that look really good at the beginning turn out not to be so good, because you really don't know [prior to discovery]." Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Plaintiffs' Counsel #3, at 8 (May 25, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Plaintiffs' Counsel #3]. Similarly, a defense lawyer noted that neither side can get a firm sense of scienter until discovery: " [Y] ou want to get a sense of. . . what your documents look like. In the days of electronic discovery and e-mail, there is usually something, enough smoke in there that can be a concern to both sides. There is a lot more detail than there used to be." Id., Interview with Defense Counsel #1, at 14-15 (Mar. 24, 2007) [hereinafter D&O Interviews, Defense Counsel #1];
72. see also id., Interview with Claims Head #6, at 26 (May 16, 2007) [hereinafter D&O Interviews, Claims Head #6] ("Sometimes you get into discovery, and the discovery shows that[] what these plaintiffs thought was a real meritorious case really is nothing.").
73. See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976) (deeming information to be material if there is "a substantial likelihood that the disclosure . . . would have been viewed by the reasonable investor as having significandy altered the 'total mix' of information made available").
74. See Basic Inc. v. Levinson, 485 U.S. 224, 246 (1988) ("Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations."). Of course, if defendants can show that the relevant market does not efficiently impound information into share price, the fraud-on-me-market presumption of reliance will not apply.
75. See, e.g., In re Polymedica Corp. Sec. Litig., 453 F. Supp. 2d 260, 272 (D. Mass. 2006) (noting that scholarship that doubts the existence of perfect information efficiency sets a significant hurdle for plaintiffs). That the plaintiffs actually traded is a necessary element of the claim.
76. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 749-55 (1975) (holding that plaintiffs must be those who purchased or sold securities, not those who merely held them, between the time of the misstatement and the corrective disclosure).
77. See 544 U.S. 336, 347 (2005) ("[A]llowing a plaintiff to forgo giving any indication of the economic loss and proximate cause . . . would bring about harm of the very sort the [PSLRA] seek[s] to avoid.").
78. Courts have long treated loss causation as an element of Rule 10b-5, and in 1995, the PSLRA codified loss causation. See PSLRA sec. 101(b), §21D(b)(4), 15 U.S.C. §78u-4(b) (4) (2006) ("[T]he plaintiff shall have the burden of proving mat the act or omission of the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover damages.").
79. Dura, 544 U.S. at 347.
80. See Merritt B. Fox, After Dura: Causation in Fraud-on-the-Market Actions, 31 J. CORP. L. 829, 847-48, 850-56 (2006) (including in the issues that remain open situations where the plaintiff sells the security at a price higher than her purchase price, the price does not drop immediately after the corrective disclosure, and the plaintiff sells shares prior to the corrective disclosure).
81. See id. at 849 (noting that there is "little doubt that [such a] plaintiff satisfies the Court's requirements under Dura concerning causation").
82. See, e.g., Jay W. Eisenhofer et al., Securities Fraud, Stock Price Valuation, and Loss Causation: Toward a Corporate Finance-Based Theory of Loss Causation, 59 BUS. LAW. 1419, 1443-44 (2004) (describing a test for loss causation that determines whether disclosures revealing the effect of fraud actually affect share price).
83. See id. at 1444 ("An essential underpinning of our test is determining whether specific disclosures that reveal the effect of the fraud . . . actually impacted the share price of the stock at issue.");
84. Fox, supra note 50, at 850-51 ("The fact that there was no negative price reaction after the unambiguous announcement . . . does not rule out the possibility that the misstatement inflated the purchase price[,] . . . because . . . the market may have realized die true situation prior to the public announcement of the truth.").
85. See Eisenhofer et al., supra note 52, at 1442-43 ("The questions are: (i) was the stock price inflated by fraud; and (ii) has the stock price declined because the fraud is no longer propping up the price?");
86. Fox, supra note 50, at 854-55 ("[T]o prove that the misstatement caused a loss, the plaintiff must both show that the misstatement inflated the purchase price and that his sale occurred after at least partial market realization of the true situation.").
87. Cf. Fighting Class Actions, FIN. TIMES (U.S. & Can. ed.), Nov. 29, 2007, at 14.
88. See infra Part I.B.3.
89. See D&O Interviews, Plaintiffs' Counsel #3, supra note 44, at 8-10 (explaining that a potential case must show sufficient grounds for liability in order to survive a motion to dismiss at the outset);
90. Tom Baker & Sean J. Griffith, D&O Interviews, Roundtable Discussion, The Role of Directors' and Officers' Liability Insurance in the Settlement of Securities Class Actions, at the Fordham Corp. Law Ctr., in N.Y., N.Y., 59 (Nov. 16, 2007) (unpublished interviews, on file widi authors) [hereinafter D&O Roundtable] ("[L] et me just say I don't see a lot of this as very much different than negligence cases in the Bronx Supreme Court in lots of ways.");
91. see alsoTom Baker, Transforming Punishment into Compensation: In the Shadow of Punitive Damages, 1998 WIS. L. REV. 211, 222 (quoting a plaintiffs' personal injury lawyer who said, "I was taught on my first day of practice there are three things: liability, damages, collectibility").
92. As a plaintiffs' counsel put it, [s]o what we do is we have to figure out what we consider to be a wide range of damages very early on. Then we have to take a look at the solvency of the corporate defendant. You know, we will take a look at the company and just form some kind of rough judgment in our own minds, is this a company that is likely to have insurance and if so, a lot of insurance, a little bit of insurance? We don't even really worry about the insurance if the company is solvent.Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Plaintiffs' Counsel #5, at 7-8 (May 24, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Plaintiffs' Counsel #5].
93. See id., Interview with Plaintiffs' Counsel #6, at 2-3 (June 5, 2007) [hereinafter D&O Interviews, Plaintiffs' Counsel #6] (noting that his firm monitors market developments for institutional developments and that "one way or another we will either hear from the client, or we will be reporting to the client on what we are seeing");
94. id., Interview with Plaintiffs' Counsel #7, at 2 [hereinafter D&O Interviews, Plaintiffs' Counsel #7] ("[W]e monitor the research analyst [who] has this general Bloomberg and Dow Jones terminal [] and access to all the financial news and keeps CNN and CNBC going on a 24/7 basis, etc., etc. . . .").
95. See Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Plaintiffs' Counsel #1, at 10-11 (Jan. 31, 2007) (unpublished interviews, on file with authors) (describing how his firm obtains clients through referrals from the brokers that his firm represents in other capacities and through other lawyers);
96. D&O Interviews, Plaintiffs' Counsel #3, supra note 44, at 4-6 (describing how his firm relies on referrals from lawyers whose specific business is developing clients to pass on to litigation firms).
97. See Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Plaintiffs' Counsel #4, at 6 (May 31, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Plaintiffs' Counsel #4] (describing how his firm employs lawyers whose "sole job is to look at significant market movements," accompanied by some kind of disclosure, and then to "look at what the disclosures were sixty or ninety days before and if there is a gap, then they will do further investigation . . . to see whether [the gap is] associated with facts that suggest there was a nondisclosure");
98. see also D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 2 ("We have private investigators and use them.");
99. D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 1-2 ("We employ a team of people that includes three lawyers, a former Wall Street research analyst. . . . three or four private investigators that are led by a former FBI agent. . . , and we employ forensic accounting consultants . . . ."). 62 This may result from a selection effect in which lawyers decide not to take the less profitable cases, from the lawyers working the selected cases more intensively, or some combination of the two.
100. PSLRA sec. 101(b), §21D(a)(3)(B)(i), 15 U.S.C. §78u-4(a)(3)(B) (i) (2006);
101. see also James D. Cox & Randall S. Thomas, Does the Plaintiff Matter? An Empirical Analysis of Lead Plaintiffs in Securities Class Actions, 106 COLUM. L. REV. 1587,1595 (2006) (describing the "rebuttable presumption that the member of the class with the largest financial stake in the relief sought is the 'most adequate plaintiff'").
102. See Weiss & Beckerman, supra note 6, at 2062-63 (noting that the lawyer filing the first complaint is often appointed lead counsel by the court, and even where a court has a different procedure for appointing lead counsel, it generally also "rewards lawyers who file early").
103. Judges retain some discretion in selecting class counsel. The identity of the lead plaintiff can be affected by the definition of the class period (different institutional investors will have held different amounts of the affected securities during different periods), by the degree to which law firms are permitted to assemble groups of plaintiffs, and by the judge's assessment of the representativeness of the proposed plaintiff or plaintiffs' group. See Cox et al., supra note 14 (listing cases in which the largest plaintiff was not selected as lead plaintiff).
104. PSLRA sec. 101(b), §21D(a) (3)(B) (iii)(I), 15 U.S.C. §78u-4(a) (3)(B) (iii)(I).
105. See Stephen J. Choi, Motions for Lead Plaintiff in Securities Class Actions 13-20 (Law & Econ. Research Paper Series, Working Paper No. 08-53, 2008), available at http://ssrn.com/abstract=1293926 (reporting that even after the PSLRA, plaintiffs' lawyers remain influential in the selection of the lead plaintiff-often by aggregating groups of plaintiffs and cutting side deals);
106. see also Cox & Thomas, supra note 63, at 1588-90 (noting that the PSLRA's rebuttable presumption that the investor with the largest financial stake has the most interest produces strong incentives for plaintiffs' firms to seek out that investor);
107. D&O Interviews, Plaintiffs' Counsel #4, supra note 61, at 7 (describing how in a potentially significant class action, leading plaintiffs' law firms often wait until the very last day to file, so as not to tip off their competitors about the size of the potential losses that they have accumulated for their lead plaintiff application). The leading lawyers know each other, know who the key institutions are, and know which institutions tend to go with which lawyers, and our participants described a level of gamesmanship in trying to assess the extent of potential losses accumulated on competitors' lead-plaintiff applications.
108. As described by a prominent mediator, In a typical pre-PSLRA mediation, the mediator would ask the plaintiffs' lawyer to go out in the hall and speak to the client about a proposed offer. Perplexed, the plaintiffs' lawyer would respond, "I don't have a client here." "Well then," the mediator would respond, "why don't you go to the restroom, look in a mirror, talk to yourself, and come back here and tell me whether you want to accept the settlement or not."Nicholas Politan, Mediating Securities Class Actions: A View From the Captain's Quarters, INSTITUTIONAL INVESTOR ADVOC., Fourth Quarter, 2005, at 1,9.
109. Cox & Thomas, supra note 63, at 1623 & tbl.3;
110. see also James D. Cox & Randall S. Thomas, Leaving Money on the Table: Do Institutional Investors Fail to Fale Claims in Securities Class Actions?, 80 WASH. U. L.Q. 855, 877 tbl.3 (2002) (reporting similar findings).
111. See Stephen J. Choi & Robert B, Thompson, Securities Litigation and Its Lawyers: Changes During the Erst Decade After the PSLRA, 106 COLUM. L. REV. 1489, 1529 (2006) (reporting that institutional investors "tend to develop repeat relationships with only ahandful of the top-tier plaintiff law firms");
112. see alsoTom Baker & Sean J. Griffith, D&O Interviews, Interview with Plaintiffs' Counsel #8, at 13 (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Plaintiffs' Counsel #8] ("[The plaintiffs' firms are] spending money left and right going to political things. . . . [T] he guys who control the business in the public pension funds are all people who stand for election, and I don't have to tell you that somebody who stands for election [is interested in receiving campaign contributions].").
