Moin argues, essentially, that allowing trades by lawyers and plaintiffs in advance of suing (1) violates 10b-5, and (2) allows “double recovery” of fees.

On (1), I pointed out in my previous post that these trades do not violate 10b-5 and regulating them would abandon an important principle limiting liability for trading on nonpublic information to abuse of property rights.

On (2), the double recovery argument assumes that incentives to class action lawyers are optimal in the absence of trading profits, a proposition Bruce Kobayashi and I have questioned in theory. Again, I emphasize that the issue here is not simply the number of lawsuits, but incentives relating to the quality of lawsuits.

Trading may provide such incentives because it operates through the mechanism of the efficient securities markets, which are the best available (even if imperfect) way of valuing information, including information about lawsuits. I argued in my earlier post that the problems inherent in dumping and suing, such as incentives for market manipulation, should be addressed by targeting those problems under existing laws regulating fraud and manipulation.

In his response to the “insider trading” point, Moin shifts ground. Now he wants a special SEC rule targeting dumping and suing, rather than liability under 10b-5. He still doesn’t get it. As I said the last time around, the Supreme Court interprets the securities laws as not extending to this conduct. The SEC can't change the law. Congress could if it wanted to. But then we would have abandoned a fundamental principle limiting insider trading liability, with potentially disastrous consequences for business.

Moin bolsters his argument about insider trading by claiming that by allowing these suits we’re encouraging all kinds of bad acts, akin to allowing the 9/11 terrorists to short the stock market. Here, again, he misses the point. We do not try to curb crimes – even terrorism – by restricting short selling. That’s what the criminal laws are for. Why start down this misguided road with dumping and suing?

As for the “double recovery” argument, Moin simply ignores my incentive argument, preferring to focus on the evils of the trial bar. I share his concerns about excessive litigation, which is why I think we need real and politically feasible solutions. Again, my argument about incentives was about the quality of litigation, not the quantity. Moreover, if there's too much litigation, more securities regulation is not the answer.

Moin spends a lot of time debunking the idea that efficient markets can distinguish good and bad lawsuits, which is what underlies the incentive effect of trading on lawsuits. But Moin misunderstands how efficient markets operate.

First, Moin says that if the market could discern the merits of a lawsuit, there would be no need for a trial. But the market discounts the likely result at trial or pre-trial settlement in the same way that pre-trial settlement discounts the likely outcome of the trial. Both processes operate in the shadow of the likely judgment, and neither process creates a magic remedy out of thin air.

Second, Moin says that the market can distinguish only between fully meritorious or frivolous lawsuits, nothing in-between. He doesn't explain why securities markets would be so much more helpless in the face of litigation than they are in evaluating the countless other events and characteristics that have been shown, in thousands of studies, to affect stock prices. Moin doesn’t help his case by demanding that we disregard so much financial economics.

Third, Moin points out that the market will produce a profit even for a claim in which there’s only a small chance of recovery, painting such a case as “frivolous.” So, it seems, the market can accurately value cases after all. The problem, apparently, is that the market is applying a positive value to a case that has a positive value. So what? No matter what litigation rules we have, there will be a continuous distribution of outcomes. What's the problem?

Fourth, Moin points to a study showing that a big part of the market value of litigation is costs and fees. But that’s a condemnation of our costly and wasteful litigation system, not of the market. We need to fix litigation. We are not going to fix it by eliminating dumping and suing. Instead, as I've said, we may make it worse by reducing the incentive to bring valuable lawsuits and increasing the incentive to bring “strike” suits.

After misunderstanding how efficient markets react to litigation, Moin points to how plaintiffs and lawyers can manipulate markets through short-sales apart from suing. That only emphasizes that dumping and suing is not the problem here. The problem may be market fraud and manipulation, which can and should be addressed under current law.

In short, to the extent lawyers and plaintiffs are manipulating the markets we should punish that conduct. To the extent that efficient markets reveal defects in current litigation rules, we should change those rules. We should not waste time on an ill-considered attack on the capital markets.