This post is drawn from the following article: Wendy Gerwick Couture, “Securities Regulation of Alternative Litigation Finance,” Securities Regulation Law Journal (forthcoming). To download the full article, please click here.
In my prior post, titled “Are Litigation Finance Contracts Securities?”, I argued that a litigation finance contract, as entered into between a claimant and a funder in the current marketplace, probably satisfies the elements of an “investment contract” in those jurisdictions applying a vertical commonality test, thus potentially subjecting these contracts to federal securities regulation. I recognized, however, that the Supreme Court has declined to classify as securities those agreements that, albeit arguably satisfying the definition of an “investment contract,” fail to implicate the policies underlying the securities laws. In this post, therefore, I analyze whether litigation finance contracts implicate the policies underlying the securities laws so as to bring these contracts within the scope of securities regulation.
The central purpose of the federal securities laws is to ensure full and fair disclosure to investors (here, the funders). As numerous commentators (including Maya Steinitz and Abigail Field in “A Model Litigation Finance Contract”) have noted, funders are at an informational disadvantage with respect to claimants because claimants know more about the facts underlying the litigation and because funders’ ability to engage in meaningful due diligence is limited by the risk of inadvertent waiver of the claimants’ attorney-client privilege and/or work product protection. As such, funders are forced to rely on claimants’ representations about the merits of the litigation, which claimants have an incentive to exaggerate. (Indeed, regardless of their merits, Burford Capital LLC’s recent allegations that it was fraudulently induced into investing in the Ecuadorian Lago Agrio Litigation against Chevron Corporation demonstrate the potential for fraud in this industry.) This information asymmetry and potential for moral hazard implicate the federal securities laws’ concern with full and fair disclosure to investors.
Additionally, the federal securities laws arguably have a broader purpose of ensuring full and fair disclosure to all parties to a transaction, including the issuer (here, the claimant). As has been widely discussed, consumer litigation finance has the potential to be predatory, and information asymmetry between the parties about the content of the litigation finance agreement exacerbates that potential. Even in the commercial litigation finance context, however, there is the potential that a relatively unsophisticated business might enter into a litigation finance contract without fully appreciating its terms. Therefore, the risk that claimants might enter into litigation finance contracts without understanding their terms arguably implicates the securities laws’ concern with full and fair disclosure to all parties to a transaction.
In sum, litigation finance implicates the securities laws’ policy of ensuring disclosure. Therefore, to the extent that a litigation finance contract satisfies the elements of an “investment contract,” it should be subject to securities regulation. For a discussion of how securities regulation would affect litigation finance, see my next post, titled “Who Cares If A Litigation Finance Contract Is A Security?”