113. See Cox & Thomas, supra note 63, at 1624 & tbl.4, 1625 (reasoning that because institutional investors choose to appear in bigger, high-quality cases, settlement amounts will be higher when an institutional investor is present) ;
114. Michael A. Peřino, Institutional Activism Through Litigation: An Empirical Analysis of Public Pension Fund Participation in Securities Class Actions 3 (St. John's Univ. Sch. of Law, Legal Studies Research Paper No. 06-0055, 2006), available at http://ssrn.com/abstract=938722 (finding that cases with public-pension-fund plaintiffs have greater settlement amounts and lower attorneys' fees).
115. TODD FOSTER ET AL., NERA ECON. CONSULTING, RECENT TRENDS IN SHAREHOLDER CLASS ACTION LITIGATION 13 (2007), available at http://www.nera.com/ image/PUB-Recent-Trends-Sep2007-FINAL-4color.pdf (reporting that, on average, class actions with an institutional investor acting as lead plaintiff settle for approximately one-third more man actions involving other kinds of lead plaintiffs).
116. But for the fraud-on-the-market theory, each individual plaintiff would need to demonstrate reliance on the misrepresentation, a showing that would cause individual issues to dominate common-class issues, thereby preventing class certification. See Fox, supra note 50, at 839 (explaining that the fraud-on-the-market theory allows plaintiffs to prove reliance based on their paying a price that was too high in a purchase and not based on the defendant's actual misstatement). Federal Rule of Civil Procedure 23(b) (3) states that an action may be maintained if "the court finds that the questions of law or fact common to the members of the class predominate over any questions affecting only individual members." But some defendants have been successful at challenging the efficiency of the relevant market, thus requiring plaintiffs to make individual showings of reliance and thereby successfully challenging class certification.
117. See, e.g., In re Polymedica Corp. Sec. Litig., 453 F. Supp. 2d 260, 271 (D. Mass. 2006) (holding mat the plaintiffs did not make a strong enough showing of their own market efficiency to apply the fraud-on-ťhe- market theory);
118. see also Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Defense Counsel #4, at 13-14 (May 31, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Defense Counsel #4] (explaining ways to challenge class certification and citing Polymedica as an example of what can work).
119. See D&O Interviews, Defense Counsel #5, supra note 14, at 18 ("[C] lass certification . . . is becoming a much more rigorous process than it had [been].").
120. See, e.g., Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 271 (5th Cir. 2007) (vacating a class-certification order in a securities action because plaintiffs had not shown loss causation). However, most district court decisions in other circuits are at odds with this holding.
121. See Lapin v. Goldman Sachs & Co., No. 04-2236, 2008 WL 4222850, at *15 (S.D.N.Y. Sept. 15, 2008) (providing an overview of district court decisions that "have rejected the notion that a showing of loss causation is a requirement at the class certification stage");
122. See also Richard A. Nagareda, Class Certification in the Age of Aggregate Proof, 84 N.Y.U. L. REV. (forthcoming 2009) (manuscript at 3), available at http://ssrn.com/abstract=1247720 (critiquing the analysis performed by courts at class certification and emphasizing the role of courts in clearly articulating the governing law).
123. Compare Eisen v. Carlisle &Jacquelin, 417 U.S. 156, 177 (1974) ("[N]othing in either the language or history of Rule 23 . . . gives a court any authority to conduct a preliminary inquiry into the merits of a suit in order to determine whether it may be maintained as a class action."), with Gen. Tel. Co. v. Falcon, 457 U.S. 147, 161 (1982) (holding that courts must conduct a "rigorous analysis" of the Rule 23 requirements), and Coopers & Lybrand v. Livesay, 437 U.S. 463, 469 n.12 (1978) (stating that the analysis of Rule 23 requirements will be "intimately involved with the merits of theclaims"
124. (quoting CHARLES A. WRIGHT ET AL., FEDERAL PRACTICE AND PROCEDURE§ 3911, at 489 n.45 (1976))).
125. See, e.g., Szabo v. Bridgeport Machs., Inc., 249 F.3d 672 (7th Cir. 2001) (permitting courts to "look[] beneath the surface of a complaint to conduct the inquiries identified in [Rule 23]," and holding that if those Rule 23 inquiries "overlap [with] the merits . . . then the judge must make a preliminary inquiry into the merits"). A similar rule is followed in the First, Second, Third, Fourth, Fifth, Sixth, and Eleventh Circuits.
126. See, e.g., Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., 546 F.3d 196, 202 (2d Cir. 2008) (holding that in the Second Circuit, "the preponderance of the evidence standard applies to evidence proffered to establish Rule 23's requirements");
127. In re IPO Sec. Litig., 471 F.3d 24, 41 (2d Cir. 2006) (holding that district courts must determine that each of the Rule 23 requirements has been met prior to certifying a class, even where Rule 23 requirements involve factual disputes and overlap with the merits);
128. Waste Mgmt. Holdings, Inc. v. Mowbray, 208 F.3d 288, 298 (1st Cir. 2000) (noting that "a district court must formulate some prediction as to how specific issues will play out in order to determine whether common or individual issues predominate in a given case").
129. Stephen J. Choi et al., The Screening Effect of the Private Securities Litigation Reform Act 32 tbl.l (Univ. of Mich. Law Sch., John M. Olin Ctr. for Law & Econ., Working Paper No. 07-008, 2007), available att http://ssm.com/abstract=975301.
130. See Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Claims Head #2, at 21 (Jan. 30, 2006) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Claims Head #2] ("The events surrounding a motion to dismiss are the first genuine settlement opportunity.");
131. D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 18-19 ("[T]here are natural breaking points for settlement discussions. The first is generally after the motion to dismiss is decided . . . .");
132. D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 27-28 ("Well, the biggest issue is surviving the motion to dismiss. I mean if you survive a motion to dismiss you're going to be okay until you get to summary judgment, and usually those cases settle.").
133. See FED. R. CIV. P. 8(a) (establishing the pleading standard in federal courts).
134. See Bell Atlantic Corp. v. Twombly, 127 S. Ct. 1955, 1974 (2007) (holding that to survive a motion to dismiss, a complaint must allege sufficient facts to support a "plausible"-and not merely "conceivable" -claim for relief).
135. See Cool v. Int'l Shoe Co., 142 F.2d 318, 320 (8th Cir. 1944) ("[0]n a motion to dismiss for insufficiency of statement, the complaint should be construed in the light most favorable to the plaintiff and with all doubts resolved in his favor.").
136. See supra notes 42-44 and accompanying text.
137. See supra notes 47, 49 and accompanying text.
138. See D&O Interviews, Plaintiffs' Counsel #4, supra note 61, at 4 (describing how plaintiffs must invest more in a case to prove its strength in order to survive the motion to dismiss after the PSLRA) ;
139. See also Stephen J. Choi, Do the Merits Matter Less After the Private Securities Litigation Reform Act?, 23 J.L. ECON. & ORG. 598, 620-21 (2006) (providing evidence that claims lacking hard evidence of fraud are more likely to be dismissed in the post-PSLRA period) ;
140. Johnson et al., supra note 11, at 643-45 (finding that plaintiffs after the PSLRA tailor their accusations to a real likelihood of fraud in order to survive a motion to dismiss).
141. See, e.g., Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Monitoring Counsel #8, at 11 (June 13, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Monitoring Counsel #8] ("[T]here is a lot of talk in the industry about how some of these cases need to be pushed to summary judgment and not to settle until a decision is made at the summary judgment level, but to date I am literally not aware of a single one.").
142. As one monitoring counsel noted, [T] here is often a big pressure to settle, Often you want a relatively quick space after the motion to dismiss litigation phase.... Some people are kind of thinking through that a little bit more because it makes sense to push some of these cases towards summary judgment or not [depending on] how likely [it is] that you can likely get summary judgment in a 10b-5 case where the motion to dismiss is denied. . . . I am not aware of any 10b-5 cases that have been dismissed at the summary judgment stage.Id. at 10.
143. An exception to this rule is the WorldCom case, which generated a summary judgment opinion. In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y, 2004).
144. NERA reports that between 1991 (when they started collecting this data) and 2007, around 3900 federal securities cases were filed against public companies. See PLANCICH ET AL., supra note 21, at 2 (charting the total number of federal filings annually);
145. see also CORNERSTONE RESEARCH, supra note 38, at 5 exhibit 3 (reporting 2218 class actions filed from 1996 to 2007);
146. PRICEWATERHOUSECOOPERS, supra note 21, at 2 (2007) (reporting similar numbers).
147. Black et al., supra note 22, at 1064. The statistic includes only securities law cases seeking damages from "public companies, their officers and directors, or both."
148. Id.
149. See ADAM T. SAVETT, RISKMETRICS GROUP, SECURITIES CLASS ACTION TRIALS IN THE POST-PSLRA ERA 2 (2008), available at http://slw.riskmetrics.com/ SCAS% 20Trials.pdf.
150. See Fighting Class Actions, supra note 55.
151. See D&O Interviews, Defense Counsel #4, supra note 73, at 29 ("What you do know is that when it goes to trial, defendants tend to win. You do know when it goes to trial, our experts will outperform their experts . . . .");
152. D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 11 ("[H]aving a firm trial date where a jury is going to decide for you or against you is often a driver for settlement."). Of course, if every case settles well before reaching the courthouse steps, the threat rings empty.
153. See Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Monitoring Counsel #2, at 51 (May 3, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Monitoring Counsel #2] (reporting that electronic data discovery alone costs $1 million to $3 million in a public-company securities case).
154. See STEVEN SHAVELL, FOUNDATIONS OF ECONOMIC ANALYSIS OF LAW 401-03 (2004) (providing a formal model and offering examples of how trial costs encourage parties to settle rather than continue litigation).
155. See Black et al., supra note 22, at 1098 ("In securities and corporate litigation, defendants' costs are usually higher man plaintiffs' costs . . . .").
156. See Baker & Griffith, supra note 8, at 495 n.29 (estimating that defense costs represent at least 25% of a typical class action settlement).
157. Our participants reported that the immediate impetus to settle is likely to be a corporate event-a change of CEO, merger, or acquisition transaction, or other corporate event that causes the defendant to wish to eliminate contingent liabilities, including the pending securities claim. See, e.g., D&O Interviews, Defense Counsel #5, supra note 14, at 14-15 ("[I]t could be that they want to sell the company and they want to get everything behind them[,] . . . [or] that they are going to get rid of the CEO . . . and they want to have everything happen on the watch of the old CEO."); Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Defense Counsel #6, at 1 (May 15, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Defense Counsel #6] (explaining that litigation usually results from corporate-governance problems or the hiring or firing of a CEO) ;
158. id., Interview with Monitoring Counsel #6, at 22-23 (May 8, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Monitoring Counsel #6] (describing situations such as a change in general counsel, a new CEO, or a proxy fight threatening exposure preceding litigation). Such events can, of course, occur at any time during the life of a claim.
