Overlitigating Corporate Fraud: An Empirical Examination

• Author: Jessica M. Erickson
• Position: Associate Professor, University of Richmond School of Law. B.A., Amherst College; J.D., Harvard Law School.
• Pages: 49-100

49

Overlitigating Corporate Fraud: An

Empirical Examination

Jessica M. Erickson

ABSTRACT: Corporate law leaves no stone unturned when it comes to

litigating corporate fraud. The legal system has developed a remarkable

array of litigation options—shareholder derivative su its, securities class

actions, SEC enforcement actions, even criminal prosecutions—all aimed at

preventing the next corporate scandal. Scholars have long assumed that

these different lawsuits offer different avenues for deterring the masterminds

of corporate fraud—yet this assumption has gone untested in the legal

literature. This Article aims to fill that gap through the first empirical

examination of the broader world of corporate fraud litigation. Analyzing

over 700 lawsuits, the study reveals that these lawsuits do not target

different types of corporate wrongs. Instead these lawsuits too often target the

same alleged misconduct, the same defendants, and the same corporate

coffers. The data also demonstrate that certain types of lawsuits consistently

outperform others, creating a litigation hierarchy within corporate law.

These findings raise critical questions about traditional theories of

deterrence, suggesting that more may not always be better when it comes to

combating corporate fraud. The Article then brings these empirical insights

to bear in developing a new framework for more targeted deterrence of

corporate fraud.

I

NTRODUCTION ........................................................................................ 51

I. METHODOLOGY ....................................................................................... 54

A. STUDY PARAMETERS ........................................................................... 55

 Associate Professor, University of Richmond S chool of Law. B.A., Amherst College;

J.D., Harvard Law School. The research conducted for this Article was supported by a research

grant from the American Bar Association (“ABA”) Section of Litigation; however, the views

expressed here are not intended to represent ABA positions or policies. This Art icle benefited

from suggestions made at the Vanderbilt Law & Business Conferenc e, the Law & Society Annual

Conference, and the Virginia Junior Faculty Forum. I want to thank Bernard Black, Elizabeth

Burch, Stephen Choi, Jill Fisch, Jim Gibson, Sean Griffith, Lee Harris, Corinna Lain, Kristen

Osenga, Jack Preis, Adam Pritchard, Tony Rickey, and Noah Sachs for their helpful comments

and thoughts in developing this Article. I also want to thank Shan Xu for his assistance with the

data analysis.

50 IOWA LAW REVIEW [Vol. 97:49

B. STUDY DESIGN .................................................................................... 57

II. EMPIRICAL RESULTS ................................................................................. 60

A. THE PARALLEL WORLD OF CORPORATE FRAUD LITIGATION ................. 61

1. Incidence of Parallel Litigation ............................................... 61

2. Locus of Parallel Litigation ..................................................... 66

3. Allegations in Parallel Litigation ............................................. 69

B. SHAREHOLDER DERIVATIVE SUITS AS PARALLEL LITIGATION ................ 72

1. Comparing Filing Dates ........................................................... 72

2. Comparing Defendants ........................................................... 74

3. Comparing Judgments ............................................................. 76

III. IMPLICATIONS: TOWARD TARGETED DETERRENCE OF CORPORATE

FRAUD IN SHAREHOLDER DERIVATIVE LITIGATION ................................. 81

A. PRIVATE COMPANY DISPUTES .............................................................. 82

B. LITIGATION VACUUMS ........................................................................ 84

C. THE CASE OF CORPORATE OUTSIDERS ................................................. 88

D. THE ROLE OF CORPORATE NORMS ...................................................... 92

CONCLUSION ........................................................................................... 98

APPENDIX ................................................................................................. 99

2011] OVERLITIGATING CORPORATE FRAUD 51

INTRODUCTION

In the wake of the unprecedented meltdown in the financial markets,

few would argue that the law should curtail available avenues to combat

corporate fraud. Scholars and politicians alike have turned to legislation—

and litigation—to prevent future financial catastrophe.1 Congress responded

to fiscal duplicity in the mortgage industry, for example, by passing

landmark legislation that overhauled regulation of financial institutions and

made it easier to sue credit rating agencies.2 The federal government

similarly reacted to the sweeping fraud orchestrated by Bernie Madoff by

giving the Securities and Exchange Commission (“SEC”) a wide array of new

tools to bring corporate wrongdoers to justice.3 When it comes to combating

corporate fraud, conventional wisdom holds that more is better.

The reason is simple: Corporate managers, like burglars or tax evaders,

are less likely to engage in misconduct if they know that this misconduct

could expose them to legal liability. This deterrent potential has been used

to justify nearly every type of corporate lawsuit.4 Scholars have even

defended oft-criticized types of corporate fraud lawsuits, such as securities

class actions and shareholder derivative suits, on the ground that these

lawsuits help deter corporate misconduct.5

Yet this simple story masks the complex reality of corporate fraud

litigation. Corporate law differs from criminal law or tax law in a

fundamental way—corporate law uses multiple means to punish the same

conduct. Take the example of Goldman Sachs Group, Inc. Last year,

1. See, e.g., S. REP. NO. 111-10, at 3 (2009) (“To make sure this kind of collapse cannot

happen again, we must reinvigorate our anti-fraud measures and give law enforcement agencies

the tools and resources they need to root out fraud so that it can never again place our financial

system at risk.”); John C. Coffee, Jr. & Hillary A. Sale, Redesigning the SEC: Does the Treasury Have

a Better Idea?, 95 VA. L. REV. 707, 717 (2009) (arguing that the relaxation of traditionally

aggressive antifraud laws was a “leading cause” of the current financial crisis).

2. See Dodd–Frank Wall Street Reform and Consumer Protection Act , Pub. L. No. 111-

203, § 933, 124 Stat. 1376, 1883–84 (2010) (to be codified at 15 U.S.C. § 78u-4(b)(2)(B)).

3. See id. passim; Zachary A. Goldfarb, As Financial Reform Becomes Law, SEC Emerges with

New Powers and Duties, WASH. POST, July 22, 2010, http://www.washingtonpost.com/wp-

dyn/content/article/2010/07/21/AR2010072106390.html (stating that the Dodd–Frank Act

requires the SEC to issue nearly one hundred new regulations).

4. See Tom Baker & Sean J. Griffith, How the Merits Matter: Directors and Officers Insurance

and Securities Settlements, 157 U. PA. L. REV. 755, 762 (2009) (“Scholars customarily treat

deterrence as the principal objective of civil damages in corporate and securities litigation.”) ;

John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and Its

Implementation, 106 COLUM. L. REV. 1534, 1556–66 (2006).

5. See, e.g., Kenneth B. Davis, Jr., The Forgotten Derivative Suit, 61 VAND. L. REV. 387, 405

(2008) (stating that “justification for the derivative suit” increasingly relies “on the suit’s

deterrent role”); Carol B. Swanson, Juggling Shareholder Rights and Strike Suits in Derivative

Litigation: The ALI Drops the Ball, 77 MINN. L. REV. 1339, 1346 (1993); see also infra notes 9–10

(addressing the role of deterrence in securities class actions).