When Lawyers Run Wild

In oral arguments before the U.S. Supreme Court last fall, the justices wrestled with a seemingly absurd question: Should lawyers be able to earn a fee for negotiating a settlement that pays their clients nothing?

The case, Frank v. Gaos, represents the latest turn in an argument that has raged since a little-known committee amended Rule 23 of the Federal Rules of Civil Procedure in 1966 to allow multiple plaintiffs to join what became known as a class action. The rule was designed to facilitate civil rights lawsuits where numerous people suffered the same wrong, such as racial discrimination. But plaintiff’s lawyers have transformed it into a multi-billion dollar moneymaking machine. Securities class actions yielded $6 billion in settlements in 2016 and another $1.5 billion in 2017, with plaintiff’s lawyers typically collecting 20 percent or more of each agreement. (Defendants rarely risk going to trial, given the potential for enormous damages.)

Congress and the Supreme Court have repeatedly stepped in to address abuses in the class-action business, but entrepreneurial plaintiff lawyers always seem a step ahead. Frank v. Gaos, for example, deals with a mechanism lawyers dreamed up to deal with a perennial problem with class actions: Very few of their supposed clients ever bother to fill out the paperwork to claim their settlement money. Claim rates in consumer class actions rarely exceed fractions of a percent, with the rest of the money either going to lawyers or back to the settling company in a wink-wink arrangement where plaintiff lawyers know the real settlement negotiations are over how big their fee will be.

To get around this lawyers came up with cy pres, legal Latin roughly meaning “as good as,” under which they give up on distributing money to their clients and hand it to unrelated charities instead. There are constitutional objections to this—how can parties with no connection to a lawsuit win money from it?—but also conflicts of interest. Lawyers tend to direct cy pres awards to organizations close to their hearts.

Frank v. Gaos challenges an $8.5 million settlement between Google and 129 million search engine users in which lawyers kept $2.2 million for themselves and directed the rest to six charities, including Harvard, Stanford and Chicago-Kent College of Law, which happened to be the alma maters of some of the attorneys negotiating the deal. One of the grateful recipients, the Stanford Center for Internet and Society, already had received millions of dollars in grants from Google, meaning the settlement was a tax-deductible donation to an organization it would have supported anyway.

All this struck attorney Ted Frank as distasteful, if not downright illegal. The head of the Center for Class Action Fairness, Frank intervenes in class action settlements that he believes are abusive or represent collusion between lawyers hungry for fees and defendants eager to end litigation.

“If you think class actions are supposed to benefit the class, these charitable donations have nothing to do with that,” Frank says.

Ah, but they do serve an important purpose: They end any chance of litigation by the class members, for the modest price of a $2.2 million fee to lawyers who claim to represent them. This conflict lies at the heart of every class action, and the Supreme Court has pecked away at it with decisions enforcing contracts shunting disputes off to arbitration and limiting securities class actions. But the justices seemed little inclined to end the cy pres game this session.

In oral arguments, they fumbled toward the easier solution of dismissing the case on jurisdictional grounds, leaving for another day the argument over whether it is legal for lawyers to pay themselves fees for nothing.

Daniel Fisher: Daniel Fisher is a writer, financial analyst and former senior editor with Forbes magazine. He previously worked for Bloomberg Business News and newspapers in Texas and Wisconsin.