U.S. companies facing private securities litigation appear to be paying more than ever to settle, according to a new report.
While slightly fewer civil suits were filed last year than in 2004, the cost of settling those cases skyrocketed 156 percent, according to research from PricewaterhouseCoopers. Excluding the mammoth Enron and WorldCom settlements, the average settlement in 2005 still totaled $71.1 million, up from $27.8 million one year earlier.
The number of cases reported in 2005, meanwhile, fell to 168, down 17 percent from the 203 cases filed in 2004, and slightly lower than the 10-year average of 188 cases per year. The dip in civil suits last year continues a “clear zigzag pattern” evident in recent years, according to PwC partner Grace Lamont, co-editor of the firm’s annual Securities Litigation Study.
Lamont
Lamont says one possible reason for the decline could be a backlog due to the enormously high-profile and complicated Enron, WorldCom and Adelphia cases. “Those mega-cases maybe preoccupying the plaintiff’s bar,” she says. “If we see the end of those cases, we may see a pick up in interest by the plaintiff’s bar to finding more cases.” Lamont also speculates that Sarbanes-Oxley might have a deterrent effect.
The drop in cases filed last year “is not a significant decrease when viewed in context,” says Bruce Carton, vice president of Institutional Shareholder Services’ securities class action services. “The number of cases has gone up and down in a pretty narrow range since 1997, and the move in 2005 is consistent with this past movement.”
PwC attributes the dramatic spike in settlement prices to three factors. One is the role of lead plaintiffs, which now include many pension funds able to wage formidable legal battles if necessary. Another is the huge economic case-related losses that result when steep drops in stock price collide with companies’ multibillion dollar market capitalizations; civil suits against healthcare consulting giant McKesson HBOC, for example, alleged an investment loss of $9 billion. Finally, the expansion of cases to auditors, investment bankers and other third parties is also driving up settlements.
The Enron and WorldCom settlements are “perfect examples of the confluence and effect of all three factors,” the report notes. Settlements with financial institutions and other third parties have pushed total settlements for the Enron and WorldCom cases to more than $7.1 billion and $6.1 billion, respectively.
Savett
“I think it boils down to better cases are being brought, with stronger institutional investor participation, and plaintiffs’ firms have shown that they are not afraid to take cases to trial, with a substantial increase in securities class action cases going to trial over the last few years,” says Adam Savett, an associate at Washington D.C.-based Mehri & Skalet.
Indeed, the jump in settlements is so high that PwC changed its definition of a “high dollar” settlement. Previously the firm viewed high dollar settlements as those above $20 million. “We had to redefine that this year, in view of amount of these settlements,” Lamont says. PwC now considers settlements of $60 million or more as significant—and Lamont is quick to note that in 2001, only six settlements topped $60 million; last year saw 20, including 11 “mega-settlements” of more than $100 million.
PwC partner Daniel Dooley warns that while the U.S. economy has been strong since 2001, if another recession strikes, “it’s likely that securities litigation and mega-settlements will increase.” Today’s climate, expensive as it is, “may be the lull before the next storm.”
Carton
“I think that the big settlements in WorldCom, Enron, Cendant and other cases have raised the stakes in smaller cases, and led plaintiffs’ attorneys to demand more than they might have a few years ago,” says Carton of ISS. That has also led to the recent surge in trials in securities class actions, he adds. “When the demands get to a certain level, at some point the defendants decide it makes more sense to take their chances at trial.”
Same Trend, Different Place
Foreign issuers endured much the same ups and downs as American companies. The number of civil cases filed against foreign companies in 2005 mirroring the overall downward trend, dropping 34 percent from 29 in 2004 to 19 in 2005. But Dutch retailing giant Ahold and Deutsche Telekom both ranked among the 10 largest settlements, at $1.1 billion and $120 million respectively.
Lamont says increased cooperation among global regulators and the increased focus by the Securities and Exchange Commission on matters related to foreign issuers should “serve to confirm that U.S. domestic companies and foreign issuers are equally accountable.”
SETTLEMENTS
The table below is settlement information from 2003 through 2005, excerpted from the "2005 Securities Litigation Study," published by PricewaterhouseCoopers.
Please note that the average and median settlement values below do not include Cendant, Enron and WorldCom settlements.
Year Settled
2003
2004
2005
Cases Settled
116
106
108
Total Settlement Value
$2,708,800
$5,491,600
$17,925,000
Total Settlement Value
(Minus Cendant, Enron, WorldCom)
—
$2,916,600
$7,603,000
Average Settlement Value
$23,400
$27,800
$71,100
Median Settlement Value
$5,600
$6,750
$9,250
PricewaterhouseCoopers' 2005 Securities Litigation Survey (Free; Requires Registration)
(Note: The average and median settlement values above do not include Cendant, Enron and WorldCom settlements)
She also cites two factors that will affect foreign issuers this year: Foreign companies will file financial statements prepared according to International Financial Reporting Standards, and the SEC will start reviewing those filings—which means increased scrutiny and exposure. “Depending on how that shakes out, we could see an increase in cases filed against foreign companies,” she says.
In 2005, accounting cases represented 46 percent of private securities class actions filed, the lowest percentage since 1996 and the first time in a decade that the figure fell below 50 percent.
One explanation for the decline is a rise in the number and settlement values in pharmaceutical efficacy cases, which accounted for 10 percent of cases filed in 2005. Up until this year, Lamont says, the settlements in those cases have been “relatively small” compared with others. “Until 2005, the largest product efficacy settlement was around $75 million, and the average was far below that,” says Lamont.
The decline may also be the result of improved internal accounting and financial reporting controls and increased anti-fraud auditing by independent auditors, she said.
The average settlement value of accounting cases in 2005 (excluding Enron and WorldCom) was $94 million, 178 percent higher than the $33.8 million average value in 2004. More than half of all accounting cases filed in 2005 (55 percent) asserted that companies’ internal controls were materially weak and contributed to financial fraud.
Noting that the trend of frauds involving hedge funds is on the rise, PwC began tracking SEC enforcement actions and private litigation involving hedge funds in 2005. The total number of hedge fund enforcements in 2005 was 22 cases, up from 19 in 2004.
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