SCHONBRUN: Class action lawyers game the system for personal gain

Shareholders bilked of $17 billion over 10 years

Recently, the 6th U.S. Circuit Court of Appeals decided an interesting case involving big-money lawyer fees in class actions, U.S. v. Gallion, et al.

We all remember the diet drug Fen-Phen. It was touted by its manufacturer, American Home Products, as the new miracle weight loss drug. Later, it was alleged to cause health problems and even deaths, leading to a sprawling mass tort class action lawsuit, with billions of dollars in settlements and attorneys’ fees. In one of the cases, two Kentucky attorneys, representing 440 clients, were convicted of taking more than they agreed to in their retainer agreements. Their clients, who got $74 million, should have received $135 million, while the two lawyers, who should have received around $22 million each, took nearly twice that amount. Apparently, the lawyers felt that $22 million each was not enough, so they concocted a scheme to steal tens of millions of dollars from their clients. They were caught, subsequently disbarred from practicing law, and convicted of wire fraud and conspiracy. The Court of Appeals has rejected the lawyers’ appeal, affirming that they “participated in a massive scheme to defraud their clients.”

You may also recall another fraudster, Texas billionaire financier R. Allen Stanford, was recently sentenced to 110 years in prison for running what authorities called one of the largest Ponzi schemes in U.S. history. Stanford sold billions of dollars of phony certificates of deposit issued by his Caribbean bank, which had insufficient assets to pay his investors’ claims. Newspapers describing Stanford’s scheme recount the plight of his victims facing “pennies on the dollar” in recoveries. They have around $5 billion in claims, but may only be dividing up some $70 million that remains. Unfortunately, such schemes “to defraud their clients out of millions of dollars” and clients getting mere “pennies on the dollar recoveries” have been standard operating procedure for the class-action system for decades. Surprisingly, neither our courts of law nor the press seem to have noticed. Stanford and the Fen-Phen attorneys are going to prison, while class action lawyers who perpetrate their scheme every day in courtrooms around the country are praised for protecting the “little guy” from big business.

Take, for example, the Ford Explorer SUV coupon class action settlement. In that case, the plaintiffs’ lawyers were awarded $25 million in attorneys’ fees by claiming that the class members were receiving coupons valued at $500 million. Only 148 class members redeemed their coupons, however, for a total value of $74,000. That’s right. The class action lawyers said that the class would be receiving $500 million in benefits, although class members actually received only $74,000. Courts typically facilitate this ruse by accommodating the settling parties’ request that actual class payouts not be made a part of the court’s record. Fen-Phen’s $74 million to clients instead of $135 million looks pretty good by comparison.

Just like Stanford’s victims, “pennies on the dollar” is standard operating procedure in the world of securities class action settlements. In one of the largest securities class actions in history, In re: Initial Public Offering Securities Litigation, the best the plaintiffs’ lawyers could do was a settlement in which class members got 1 cent for every $1 of damages claimed. That’s not pennies, that’s a penny. The lawyers, on the other hand, were awarded $170 million in attorneys’ fees.

Studies show that class members in these securities class action settlements are only getting about 2.5 cents for every dollar of alleged damages, or literally pennies on the dollar. Meanwhile, the class action lawyers in these cases are raking in billions of dollars in attorneys’ fees. The class action system has picked the pockets of America’s shareholders for nearly 40 years. This is money taken not from wheeler-dealer market operators who directly trade securities, but from those of us who own mutual funds, have 401(k)s, pensions or other types of retirement plans. That is because the settlements are actually paid for by the companies’ insurance, which is paid for by the shareholders. Thus, the shareholders are essentially suing themselves and then paying for the alleged crime they are the victims of.

According to a recent law review article, over the past 10 years, plaintiffs’ lawyers have siphoned off nearly $17 billion of shareholder equity in the form of attorneys’ fees for securities class actions. That is $17 billion in one decade alone, which dwarfs the Stanford and Fen-Phen scams. Moreover, unlike those schemes, which ensnared a relatively small group of unlucky participants, class actions take money from all of us in the form of increased insurance premiums, higher prices, fewer products and reduced service. The newspapers don’t write about The Great Class Action Swindle, perhaps because the headline doesn’t read, as it did in the Stanford scam, “Many face financial ruin, shattered retirements, or the loss of medical treatments they can no longer afford.” Class action lawyers, in their conniving genius, have spread the costs around to all consumers, which makes all of us suffer — but just a little bit.

The class action system was meant to protect us from businesses that cheat large numbers of people out of small amounts of money. The cruel irony, however, is that class action lawyers inflict the very harm the class action was intended to remedy.

Lawrence W. Schonbrun is the executive director of Class Action Watch.

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