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A Bar Barometer: Securities Suits Swell

o Karen M. Kroll
16.05.2011 kl 23:26 | CFOworld (US)

Last year was lacking -- fortunately -- in the kind of outsize corporate accounting and financial frauds that a few years ago filled the headlines with names like Enron, Worldcom, and AIG. Even so, reviewing the annual reports from organizations that study trends in securities litigation reveals a significant increase in recent class-action activity.


Last year was lacking -- fortunately -- in the kind of outsize corporate accounting and financial frauds that a few years ago filled the headlines with names like Enron, Worldcom, and AIG. Even so, reviewing the annual reports from organizations that study trends in securities litigation reveals a significant increase in recent class-action activity.

And now, as companies enter shareholder meeting season, is a particularly good time to take notice.

Last year 174 federal securities class action lawsuits were filed, 12% more than in 2009, according to the PwC annual Securities Litigation Study -- marking the second highest level in the past five years. "Securities class action litigation is alive and well," says William Baker, partner with the law firm of Latham & Watkins LLP, and a contributor to the PwC report.

At the same time only 86 settlements were reported, a drop of 15% from 2009, and the lowest level in more than a decade, according to "Securities Class Action Settlements -- 2010 Review and Analysis," by consultancy Cornerstone Research. That report said the average settlement amount also slipped, from $37.2 million to $36.3 million, although the median settlement jumped by nearly half, to $11.3 million, because of some mega-awards that skewed the result. "When adjusted for inflation, [the median] was the highest in 10 years," says Laura Simmons, a senior advisor with Cornerstone, and an accounting professor at the College of William and Mary in Williamsburg, Va.

The increase in securities litigation runs counter to what's happening in other areas of class action -- where the Supreme Court recently sided with corporations to make plaintiff chances slimmer, for example, in the product-claim arena. In the case of aggrieved shareholders, however, their large numbers in certain cases -- all experiencing the same alleged damages during a specific time period -- continue to make the class action "the most common form ... for securities suits," says Simmons.

A few trends of great interest to CFOs stand out in the PwC securities-litigation study. In what might be viewed as a welcome change, the percentage of cases alleging an accounting misstatement -- such as an overstatement of revenue or an understatement of liabilities, or a failing in internal controls -- dropped to a low of 35%. In 2002, and thus pre-Sarbanes-Oxley, the percentage of these types of cases peaked at 77%.

And after several years in which the financial sector dominated filings, last year plaintiffs targeted a wider range of industries. "Financial services is still the most sued, but now it's comparative with other industries," says Grace Lamont, a partner and leader of the securities litigation and investigation group within PwC. Lawsuits against financial services firms accounted for 22% of the filings in 2010, down from 41% last year.

Coming in second was health care, including pharmaceutical, medical device and health services companies. More than one-fifth (21%) of the 2010 filings focused there, with many cases concerning the efficacy of the products the companies sold, Lamont says.

A Jump in M&A Cases

Filings involving mergers and acquisitions also jumped, accounting for nearly one-quarter of cases in 2010, up from 4% a year earlier. "Almost every deal is challenged," Baker says.

These cases often allege a breach of duty by directors and officers of the target firms, says Indiana University law professor, Donna Nagy. "In M&A, the challenges tend to come in three categories," she says: conflicts of interest among the officers negotiating a deal, failure to obtain an appropriate price, and inadequate exploration of alternatives.

Another industry finding itself on the receiving end of securities lawsuits was the for-profit educational sector, which attracted 13 filings. All were filed between August and December, PwC reports, and appear to have been driven by an August 2010 Government Accountability Office report, "For-Profit Colleges: Undercover Testing Finds Colleges Encouraged Fraud and Engaged in Deceptive and Questionable Marketing Practices." Among other findings: Personnel associated with all 15 for-profit colleges studied made deceptive or otherwise questionable statements to GAO's undercover applicants.

While the flurry of cases was specific to this sector, other industries aren't immune. "We could see this in other industries, as new reports are released or an issue comes up," Lamont says.

No Major Rise in Cases Singling Out CFOs

In one more shift that might hearten finance chiefs, the percentage of cases specifically targeting the CFO held fairly steady at 63%. That's up slightly from 62% in 2009, but down significantly from 2006, when 84% of lawsuits targeted the CFO. The decline, says Lamont, seems to correlate to the drop in accounting-related cases.

Whether one can reasonably give Sarbanes-Oxley credit for the reduction in financial-misstatement cases is unclear. "You can't conclude that Sarbanes-Oxley helped, but you can speculate," says Hillary Sale, professor of law and management at Washington University in St. Louis. While many people charged with implementing the law have complained about its cost and administrative burden, they also acknowledge an improvement in the quality of the information their companies produce, she adds.

Looking more deeply into the securities-litigation settlement picture, Laura Simmons cites several factors as contributing to the sharp rise in median awards. One element is the increasing participation of institutional investors, such as public pension plans, as lead or co-lead plaintiff. In fact, institutions were lead plaintiffs in more than two-thirds of settlements in 2010, the highest proportion to date since the passage of the Private Securities Litigation Reform Act of 1995. "We find that the presence of public pension plans as lead plaintiffs is associated with significantly higher settlement amounts," the Cornerstone report notes. This could be due to the fact that they would choose to pursue cases that are stronger and/or larger to begin with.

What's more, the percentage of settlements that involved a corresponding SEC action, such as an administrative proceeding, rose from 20% to 30% between 2009 and 2010. "Cases that involve SEC actions are associated with significantly higher settlements," the Cornerstone report notes.

During 2009 and 2010, 15 suits that related to the credit crisis were settled -- out of more than 200 filed. These settlement amounts tend to be dramatically higher than for other lawsuits, according to Cornerstone's research. The median amount tops $31 million, compared with $10 million for other suits.

'Increased Vigor'

The increase in the number of securities lawsuits filed, along with the bump in the median settlement amounts, "deserve some attention" from CFOs and senior executives, says Lamont, who believes they should be more aware of the changing regulatory landscape.

In addition, the SEC's "increased vigor" when it comes to enforcing securities regulations is likely to be sustained. "Dodd-Frank enhanced the SEC's enforcement authority, and I think the SEC can be expected to use it," says Nagy of effect of the Wall Street Reform and Consumer Protection Act. For instance, the law expands the SEC's ability to seek civil monetary penalties in administrative proceedings, as well as its ability to pay for tips that lead to enforcement actions -- the whistleblower provision.

"Companies really need to be sure that their governance and compliance programs are as strong as possible," says Lamont. "If there are issues, they'll be in the best position to defend themselves."

Keywords: Legal  
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