Corporate aggregate litigation differs between European and U.S. jurisdictions. In the U.S., under the securities regulations, the Private Securities Litigation Reform Act of 1995 established the rebuttable presumption that the lead plaintiff is the entity with the largest financial interest. In European aggregate litigation, lead plaintiffs are for the most part qualified associations. This paper argues that association-driven aggregate litigation can be a valuable and effective alternative to some of PSLRA’s shortcomings. The difference in risk attitudes between large and small claimants poses agency problems in the U.S. system where large plaintiffs are put in charge of aggregate litigation as lead plaintiffs. Due to large plaintiff’s risk aversion, the settlements agreed by the lead plaintiffs/large claimants might bring comparatively lower utility to small claimants. Small claimants with negative value claims would not be able to opt-out, and they would be left with the low-utility recovery. On the other hand, the association-driven litigation not only diminishes this agency problem, but also has the potential to increase the negotiated outcome. Small claimants’ risk seeking behavior in low settlement levels is known in psychology and decision-making theory as 'peanuts effect,' and comes in contrast to large claimants’ risk averse attitudes. As early as 1952, Markowitz had noted that people would tend to be risk seeking in low levels of wealth. In 1980s, experimental designs in psychology yielded the first empirical signs of risk-seeking behavior for small gains. Hershey and Schoemaker when presenting the subjects with a series of hypothetical situations of varying probabilities and returns, they found a risk seeking behavior for small gains. Green, Myerson, and Ostaszewski have found that risk attitudes indeed change with the level of reward; as the reward decreases, risk aversion decreases as well. Recently, Weber and Chapman found in experimental settings that the peanuts effect positively correlates with low magnitude gambles, larger probabilities, and larger ratio between probabilities. This paper employs a two-level game structure, following Putnam’s seminal two-level approach on negotiations. Level I is the main negotiations level, in our case between the association and the defendant. Level II is the interaction level between the negotiator and its constituents, in our case the association and its members. The association has its own utility function based on its expected payoffs. The association’s utility depends very much on the utility of its constituents (claimants). Associations are accountable to their constituents through a variety of ways: board election, membership fees, annual evaluative reports, state certification as 'qualified' entities. Since the associations’ utility function will depend on the number of large and small claimants, this leads effectively to the democratization to a certain degree of the internal decision process. As long as the shift in association’s reservation point due to the risk-seeking small claimants does not exceed the defendant’s expected litigation exposure, settlement will be possible in higher agreed damages than without the small claimants. We would expect that the defendant will know of association’s constraints (since its membership structure would probably be public information) rendering the shift in its reservation point more credible. Essentially, this creates a tied-hands constraint for the association. Since the defendant would still find some settlement values advantageous, the association’s bargaining power would be increased and the final settlement could be higher than without the small claimants. On the other hand, if the shift exceeds the defendant’s expected exposure, then no settlement is possible. This, interestingly, could prompt the large claimants to opt-out (or not opt-in) and try to settle independently. Without large claimants, the associations’ reservation point will increase even further (due to the risk-seeking nature of the remaining small claimants), the defendant’s litigation exposure under the association’s suit would drop (since aggregate damages would decrease), which would bring down defendant’s expected litigation and render settlement less possible than before. In light of this potential scenario, small claimant’s risk appetite would be mitigated up to the defendant’s reservation point, potentially reducing any adverse effects and creating a symbiotic relationship between the two types of claimants.
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Apr 1, 2010
Susan M Pettey 
Open Access
