The Inefficiency of Litigation

A Trillion $ Problem At
The Heart of the Market

The Inefficiency of Litigation

The speed and sophistication of the financial markets grown out of step with the nature of the judicial system and the present model for managing legal rights in investments creates challenges for all of its participants.

Currently, the judicial system (courts or arbitration) is used by investment issuers and their investors as a manager-of-last-resort . While the flexibility of its process allows it to function well when faced with a broad range of issues, it is not aligned with the demands of a quick-moving and sophisticated financial market. Conventional adjudication and enforcement of investor rights is slow, expensive, requires proactive engagement and provides uncertain outcomes for both parties. In an economy where the time value of money is substantial, the cost of tying up assets in slow and risky processes means that any investor action using the legal system represents a negative outcome, even if eventually successful.

At the same time, using the judicial system a manager-of-last-resort also exposes investment issuers to increasingly large amounts of litigation. Can a decentralized model both decrease the transactional friction of legal rights enforcement while simultaneously reducing litigation risk?

Data

The majority of general investor complaints are resolved between the parties or pertain to the confidential private market. As a result, broad market data on the severity of the issue is scarce. However, public information about securities class action lawsuits (in the US market) provides valuable insight into the overall impact on the broader corporate finance market.

In this context, 2018 was a record year for investor legal action. For example, nearly 9 in 10 mergers or acquisitions valued at $100 million or more involving public companies were challenged in court. The average cost of settling these lawsuits was $3.8 million and, in 85% of the cases, the shareholders saw no participation in any eventual settlement. (source)

For investors holding the securities subject to class action lawsuits, their losses have been quantified at over $700 billion during the period between 1995-2014 in market value alone (not including any original bona fide grievances that led to the investor action). Only $90 billion was recovered over the same period. (source)

While eye-opening, these statistics represent the portion of the iceberg visible above the waterline. Below it lies the rest of the global economy including private capital markets, corporate bond markets, and other corporate finance structures. These statistics also omit the hypothetical cost of legitimate grievances that went uncorrected as the transactional friction of exercising investor rights was deemed too great for the matter at hand.

Conventional Investor Rights Management

Is tiresome, expensive and uncertain

Entering into an investor lawsuit is losing, losing one is worse

Suppresses legitimate investor grievances

The magnitude of the claim must be substantial to warrant action

Is geographically limited

The developing world offers amazing opportunities, but the lack of robust investor protection limits inflows

Opens companies to broad litigation risks

Legitimate complaints can get resolved in un-constructive ways and there are few filters to meritless litigation

 

Results in massive losses of investor wealth

Over $0.5 Trillion in net investor losses in less than 10 years from one category of legal action against a subset of corporations – the problem is big and growing