Fewer Class-Action Suits, for Many Reasons

Corporate America seems to be slipping out of the crosshairs of litigation-hungry plaintiffs these days.

The number of class-action securities lawsuits has plunged this year to only 59 such suits filed in the first half of 2007—42 percent below the average midyear mark for the last decade, according to the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research.

That number is slightly below the 61 lawsuits filed in the first half of 2006, and continues a downward march from this decade’s high-water mark of 227 class-action lawsuits filed in 2002.

Grundfest

“This is starting to look like a permanent shift, not a transitory phenomenon,” says Joseph Grundfest, director of the Securities Class Action Clearinghouse and former Commissioner of the Securities and Exchange Commission.

Many say the decline in shareholder lawsuits is a by-product of less corporate fraud today generally, thanks to increased government regulation and stepped-up enforcement against offenders. John Coffey, a plaintiff’s attorney with the law firm Bernstein Litowitz Berger & Grossmann, particularly credits a 2005 settlement that required directors of WorldCom to pay nearly $20 million in fines from their personal bank accounts. The decision was “a shot fired across the bow” that prodded directors to crack down on good governance, he says. “Auditors are doing their job better, and bankers are doing more due diligence.”

Grundfest describes the decline as straightforward cause and effect: more enforcement means fewer people willing to commit fraud and risk being detected. “Economic theory suggests these factors should lead to a decline in the incidence of fraud—exactly what we have seen occur since the middle of 2005,” Grundfest said in a statement.

Legal experts, however, also say the drop in shareholder lawsuits may be due partly to the overall healthy stock market since 2003 (the last four weeks of turbulence excepted). In a rising stock market, they say, fewer stocks take precipitous plunges and fewer aggrieved shareholders then file suit.

According to John Coffee, a law professor at Columbia University, the principal requirement for a shareholder lawsuit is a dramatic drop in stock price over only a few days. Slow declines won’t carry much weight, and neither will mere underperformance or a flat stock price while the overall market surges. “If it doesn’t go down, it can’t be litigated,” Coffee says.

Grant

Companies can also mask problems more easily during boom times, says Stuart Grant, of the law firm Grant & Eisenhofer; only when the market turns sour are frauds exposed, and shareholders flock to the courthouse. Companies “may not be able to grow out of the problem,” Grant says. (Or, as Coffey puts it: “When the tide goes out, more rocks are visible.”)

Or Something Simpler

Good governance aside, another theory to the decline in lawsuits is also making the rounds these days: fewer plaintiff lawyers filing them. In particular, the law firm Milberg Weiss—notorious for filing class-action lawsuits in droves—was indicted last year on kickback and fraud charges of its own. In July, one of the firm’s name partners, David Bershad, pleaded guilty in connection with the case.

Some corporate counsels believe the Milberg Weiss indictment was such a blow against plaintiff lawyers that others are curbing their own litigation. “The plaintiff bar is not filing as much, and Milberg was a major player,” says Andrew Kaizer of the law firm McDermott Will & Emery.

“This is starting to look like a permanent shift, not a transitory phenomenon.”

— Joseph Grundfest,

Director,

Securities Class Action Clearinghouse

“The implosion of Milberg … must be working a serious chilling effect throughout the plaintiffs’ securities bar,” insists Edward Gallion, a partner at the law firm Gallion & Spielvogel. “In light of these recent developments, plaintiffs’ firms may now be much more cautious about continuing to perpetuate their reflexive and immediate resort” to class-action lawsuits.

Gallion adds that prosecutors now have a heightened interest in such practices generally, and the bench has stepped up its scrutiny of how lead plaintiffs are selected in class-action suits. Both of those trends might add yet more pressure on the plaintiffs’ bar to cool its exuberance for lawsuits, he says.

Experts also cite the Private Securities Litigation Reform Act of 1995, which set higher standards for what plaintiffs must demonstrate before class-action lawsuits are allowed to proceed. As recently as two years ago skeptics noted that the law did not change much, but some experts are now crediting it with reigning in nuisance, flimsy lawsuits.

Schwinger

Robert Schwinger, a lawyer with the firm Chadbourne & Parke who handles class-action lawsuits and similar litigation, says the PSLRA has cracked down on pretrial discovery, giving plaintiffs less of an opportunity to “take a guess,” he says. “It does not knock out cases that involve real fraud.”

Deciding Against Lawsuits

Attorneys also attribute the fall in litigation to several recent court decisions, which they believe have quelled the number of suits filed. Because the decisions are recent, the rulings are likely to have more of an effect on the number of suits filed in future years, they stress.

Coffee

Coffee, for example, cites the Supreme Court’s 2005 decision that Dura Pharmaceuticals could not be sued for securities fraud, ruling that plaintiffs must plead and prove that a company’s misrepresentation or other fraudulent conduct “proximately caused the plaintiff’s economic loss.”

And in 2006, the Supreme Court decided in Merrill Lynch, Pierce, Fenner & Smith v. Dabit that shareholders who claim they held a security—but didn’t purchase or sell it—as a result of a fraudulent statement cannot bring class actions in state court to get around the federal Securities Litigation Uniform Standards Act.

Schwinger believes the recent decision Tellabs v. Makor Issues & Rights will also throw a wet blanket on certain types of shareholder claims, since the decision sets a very high standard of what “scienter” (knowing intent) companies had when committing the alleged fraud.

Still, many attorneys disagree with Grundfest that the historical level of litigation has cooled. “I would be worried about describing anything as a permanent shift,” Schwinger says.

Securities lawyers also await another Supreme Court decision in Stoneridge v. Scientific-Atlanta, which should spell out how much legal liability “secondary actors” to a fraud can face. That might open up new opportunities to sue bankers, suppliers, and other vendors who helped a company commit fraud or shut them down. “It could have a dampening effect,” Schwinger says.