In Group Arbitrations, a Lot of Little Can Be Really Big
We’ve said it before, we are not a fan of class actions. In fact, except for the lawyers who handle them, no one is a fan of class actions. Class actions definitely play at least a small role in deterring bad corporate behavior, but as a remedy for victims seeking compensation, it grades out at a D-minus. Yes, you can opt out of a class actions and sue on your own. But what happens if you’re in litigation limbo, with losses big enough to really hurt but not big enough to justify pursuing a claim on your own?
Medical Capital Fraud
A few years ago, we were contacted by a couple we’ll call Tom and Sally Garnett. Those aren’t their real names, but they are real people. Tom and Sally had been persuaded by their stockbroker to invest $50,000 of their precious retirement money in a promissory note issued by a California corporation called Medical Capital. The broker told them the note was a safe, conservative investment and would produce an excellent return. But he failed to mention that Medical Capital’s CEO had a well-documented history of shady business practices, legal problems, and corporate bankruptcy. Nor did he disclose that independent due diligence experts examining Medical Capital had expressed concerns about the integrity of the company’s unaudited financial records.
Medical Capital turned out to be riddled with fraud, and its collapse caused thousands of investors across the country to collectively lose nearly $1 billion. While some victims suffered losses ranging from hundreds of thousands to millions of dollars, many others like the Garnetts lost only the minimum investment of $50,000 – a significant blow, but not large enough to justify the expense of pursuing an individual claim. The Garnetts seemed destined to be stuck in a class action along with thousands of other similarly situated victims, each of whom likely would recover no more than pennies on the dollar.
Fortunately, the Garnetts happened to hear about another option. Under the rules of FINRA — the brokerage industry’s self-regulatory organization — multiple parties can join in a single arbitration proceeding if their claims have questions of law or fact in common and arise from the same series of transactions. Our securities litigation team was preparing several group cases, each one advancing the claims of a dozen or more separate households who had purchased Medical Capital notes from the same broker. While the Garnetts’ loss was too small by itself to justify a stand-alone arbitration proceeding, we were able to include them in one of the groups we had assembled.
Though the Garnetts’ losses may have been at the low end of the continuum, a $50,000 loss is a meaningful loss. For anyone who suffers a meaningful loss, which we define as one that constitutes more than a mere inconvenience, group arbitration is vastly superior in almost every way to being stuck in a class action. Class actions are only a good remedy when large numbers of people have suffered minuscule individual losses for which no one would ever sue on their own. But class actions make very little sense for injured investors who have meaningful losses. According to one fairly recent study of securities class actions, settlements typically return in the range of just 2-3%. In other words, the median recovery by a class member in a securities fraud class action is two or three pennies for each dollar of loss.
All things being equal, an investor is likely to recover vastly more money by actively pursuing individual claims in a group format than by passively participating as a class member.