(Editor’s Note: This post is based on an op-ed piece published in today’s print edition of the Financial Times and is available here.)
The UK is reviewing rules governing its civil justice system, including class actions. Lord Justice Jackson is expected to publish a report in the next few months that will take up a number of proposals, including proposals to abolish the “loser pays” rule in collective lawsuits. Yet US experience – as illustrated by a current case before the US Supreme Court – may provide a useful caution. Jones v. Harris Associates L.P., argued on November 2, 2009, demonstrates that lowering the “loser pays” barrier could have serious consequences.
In the US, of course, each side in a lawsuit – including class actions pays its own costs regardless of outcome, and plaintiff lawyers can often extract a settlement that covers their costs (plus a bit), even if the case would lose at trial. A prime example is Jones v. Harris. In that case, plaintiffs’ attorneys allege a financial adviser breached its duties by overcharging clients of its collective investment schemes (mutual funds) for services. In the trial court, they lost. The adviser, after all, had produced above-average returns over many years in return for fees well within industry norms – and well below typical advisory fees in the UK. But the case has survived two rounds of appeal – despite independent trustees having negotiated the fees on behalf of investors, despite investors having approved the fees, and despite the fact that investors are free to liquidate at net asset value at any time and move their funds elsewhere in a highly competitive market.
How can such cases make it to the highest court in the land? Plaintiffs’ lawyers are able to file these cases because of three features of the US legal system. First, investors are dispersed, and cannot easily work together to protect their own interests. Collective action costs are often identified as a reason that investors cannot protect themselves from predatory institutions – and sometimes that is true. But those same costs also make it impossible for investors to control the lawyers who nominally represent them. Investors cannot stop lawyers from using weak or even frivolous claims to extract rich legal fees. Nor need lawyers even listen to investors with the most at stake in a case. Unlike the advisers, the lawyers are not required to negotiate with independent trustees, or to submit their lawsuit for approval to the investors. Once lawyers have appointed themselves as investor guardians, they face little competition – again, unlike the advisers, who compete with other advisers to attract new investments. Second, relevant US law is vague. A federal statute imposes on advisers an undefined “fiduciary duty with respect to the receipt of compensation”. Without clear or uniform rules to guide courts, without clear direction that judges consider the effects of competition, cases can be brought and slip through the barriers that are supposed to limit frivolous claims and discipline plaintiffs’ lawyers.
In these two respects, the UK and the US are much alike. UK investors (and consumers) are dispersed, and would have no easier time controlling lawyers who nominally represent them in collective actions. UK law is also full of vague standards – including fiduciary duties. That leaves the third element of the US system – the one distinguishing the UK at the moment. In the US, plaintiffs’ lawyers face no deterrent other than their own time and costs – they never need worry about compensating the adviser even if the defendant prevails. Lord Justice Jackson should pause long before giving up that distinction.