159. See Choi et al., supra note 78, at 5 (noting that the PSLRA prevents discovery while there is a pending motion to dismiss);
160. see also D&O Interviews, Defense Counsel #1, supra note 44, at 14 ("[T]he real opportunity [to settle] is right after the motion [to dismiss] is denied . . . .");
161. D&O Interviews, Monitoring Counsel #8, supra note 86, at 10 (noting that a promising opportunity for settlement comes "after the motion to dismiss litigation phase"); D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 19 ("I don't know what the percentages are, but there are a group of cases that will be settled in between the date the judge comes down with the decision [on the motion to dismiss] and the date you start to get heavily involved in discovery,").
162. We note that it is also reasonable to suppose that some claims that would ultimately prove meritorious are disposed of at the motion to dismiss because, without discovery, not enough facts could be found to support the "strong inference" standard for scienter. The motion to dismiss, in other words, is probably both over- and underinclusive as a filter for merit.
163. See, e.g., Robert G. Bone & David S. Evans, Class Certification and the Substantive Merits, 51 DUKE L.J. 1251, 1251, 1254 (2002) (critiquing the class-certification rules for "avoid[ing] inquiring into the merits of substantive issues" and thus "inviting frivolous class action suits");
164. Choi, supra note 85, at 599 (noting that "the PSLRA requires courts to review a class action on the merits . . . and impose sanctions. . . on frivolous litigation").
165. See generally Choi, supra note 9, at 1472-73 (noting the problematic character of "merit");
166. Johnson et al., supra note 11, at 649 (cautioning that the proxies used in their article may not fully capture "merit").
167. See supra notes 74-77;
168. see also D&O Interviews, Claims Head #6, supra note 44, at 62 ("Well, it's impossible for me to guess what other people mean when they say 'merits,' and I, well I like the concept of settling the cases based on the merits. I haven't quite given up on that hope, but it just doesn't happen. The most I can hope to achieve is to get a reasonable settlement value based on what other cases, similar cases are being resolved for.");
169. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Defense Counsel #2, at 3 (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Defense Counsel #2] ("[I]t's like the difference between gross motor skills and fine motor skills. Merits matter, but they matter at the level of the gross motor skills.");
170. D&O Interviews, Defense Counsel #6, supra note 97, at 10 ("[M]y experience is that the level of settlement has nothing to do with the merits of the claim.");
171. D&O Interviews, Monitoring Counsel #6, supra note 97, at 29 ("I have almost religiously said merits do matter, because most of the time if you pay attention to what really happens meaningful [Iy] at the friction points in either mediations or other settlement discussions, it is ultimately the fear of bad facts being proven, and I think that is merits.").
172. This may explain why some of the closed-claim research treats payment as an on/off variable rather than a continuous variable. See, e.g., Frederick W. Cheney et al., Standard of Care and Anesthesia Liability, 261 J. AM. MED.ASS'N 1599,1601-02 (1989) (using payment as bom an on/off and continuous variable) ;
173. Frank A. Sloan & Chee Ruey Hsieh, Variability in Medical Malpractice Payments: Is the Compensation Fair?, 24 LAW & SOC1Y REV. 997,1006 (1990);
174. Stephen J. Spurr & Sandra Howze, The Effect of Care Quality on Medical Practice Litigation, 41 Q. REV. ECON. & FILN. 491, 502-04 (2001);
175. see also Mark I. Taragin et al., The Influence of Standard of Care and Severity of Injury on the Resolution of Medical Malpractice Claims, 117 ANNALS INTERNAL MED. 780, 781-82 (1992) (treating settlement or jury award as simply "payment" while also subdividing jury award by amount).
176. For a criticism of that approach, see Tom Baker, Reconsidering the Harvard Medical Practice Study Conclusions About the Validity of Medical Malpractice Claims, 33 J.L. MED. & ETHICS 501, 508 (2005).
177. See TOM BAKER, THE MEDICAL MALPRACTICE MYTH 68-87 (2005) (collecting and analyzing the closed-claim-file literature published through March 2004);
178. David M. Studdert et al., Claims, Errors, and Compensation Payments in Medical Malpractice Litigation, 354 NEW ENG. J. MED. 2024, 2024 (2006) (reporting the results of the most recent and most definitive medical malpractice closed-claim-file review);
179. see also Philip G. Peters, Jr., What We Know About Medical Malpractice Settlements, 92 IOWA L. REV. 1783, 1787-1802 (2007) (explaining the latest effort to collect malpractice-settlement research).
180. Cf. D&O Interviews, Defense Counsel #4, supra note 73, at 50 ("I count damages as part of merits.").
181. See, e.g., Steven Shavell, Suit, Settlement, and Trial: A Theoretical Analysis Under Alternative Methods for the Allocation of Legal Costs, 11J. LEGAL STUD. 55, 74 (1982) (modeling settlement outcomes based on different variables).
182. See Johnson et al., supra note 11, at 632 (opting to investigate multiple attributes instead of a single attribute as was done in prior research).
183. See id. at 649 (concluding that the "study provides some evidence that the merits do matter more, at least in the filing of complaints and the allegations included in those complaints"). 109 In the first phase of our research we interviewed forty-one people involved in selling and buying D&O insurance: brokers, underwriters, risk managers, reinsurers, and attorney advisors.
184. See Baker & Griffith, supra note 24, at 1798 (describing interviews with over forty people regarding "the relationship between D&O insurers and their public company insureds");
185. Baker & Griffith, supra note 8, at 493 (describing the breakdown by job type of the forty-one people interviewed).
186. See generally D&O Roundtable, supra note 57, at 4 (describing the goals and conditions of the discussion).
187. It is worth noting that no one whom we approached refused to be interviewed. We did not interview everyone we approached because of the limits of time. In order to avoid a potential bias attributable to the time constraints of the most busy attorneys, we made a special effort to interview attorneys with a reputation for being in great demand during the period of our interviews. 112 As one of our participants said, quoting a co-coverage counsel, "it's a really small sandbox. You don't want to pee in it." Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Monitoring Counsel #3, at 73 (May 25, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Monitoring Counsel #3]. As another monitoring counsel noted, Because the bar is so small, your personal reputation counts. Integrity counts. Saying you are going to do a deal means something. You know double crossing someone, maybe you can pull it off once, but you are going to be caught. So there is that, that you trust people within this circle, and of course you do have all the due diligence and documentation and settlement agreements that are [a] million pages long, but there is some level of trust, some level of candor.D&O Interviews, Monitoring Counsel #8, supra note 86, at 25.
188. See Choi & Thompson, supra note 70, at 1518 (arguing that the PSLRA initially succeeded in making this universe smaller, but that in recent years the universe has expanded to pre-PSLRA levels). Even as firms have split, the major players have remained the same, as the pay-to-play controversy surrounding Mel Weiss and Bill Lerach has shown.
189. See, e.g., Barry Meier, Another Notch for U.S. Prosecutors: Lawyer Pleads Guilty in Kickback Case Involving His Firm, N.Y. TIMES, Sept. 19, 2007, at C3 (describing Lerach's indictment on behavior stretching back to the 1970s);
190. Barry Meier, Top ClassAction Lawyer Faces Federal Charges: Accused of Payoffs to Enhance Legal Fees, N.Y. TIMES, Sept. 21, 2007, at C3 (reporting on the indictment of Melvyn Weiss for obtaining $250 million in legal fees on class action cases for which his firm paid kickbacks to plaintiffs) ;
191. David Weidner, No Class, But a Lot of Action: Bill Lerach, MARKET WATCH, Aug. 30, 2007, http://www.marketwatch.com (enter "Bill Lerach" in Search Box in upper righthand corner; then follow second hyperlink to "David Weidner's Writing on the Wall") (reporting that despite Lerach's departure, his firm had filed twelve class actions in August 2007).
192. See ADAM SAVETT, RISKMETRICS GROUP, SCAS 50 POWER RANKINGS 1 (2007) (providing data on settlement amounts from 2003 to 2006 for the top fifty securities class action firms). Of note, we treat Milberg Weiss and Lerach Coughlin as two separate firms even in 2003, and we treat firms that have retained the same key named partner(s) over the years as the same firm.
193. See also Choi & Thompson, supra note 70, at 1515 tbl.3 (reporting that four plaintiffs' firms have handled cases that represent 50% of the total settlement value since 1995).
194. See Baker & Griffith, supra note 24, at 1816-17 (noting that though the panel counsels from two of the leading D&O insurance companies did not include all leading securities defense firms, those firms on the list were primarily large national firms or specialized litigation firms with distinguished reputations).
195. AIG and Chubb account for approximately 60% of the market by premium volume. TOWERS PERRIN, supra note 20, at 39 exhibit 54. By policy count they rank third and first, respectively, while ACE ranks second.
196. Id.
197. Only about twenty-six firms are active in the public D&O insurance market at any time. Id.
198. Consider the following description of the settlement process, as related by a monitoring counsel: A. It's starting off on opposite extremes and working to the midpoint. Q. And what is . . . one of the tools that you use to get to the midpoint? A. Basically, arguing to the plaintiffs that their case doesn't have a sex appeal, doesn't have the players, doesn't have the damages, doesn't have any of the factors that make a case expensive, and sometimes you win, sometimes you lose. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Monitoring Counsel #7, at 35-36 (June 13, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Monitoring Counsel #7].
199. See, e.g., George L. Priest & Benjamin Klein, The Selection of Disputes for Litigation, 13 J. LEGAL STUD. 1, 6-30 (1984) (presenting a model that predicts litigation outcomes based on economic conditions).
200. See, e.g., D&O Roundtable, supra note 57, at 57 ("[I]t's not just a question of 'Is it liability or damages?' It's really, 'What are the probabilities for success?' You can call it any label you want.").
201. Cf. Marc Galanter, The Civil Jury as Regulator of the Litigation Process, 1990 U. CHI. LEGAL F. 201, 246-51 (questioning the ability of trial lawyers to predict jury verdicts).
202. See Johnson et al, supra note 11, at 634-36 (examining factors such as false or misleading forward-looking statements, stock sales by executives and directors, and weak corporate governance (which often leads to SEC investigations), and the ability of these factors to predict settlement outcomes in cases of alleged securities fraud).
203. A plaintiffs' counsel listed the factors that increase settlement value as including " [r]estatement, insider selling[,] , . . suspicious stock repurchase programs [,] . . . accounting violations . . . [, and] rebates which often go[] on in the . . . resale wholesale industry." D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 18. In addition, a mediator told us that [the mediator will say] "Look, there is no sizzle in this case. You don't have any of the upgrades," he said, "that make this a nice case. You don't have the accounting restatement. You don't have the SEC investigation. You don't have the executives being led out of the office in handcuffs, all of which are sort of sizzle facts," he said, "that might lead to a nice settlement for the plaintiffs. You don't have any of that stuff. This is kind of a boring case." Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Mediator #2, at 8 (June 4, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Mediator #2];
204. see also D&O Interviews, Monitoring Counsel #7, supra note 118, at 8 ("[T] here are some factors in the litigation that give it what is normally referred to as sex appeal. And you know insider trading . . . where the defendants have profited greatly from their sale of the company stock, that gives a case sex appeal. And the backdated options cases are a perfect example of that, and there is not really much in the way of hard injury to the company from these backdated options. . . .").
205. See D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 18 ("What else [might affect settlement outcomes]? Obviously bonuses associated with stock performance.").
