A Necessary Gatekeeper: The Fiduciary Duties of the Lead Plaintiff in Shareholder Derivative Litigation

I. INTRODUCTION II. BACKGROUND A. The Historical Development of the Shareholder Derivative Action B. Representative Litigation C. Comparing Shareholder Derivative Actions and Class Actions 1. Shareholder Derivative Actions a. Direct Versus Derivative b. The Demand Requirement 2. Class Actions D. Fiduciary Duties Generally E. Lead Plaintiff Fiduciary Duties in the Context of Class Action Litigation F. The Private Securities Litigation Reform Act of 1995 G. Litigation Costs III. ANALYSIS A. Current Gatekeeping Functions Do Not Prevent Plaintiffs from Filing Detrimental Shareholder Derivative Actions 1. Special Litigation Committees, Demand Requirements, and High Pleading Standards are Inadequate Gatekeepers Because of Timing 2. The Lead Plaintiff is in a Better Position than the Plaint's Attorney to Police the Course of the Litigation a. Problems with Relying on Plaintiffs' Attorneys to Police Derivative Litigation B. Institutional Investors Provide a Source of Lead Plaintiffs with Knowledge of the System and the Likelihood of a Claim's Success C. Why Settle a Worthless Suit? D. Bringing a Worthless Suit Breaches a Lead Plaint's Fiduciary Duties to the Corporation and Other Shareholders by Wasting Corporate Assets IV. RECOMMENDATION A. State Legislatures Should Enact a Statutory Framework Addressing Lead Plaintiff Fiduciary Duties 1. Require a Plaintiff Filing a Derivative Action to Provide Notice to Shareholders Who May Then Move to Serve as Lead Plaintiff 2. Allow the Court-Appointed Lead Plaintiff to Dismiss the Case 3. Introduce Incentives for Institutional Investors to Serve as Lead Plaintiffs a. The Statutory Scheme Should Fully Compensate Lead Plaints for Their Time and Efforts b. The Statutory Scheme Should Award Bonuses Based on Who Pays the Settlement and for Significant Governance Reforms i. The Statutory Scheme Should Allow Courts to Award a Bonus When the Actual Defendants Contribute to the Settlement ii. The Statutory Scheme Should Allow Courts to Award a Bonus for Significant Governance Reforms iii. Incentives Independent of the Proposed Statutory Scheme 4. Clearly Impose Fiduciary Duties on Shareholder Derivative Action Lead Plaintiffs a. Borrow from Current Statutory Fiduciary Duty Frameworks b. Borrow from Case Law Defining Fiduciary Duties c. Leave Room for Court Discretion 5. Sanction Lead Plaints Who Violate Their Fiduciary Duties V. CONCLUSION I. INTRODUCTION Fraudulent behavior by corporate directors is not a new problem (1) and neither is the derivative action--the tool often used to address this problem. (2) In 1957, one commentator noted that [i]n 1832 it must have appeared, as it does today, that the individual stockholder was in need of a means of invoking judicial power to curb managerial abuse. (3) This statement is just as true in 2009, as is apparent from the managerial and director abuses that continue to plague corporations. Although the shareholder derivative action provides a useful tool to address the important problem of director misconduct, the action has faults that can prevent it from accomplishing this goal. Shareholder derivative litigation is representative litigation, meaning that the person who brings the suit represents others' interests. (4) A major weakness of representative litigation in general is that the agent controlling the litigation often does not have the same interests as the principal. …