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In an article today entitled “Unscrewing Shareholders,” Daniel Fisher of Forbes reviews a decision by U.S. District Judge for the Southern District of New York Jed Rakoff rejecting a settlement between the Securities and Exchange Commission and Bank of America.  The case involves allegations that Bank of America committed securities fraud by paying bonuses to Merrill Lynch executives in acquiring the company last year, without telling its policyholders.

Judge Rakoff was troubled by, among other things, the fact that the settlement called for a $33M payment to the government, a cost that would be born by the same shareholders who were supposedly victimized by the settlement, stating, “[t]o have the victims of the violation pay an additional penalty for their own victimization was enough to give the Court pause.”  Although the opinion comes in a regulatory enforcement case and not a class action, Fisher observes that this same phenomenon occurs in many securities class actions:

The ironic part is this is exactly what happens in most securities fraud cases. A company’s stock price falls, the class-action lawyers file a complaint, and after months of expensive pretrial jousting, the parties settle with the company’s shareholders picking up the tab. The fact that insurance is often the source of the money doesn’t change things: Insurance companies aren’t charities–they collect those payouts by increasing rates.

This criticism about the social utility of class actions as a means of remedying corporate misconduct is not limited to the context of securities fraud class actions.  Much like the cost of a securities class action settlement is borne by the company’s shareholders, the cost of settling a class action against an insurance company may be borne by the company’s policyholders in the form of higher premiums, while much of the cost of a consumer fraud class action against a provider of goods and services will be borne by consumers themselves in the form of higher prices for those products.  One can argue that class actions offer a deterrent effect against future corporate wrongdoing, but in many cases, it is often difficult to argue that they result in meaningful net compensation for the true victims of past misconduct.

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