206. See supra note 39 and accompanying text (discussing the standards that the courts of appeals have created for establishing scienter).
207. D&O Interviews, Monitoring Counsel #7, supra note 118, at 8;
208. see also Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Claims Head #1, at 22 (Dec. 2005) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Claims Head #1]. The same Claims Head also noted that "the sexier the case, the more interest there is."
209. Id.
210. Describing how he gets an initial impression of the value of a claim, one claims head distinguished between cases with sex appeal and those without: "[Y] ou take a look at what is alleged. You know, is this part of a scandal? Is this one of these where it is outright cooking of the books? Or is it. . . just old-fashioned misrepresentations of what they call projection cases?" Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Claims Head #3, at 35 (Feb. 12, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Claims Head #3].
211. D&O Interviews, Mediator #2, supra note 123, at 8,
212. D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 30.
213. See Norbert Schwarz & Leigh Ann Vaughn, The Availability Heuristic Revisited: Ease of Recall and Content of Recall as Distinct Sources of Information, in HEURISTICS AND BIASES: THE PSYCHOLOGY OF INTUITIVE JUDGMENT 103, 103 (Thomas Gilovich et al. eds., 2002) (describing the "availability" heuristic as the means by which individuals estimate the likelihood that an event will occur, and examining studies that attempt to explain the underlying mental processes involved in the availability heuristic).
214. As one observer explained,More often than not . . . we hear there is really noming there, but there's these documents and these e-mail messages that if taken out of context could be embarrassing and maybe would put things together so that we would have something to explain to a jury, and by the way, our president and CFO and CEO, there's no way we can possibly present them to a jury.D&O Interviews, Claims Head #6, supra note 44, at 26-27.
215. D&O Interviews, Defense Counsel #6, supra note 97, at 9-10, 14-15 (emphasizing the cost to the organization of executive testimony in terms of lost executive time, bad publicity, and legal costs in preparing for deposition and testimony, and also noting the possibility that the relevant people may no longer be with the organization and would therefore make unreliable witnesses).
216. See D&O Interviews, Monitoring Counsel #6, supra note 97, at 31 ("[I]t's about telling you the story and having somebody gasp as you are saying it and say, you know, 'I can't believe it.'").
217. D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 28-29. As one defense lawyer put it, "[I]nsider trading makes a dramatic difference in terms of the value of a case. Now you say, 'Well that's not really the merits. That's the cosmetics.' OK, [but] they merge a little bit."
218. D&O Interviews, Defense Counsel #4, supra note 73, at 50.
219. See supra note 39 and accompanying text (discussing the standards that the circuit courts have created for establishing scienter).
220. See, e.g., D&O Interviews, Claims Head #3, supra note 127, at 35 (distinguishing between weaker "old-fashioned misrepresentation of projection cases" and "accounting manipulations" that involve "outright cooking of the books");
221. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Claims Head #5, at 59-64 (Mar. 14, 2007) [hereinafter D&O Interviews, Claims Head #5];
222. id., Interview with Claims Head #7, at 34-35 [hereinafter D&O Interviews, Claims Head #7] (describing conflicts among parties on the defense side, such as the mistrust between outsiders and insiders when outsiders believe that they are not receiving adequate information);
223. id., Interview with Defense Counsel #3, at 20 (May 23, 2007) [hereinafter D&O Interviews, Defense Counsel #3] (" [I]f people have been convicted of crimes and stuff like that, then the plaintiffs are going to hang tougher for a bigger number to get a better case.");
224. D&O Interviews, Monitoring Counsel #8, supra note 86, at
225. D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 7-8 (describing board-member resignation occurring immediately before a decrease in the value of a stock) ;
226. D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 19 (citing "suspicious stock repurchase programs" as a sign of internal problems within a company). For a more concrete illustration, consider the following:Yeah, we've had situations where literally there were allegations of trucks just going in a circle and then you know coming back, you know like an airplane that never lands, but they log it in as a flight. You know the flight to nowhere. I remember once with a prominent firm you danced around it, but essentially didn't deny that trucks were kind of parked somewhere, and it was like a question of you didn't have enough space we think in these storage facilities. They had to move space somewhere else and there were some lame things, and those kind of cases are obviously very troubling.
227. D&O Interviews, Monitoring Counsel #8, supra note 86, at 42-43.
228. D&O Interviews, Monitoring Counsel #6, supra note 97, at 29.
229. See, e.g., D&O Interviews, Defense Counsel #1, supra note 44, at 29 (asserting that while the merits are a factor in settlement negotiations, the driving force is the amount of investor loss, which is reflected in the amount of damages).
230. See PLANCICH ET AL., supra note 21, at 14 (finding that investor losses are the most powerful determinant of settlement values and account for upwards of 50% of settlement values' variation);
231. D&O Interviews, Defense Counsel #5, supra note 14, at 16-17 (arguing that plaintiffs often drive settlement values because insurers pattern their responses to claims based on the potential damages to the corporation's stock value caused by harmful disclosures).
232. D&O Interviews, Defense Counsel #1, supra note 44, at 29;
233. see also D&O Interviews, Defense Counsel #4, supra note 73, at 11 ("By the time you get to mediation, damages is very much in the forefront of the discussion.");
234. D&O Interviews, Mediator #2, supra note 123, at 4 ("Potential damages is the number one thing. . . .");
235. D&O Interviews, Monitoring Counsel #7, supra note 118, at 8-9 ("I think the largest and mostdetermining factor is potential damages. . . .");
236. D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 22 (" [T] he most important factor is the amount of the damage. . . .") ;
237. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Policyholder #2, at 6 (May 31, 2007) (unpublished interviews, on file with authors) ("He said that he thinks they do argue about liability but the damages more.").
238. D&O Interviews, Defense Counsel #5, supra note 14, at 16.
239. D&O Interviews, Monitoring Counsel #6, supra note 97, at 25;
240. accord D&O Interviews, Monitoring Counsel #8, supra note 86, at 13 ("[Y]ou said you wanted to talk to me about why they don't get tried, and it's real simple. The stakes are just too high. . . . [I] t is difficult for insurers to really want to run that risk.") ;
241. see also D&O Interviews, Defense Counsel #3, supra note 136, at 46 ("I mean you could tick off all the reasons you want to settle. . . . The numbers are too big . . . .");
242. D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 11 ("[Y] ou are driving your case to trial, and very few people want to shoot the moon.");
243. D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 16 ("[T] tying one of these big huge cases, it's hugely time consuming, hugely costly, and hugely risky.");
244. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Mediator #1, at 3 (May 25, 2007) (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Mediator #1] ("The stakes are huge, and oftentimes it requires massive document and discovery investigation, and lots of unsettled questions as to actually how to finish the case.");
245. id., Interview with Monitoring Counsel #4 & #5, at 3 (May 16, 2007) [hereinafter D&O Interviews, Monitoring Counsel #4 & #5] ("[T]here is too great of a risk for the insured.");
246. D&O Interviews, Monitoring Counsel #7, supra note 118, at 18 (explaining that "the potential exposure is overwhelming").
247. 2 THOMAS LEE HAZEN, THE LAW OF SECURITIES REGULATION §§12.12[1], at 533, 12.15[I][J] (4th ed. 2002) (describing damages as a "confused area," but noting that under the 1995 Reform Act, damages are limited to the losses actually caused by material misstatements or omissions or what can be legally proven).
248. "10x80" means that his company sold a $10 million layer of insurance that does not come into play until $80 million has been paid by some combination of the insured and the underlying layers of insurance.
249. D&O Interviews, Claims Head #3, supra note 127, at 34-36.
250. Id. at 95-96. The participant, however, conceded in the next breath that "a better fraud case . . . would settle faster."
251. Id. at 96,
252. See D&O Interviews, Monitoring Counsel #7, supra note 118, at 8-9 ("I think the largest and most determining factor is potential damages[.] . . . [S]tudies . . . that we refer to are extrapolations from . . . plaintiffs'-style damages. And they say if the plaintiffs'-style damages expert say[s] that damages are X, then the settlement value is a percentage within a fairly narrow band of X").
253. Our participants used the term "plaintiffs'-style damages" imprecisely. As a result, it took us some time to realize that they were using the term differently in different contexts. Sometimes, as in this quotation, the term means the investor-loss amount. Other times it was simply a term of opprobrium for an inflated damages number produced using methods that, in the defense lawyers' view, failed to take loss causation adequately into account.
254. D&O Interviews, Claims Head #5, supra note 136, at 62.
255. See FOSTER ET AL., supra note 72, at 9 (finding that investor losses are the greatest predictor of settlement values).
256. See Baker & Griffith, supra note 8, at 527-32 (exploring the three components-"the algorithm, the system of credits and debits, and the market constraint"-that D&O underwriters use to derive an insurance price).
257. Id. at 528-29.
258. Id. at 490.
259. Id. at 529-32.
260. D&O Interviews, Defense Counsel #5, supra note 14, at 17-18.
261. D&O Interviews, Defense Counsel #4, supranote 73, at 11-12.
262. See, e.g., D&O Interviews, Monitoring Counsel #4 & #5, supra note 142, at 2-3 ("These damages models ... were very often BS, but an important factor here ... is that the damages models are never tested.");
263. D&O Interviews, Monitoring Counsel #7, supra note 118, at 12 (noting that Dura offered "a great windfall that the defense lawyers thought was coming their way [but that] just hasn't materialized because the plaintiffs have said, 'No, you can't have periodic disclosures which have a cumulative effect of bringing the price down.' So you look at the drop at the occasion of each what they call partial disclosure, and that's what creates the damages").
264. D&O Interviews, Claims Head #9, supra note 14, at 20.
265. See Baker & Griffith, supra note 24, at 1797 ("U.S. publicly traded corporations - virtually all of them - protect themselves against the costs associated with corporate and securities law liability by purchasing D&O insurance.").
266. See Baker & Griffith, supra note 8, at 499-501 ("[A]ll D&O policies have the effect of shifting the risk of shareholder litigation from individual directors and officers and the corporation they manage to a third party insurer.");
267. supra text accompanying note 19.
268. The D&O insurer compensates individual directors and officers only when the corporation itself cannot indemnify them, as, for example, when the corporation is insolvent or when the payment is to settle a derivative claim. Baker & Griffith, supra note 24, at 1802-03.
269. A typical policy under "Side A" coverage protects each individual officer or director, "Side B" coverage protects the corporation itself from losses resulting from its indemnification obligations to individual directors and officers, and "Side C" coverage protects the company when it is itself a defendant in a shareholder claim. Baker & Griffith, supra note 8, at 499.
270. Baker & Griffith, supra note 24, at 1802-04.
271. See D&O Interviews, Claims Head #1, supra note 126, at 40 ("I think it is easier to get money out of an insurance carrier than it is out of an insured. Why? Because it is a third party's money. We are in the business of paying claims. That is what we do for a living.");
272. D&O Interviews, Defense Counsel #3, supra note 136, at 34 ("You know, the company doesn't care about the insurance company's money.");
273. D&O Interviews, Monitoring Counsel #6, supra note 97, at 25 ("[I]t is much easier to [talk settlement] when you can play with somebody else's money.").
