As lawyers and marketers employed by securities class action law firms descend upon America’s pensions, questions regarding the financial arrangements these firms enter into with referring lawyers and potential plaintiffs are swirling. The Private Securities Litigation Reform Act of 1995 (“PSLRA”) that was intended to eliminate abusive securities litigation changed the rules of the game for securities class action firms. Instead of the old “first to file” rule, whereby the first law firm to file suit against a corporation would often be permitted to be lead counsel, today the firm representing investors with the largest financial interest (loss) is generally selected by the court as lead counsel. Lead counsel receives the vast majority of the staggering fees these cases often involve.
As a result of the PSLRA, today securities class action firms (in order to secure lucrative lead counsel fees) must persuade pensions to serve as lead plaintiffs in cases the firms seek to bring. This is no easy task. Marketing to pension funds is challenging for even the largest investment managers, custodians, brokerages and consulting firms. Some of the largest investment firms aggressively enter this marketplace for a few years, spending lots of money and then give up when they fail to see the quick results they envisioned. Experienced pension marketers know that pensions do not make decisions quickly and relationships must be forged before business can be transacted. Those who attend pension conferences year-in and year-out witness the comings and goings of firms that enthusiastically discover and subsequently become disillusioned with pension marketing.
Pensions, on the other hand, are subject to sales pitches of all sorts. Fiduciaries that initially jump at the latest “hot” idea quickly learn their lesson. Those that move slowly into uncharted waters have fewer regrets. Consequently, like it or not, pension marketing takes time. And a law firm seeking to be lead counsel in connection with the latest corporate scandal is in a race against time. Generally all lead counsel motions must be filed within sixty days. While ten years ago you’d hardly find a lawyer in the crowd at a pension conference, today pension conferees are subject to an “invasion of the securities class action lawyers.”
The problem many securities class action firms face in marketing to pensions is that they are not skilled at relationship–building. Apparently the skills that are required to be a successful lawyer representing a class of wronged investors are not necessarily the same as those required to form sound on-on-one relationships. So, in order to bridge this gap, these law firms have turned to relatives of prominent national politicians, former state elected officials and pension trustees and others with ready-made relationships that can assist firms that are impatient or incapable of establishing relationships on their own. While this may be a bit unseemly and involve the all-too-familiar “revolving-door,” it is not unusual nor is it illegal.
However, when these securities class action law firms pay lawyers who represent pensions hefty referral fees (which may or may not be disclosed to the fund-client) that DOES raise some very serious ethical and possibly legal issues.
Pension boards rely upon their lawyers to provide them with advice regarding (1) whether to participate in a securities class action lawsuit; (2) which law firm to retain to represent them and, finally, (3) what level of contingency fee the firm should be paid. Obviously, if fund counsel is receiving 10-18% of a class action law firm’s fee for the referral, he cannot be relied upon to provide the fund with impartial advice.
It is our understanding that many legal advisers to pensions and others receiving referral fees do not disclose the financial arrangements. While states may differ as to the ethical requirements applicable to lawyers within their boundaries, in our opinion those who serve as legal advisers to pension fiduciaries should observe the highest ethical standards.
Disclosure of referral fees should be made to the pension client both by the firm paying the fee and the firm receiving it. Further, pensions should ask all their legal service providers to disclose any financial arrangements. The codes of ethics many pensions have adopted often do not address conduct of outside counsel and should be amended.
While pension participation in securities class actions is a new development, it is here to stay. Pensions should take the time to become knowledgeable about the hidden financial incentives that may motivate their advisers so they can make informed decisions. A huge amount of money is involved in these cases and decisions regarding whether to participate as a lead plaintiff may have to be made quickly. If you don’t learn, you may get burned.
Our research publication, "Examining Active Investment Advisory Fees: 2003 "Actual " Fee Survey of 100 Pensions," is now available for purchase. The report provides guidance to plan sponsors for negotiating fees with managers and may be useful to managers in pricing their services. Please call Ted Siedle at (954) 360-0557 if you are interested.
