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Johnson & Johnson lawsuit thrown out

Alison Frankel finds it problematic that a derivative shareholder suit against the Johnson & Johnson board was thrown out before it could incur millions of dollars of discovery costs and an extortionate settlement. I'm more sanguine.

Let's leave aside the fact that the underlying allegations are mere piling on: the lawsuit stemmed from the settlement of criminal allegations over Risperdal marketing and similar problems. Let's also leave aside the fact that every major pharmaceutical company is entirely at the mercy of prosecutors, and thus a criminal settlement is evidence of nothing other than ambitious prosecutors: given the fact that any criminal sanctions would cost the company tens of billions of dollars, no global pharmaceutical company is ever going to risk defending itself when prosecutors come after it, and the only question is the terms of surrender, given that even a risk-neutral set of executives would refuse to go to trial on criminal charges that they had a 95% chance of winning.

The issue is this: first, any corporate law is going to have to balance false negatives (valid suits against directors being thrown out prematurely) and false positives (invalid suits against directors costing tens of millions of dollars in time and money to resolve). Any opening up of the courtroom doors to challenge directors will reduce false negatives at the expense of more false positives; any increase in the burden to bring suit will reduce false positives at the expense of more false negatives.

Which brings us to my second point: the fact of the matter is that being a shareholder is a voluntary transaction. Different corporations can incorporate under different state laws that balance the interest of preventing false positives against the interest of false negatives. Shareholders can vote with their feet. If Frankel or other shareholders feel that New Jersey law is too protective of corrupt or incompetent directors, they can readily vote with their checkbooks to instead invest in companies incorporated in states that allow Bernstein Litowitz and Robbins Geller fishing expeditions. Such capital flows create premiums for incorporating in states that strike a good balance and penalties for incorporating in states that make it too easy or too hard to sue. Even if the legal standard here produced a false negative (and it's hard to say that it did if one believes that federal prosecutions of pharmaceutical companies are frequently just a lawless arbitrary expropriative tax that can strike good companies as easily as bad ones), it's good for New Jersey corporations in the systemic sense that the legal gatekeeping standard for such derivative suits is upheld.

See also Larry Ribstein and Erin O'Hara, The Law Market.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.