274. D&O Interviews, Monitoring Counsel #6, supra note 97, at 26.
275. In the words of one of our participants, "insurers more often than not are not really interested in how good or bad your case is. ... [W]hat they really want to do is save money." D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 23.
276. The precise percentage of D&O insurer profits from investment on reserves cannot be calculated because the aggregate financial statistics used for studying insurance solvency and other topics do not separately report the results of D&O insurance. Nevertheless, it is possible to report that in the general category that includes D&O insurance ("other liability"), investment income has varied between a high of almost 28% of net premiums in 1998 and a low of 11% of net premiums in 2002. See A.M. BEST CO., AGGREGATES & AVERAGES: PROPERTY/ CASUALTY 415 (2007) (reporting results for net underwriting experience in the insurance industry through 2006).
277. See AM. INT'L GROUP (AIG), EXECUTIVE AND ORGANIZATION LIABILITY INSURANCE POLICY § 8 (2000) ("The Insureds shall not admit or assume any liability, enter into any settlement agreement, stipulate to any judgment, or incur any Defense Costs without the prior written consent of the Insurer.").
278. See id. ("The Insurer's consent shall not be unreasonably withheld, provided that the Insurer shall be entitled to effectively associate in the defense, the prosecution and the negotiation of any settlement of any Claim that involves or appears reasonably likely to involve the Insurer.").
279. D&O Interviews, Monitoring Counsel #4 & #5, supra note 142, at 6.
280. See Kent D. Syverud, The Duty to Settle, 76 VA. L. REV. 1113, 1116-17 (1990) (noting that an insurer's failure to accept a reasonable settlement demand within the policy limits is evidence of bad faith).
281. See Black et al., supra note 22, at 1100-01 (arguing that several countervailing pressures motivate insurers with low risk exposure to settle rather than take a chance at trial).
282. As one plaintiffs' lawyer has stated, insurance is very much a factor in settlement amounts, ... [since] companies are [much] more willing to pay with insurance-company money than with their own money.... [T]hey are very much mindful of setting up the bad-faith case in their settlement strategy, that they always try to offer within limits with exceptions, ... and when they craft settlement offers that are less thanthe total tower, they will craft those offers mindful of the structure of the tower so as to put pressure, say, on Level 3 carrier. ... Any time that you offer to settle within limits of Level 3, then what you have got as your ally Levels 4, 5, and 6 who are pushing Level 3 to settle, and if Level 1 and 2 have already decided that it is into the third carrier level, that brings a lot of pressure on that third carrier. D&O Interviews, Plaintiffs' Counsel #4, supra note 61, at 13-14;
283. see also D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 23 ("[R]eally good mediators are particularly sensitive to insurance carriers and particularly sensitive and aware of putting carriers in a bad-faith posture. ... [T]hat's the only thing that can really create the leverage. Because otherwise, the worst that could happen to them is they pay out insurance money that... someone is paying a premium for."). This is part of the stock in trade of plaintiffs' lawyers any time that a defendant has liability insurance.
284. See Baker, supra note 57, at 223-25 (explaining how plaintiffs' lawyers craft settlement offers to place pressure on insurers).
285. One plaintiffs' lawyer described it as follows: Q. Do you feel like [insurers] use [coverage defenses] in settlement negotiations? A. Oh, yes. Q. Because they say, "Hey, we have this good coverage defense." Is that meaningful to you? .... A. Absolutely, because I mean it's a credible threat. D&O Interviews, Plaintiffs' Counsel #3, supra note 44, at 38-39.
286. See Baker & Griffith, supra note 8, at 514-16 (detailing the financial features, such as "the prospective insured's industry and maturity, its market capitalization, volatility, and various accounting ratios," which "enable underwriters to form an initial estimate of a prospective insured's exposure to shareholder litigation risk" (footnotes omitted)).
287. See, e.g., Cutter & Buck, Inc. v. Genesis Ins. Co., 144 F. App'x 600, 601-02 (9th Cir. 2005) (holding that Genesis had a right to rescind because misrepresentations in the insurance application by its signor could be imputed to other directors and officers).
288. See, e.g., D&O Interviews, Claims Head #3, supra note 127, at 42-43.
289. Id.
290. See D&O Interviews, Claims Head #5, supra note 136, at 69 ("Genesis successfully rescinded Cutter & Buck. That was a huge nail in their coffin. Brokers talked about that endlessly. They pulled accounts from them and wouldn't put new business with them.").
291. See Baker & Griffith, supra note 24, at 1828 (explaining that "[t]he cost of the premium [of D&O insurance] will be worth incurring when it is less costly to the firm than other forms of contingent financing" in the event of shareholder litigation). Moreover, almost every time insurance-company lawyers develop a new tactic or defense, the D&O underwriters prepare a new insurance-policy form that explicitly provides the coverage currently in dispute and thus protects D&O policyholders on a prospective basis. The most recent examples are "nonrescindable" D&O insurance policies and a new endorsement that explicitly provides coverage for a category of claims that is hotly contested: section 11 disgorgement actions.
292. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Broker #2, at 2 (Nov. 6, 2008) (unpublished interviews, on file wiťh authors).
293. As described by one of our participants, [A]t some point the brokers would stop bringing business, because they were just too much of a hassle to deal with, and ... every time you raise a rescission issue, you raise a broker [liability] issue, and you know, as long as it is an intermediary-driven market, the brokers are going to help steer where the business goes. D&O Interviews, Monitoring Counsel #2, supra note 93, at 11.
294. See JOHN H. MATHIAS, JR. ET AL., DIRECTORS AND OFFICERS LIABILITY: PREVENTION, INSURANCE AND INDEMNIFICATION § 8.04, at 8-13 to 8-14 (release 7 2004) (collecting cases holding that "[i]f the exclusion requires a final adjudication, that adjudication must take place in the underlying action for which coverage is sought");
295. see also Little v. MGIC Indem. Corp., 836 F.2d 789, 794 (3d Cir. 1987) (noting that the final-adjudication language requires an insurance company to "pay loss as the insured incurs legal obligation for such loss, subject to the requirement that the insured reimburse any monies received if it is subsequently determined in a judicial proceeding that he engaged in active and deliberate dishonesty"). Some more recent policies contain broader fraud exclusions, but these exclusions have not yet been tested.
296. See MATHIAS, JR. ET AL., supra, at 8-16 (suggesting that policyholders contest such exclusions on the basis that they render the coverage illusory). Our participants confirmed that the adjudication-in-fact requirement takes most of the teeth out of the fraud exclusion.
297. See, e.g., D&O Interviews, Claims Head #1, supra note 126, at 45-46 (noting that the fraud exclusion is "[r]aised all the time," but "[r]arely ... ever actually triggered" because of the adjudication-in-fact requirement). During the "hard market" years of 2002 to 2005, some D&O insurers began to use a broader exclusion, without the final-adjudication language, but many corporations were able to insist on the traditional language even during that period.
298. See Baker & Griffith, supra note 24, at 1805 (reporting that insurance-market conditions would inhibit insurers' ability to insist on the broader term, and that brokers confirm that the final-adjudication language is almost always available).
299. See MATHIAS ET AL., supra note 182, at 8-15 (noting that the application of the final-adjudication provision "drastically diminishes the force and effect of the [actual fraud] exclusion").
300. See Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376, 398 (D. Del. 2002) (holding that a deliberate fraud exclusion should not apply to securities claims since such an exclusion would essentially eliminate coverage);
301. Black et al., supra note 22, at 1100 ("D&O policies typically stipulate that the insurer cannot unreasonably withhold consent to a settlement that the policyholder favors.");
302. Mary E. McCutcheon, Directors and Officers Liability Insurance: Tensions Between Corporate and Individual Insureds, 3 INT'L J. DISCLOSURE & GOVERNANCE 148, 152 (2006) (observing that the requirement of a "final adjudication" before an exclusion can be enforced makes it difficult for insurersto refuse to indemnify defendants);
303. Roberta Romano, The Shareholder Suit: Litigation Without Foundation?, 7 J.L. ECON. & ORG. 55, 57 (1991) (reporting that as long as a claim is settled, insurers cannot seek an adjudication of guilt and thereby avoid paying the claim).
304. SEE Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Monitoring Counsel #1, at 13 (Jan. 24, 2006) (unpublished interviews, on file with autthors) [hereinafter D&O Interviews, Monitoring Counsel #1] ("There is also severability of exclusions, which means that there is always an individual for whom the exclusion won't apply, which means that the carrier's on the hook....").
305. Id., Interview with Plaintiffs' Counsel #2, at 34 (May 3, 2007) [hereinafter D&O Interviews, Plaintiffs' Counsel #2] (describing a case "where the fraud was too good, and the judge voided the insurance policies on grounds of fraud and inducement. So we end up arguing and structuring our arguments more in terms of recklessness, because recklessness [is sufficient] under 10b-5. You can't insure against an intentional tort - the old principle");
306. D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 23 ("[We] make sure that we don't use words like 'you intentionally cook the books' or 'you did this or you did that.' We don't want to provide any sort of out for the insurance carriers. We are careful to emphasize that recklessness can prove [scienter] and that is not intentional....");
307. D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 22 ("Typically, why would you want to plead yourself into a coverage denial that is valuable to the case?");
308. see also Ellen S. Pryor, The Stories We Tell: Intentional Harm and the Quest for Insurance Funding, 75 TEX. L. REV. 1721, 1722-23 (1997) (chronicling instances of "underlitigation," where the plaintiff chooses "to plead and prove negligence rather than or in addition to intentional tort theories when, absent insurance considerations, the plaintiff would either frame the case solely as an intentional tort claim or emphasize the intentional tort claim," because most insurance policies exclude harm caused intentionally by the insured);
309. cf. Baker, supra note 57, at 223-25 (reporting similar underpleading in bodily injury torts).
310. See, e,g., SIMMONS & RYAN, supra note 21, at 20 n.12 (noting that both the relative merits of the case and the limits of available insurance influence settlement outcomes);
311. Alexander, supra note 3, at 562 (explaining that the fear of paying damages that far exceed policy limits leads insurers to prefer to settle rather than risk going to trial and being subject to a bad-faith claim);
312. Black et al., supra note 22, at 1104-05 (enumerating the factors that motivate plaintiffs' attorneys to settle within policy limits even if they believe the value of the suit to be higher than the policy limit);
313. Romano, supra note 184, at 57 ("The plaintiff's attorney's calculus [points to settlement]. With a settlement, attorneys' fees will be recovered, as defendants routinely agree not to oppose petitions for fees, and, in any event, the benefit the plaintiff has conferred on the firm will be recognized in the settlement. If a claim is litigated, however, there is some probability that the plaintiff will lose,");
314. D&O Interviews, Claims Head #9, supra note 14, at 20 (describing how plaintiffs are influenced by policy limits when calculating settlement demands),
315. See supra note 164 (quoting a defense counsel, monitoring counsel, and claims head to the effect that it is easier to obtain money from insurance companies than from the insured).
316. D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 15;
317. accord D&O Interviews, Defense Counsel #3, supra note 196, at 34 ("[M]ost plaintiffs' lawyers are very mindful of the policy limits, and they realize that if they are reaching beyond the policy, this is a different case.... [If] you talk about the company coffers, people are going to resist heavily, ... [but] the company doesn't care about the insurance company's money.").
