Compensation's role in deterrence.

• Author: Gold, Russell M.
• Position: Abstract through II. Reputational Harm and Optimal Deterrence A. Nature of Reputational Harm, in Class Actions, p. 1997-2021

ABSTRACT

There are plenty of noneconomic reasons to care whether victims are compensated in class actions. The traditional law-and-economics view, however, is that when individual claim values are small, there is no reason to care whether victims are compensated. Rather than compensation deterring wrongdoing is tort law's primary economic objective. And on this score, law-and-economics scholars contend that only the aggregate amount of money that a defendant expects to pay affects deterrence. They say that it does not matter for deterrence purposes how that money is split between victims, lawyers, and charities. This Article challenges that claim about achieving tort law's primary objective and argues that there is an economic reason to care whether victims are compensated in class actions. It offers reason to think that compensating victims deters more wrongdoing than the same amount of relief in other forms, at least in damages class actions.

Put a different way, this Article contends that the primary objectives of class actions--compensation and deterrence--are intertwined in ways that scholars have not previously recognized. Compensation affects the amount of reputational harm that class actions inflict on defendants, and anticipating that reputational harm provides a source of deterrence. Because the public cares whether victims are compensated in civil litigation, if class actions were frequently to slight compensation that would undermine public perception of the class device; class actions would come to seem more like plaintiffs' lawyers' extortion mechanisms than legitimate means of redressing harm. Diminished procedural legitimacy makes the class action a less powerful signal about the validity of the underlying claims, which undermines reputational deterrence.

INTRODUCTION

In 2014 Pepsi settled a labeling class action regarding Naked Juice for $9 million. (1) Of that $9 million settlement fund, $5.5 million was allocated to compensate customers. (2) A few years ago Facebook settled a privacy class action for $9.5 million; (3) in contrast to the Naked Juice settlement, none of the money went to victims. (4) It went instead to charity and class counsel as attorneys' fees. (5)

There are, of course, noneconomic reasons to care whether victims are compensated in class actions: class counsel's professional responsibility or agency obligations to the class, (6) philosophical commitments to compensating victims, (7) or the Rules Enabling Act. (8) From an economic perspective, however, scholars have argued that for purposes of tort law's primary objective--deterring wrongdoing (9)--it does not matter whether victims are compensated in class actions. (10) Rather, they argue, only the aggregate amount and likelihood of payment matter when considering the settlement's deterrent effect. (11) Whether class actions typically follow the Naked Juice approach of giving much of the judgment to victims or the Facebook approach of giving nothing to victims--the thinking goes--does not affect deterrence. (12) This Article challenges that notion.

Instead, it offers reason to think that compensation affects deterrence in ways that scholars have not recognized. A class action judgment will likely do more harm to a defendant's reputation if class action damages (13) are typically paid primarily to victims than if they are typically paid primarily to attorneys or charities. (14) Although class action judgments in practice typically compensate victims, some cases have recently pushed the boundaries of using cy pres awards for charity or attorneys' fees instead of compensating victims, (15) and the Supreme Court seems poised to consider the proper role for such compensation-less class settlements. (16) Although the primary goal of this Article is to refine the scholarly understanding of deterrence in damages class actions and recognize that compensation plays a role in deterrence, developing the theoretical underpinnings for how compensation-less settlements affect tort law's primary economic objective is particularly important in light of likely Supreme Court review.

Avoiding reputational harm constitutes a largely unrecognized form of deterrence. Most scholars have focused on damages as though it were the sole source of deterrence in litigation. (17) A few scholars, however, have recognized that nonlegal harms--including harms that litigation inflicts on defendants' reputations--deter wrongdoing. (18) The literature on reputational deterrence in class actions has been particularly thin. Only one scholar has noted, in passing, this idea that reputational harm may deter wrongdoing. (19)

Class actions provide reputational deterrence so long as the filing or settlement of a class action is seen to signal wrongdoing. Because class action settlement agreements explicitly deny wrongdoing, reputational harm and the extent to which potential defendants can anticipate such harm depend in part on whether the class device is viewed as a meaningful signal of wrongdoing despite that denial. Drawing on corporate crime and derivative suit literature, this Article contends that whether a class action is seen to signal to the casual observer that the underlying claims have merit turns on the procedural legitimacy of the class device. (20) That's where compensation comes in.

Whether victims are typically compensated in class actions affects the procedural legitimacy of the class device because the American public values compensation and expects civil litigation to compensate victims, including class actions. (21) Scholars agree as a descriptive matter that the public desires victim compensation in civil litigation. (22) This compensationalist sentiment that ties compensation to procedural legitimacy can be seen from several different perspectives. First, it can be seen through elected officials. Congress relied on compensationalist rhetoric to advance several pieces of legislation affecting class actions: the Class Action Fairness Act of 2005 (CAFA), (23) the Private Securities Litigation Reform Act of 1995 (PSLRA), (24) the FAIR Funds Act, (25) and the FTC Improvement Act. (26) Using compensationalist rhetoric suggests that members of Congress thought the compensationalist message would resonate with their voters. Moreover, for those wary of concluding that congressional rhetoric means anything, there is evidence from the judicial branch about compensationalist public sentiment and its relationship to the legitimacy of the class device. Two prominent judges relied on the need to preserve public legitimacy in aggregate litigation as reason to modify private attorneys' fee arrangements. (27) Similarly, a Judicial Conference Report expressed concern that affording too little compensation for victims risked jeopardizing the legitimacy of the class device. (28) Lastly, polling data confirms this compensationalist sentiment. (29)

If class actions are typically seen as shakedowns by plaintiffs' lawyers trying to make a buck, class action filing or settlement will send a different message than if class actions are seen as compensatory. If victims are typically compensated, class actions will tend to be seen as fulfilling the public's expectation of civil litigation--providing a means to redress widespread harm to actual victims. (30) The perception that some have been wronged necessarily carries with it the perception of wrongdoing and a wrongdoer--likely the defendant.

The intertwinement of compensation and deterrence means that compensation is not merely a "[f]alse [i]dol" (31) or relevant only to those who approach tort law and complex litigation from a noneconomic perspective. Rather, compensation matters for economic reasons, including in small-claim class actions. In small-claim cases, several scholars have recently advocated focusing only on the aggregate judgment without considering how much of the money goes to victims because--they contend--how much money goes to victims does not matter for deterrence. (32) Brian Fitzpatrick argues that compensation impedes deterrence, and he thus advocates...