The class-action vultures are circling ...
Coming soon to a federal courthouse near you--a chilling complement to our economic malaise: class actions against financial institutions, which will add to our economic woes. Many of these filings will be brought in the name of the shareholders of these institutions, claiming lack of timely disclosure of holdings of toxic mortgage portfolios.
Shareholders class actions were invented by courts to protect investors. But lawyers have turned these suits into ATM machines. Since many investors are diversified and over time are both present and previous owners of stocks of various corporations, the net aggregate effect of most shareholder class actions is to transfer wealth from all shareholders’ left pockets to their right pockets less the billions of dollars in fees levied by the lawyers, ranging from 10% to 30% of the funds transferred.
Recently, evidence has surfaced that indicates how these lawyers manage to run up the hundreds of thousands of hours of time that they record to justify their enormous fees. It is by the use of temporary lawyers, called “contract lawyers,” who are hired on an hourly basis to work on a specific case. After a class action filing has survived the initial hurdles, plaintiffs’ counsel usually demand that the defendant corporation produce a wide range of documents that may be relevant to the case, including e-mails, spread sheets, letters, photos and electronically stored communications or information. The task of responding to the document request is both costly and disruptive, especially for large multinational companies with offices around the world. To aid in producing the millions of documents demanded, defendants’ law firms frequently hire outside vendors to locate and catalog the electronic and paper documents.
As part of this process, each document is coded as to document type, author, recipients, date, subject and other bibliographical data and put into a searchable data base. The coding is largely done electronically by data processors or paralegals. Documents that exist in paper form are converted to electronic form so that they can be electronically searched as well using “optical character recognition.” In addition to this objective coding, the documents are also searched to determine relevancy, whether they are protected by the attorney-client privilege or whether they involve sensitive business information that may call for a protective order to maintain some degree of confidentially. Initially, this subjective search is usually performed by contract lawyers working either for the vendor or the law firm. Law firm associates then do additional review as required.
In securities class actions, document review is done differently on the plaintiffs’ side. Instead of using electronic means and clerical personnel to objectively code documents, the lawyers use contract lawyers to do this task, document by document. In the Tyco ( TYC - news - people ) securities litigation, of the 423,380 hours that the lawyers for the class claimed to have worked (not including clerical staff), 290,552 hours (69%) were accounted for by contract lawyers reviewing 83.5 million documents. In the Xerox ( XRX - news - people ) securities litigation, 201,506 of the 290,759 hours claimed to have been worked by class counsel were run up by contract lawyers reviewing 4 million pages of documents.
Defendants’ law firms used to add a substantial profit margin to these expenses but clients and competition drove out much of that profit. Instead, though there are many variations, when defendants’ law firms now submit their bills and expenses to their corporate clients, typically the outside vendors’ bills for objectively coding documents are considered an expense and reimbursed at cost.
Not so on the plaintiffs’ side, where there is no actual client footing the bill. Here, the law firms collapse the separate processes of objective and subjective coding so that it is all done “by hand” using contract lawyers. Though contract lawyers are paid about $35 to $40 an hour, plaintiffs’ firms “bill” this time to the class at $300 an hour or more, sometimes without disclosing that work was not done by the firm’s lawyers.
In addition, class action firms are typically permitted to add a multiplier to the product of their time and hourly rates which may raise the hourly charge to $450 to $1,000 an hour. Consider this class action math. One contract lawyer working for 30 hours a week for 45 weeks per year can generate a profit for the class action law firm of about $1 million. Multiply that by hundreds of contract lawyers, and soon you are talking about real money.
Recently, several contract lawyers that had been hired by class action law firms blew the whistle about how contract lawyers are used. They asserted that much of the work they did was simply make-work so that the firms could add hundreds of thousands of hours to the time records submitted to the court. (I review the extensive evidence they present in a book I am writing on contingency fees.) They also alleged that the hourly totals attributed to them were significantly padded.
Courts have rejected the charge of padding and have routinely approved this use of contract lawyers by plaintiffs’ firm to do objective coding. They have also approved the enormous mark-ups agreeing with the plaintiffs’ lawyers that this is the “market” rate. But it is not the market rate on the defense side where a real client is footing the bill. In fact, there is only one “market” in which the rate for contract lawyers hired by plaintiffs’ class action law firms to do document review is $300 an hour or more, and that is in federal court rooms.
As U.S. Treasury trucks pull up to the front doors of our financial institutions to unload billion dollar sacks of bailout money, class action lawyers are staking out their places at the back doors to siphon off their fair share. Perhaps it would be more cost efficient if the government routed the money to them directly.
This piece originally appeared in Forbes