318. See D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 44-45 ("In my mind the amount of D&O coverage ... does impact a group of cases depending upon various economic aspects of what is going on. There are a class of cases where as a practical matter, it's going to be nearly impossible to get more than the amount of insurance coverage ....").
319. See supra text accompanying note 22 (describing average D&O insurance limits for mid- and large-cap companies). Settlement amounts increase much more slowly than investor losses increase, A $100 million loss would result in an expected settlement of 5.1% of the loss value compared to only 1.1% for a $1 billion loss. In 2007, the median investor loss for settled cases was $310 million, compared to $407 million in 2006. With the settlement of several megacases, the average investor loss in 2007 was $1.75 billion.
320. PLANCICH ET AL., supra note 21, at 14.
321. See Baker & Griffith, supra note 8, at 535 (postulating that the growth in market capitalization as D&O insurance remained stable has resulted in settlements that reflect the growth rate of insurance limits, rather than the real cost of liability);
322. D&O Interviews, Monitoring Counsel #8, supra note 86, at 45 ("[O]nce you have the top [limits of insurance], you can almost always work something off of it, So here's something that had nothing to do with the merits of the case, and we were able to get some reasonable savings off of our limit because it now became the ceiling and could work down from it. ...").
323. See D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 15 ("If it is a largecap company, I don't care what the policy is....").
324. See, e.g., Thomas O. Gorman et al., Securities Class Actions and Derivative Litigation: Issues that Keep Corporate Counsel Awake at Night, BUS. L. TODAY, Nov. - Dec. 2007, at 37 (reporting that defendants are increasingly paying part of the settlement, with WorldCom directors paying more than 40% of the total settlement); J
325. anet McFarland, the Soaring Cost of a Boardroom Safety Net, GLOBE AND MAIL (Can.), Feb. 23, 2006, at B12 (reporting that directors in the WorldCom and Enron cases paid part of the settlement out of their own pockets).
326. Cases with payments in excess of the limits are very large settlements, and, all other things being equal (most importantly, the size of the investor loss at issue), a case with a large settlement seems less likely to be frivolous than a case with a small settlement. See Choi, supra note 9, at 1494 n.142 (citing literature treating low-value settlements as nuisance settlements).
327. D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 10;
328. see also D&O Interviews, Plaintiffs' Counsel #2, supra note 186, at 19;
329. D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 38-39.
330. See D&O Interviews, Defense Counsel #3, supra note 136, at 35 ("[I]f you are a defendant, you want a policy-limits demand because that is what puts you in a position to say, 'You can now settle this case without hurting me, and I demand you do it'. ...").
331. D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 22.
332. Consider the following anecdote, described by an insurer's monitoring counsel: I can remember a mediation I was once at, and the mediator was going around the room and asking everybody to introduce themselves with the plaintiffs' counsel. There was a company principal senior officer, and he said, "My name is such and such, and I'm" - I can't remember, the CFO or the treasurer or whatever - "and my purpose of being here today is to get the case settled for any amount up to and including the full amount of the limit." D&O Interviews, Monitoring Counsel #8, supra note 86, at 29-30.
333. One claims head described the scenario in the following exchange: A. You know, asserting that the failure to consent to the settlement has been made in bad faith is something which is, you know, an occurrence that people are used to in this arena. Q. It is part of the dance. A. Well, I wouldn't call it a dance, because at that point is kind of a - it's more wrestling than a dance. D&O Interviews, Claims Head #2, supra note 79, at 33-34;
334. see also D&O Interviews, Defense Counsel #1, supra note 44, at 36 ("I think that [the concern about bad faith] probably has a lot to do with [how they conduct] business.... You know, it's interesting, when I'm talking to coverage counsel, I always use little terms to remind them [about bad faith]. I said, 'Well your client would like to do this.' ... Because they know that if their reputation gets out, the only way they pay for all of these is by underwriting more insurance.");
335. D&O Interviews, Monitoring Counsel #7, supra note 118, at 31 ("[S]ome [defense counsel] are not afraid to use the term 'bad faith.'").
336. D&O Interviews, Defense Counsel #4, supra note 73, at 19.
337. Consider the following description by a claims head: It is almost routine now to see a plaintiffs'-style-damage analysis filed by Cornerstone and others and given to defense counsel, but many carriers become rather cynical about that because most of them are sophisticated enough to know that those kinds of plaintiffs'-style-damage analyses really are not a good reflection of what the case is truly worth.... They are often given to defense counsel who tend to use those, not necessarily with the plaintiffs' counsel, but with the carriers saying, "Oh my God, we hired this big expensive group of economists, and they are smart people and they did all this number crunching, and look, there is a catrillion dollars in potential damages here." D&O Interviews, Claims Head #6, supra note 44, at 37-38.
338. See Tom Baker, Blood Money, New Money, and the Moral Economy of Tort Law in Action, 35 LAW & SOC'Y REV. 275, 280 (2001) (describing the conflict of interest for defense counsel in being paid by the defendant's insurance provider);
339. Baker, supra note 173, at 224-25 ("[D]efense lawyers readily acknowledge the alignment of interests between plaintiffs and defendants with respect to preserving insurance coverage.");
340. Pryor, supra note 186, at 1734 n.44 (discussing agreements of assignment and covenants not to execute between plaintiffs and defendants).
341. See generally Tom Baker, Liability Insurance Conflicts and Defense Lawyers: From Triangles to Tetrahedrons, 4 CONN. INS. L.J. 101 (1997) (detailing the diverse set of incentives placed on defense counsel in representing both the insurance companies and the insured defendant).
342. See Baker & Griffith, supra note 24, at 1814-15 (explaining how a D&O insurance policy differs from the industry norm). Our interviews for this phase of the research confirmed this finding, The only additional example of defense cost control that our participants described to us was refusing to approve separate lawyers for different defendants unless there was an active conflict. Our insurer- and defense-side participants all agreed that D&O insurers otherwise do not have control over defense costs, except in the very rare, truly egregious case bordering on lawyer fraud.
343. E.g., D&O Interviews, Claims Head #3, supra note 127, at 49-51;
344. D&O Interviews, Claims Head #7, supra note 136, at 29-31;
345. D&O Interviews, Monitoring Counsel #6, supra note 97, at 19-20;
346. D&O Interviews, Monitoring Counsel #7, supra note 118, at 30-31.
347. Baker & Griffith, supra note 24, at 1814. The two leading D&O insurance carriers maintain lists of "panel counsel" that policyholders generally must use in defending securities claims. The panel-counsel list, however, does not appear to be a cost-saving device for carriers, as the most prestigious (read: expensive) national law firms appear on both lists and insurers have not made any arrangement for a discount of their customary fee, This makes D&O panel-counsel arrangements different from insurancepanel-counsel arrangements in more typical torts contexts, in which the lawyers on the panel have agreed to insurance-company payments that are lower than their customary fees and to the insurance company's case-management and billing guidelines,
348. Id. at 1817-19.
349. D&O Interviews, Defense Counsel #2, supra note 102, at 1.
350. See id. ("[R]emember who drives the case. The case is driven by the primary carrier. It's very rare that the excess carriers are engaged.").
351. But see D&O Interviews, Monitoring Counsel #3, supra note 112, at 70-71 (reporting that in recent years insurers higher in the coverage tower have begun participating in conference calls earlier in the case).
352. D&O Interviews, Defense Counsel #2, supra note 102, at 1.
353. Id. at 2. The same participant, a defense lawyer, prided himself on his willingness to settle early if early settlement suited the particular claim. In such cases, however, he reported that he often received resistance from insurers who frequently insisted on continuing the procedural fight notwithstanding his advice.
354. Id.
355. See D&O Roundtable, supra note 57, at 52 (quoting a defense counsel as saying that "often what you find is that defense counsel is aligned with an excess layer to try to put pressure on a lower layer that won't exhaust or won't basically open up the coffers").
356. D&O Interviews, Mediator #2, supra note 123, at 16.
357. Those carriers who frequently find themselves in the middle level of the tower may find that it is in their particular interest to develop an early and independent assessment of claims. One carrier in our sample confirmed this: "[C]arriers [that] tend to be in the [middle] excess layer are required to do more of this kind of merit-based, detailed analysis to get to what we think is a reasonable result and what is a fair result for our insured." D&O Interviews, Claims Head #9, supra note 14, at 38.
358. As one participant recounted, I remember one instance where there was a carrier who does a lot of primary who happened to be excess in a particular case and was being asked to just throw in $100,000. And the notion was basically to pressure the primary to collapse, because if the first layer of excess is throwing in a little bit on top, then the implication is that the primary should be exhausted .... The response from the claims lawyer for that usually primary and now sitting first layer excess was, "No, I don't need authority for just $100,000. I need authority for this case to settle at
359. A settlement too close to a carrier's total limits may induce that carrier to take a chance on continuing the case to the next motion or the next procedural stage. See, e.g., D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 21 (discussing an example where the defendant had $18.5 million in limits and the settlement demand was for $17 million, and the insurer just said, "Why don't I just basically take a chance?"), As a prominent mediator said, I've done mediations where I simply looked at a plaintiff and said, "Look, if you really want to settle this case now,... reasonable people can disagree as to whether it is a $5, $10, $11 or $12 million case, but the truth is you are not going to settle this case now unless you give AIG or Chubb some opportunity to save some money off their $10 million policy, because if they get the choice of tapping themselves out now and paying their $10 million now or continuingto pay this fireman becoming toast, you get a pretty easy choice, but if you offer them the opportunity to save $1 million off their policy, they are going to be highly incentivized to perhaps get this done."
360. D&O Interviews, Mediator #2, supra note 123, at 14.
361. See, e.g., D&O Roundtable, supra note 57, at 51 ("I think the vision of the insurance carriers working together is sort of funny, because they are rooting against each other.").
362. See, e.g., Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3d 1175, 1181 (7th Cir. 1994) (holding the primary insurer liable to an excess insurer in a case in which the excess insurer reasonably settled the case above the primary insurer's policy limits, on the grounds that the primary insurer's earlier failure to settle the case within the limits of the primary insurer's policy breached the duty of good faith).
363. As one defense counsel stated, [I]f there's a $25 million first layer and there is a case that is going to settle around $25 million, sometimes you will tell the plaintiffs, "Look, I can give you $25 million assuming the first layer is on board.... [B]ut if you want $28 million, you know, I'm not sure I can get it, and it's going to slow everything down by six months." D&O Interviews, Defense Counsel #5, supra note 14, at 9-10;
364. see also D&O Interviews, Defense Counsel #2, supra note 102, at 2 ("In a case that's not Enron or some massive fraud case, every time [the plaintiffs] hit another layer, it acts like a firebreak and makes it easier to negotiate a settlement.");
365. D&O Interviews, Mediator #2, supra note 123, at 15 (referring to the tiers as a "nonmerits savings issue").
366. But see Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Mediator #3, at 17 (July 2, 2007) (unpublished interviews, on file with authors) (reacting to the suggestion of firebreaks between layers by exclaiming, "It's a myth!").
