Do Institutions Matter? The Impact of the Lead Plaintiff Provision of the Private Securities Litigation Reform Act

When Congress enacted the Private Securities Litigation Reform Act in 1995 (“PSLRA”), the Act’s “lead plaintiff” provision was the centerpiece of its efforts to increase investor control over securities fraud class actions. The lead plaintiff provision alters the balance of power between investors and class counsel by creating a presumption that the investor with the largest financial stake in the case will serve as lead plaintiff. The lead plaintiff then chooses class counsel and, at least in theory, negotiates the terms of counsel’s compensation. Congress’s stated purpose in enacting the lead plaintiff provision was to encourage institutional investors—pension funds, mutual funds, hedge funds, etc.—to come forward to serve as lead plaintiff. The theory was that an institutional investor with a substantial damages claim would have the incentive to bargain hard with class counsel on behalf of the class, reducing the percentage of the recovery awarded to class counsel. Congress also expected institutions to play an oversight role, monitoring to make sure that class counsel was vigorously pursuing claims on behalf of the class and not settling claims on the cheap. Our study offers evidence on the extent to which the lead plaintiff provision furthers these goals. We have collected two samples of securities class actions—one from 1991 to 1995 (pre-PSLRA) and one from 1996 to 2000 (post-PSLRA). We compare the class representatives from the two periods to determine if institutional investors are stepping forward in significantly greater numbers. We also sort the institutional investors—distinguishing public from private—to see what types of investors have stepped forward to serve as lead plaintiff. Consistent with other research, we find a significant difference only in the number of public institutions serving as lead plaintiff. Our sample also allows us to analyze the impact of the lead plaintiff provision: Does the presence of an institutional investor increase the likelihood of a high-value settlement? Despite the visible participation of institutions in several high-profile cases, we find no systematic evidence that private institutional lead plaintiffs are associated with larger class recoveries. Public pension fund lead plaintiffs, on the other hand, are correlated with higher class recoveries as a fraction of the potential damage award in the post-PSLRA period. Our results are, however, consistent with the possibility that public pensions “cherry-pick” the actions in which they seek to become lead plaintiff, selecting only the cases with the largest potential damages and the strongest evidence of fraud. Further analysis is needed to evaluate this possibility. We also evaluate the effect of lead plaintiffs on the selection of attorneys and attorneys’ fees. We find that, for the time period of our study, institutional investors tended to avoid the Milberg Weiss plaintiffs’ attorney firm. On the more fundamental issue of whether the presence of an institutional investor as a lead plaintiff reduces the fees paid to the lawyers, after controlling for the size of the case, we find no systematic evidence that institutional involvement correlates with lower fee awards