Lawyering today is an awkward blend of a business and a profession. Even conscientious private attorneys experience the tension between their economic obligations to their firms (to maximize revenues and profits) and their ethical obligations to their clients (to settle problems quickly and cheaply). Similar conflicts afflict many professions. Doctors often practice more medicine than their patients need, because it’s financially advantageous. Journalists, who are supposedly truth seekers, often take a selective and sensationalized view of the truth, because that’s what sells.
But the conflicts for lawyers are especially acute, and attorneys constantly strive to rationalize economic self-interest as legal virtue. Sometimes the economic incentives overwhelm everything else. Class-action securities suits are a shining example of this phenomenon. Numbering about 160 a year, they throw off enough cash to sustain a tiny but lucrative industry of Lawyers who represent supposedly defrauded shareholders. In general, lawyers initiate these suits and are the biggest beneficiaries. Between 1991 and 1994, sued companies paid out a total of about $2.5 billion, of which the lawyers collected about a third, estimates National Economic Research Associates, a consulting firm.
But just how much “fraud” exists is unclear, because most suits (about 85 percent) are settled before going to trial. Companies settle not because they’re necessarily guilty but because it’s easier – and often cheaper–to pay the Lawyers to go away. To see why, examine a suit against Cypress Semiconductor, a maker of computer chips. In 1991 Cypress’s quarterly profits came in at 15 cents a share instead of the 20 cents that investment analysts (and the company) had expected. The firm’s stock slumped. Suits materialized alleging that investors had been deliberately misled. One aggrieved shareholder had been a plaintiff in 18 other suits; damages of $120 million were sought.
The temptation to settle was huge, T. J. Rodgers, Cypress’s president, wrote in the San Jose Mercury News. When lawyers are unloosed, they can often find documents that can be made to look like a cover-up. Cypress spent about $1 million producing 750,000 pages of internal memos. A settlement could have been had for about $8 million, and insurance would have covered roughly half of that. Going to trial would cost another few million in legal fees–about the same total cost, and Cypress could lose. Rodgers took the risk, in part because he so loathed the suing attorneys (“a low-life form, somewhere below pond scum,” he wrote). A judge later dismissed the suit as baseless.
These eases look like legalized extortion because, in the main, they are. Shareholders’ interests are almost incidental. Not only do the lawyers collect the most money, but the settlements cover only about 5 to 12 percent of investors’ alleged losses. (All estimates come from the NERA study.) The idea that lawyers usually aim to protect the “small investor” is a myth. After a settlement, perhaps 40 to 50 percent of the investors entitled to a recovery don’t even file a claim, estimates a study by Stanford law professor Janet Cooper Alexander. For many, the paperwork is too complex and the possible payout too small.
The abuses of this type of litigation are, unfortunately, not unique. Consider another area ripe for reform: “pain and suffering” suits in auto accidents. These payments go beyond victims’ medical bills or their economic losses (unpaid wages, etc.) and rely resent about 25 percent of auto-insurance premiums, according to the Insurance Information Institute. About half of that goes for lawyers, including the insurance industry’s defense lawyers. What this means is that most drivers subsidize (through higher auto premiums) a system of subjective damages whose largest beneficiaries are the lawyers who administer the system.
Michael Horowitz of the Hudson Institute and Jeffrey O’Connell of the University of Virginia Law School argue that this system could–and should–largely be eliminated. Under their sensible proposal, drivers who wanted lower premiums would insure themselves only against economic losses and health expenses. They would forgo the right to sue for “pain and suffering.” Anyone who wanted the added protection could pay higher premiums for a more comprehensive policy. (Such drivers would be covered by their own insurance company for “pain and suffering.”)
What we need from Congress (and state legislatures) is not gratuitous lawyer-bashing but better laws. People and companies do bad things. When they do, they should be punished. Suits do that, and the threat of a suit deters bad behavior. Some companies do lie about their prospects. But suits–and other acts of lawyering–driven by lawyers’ own needs do more than impose a cost on society. They also corrupt the law, because it is no longer seen as operating fairly, predictably or honestly. Not surprisingly, studies suggest that “pain and suffering” suits inspire much medical fraud: unneeded trips to the doctor to inflate damage claims.
Congress should always monitor its handiwork. Just because we want the law to work better doesn’t mean that it will. The new securities law tries to squelch frivolous suits by making it harder for lawyers to use “professional” plaintiffs (a.k.a. the guy who filed 19 suits) and to abuse the “discovery” process (searching for documents) to extort settlements. Some experts believe the law goes too far and will shield genuine securities fraud; others believe that clever lawyers will circumvent the changes. It will be important to watch. But the underlying impulse is sound and ought to be extended. It is simple: the law belongs to the people and not to the lawyers.