367. One of the claims heads interviewed explained why carriers would be willing to incur such large defense costs: [D]epending upon the size of the primary layer, some carriers take the attitude of, "Well, my money is gone. If I'm a primary carrier and I have a little retention below me, and I've only got $5 million worth of coverage, then I've got big expensive Law Firm X and I've got co-counsel from big expensive Law Firm Y. You know, my $5 million is gone as soon as I lose the motion to dismiss." So you sometimes observe those carriers as kind of going to sleep, not doing anything, just kind of rubberstamping: "Yeah, do whatever you want."
368. D&O Interviews, Claims Head #6, supra note 44, at 23-24.
369. D&O Interviews, Mediator #1, supra note 142, at 32-33.
370. See, e.g., D&O Interviews, Plaintiffs' Counsel #8, supra note 70, at 35 ("[A program with layers] really adds a burden to the situation. I think that truthfully instead of three layers of $5 million for a $15 million program, you could ... probably pay less if you had fifteen single million-dollar things."),
371. See D&O Interviews, Plaintiffs' Counsel #3, supra note 44, at 48 ("[The structure of the tower matters] because you've got sort of a separate negotiation at each level. Sometimes it can work to your advantage.");
372. D&O Interviews, Plaintiffs' Counsel #6, supra note 59, at 11 (noting that a layered program "makes it very difficult particularly if you have a recalcitrant level in the middle .... [But] I don't think it really saves them at the end of the day. It just makes the process less pleasant.... I don't know that it changes the outcome very much");
373. D&O Interviews, Plaintiffs' Counsel #7, supra note 59, at 16 (acknowledging that the structure of the policy is a factor influencing settlement, but stating that the structure of the policy is a "smaller factor than ... the damages and the risks and all that.... [When] you have a case that you really think is worth $40 million, you are not going to settle for $12 million because that is the first layer").
374. See Boris Feldman, The Veil of Tiers: Shareholder Lawsuits and Strategic Insurance Layers, RISK MGMT., Apr. 1997, at 77, 86, available at http://www.borisfeldman.com/ Veil-of-Tiers.htm (last visited Jan. 15, 2009) (offering a similar example, noting that Company A's structure of layers "would provide strong, natural firebreaks at $5 million and $10 million," and concluding that "[i]t's a safe bet that the identical claim against [Company A] would settle for less with that structure" than it would have if it had the structure of either Company B or Company C).
375. Some participants provided a similar numerical example that contrasted companies with different tiered structures. See, e.g., D&O Interviews, Mediator #2, supra note 123, at 15 ("[Even if] the case is a $20 million to $30 million case ... that case might settle for $18 million because the only two insurance companies you can get to tap themselves out are the primary and the first excess.").
376. See, e.g., Feldman, supra note 223, at 84, 86, 88 (recommending strategic tiering at the outset in order to induce favorable settlements in the event of litigation).
377. See Baker & Griffith, supra note 8, at 504 (describing the tendency of underwriters, after the scandals of Enron and WorldCom, to reduce their individual risk exposure by selling smaller amounts of insurance to more companies),
378. For a thoughtful treatment of the impact that the structure of excess insurance programs can have in the asbestos mass-settlement context, see Michelle J. White, Why the Asbestos Genie Won't Stay in the Bankruptcy Bottle, 70 U. CIN. L. REV. 1319, 1334-36 (2002), observing that carriers in low layers have no incentive to take an aggressive approach to weeding out no-injury claims when it is clear that the damages incurred in the serious injury claims will exceed the carriers' limits.
379. D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 11-12. Or, as described by a mediator, [T]here are many different kinds of pressure points. They can range from ... the defendant issuer or company want[ing] to make an acquisition or divestiture, ... [to the fact that] if me litigation is material enough, ... the litigation itself has to be disclosed and discussed in filings that the company is coming up against a quarterly filing where they have to say something about the exposure in this litigation if it is big enough. I can think of one case where the setdement for the company in this case was in the billions of dollars, and that was the pressure point. They were at risk of making another, new false statement, and you know to make the disclosure and not have the case settled would put enormous pressure on them. Or it could be [that] ... something happened in an SEC matter.
380. D&O Interviews, Mediator #1, supra note 142, at 56;
381. see also D&O Roundtable, supra note 57, at 36 (using the example of a bank that suffers a loss at the same time that the housing market suffers a downturn as an illustration of a typical loss-causation assessment, and noting that the question that must be asked is whether the bank failed "because the housing industry itself is falling apart? Was the bank maybe the cause of the housing industry falling apart?").
382. D&O Interviews, Defense Counsel #5, supra note 14, at 14-15.
383. See D&O Interviews, Claims Head #6, supra note 44, at 21-22 (stating that insureds sometimes take the position that "we are about to do this big transaction. We are selling the company, so we have to get rid of this in order to maximize the ability to sell the company to somebody else").
384. As noted by our participants, an insolvent entity cannot contribute to the settlement. See, e.g., D&O Interviews, Claims Head #3, supra note 127, at 76-77. By contrast, a defendant with a "very substantial cash position ... [will] have the effect of... increasing or tending to increase the settlement fight because they know there's more to be gotten."
385. Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Defense Counsel #7, at 12 (unpublished interviews, on file with authors) [hereinafter D&O Interviews, Defense Counsel #7].
386. See supra notes 78-79 and accompanying text.
387. D&O Interviews, Defense Counsel #2, soupra note 102, at 1.
388. D&O Interviews, Plaintiffs' Counsel #5, supra note 58, at 20.
389. D&O Interviews, Claims Head #9, supra note 14, at 12.
390. See, e.g., D&O Interviews, Monitoring Counsel #7, supra note 118, at 30 ("The defense counsel, however, and I don't mean to be overly cynical, but you get cynical after you've done this stuff for a while. Defense counsel will work a case until they have decided they have earned enough money and then they will tell you it's time to settle ....");
391. D&O Interviews, Defense Counsel #7, supra note 231, at 20, 26 (noting that "defense lawyers' compensation is a function of their billable hours and they have an incentive to take these cases downstream," and concluding that "as a defendant's lawyer, we can litigate this all you want and I'm happy to because I can use the billings").
392. See, e.g., Tom Baker & Sean J. Griffith, D&O Interviews, Interview with Defense Counsel #8, at 4 (July 25, 2007) (unpublished interviews, on file with authors) ("[P]laintiffs' lawyers would love to settle a case as soon as possible in the litigation, but often they will be aware of the fact that they need to get their settlement approved by a court.... [T]hey believe that they must do some amount of work and have some sort of a paper record in order to get the settlement approved by a court.");
393. D&O Interviews, Monitoring Counsel #1, supra note 185, at 6 (reporting that "in jurisdictions where there is a lodestar approach to fee awards, there tend not to be early settlements, because [this] rewards the plaintiffs' lawyers working the file-notwithstanding ... an acknowledgment on all parties that there is decent liability").
394. See, e.g., Baker, supra note 204, at 110-11 (reporting on lawyers' incentives and potential conflicts of interest);
395. Herbert M. Kritzer, The Commodification of Insurance Defense Practice, 59 VAND. L. REV. 2053, 2064 (2006) ("[F]or open-file billing, there is an incentive to keep a file open at least until costs have been covered.");
396. Herbert M. Kritzer, Defending Torts: What Should We Know?, J. TORT L., 2007, at 7, http://www.bepress.com/jtl/voll/iss3/art3/ (last visited Jan. 15, 2009) (observing that there is a "common perception among plaintiffs lawyers... that... settlement is not likely until the defense counsel has had the chance to 'run the meter' for a while to build up a fee," but noting that this has not been carefully studied and that there are countervailing incentives).
397. See, e.g., Lucian Arye Bebchuk, The Questionable Case for Using Auctions to Select Lead Counsel, 80 WASH. U. L.Q. 889 (2002) (analyzing drawbacks to using auctions to select class counsel, including minimizing the percentage of recovery paid to plaintiffs' counsel);
398. Jill E. Fisch, Lawyers on the Auction Block: Evaluating the Selection of Class Counsel by Auction, 102 COLUM. L. REV. 650 (2002) (scrutinizing the claimed benefits of leadcounsel auctions);
399. Andrew K. Niebler, In Search of Bargained-For Fees for Class Action Plaintiffs' Lawyers: The Promise and Pitfalls of Auctioning the Position of Lead Counsel, 54 BUS. LAW. 763 (1999) (suggesting improvements to the auction system designed to modify quality and cost incentives faced by counsel).
400. See D&O Roundtable, supra note 57, at 45 ("[D]o you need to fund the engine while you are waiting for the huge pot of money?").
401. See Choi et al., supra note 78 (noting that since the passage of the PSLRA, 100% of securities class actions have been either dismissed or settled).
402. The most obvious gaps are rules regarding the application of loss-causation rules to facts, but lawyers also have no evidentiary basis for comparing the views of the mock juries that they sometimes convene with those of real juries.
403. See supra Part I.B.3 (discussing the roles of the motion to dismiss and the motion for summary judgment).
404. Depending upon the circuit, class certification may involve some consideration of the claim's underlying merits and may be seen as a dispositive ruling. See supra notes 73-77 and accompanying text. The only other dispositive ruling that the court will make is to approve the final settlement negotiated by the parties and their insurers. The approval of settlement is a pro forma ruling.
405. Cf. Choi, supra note 9, at 1472-73 (arguing that the stay of discovery until after the motion to dismiss may chill the filing of some meritorious claims).
406. See supra text accompanying notes 155-156.
407. Often, we found, the calculation performed by any one insurer at this point is, more simply, whether the discounted present value of the claim exceeds the limits of that insurer's policy. If so, that settlement control is passed to the next layer of insurance within the tower, which then becomes the working layer. See, e.g., D&O Interviews, Monitoring Counsel #6, supra note 97, at 12-13 ("The old timers in the industry really can't believe that this is happening, but it is happening more and more ... [and] there's no chance that they are going to say anything because the ad damnum is so big and the defense costs are going to say goodbye....[They are just going to] turn to the next up and say 'I'm done. I'm about to roll. You want to take over? What do you want to do?' So you politely leave it to the next carrier.").
408. "Objective" is used here to describe information not fed to the insurer by plaintiffs' or defense counsel.
409. The presence of business reasons to settle quickly could be an alternative explanation for a within-limits contribution by the defendant. A measure of the time between filing of suit and settlement would be one, admittedly crude, way to control for that variable.
410. Moreover, once the defendants reach the settlement table, they focus on loss causation and damages, not fraud. While loss causation and damages might be "merits" factors in an economic model of settlement, when most people ask whether the merits matter, we understand them to be taking the narrow perspective that focuses on the elements of liability. They are asking the basic question of whether or not there was fraud.
411. "It's turtles all the way down" is a classic formulation of the problem of infinite regress, the essential problem created by basing settlement upon settlement without a solid foundation of adjudicated fact. Stephen Hawking refers to the problem in a parable about a scientist giving a lecture on the nature and origin of the galaxy: At the end of the lecture, a little old lady at the back of the room got up and said: "What you have told us is rubbish, The world is really a flat plate supported on the back of a giant tortoise." The scientist gave a superior smile before replying, "What is the tortoise standing on?" "You're very clever, young man, very clever," said the old lady, "But it's turtles all the way down!" STEPHEN W. HAWKING, A BRIEF HISTORY OF TIME l (1988). Justice Scalia offers another version of the story: [A]n Eastern guru affirms that the earth is supported on the back of a tiger. When asked what supports the tiger, he says it stands upon an elephant; and when asked what supports the elephant he says it is a giant turtle. When asked, finally, what supports the giant turtle, he is briefly taken aback, but quickly replies "Ah, after that it is turtles all the way down."
