When the Enron scandal broke, no one thought to blame the natural gas industry for it. And when Elon Musk’s colorful tweets run afoul of the U.S. Securities and Exchange Commission, no one attributes that to the practice of making electric cars. In other words, just because some corporate behavior in the capital markets comes under scrutiny — rightly or wrongly — doesn’t mean that company’s products or services are poor, let alone those of an entire industry sector.
These facts are obvious. And yet, for those of us in litigation finance — the increasingly popular practice in which third parties fund costly lawsuits and in exchange take a portion of any recovery — they have become a consolation. This month, our emerging industry has been consumed by controversy surrounding a large litigation financier, and we have a legitimate fear that opportunists will use the story to disparage our industry as a whole.
The juicy story to which I’m referring relates to Burford Capital, a titan in litigation finance, squaring off against a short-selling firm that just released a scathing report on Burford’s financials. The report claimsthat Burford has “egregiously” misrepresented returns, using Enron-style fair-value accounting to book profits on lawsuits while they are still pending, as well as several other allegations of wrongdoing. The short-seller’s report concluded that Burford is “arguably insolvent,” and wiped out more than 60% of itsmarket cap in 24 hours.
Burford fired back with a response that called the tactics of the short-selling firm, Muddy Waters, “deeply disgusting.”
It’s all very dramatic, but for now, it’s impossible to pass judgment on the dispute without additional insight into the allegations. Toward that end, Britain’s Financial Conduct Authority has announced that it is making “wide-ranging enquiries” into the circumstances surrounding Muddy Waters’ report on Burford, and related trading patterns.
For litigation financiers watching on the sidelines, the merits of Muddy Waters’ claims are beside the point. We risk perception overtaking reality.
That’s not to say, of course, that financial reporting standards are no concern to litigation financiers. The Burford story has revealed at least some degree of inconsistency in the way financiers report their financials to investors. As litigation finance continues to mature as an asset class, it would benefit the industry and its investor community to develop standardized practices in financial reporting for all to follow.
The larger point, however, is that accounting policies and capital markets issues have nothing to do with the service that litigation financiers provide — a service that improves our civil justice system. Litigation finance could be rightfully challenged if it did not impact the litigation system positively, but thankfully the pioneers of our industry — virtually all of them lawyers — took a conscientious approach to the policy issues that do relate directly to civil justice.
They include, notably, the issue of whether litigation financiers assume control over litigation decisions; reputable financiers universally have left control and decision-making to the parties and their lawyers. A second major issue is the prospect of interference in the attorney-client relationship; here again, litigation financiers have uniformly respected the sanctity of that relationship. A third issue is the concern that the availability of litigation funding will open the floodgates of frivolous litigation; once again, the rigorous underwriting standards adopted by litigation financiers have had the opposite effect.
This conscientious approach has allowed our industry to deliver all the benefits of litigation funding without downside to the judicial system. Those benefits are significant. Modern courtrooms are effectively closed to individuals and corporations that can’t afford either the high cost of litigation or the long wait for justice. The availability of financing eases those barriers, but only for parties with cases strong enough to back financially.
Financiers provide access to courts, that is, without encouraging meritless lawsuits. Litigation financing also levels the uneven playing field that tilts civil litigation in favor of the party with a bigger wallet. For state and federal court systems under financial strain, one under-appreciated benefit of litigation finance is that it encourages parties to make economically rational decisions on settlement and other major issues. As every judge knows, emotion-driven litigation decisions, by contrast, only drain court resources.
Accounting and corporate governance practices are entirely divorced from the above benefits. They should not reflect poorly on the work of litigation financiers — even Burford — any more than MicrosoftCorp’s anticompetitive practices of long ago should have reflected poorly on internet browsers. And yet, there are multiple reasons to believe that we face a challenge in keeping the Burford story distinct from a debate over the value of litigation finance itself.
First, unlike the internet or electric cars, our product isn’t one that consumers — or even courts — deal with on a regular basis. That makes it easy to paint us with a broad and inaccurate brush.
Second, critics of litigation finance have made a practice of levying bad-faith attacks. Primary among them is the U.S. Chamber of Commerce, which represents the interests of corporate defendants threatened by the leveling force of litigation finance. The Chamber could initiate legitimate discussion on any number of issues surrounding litigation finance, like its potential interference in the attorney-client relationship. It has not done so, in part because of the industry’s responsible practices.
Instead, the Chamber has focused on a quest to make it mandatory for parties to disclose any litigation financing arrangements in court. Judges have mostly rejected such attempts, but the Chamber continues to press this issue, which not coincidentally is ideally suited to bogging cases down in discovery disputes. Given this history, we can expect critics to hold up the Burford story as a critique of litigation finance generally, despite knowing better.
For the third and final reason, litigation financiers must look to ourselves. To this point, U.S.-based financiers have not yet come together as an industry to define a set of best business practices, and formally communicate them to the legal profession, corporate clients and the general public. As noted above, for example, it would be helpful to create uniform standards for accounting and financial reporting.
It would be even more helpful for the industry to codify standards for issues that impact the integrity of the legal profession and our civil justice system. There is essentially no disagreement among litigation financiers on these “rules of the road,” and although empirical support for the industry’s observation of these rules is limited, my firm’s “bird’s eye view” of the industry leaves me with no doubt that the industry is diligent in its adherence to these standards.
The fact is, however, that we have never formalized them through an industry association or other self- regulatory body. The failure to do so has kept our respect for the legal system largely out of view, and leaves the industry susceptible to misleading portrayals of our work.
The time has come, then, to create a set of industry best practices, and my company is committed to leading the effort. The development of a set of business standards will only facilitate the growth of our already booming industry. It will educate both the public and the legal profession itself about the work of litigation financiers. It will ensure transparency about best practices, and for purposes of accountability, could include a record of members’ adherence to them. It will also reduce the need for imprecise and uninformed regulation that could stifle the availability of litigation finance to the detriment of the justice system.
In the long run, it will have another impact. If and when scandal erupts again, it will make it far easier to see that any fault lies with individual actors, and not with litigation finance itself.
Charles Agee is managing partner at Westfleet Advisors.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.