The Stanford Law School Securities Class Action Clearinghouse and its partner Cornerstone Research released a mid-year report on July 25 that highlights a substantial rise in market capitalization losses and near record high federal class action securities fraud filings. In this Q&A, Professor Joseph Grundfest, JD ’78, who founded Stanford Securities Class Action Clearinghouse and co-authored the report, discusses key findings.

Does the report point to something significant in the overall economy?

That depends on how you look at it. The overall economy is so large that even a marketplace that sees billions of dollars in settlements every year is a tiny speck on the great windshield of life. But from the perspective of executives or general counsel who see themselves as victim of baseless litigation propagated by a legal regime that has lost the ability to filter out low-quality claims, the problem is serious. The number of issuers subject to these claims is increasing, and their consternation with the process is rising apace. I wouldn’t be at all surprised if we see more calls for reform in the coming years.

Why are the number of filings so high—for both federal class action securities fraud filings and core filings? Can you talk about that?

Sure. The high level of litigation in federal courts reflects two trends. First, several years ago the Delaware courts tightened up on the conditions when they would award attorneys’ fees to plaintiff counsel bringing litigation challenging the adequacy of disclosures in merger transactions. Essentially, every merger of a publicly traded firm involving a capitalization in excess of $100 million is today subject to litigation, no matter what. The plaintiffs’ calculus is that defendants will rationally settle these claims, even if they are entirely meritless, for amounts less than avoided litigations costs and so as not to delay the closing of the transaction. Indeed, these cases are now commonly settled, very quietly, for about $300,000 or so, per case. The Delaware judiciary became exquisitely aware of this equilibrium and, appropriately offended, adopted a form of scrutiny that made Delaware a hostile environment for attorneys looking to cut these sorts of deals. But every action has a reaction, and the plaintiffs took to filing their cases in federal court under theories that couldn’t be remanded to state court. That’s caused a big bump in the number of federal class action securities fraud cases. So far, it seems that only the Seventh Circuit has caught on to this game and has adopted an approach similar to Delaware’s in an effort to stifle this sort of litigation. My expectation is that over the coming years we will see other Circuits follow the Seventh and that this form of activity will slowly be brought to heel, but only after the plaintiffs’ bar has earned many tens of millions of dollars more by filing cases that they never intend to litigate and that they plan to settle for avoided litigation costs from day one.

At the same time, our data indicate an increase in the number of “core filings,” traditional claims alleging fraud in the purchase or sale of securities. Here, however, there is reason to believe that many of these filings are of lower quality complaints where a large percentage of them are likely to be dismissed or settled for relatively small sums that reflect avoided litigation costs. That said, there is reason to be troubled by this trend. Plaintiff counsel are rational profit maximizing agents. They file many low-quality complaints because the value of the settlements generated by portfolios of low quality complaints exceeds the cost of prosecuting these actions. As long as that’s the market equilibrium, we can expect an increased level of activity of this sort. This bump in litigation activity attributable to lower-quality complaints is a fruitful area for further academic research.

You called out Internet and communications companies in the key trends section of the report. Are increases in filings in those sectors significant?

While the bump in these sectors is real, one has to be cautious in drawing inferences from six months of data where sample sizes are small. Let’s see what happens in the next six months.

What else stands out in this report?

The basic philosophy of the Clearinghouse treats this form of litigation as though it is a well-organized market with clear trends, prices, and room for legal innovation. This philosophical “bet” has paid off big time because it provides an organizing structure for the description and analysis of a clearly defined sector of litigation practice.

Can you tell us about the Securities Class Action Clearinghouse—what it does?

We track all federal private class action securities fraud litigation filed since the effective date of the Private Securities Litigation Reform Act of 1995. We launched in 1996, the early days of the internet. Mark Zuckerberg was then just 12 years old, Google hadn’t yet even been founded, and dot com crash was still years in the future. Today, the site might well seem plain vanilla, but back in the day this was hot, hot stuff. In fact, when we launched, the Smithsonian Institution nominated the Clearinghouse as one of the best applications of the Internet in 1996.

The database provides detailed information about more than 3,000 class actions, including original pleadings, resolution information, and a range of analytics. All of the data are publicly available at no charge.

The support we have received from Cornerstone Research has been essential to the Clearinghouse’s success. Analytically, Cornerstone’s researchers compile annual and semi-annual reports with resources that are simply unavailable to us at the Law School. Moreover, the Cornerstone team has been the best possible research partner. Their commitment to accuracy and to unbiased representation and collection of the data has been impeccable. To my mind, this has been a model of objective cooperation between an academic institution and an external research organization.

Why is that information important?

The answer to that question depend on who you are.

To academics, this is a treasure trove of valuable information that is useful in event studies and a broad range of other inquiries. Indeed, Clearinghouse data are central to several of the most important academic analyses of class action securities fraud litigation. Indeed, dozens of leading papers rely on the Clearinghouse as an essential data source.

To litigators, the database is an open source repository of the briefs that represent a collated description of the state of the art in securities law litigation. The briefs are often far more valuable than the judicial opinions.

To insurers, the database is a valuable guide to current market developments. Insurers visit the site frequently for information about market trends and developments.

To the SEC, another frequent visitor, the database is an objective, third party source of information that allows the agency to track litigation in matters that might also be of interest to enforcers.

To legislators, the database also serves as an objective representation of the marketplace, not filtered by defendant or plaintiff interests.

And, to the press, it’s a reliable source of data often quoted in articles to provide context about litigation trends and developments.

Joseph Grundfest is the W.A. Franke Professor of Law and Business at Stanford Law School. A former commissioner of the Securities and Exchange Commission, he is an expert on capital markets, corporate governance, and securities litigation.