412. Rapanos v. United States, 547 U.S. 715, 754 n.14 (2006).
413. See supra text accompanying note 106.
414. Rosenberg and Shavell have proposed a new rule giving defendants the option to "have courts declare that settlement agreements will not be enforced" as a way of preventing nuisance suits in class actions. See David Rosenberg & Steven Shavell, A Solution to the Problem of Nuisance Suits: The Option to Have the Court Bar Settlement, 26 INT'L REV. L. & ECON. 42, 42 (2006). While innovative and promising, this new rule is not intended to promote additional adjudication, but rather to reduce the number of nuisance claims.
415. This is a collective action problem: all litigants would prefer to negotiate settlement in an environment of more adjudication, but no litigants want to be forced to adjudicate their dispute. The social benefit requires great individual sacrifice by some. All individuals would prefer to free-ride, with the result that the social benefit of more adjudication does not arise. See generally MANCUR OLSON, THE LOGIC OF COLLECTIVE ACTION (1971) (describing the free-rider problem).
416. Kozel and Rosenberg have proposed a rule that would bar settlement before summary judgment. See Randy J. Kozel & David Rosenberg, Solving the Nuisance-Value Settlement Problem: Mandatory Summary Judgment, 90 VA. L. REV. 1849, 1860 (2004). This rule would produce more adjudication and, for the reasons that they provide, it would be a superior way to weed out nuisance claims over precertification merits review. Nevertheless, our intuition is that this rule will be rejected as too expensive and too restrictive.
417. See, e.g., John Bronsteen, Against Summary judgment, 75 GEO. WASH. L. REV. 522 (2007) (suggesting that summary judgment is expensive and that our civil justice system would function better without such a requirement).
418. The lottery system responds to the collective action problem by changing the effective ex ante bargain among all prospective litigants. Now, when filing a claim, all litigants should do so understanding that there is a 5% or 10% chance (whatever level is chosen by the lottery system) that their claim will be chosen for adjudication rather than settlement. They should therefore factor the cost of adjudication, discounted by the probability of not being selected in the lottery, into the value of their claim when they file. In this way, viewed from an ex ante perspective, the lottery system distributes the cost of extra adjudication across all claims even though it is ultimately borne by only a few. See, e.g., NEIL DUXBURY, RANDOM JUSTICE: ON LOTTERIES AND LEGAL DECISION-MAKING 145 (1999) ("[T]he use of randomizing techniques in legal contexts may have positive effects on people's incentives and might also, on occasions, turn out to be cost-efficient and (more controversially) just.").
419. Some, for example, might raise a moral objection that lotteries are an inappropriate means of deciding rights. See, e.g., id. at 87-88 (noting that the use of a lottery may run counter to traditional notions of justice). We tend to disagree.
420. See Tom Baker et al., The Virtues of Uncertainty in Law: An Experimental Approach, 89 IOWA L. REV. 443, 482-83 (2004) (identifying and responding to moral objections to using uncertainty to promote deterrence in criminal and civil law). But the likelihood of a policymaker adopting a trial-lottery system seems sufficiently unlikely for us to treat these arguments and their answers as beyond the scope of this project.
421. From the plaintiffs' lawyer's point of view, settling a securities class action is probably a positive-net-present-value investment much more often than trying the action. Trials are expensive, and when suddenly faced with the additional costs of trial without a concomitant rise in the expected value of a claim, plaintiffs' lawyers are likely to drop the case. Dropped claims, of course, are not the objective of the lottery system, but it is likely impossible to avoid this outcome. Even were we to try such a rule, rational lawyers would likely respond by simply stopping work on the claim, ceasing to invest in the claim and ceding an early dismissal. Because there is probably no efficient means of monitoring the effort that plaintiffs' lawyers put into litigating their case, any such rule designed to force adjudication seems destined to fail. It is worth noting that, for Rosenberg and Shavell, the whole point of crafting rules in this area is to induce plaintiffs' lawyers to abandon cases that are not worth taking to trial. See Rosenberg & Shavell, supra note 253, at 44-46.
422. We also note that the cases most likely to be abandoned are those that are also most likely to produce useful precedent in adjudication-meaning those cases making unclear or unusual factual allegations and those making use of controversial damages models.
423. See generally Owen M. Fiss, Comment, Against Settlement, 93 YALE L.J. 1073, 107374 (1984) (describing how settlement has become an explicit pre-trial process);
424. Gary M. Fournier & Thomas W. Zuehlke, Litigation and Settlement: An Empirical Approach, 71 REV. ECON. & STAT. 189 (1989) (demonstrating that decisions of litigants to settle arisefrom characteristics of our legal system);
425. Andrew W. McThenia & Thomas L. Shaffer, For Reconciliation, 94 YALE L.J. 1660, 1660-65 (1985) (responding to Fiss's article and expounding the benefits of alternative dispute resolution).
426. Griffith, supra note 8, at 1150-51. Others have drawn similar conclusions.
427. See, e.g., John E. Core, On the Corporate Demand for Directors' and Officers' Insurance, 64 J. RISK & INS. 63, 68 (1997) (arguing that liability risk drives the decision to obtain D&O insurance);
428. cf. Martin Boyer, Is the Demand for Corporate Insurance a Habit? Evidence of Organizational Inertia from Directors' and Officers' Insurance 19 (CIRANO, Working Paper No. 2004s-33, 2004) (noting the possible moral hazard behind D&O insurance, and positing that demand will be higher at some companies for a reason).
429. See Baker & Griffith, supra note 8, at 488-89 (observing that D&O insurance casts liability to a third party, making deterrence contingent upon insurer practices such as monitoring governance practices).
430. See Griffith, supra note 8, at 1190-1200 (describing the legal rules affecting disclosure of D&O insurance information).
431. Public companies issuing shares under Form S-11 are required to disclose the existence and "general effect" of insurance programs, including D&O insurance. See 17 C.F.R. §229.702 (2008);
432. SEC Form S-11, available at http://www.sec.gov/ about/forms/forms-11.pdf (requiring a statement that the management is adequately insured). Not only is this disclosure of the "general effect" of D&O insurance not detailed enough to be useful, but it only appears in corporate filings in connection withthe issuance of shares. Disclosure is not required even after the occurrence of a significant event such as a policy renewal or a noticed claim. If it were required on a regular periodic basis, analysts would be able to track changes.
433. The PLUS Journal, a trade publication for the Professional Liability Underwriting Society, publishes statistics on recent settlements, including date of settlement and total settlement amount, in each monthly issue. See, e.g., PLUS Case Reviews, PLUS J., Oct, 2008, at 10;
434. see also Stanford Law Sch. & Cornerstone Research, Securities Class Action Clearinghouse, http://securities.stanford.edu/settle.html (last visited Jan. 15, 2009) (providing news of securities settlements since 1999).
435. See CORNERSTONE RESEARCH, supra note 38 (aggregating securities class action case filings);
436. see also FOSTERET AL., supra note 72, at 1 (analyzing trends and predicting that settlement sizes might not increase in the near future).
437. For example, all other things being equal, a $150 million settlement paid by the insurers of a defendant with a $100 million D&O program represents a stronger case for the plaintiffs than a $150 million settlement paid by the insurers of a defendant with a $200 million D&O program. At the lower end of the settlement range, we suspect that, all other things being equal, a $5 million settlement that is funded by the $4 million left in the primary policy after paying defense costs plus $1 million from the first layer excess carrier is a weaker case for plaintiffs than a $5 million dollar settlement funded entirely by a primary carrier that sold a $10 million policy. In addition, a settlement amount within limits that is nevertheless partially funded by the company itself may suggest more merit-related elements in the claim - for example, grounds for a potential rescission threat that caused the defendant corporation to contribute its own resources to fund settlement.
438. See Jenny Anderson, Lawyer Leaving Firm to Focus on Inquiry, N.Y. TIMES, Aug. 29, 2007, at C2 ("Critics [of Milberg Weiss] contended that many of the lawsuits were frivolous, raising the cost of doing business and delivering little or nothing to aggrieved parties.");
439. Julie Creswell, One Route Seems Closed, So Lawyers Try Different Lawsuit in StockOption Scandal, N.Y. TIMES, Sept. 5, 2006, at C4 ("Many derivative lawsuits are nothing more than efforts by attorneys who are motivated by the desire to generate fees." (internal quotation marks omitted) (quoting a defense lawyer from Sullivan & Cromwell));
440. Julie Creswell, U.S. Indictment for Big Law Firm in Class Actions, N.Y. TIMES, May 19, 2006, at A1 ("Its lucrative business made Millberg Weiss a target for political critics who saw the firm as a symbol of a national litigation industry that had gone out of control. These critics said that many of the firm's lawsuits against corporations were frivolous, raising the cost of doing business.");
441. Timothy L. O'Brien & Jonathan D. Glater, Robin Hoods or Legal Hoods? The Government Takes Aim at a Class-Action Powerhouse, N.Y. TIMES, July 17, 2005, § 3, at 1 ("To critics, the lawyers [at Milberg Weiss] embody what they say is amiss with modern class action suits: shifty and belligerent legal tactics, excessive paydays for lawyers and repeated blackmailing of straight-arrow corporations.");
442. Patty Waldmeir, Supreme Court Curbs Actions Against Companies, FIN. TIMES (U.S. & Can. ed.), June 22, 2007, at 13 (reporting that corporate America hopes that the recent Tellabs decision will reduce frivolous, lawyer-driven litigation).
443. Wrongdoers may, for example, be unable to obtain debt or equity financing on the same terms. On the ability of markets and other nonlegal norms to sanction corporate actors, see Edward B. Rock & Michael L. Wachter, Islands of Conscious Power: Law, Norms, and the Self-Governing Corporation, 149 U. PA. L. REV. 1619, 1645 (2001), concluding that "[w]hen markets are sufficiently competitive, a firm with suboptimal [nonlegal rules and standards] will be driven out of business."
444. Baker & Griffith, supra note 24, at 1841. Our term "entity-level coverage" includes both the Side C coverage that is referred to in the industry as "entity coverage" and Side B coverage. Side B coverage indemnifies the corporation for the corporation's obligation to indemnify its officers and directors. Side C coverage indemnifies the corporation for its own liability in securities actions. Both Side C and Side B coverage protect corporate assets, not the assets of the individual directors and officers. Thus, both raise the corporate-insurance issues that we analyzed in prior work.
445. See, e.g., Coffee, supra note 25, at 1536.
446. Baker & Griffith, supra note 8, at 533-37 (discussing various mechanisms that make liability fees fall evenly on good and bad firms, undermining deterrence effects).
447. Baker & Griffith, supra note 24, at 1807-13 (summarizing empirical data about insurers' failure to provide loss-prevention services).
448. See generally Baker & Griffith, supra note 8, at 536-37 ("[A] corporation's D&O premium, if disclosed, would reveal valuable information ... to capital market participants.");
449. Griffith, supra note 8, at 1203-07 ("The law should be changed to require disclosure of more details concerning a company's D&O policies.").