Judges who settle.

• Author: Sale, Hillary A.

1. GATEKEEPING AND AGGREGATE LITIGATION

   Aggregate litigation is a solution to gaps in the legal system. Administrative law, for example, provides a partial solution to the problems of individual consumers who have insufficient incentives to pursue claims on their own. (6) Resources, however, are unavailable to deal with all of the claims and concerns; thus, private litigation steps in to provide "group redress." (7) The system is not unified and the result is considerable diversity in outcomes. Scholars have focused extensively on the problems and solutions of class actions and aggregate litigation. This Article examines two key forms of litigation for corporate and securities law--class and derivative actions, focusing on the settlement stage.

   The class action has evolved considerably since the 1940s, when Harry Kalven and Maurice Rosenfield first wrote about it, (8) but it remains an important part of the enforcement mechanism for corporate and securities laws. It is a procedural mechanism available when there is both an underlying substantive claim and when the proposed class of plaintiffs meets certain specifications under Federal Rule of Civil Procedure Rule 23 or its state law equivalent. Derivative litigation, in which shareholders attempt to sue on behalf of the company, does not take the form of a class action because the plaintiffs are attempting to represent the company, not themselves. It does, however, bear similarities to class actions and is subject to some of the same procedural rules, as set forth under Federal Rule of Civil Procedure Rule 23.1 or its state law equivalent. Thus, for the purposes of this Article, the terms class or aggregate litigation refer to both traditional class actions and derivative litigation.

   The literature is filled with complaints and concerns about fiduciary issues, agency costs, and other problems at all stages of aggregate litigation. (9) This Article focuses on corporate and securities litigation, providing a brief summary of those issues. The focus is on the fiduciary-like role that judges play at the settlement stage of corporate and securities litigation. These cases are unique. They have specific procedural provisions for federal securities claims and derivative claims. These features were designed to help curb agency problems and to increase the judicial role in combating them. In addition, the injuries in these cases, unlike mass torts, for example, are financial, and, therefore, sometimes receive less attention than they ought. (10) Finally, the agency problems in these cases are similar to the agency problems in the corporate organizations where the underlying violations occur. Indeed, the underlying agency problems are part of the reason why judges end up with the gatekeeping task.

   In addition to the extensive analysis of the costs of aggregate litigation, the legal literature is filled with proposed solutions, ranging from introducing intermediate advocates--like a guardian ad litem--for classes of individuals, to eliminating causes of actions entirely, to encouraging plaintiffs who were harmed by insufficient settlements to sue their former attorneys, to giving the SEC the power to oversee and prescreen securities causes of action. (11) Focusing on the settlement stage and the specific fiduciary role assigned to the judges who review and permit settlements, this Article examines the gatekeeping role of judges as the enablers of settlements. Unlike other types of private litigation, these settlements require judicial approval. (12) The judges are prescribed a fiduciary-like role to make determinations about settlements before allowing them to proceed. I argue that judges are required to perform this role. Then, I develop a construct of judges as gatekeepers and create a set of principles to provide guidance to them.

2. THE SOLUTION AND COSTS OF AGGREGATE LITIGATION

   Delaware common law reveals that the fiduciary duties of directors and officers are enforced through private litigation. (13) The system relies on private attorneys to take the lead. Delaware is not alone. The federal securities regime also relies on private attorneys to supplement enforcement. (14) In both situations, plaintiffs' attorneys bring the cases and, if successful, receive fees for doing so. These cases, like class-action and aggregate litigation generally, are responses to what is otherwise a systemic failure. As the Supreme Court explained in Deposit Guaranty National Bank of Jackson, Miss. v. Roper:

