Institutional Investors’ Fiduciary Duties and Private Enforcement Actions
As a fiduciary charged with the oversight of a pension or similar fund, institutional investors have a tremendous responsibility to their beneficiaries and other stakeholders to ensure the financial security of the fund’s assets. Institutional investors typically hire professionals to manage fund assets and ensure growth. To this end, institutional investors often create sophisticated processes to monitor the performance of their investment professionals and the results they achieve. Another important component of the fiduciary duties invested in institutional investors, however, is the safeguarding of fund assets, including the duty to take reasonable steps to monitor and, where appropriate, prosecute claims arising from fraud or other malfeasance by corporate wrongdoers.
Certain institutional investors currently play a critical role in the prosecution of private securities fraud actions. In 1995, with the passage of the Private Securities Litigation Reform Act of 1995 (‘PSLRA’), Congress dramatically altered the federal securities laws and established many of the provisions that now govern shareholder lawsuits. One of the principal goals of the PSLRA was to encourage institutional investors to take charge of prosecuting securities class action lawsuits by becoming the ‘lead plaintiff(s)’ in the case. Congress explicitly stated its preference for institutional lead plaintiffs when it issued the following statement: ‘The Conference Committee believes that increasing the role of institutional investors in class actions will ultimately benefit shareholders and assist courts by improving the quality of representation in securities class actions.’
In recognition of the critical role that institutions can play in securities fraud class actions, in 1998, the United States Department of Labor (‘DOL’) stated in an amicus brief filed in In re Telxon Corporation Securities Litigation:
Not only is a fiduciary not prohibited from serving as a lead plaintiff, the Secretary believes that a fiduciary has an affirmative duty to determine whether it would be in the interest of the plan participants to do so. The Secretary has previously taken the position that it may not only be prudent to initiate litigation, but also a breach of a fiduciary’s duty not to pursue a valid claim.
As a result of the DOL’s position, in the last several years, a significant number of public and Taft-Hartley pension funds, as well as other institutional investors, have elected to serve as lead plaintiffs in securities fraud litigation and have consistently demonstrated an ability to increase the size of the recoveries for shareholders. In fact, as a 2003 NERA study, ‘Recent Trends in Securities Class Action Litigation,’ confirms: settlements in securities class actions were found to be about 20% higher where the lead plaintiff was an institutional investor.
Although certain institutional investors have actively pursued such litigation, it was not until the collapse of Enron and Worldcom that a significant number of institutions began taking a careful look at their own obligations and the role that they might play in curbing corporate abuses. Not many institutional investors find the prospect of participating in a class action or other corporate governance litigation particularly attractive. Many public pension funds and other institutional investors, however, now recognize the need to establish securities litigation policies, monitor fraud-related damages and, where appropriate, consider legal action to fulfill their fiduciary duties. As described below, it also is relatively simple for the prudent institutional investor to establish processes to evaluate its responsibilities and make informed judgments regarding how to fulfill these responsibilities. Furthermore, based upon the increased recoveries that institutional investor lead plaintiffs have been able to obtain in securities class actions, it also is in the best interests of institutional investors to consider taking a lead role in appropriate cases.
Private litigation offers defrauded investors, including institutions, a significantly better chance to recover their losses than government efforts, according to a Securities and Exchange Commission (‘SEC’) study issued recently. In a report dated January 24, 2004, the SEC acknowledged that, although American corporations have paid out over $20 billion in private securities class action settlements over the past decade, public regulators only have collected 14 percent of the $3.1 billion in illegally acquired assets that courts have ordered companies and executives to return between 1995 and 2001. As a result, despite the Fair Fund provision of the Sarbanes-Oxley Act of 2002 requiring the SEC to distribute some of the civil penalties it collects directly to the victims of securities fraud, the SEC’s January 24, 2004 report also includes the following candid self-assessment: ‘In contrast to Commission enforcement actions which have several aims, the aim of private litigation is solely to compensate injured investors…. The ability of investors to fully recover their losses, indeed may largely depend on the use of private actions.’ As the Financial Times has reported, the senior executives and directors of the 25 largest corporations that failed in 2001 pocketed $3.3 billion in salary, bonuses and proceeds from stock sales between 1999 and 2001. The necessity for continued vigilance in securities fraud and corporate governance litigation could not be more apparent.
In sum, based upon the realities of the investing and legal marketplace, out of self-interest, as well as fiduciary duty, every institutional investor should develop a policy to define its role in securities class action and corporate governance litigation so that it can determine how best to protect its assets and the interests of its beneficiaries or other stakeholders.