Vanderbilt Law Review
In 1995, Congress overrode President Bill Clinton's veto and enacted the Private Securities Litigation Reform Act ("PSLRA"), a key purpose of which was to put securities class actions under the control of institutional investors with large financial stakes in the outcome of the litigation. The theory behind this policy, set out in a famous article by Professors Elliot Weiss and John Beckerman, was simple: self-interest should encourage investors with large stakes to run class actions in ways that maximize recoveries for all investors. These investors should naturally want to hire good lawyers, incentivize them properly, monitor their actions, and reject cheap settlements. In other words, control by large investors should reduce agency costs, which can be severe when securities class actions are run by lawyers who may be essentially unsupervised because their clients' stakes are small. This reduced risk of opportunism should alleviate the need for judges to police the conduct of class counsel as well.
By giving large investors control of securities-fraud class actions, the PSLRA expresses greater confidence in private arrangements than in judicial regulation, which failed to protect investors sufficiently in the past. Initially, Congress's confidence in private arrangements seemed misplaced because institutional investors rarely volunteered to serve as lead plaintiffs. The statute created no incentives motivating them to serve, so they remained on the sidelines as they had before. Over time, however, a series of developments brought more public pension funds into the fray. The publicity that attended the scandals involving Enron, WorldCom, Tyco, and Cendant likely played an important role, as did the enormous recoveries obtained in those cases. Lawyers seeking appointments as lead counsel also contributed by building relationships with institutional investors. Law firms wined and dined investment managers, volunteered to monitor institutional portfolios for signs of fraud, and made campaign contributions to politicians who had influence or control over public pension funds in what some have suggested are pay-to-play relationships. Today, institutional investors are important players in securities-fraud class actions.