   The aggregation of individual claims in ... a classwide suit is an evolutionary response to the existence of injuries unremedied by the regulatory action of government. Where it is not economically feasible to obtain relief within the traditional framework of a multiplicity of small individual suits for damages, aggrieved persons may be without any effective redress unless they may employ the class-action device. (15) Aggregate litigation, then, provides the potential for remedies, recoveries, and enforcement in situations that might otherwise escape review. (16) Absent the aggregate litigation mechanisms, corporate and securities-related fraud and fiduciary breaches would go unredressed largely for two reasons. First, government resources are insufficient to pursue all of the potential cases. (17) Although the Securities and Exchange Commission has a large enforcement division, the staff is not sufficient to investigate and pursue all of the potentially fraudulent situations. As a result, private litigation is actually the "primary vehicle" for securities and corporate enforcement. (18) The existence of these cases, then, increases incentives for corporate actors to fulfill their disclosure and fiduciary duties or, put another way, helps to deter bad acts. (19)

   Second, the available damages in most securities and corporate cases on an individual basis--or in the case of derivative litigation, recovery for the corporation--do not provide an incentive for plaintiffs to pursue matters on their own. Many shareholders hold an insufficient number of shares to make it worthwhile for them to pursue fiduciary or securities breaches individually. Aggregation through derivative or class-action claims, with potential attorneys' fees, allows for litigation. (20) Thus, the underlying principle of the class action is to "overcome" incentive problems resulting from individually small recoveries by "aggregating the relatively paltry potential recoveries into something worth someone's (usually an attorney's) labor." (21) Aggregation, then, provides a solution to what is commonly referred to as a collective-action problem inherent in shareholder litigation. It makes otherwise "unmarketable" claims "marketable." (22) By doing so, it creates an enforcement mechanism for plaintiffs.

   Aggregate litigation also benefits defendants. Although they complain about aggregate litigation and make strong arguments against the certification of particular classes, (23) an aggregate settlement protects defendants from repeated litigation on the same issues because it can bind all class members. (24) The effect is to prevent future cases on the same set of facts. Preclusion of this sort is very valuable to defendants, and a court-approved settlement agreement buys it. (25) Thus, settlement is important to both sides. (26)

   Legal solutions, however, often present new problems, and aggregate litigation is no different. (27) At issue here are a series of "gaps" between the "parties," the lawyers, and the check-writers--generally, the insurers, but sometimes the corporations. On the plaintiffs' side, the thousands of shareholders, their class representatives, and the lawyers face communication and other issues. On the defendants' side, the incentive to settle is complicated by the typical funding sources. In short, settlements are rarely supported by personal contributions. Instead, corporate and insurer payments result in agency costs.

   These agency problems are not unlike those inherent in corporate law and the separation of ownership and control more generally. (28) Shareholders have stakes too small to engage in regular monitoring of the fiduciaries charged with running the corporations and issuing the disclosures. Those small stakes are at the root of the incentive problem that prevents them from litigating in the first place. They influence the attorney-client relationship as well. The representative plaintiffs arguably have investments insufficient to ensure active monitoring of the class lawyers' performance or much, if any, participation in the litigation other than what is required. The stakes also are too small to ensure they monitor their attorneys' fees. (29)

   Settlement magnifies the agency issues and costs. (30) Consider the potential conflict between the class representatives, or lead plaintiffs in securities litigation, and the class attorneys. The attorneys generally take these cases on the basis of a hoped-for return, or on contingency, advancing the costs of litigation along the way. As a result, a smaller settlement with a "higher ratio to the cost of the work than a much larger recovery obtained only after extensive discovery, a long trial and an appeal," can be attractive. (31) Thus, the attorneys may prefer to settle rather than go to trial, even if holding out or going to trial would result in a larger payment for the shareholders. Additionally, both the attorneys and representative plaintiffs may prefer settlement to save time and ensure some return, but the remaining members, who are not expending money or time, may have an interest in pursuing the litigation for a longer period in the hopes of a larger settlement.

   Rather than providing the assumed adversarial balance, the defendants contribute to these problems. Generally, defendants want "peace." (32) If they have done wrong, they want out sooner. If they have not, they still want out. After all, litigation imposes transaction and...