BLOCK-HOLDERS AS A SOURCE OF INSTITUTIONAL CAPTURE: THE

CHALLENGE OF ESTABLISHING INDEPENDENT LITIGATION REVIEW

COMMITTEES

Reaction paper to A most adequate response to excessive shareholder litigation by

Lawrence A. Hamermesh
T. Alexander Puutio

Securities litigation is an intimidating topic, not least because entering its sphere
requires dispelling the illusion of incentive-alignment and principal-agent symbiosis
that underlies the basic principles behind the formation of corporations. The topic is
further morassed by its inextricable linkages to the perennial struggle between the
ideals of judicial economy and fair adjudication. In his paper Hamermesh proposes an
insightful solution which would advance both causes - the Litigation Review
Committee. However, it is not certain that the proposal would benefit shareholders
given the likelihood of institutional capture of the proposed committee.

The author details the dimensions and functions of a Litigation Review Committee that
would have the power to disapprove the prosecution of claims concerning a
corporations internal affairs based on its independent review. Hamermesh
differentiates the Litigation Review Committee from other solutions, such as special
litigation committees, by proposing that its constituents be selected by the stockholders
having the largest beneficial interests in the corporation much in line with the most
adequate plaintiff provision.

The proposal to exclude directors from the committee would certainly improve the
likelihood that decisions on internal corporate claims are pursued based on the
economic value to the corporation. Hamermesh rightly points out that an independent
committee would ensure that decisions are not based on extraneous considerations like
the self-interest of plaintiffs counsel or bias on the part of directors. However, the
author does not follow the consequences of having the largest shareholders select the
membership of the Litigation Review Committee to its logical conclusion.

The past decades have seen the phenomenal rise of institutional investors who have
singlehandedly upended the anglo-saxon Berle Means model of stock ownership.
Riding on the coat-tails of ETF index investing, entities like BlackRock, Vanguard and
others have come to command significant portions of publicly traded companies. The
consequence has been for the US ownership model to inch closer to a block-holder
system combined with the classic European model where cross-holdings and
interdependent boards are common.

The developments above have significant impact on Hamermeshs proposal mainly

through the proposed means through which the Litigation Review Committee is
formed. Under the assumption of a Berle Mean model of ownership, the electors of
the constituents of the committee can safely be presumed to come with significant
variation in both their intrinsic interests in litigation and their desired instruments and
models for securing them, ensuring due representation of diversity within the
committee. In the block-holder model, no such diversity is guaranteed.

To be sure, the institutional owners largely operate as agents for the population at large.
However, in the role of electors they are unlikely to pass-through the interests of the
population, but rather, they are likely to operate based on more immediate incentives
which may or may not be aligned with those of their principals. Furthermore, given the
fact that the same institutional investors are all but singlehandedly responsible for
selecting the board members whose actions are a major source of internal affairs
litigation, the proposed committee is ripe for capture by special interests.

As proposed by the author the Litigation Review Committee bylaw would be silent on
the question of the role of the stockholders who select the members of the committee.
The silence will undoubtedly come at the expense of the individual shareholder. Like
Hamermesh acknowledges, the proposed by law is not necessarily a one-size-fits-all
solution. It may be appropriate to further strengthen the guarding stance and accede to
the fact that the benefits of the Litigation Review Committee are contingent, not merely
influenced, by the nature of the company in question.

In particular, whether the Litigation Review Committee passes its true litmus test
namely advancing judicial efficiency and improving access to fair adjudication
depends heavily on the composition of the body of shareholders. Given the ease with
which the proposed Litigation Review Committee could be biased towards the board
due to the shared source from which both are derived, it is likely that the realm of
counterproductive litigation would expand much beyond what would be truly
beneficial for the shareholders at large. Consequently, Hamermesh could greatly
enhance the contribution of his paper by proposing a way for the Litigation Review
Committee to be shielded from institutional capture.