January 01, 2016

Class Actions: Time for a Change

M. Todd Henderson

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If you went to law school in the 1970s or 1980s, the class action mechanism was likely sold to you as a savior. The revised Rule 23, adopted in 1966, enabled private lawyers to bring claims on behalf of large groups of individuals. There were many new causes of action in areas ranging from consumer law to environmental regulation to civil rights, and without a class action tool, there was concern no one would sufficiently press these rights. The logic was simple: without some means of consolidating many small claims, the economics of litigation would mean many large harms would go unremedied. In theory, a company could impose $100 in damages on 10 million Americans—causing $1 billion in social losses—but get away with it because no one would have an incentive to sue. Class action suits, which dramatically lower the costs for individuals pursuing these claims, could force actors to internalize the costs of their activities, resulting in improved efficiency and social welfare.

The wellspring of the class action was a 1941 article in the University of Chicago Law Review by Harry Kalven Jr. and Maurice Rosenfield, “The Contemporary Function of the Class Suit.” They argued that the class action mechanism could be an important supplement to government regulation. Government is the typical solution to the collective action problem, but it may be less effective than private lawyers at pursuing these claims because of low budgets, less talented lawyers, political pressures, and a host of other reasons. Private “attorneys general” would have high-powered incentives (especially in light of the fee structure of the typical class action), and would, by virtue of the type of lawyers attracted to government versus private work, be more innovative and comfortable with risk.

That private lawyers would innovate and press new claims aggressively turned out to be true, but the downside of the class action system was seriously underestimated. The problems of the class action system are not just too many suits, but also too few of other types of suits and, perhaps worst of all, a distortion of legal principles. To illustrate these points, consider the field that first inspired Kalven and Rosenfield—securities regulation.

Although the Securities Exchange Act of 1934 lacks an explicit private right of action in its principal antifraud provision, the courts created an implicit one that has generated thousands of cases. Over just the past two decades, over 4,000 securities fraud suits have been filed, and companies have paid out over $90 billion in settlements. Unfortunately, the consensus among observers is that many of these suits are of little merit, and those that are meritorious end up mostly lining the pockets of lawyers without doing much to deter fraud.

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