Class action and financial markets: insights from law and economics

Abstract

PurposeClass action (CA) has long been used in practice (mainly in the USA) and studied by academics especially in the shareholder protection area. This paper aims to apply the same practice within the current financial meltdown context.Design/methodology/approachThe paper faces the issue by comparing ex ante regulation with an ex post regulatory system, basically dependent on the action of the consumer who can sue firms that behave unfairly. The arguments are provided by the law and economics (LE) approach.FindingsAccording to LE, pure economic loss is a private loss that is not socially relevant but simply implies a redistribution of wealth. Consequently, wrongful behavior that induces reallocation of costs and benefits with no consequences on social welfare is not considered socially harmful, so is not necessarily subject to compensation. Since pure economic loss is very often financial, the above reasoning also applies to financial markets. However, the same LE arguments suggest that in financial markets, the policy of internalizing pure economic loss by means of CAs can be more far‐sighted than simply compensating the victims: the liability system has the particular feature of producing deterrence and driving the market towards an efficient outcome.Originality/valueThe paper maintains that CA intended as a complementary ex post regulatory device can play a significant role in addressing a failure that ex ante regulation has not in financial markets. This is coherent with the LE tradition that interprets tort law remedies as a solution for internalizing externalities and providing the correct incentive to the markets.