The pace of settlements in class-action securities settlements crept up last year and the actual payouts of those deals ballooned 35 percent, a probable harbinger of more litigation to come.
2009 saw a total of 103 court-approved settlements, up slightly from 97 in 2008, according to an annual report published by Cornerstone Research and the Securities Class Action Clearinghouse at Stanford University. Clearinghouse Director Joseph Grundfest said the increase is of little surprise, since securities fraud litigation typically settles three to five years after the first complaint is filed. That means last year’s lawsuits were first filed around 2005, a time when corporate financial restatements were soaring.
The study also noted that 2009’s poor economic climate “did not have a distinguishable effect either on the number of settled cases or on the total value of securities case settlements approved during the year.” In fact, because most credit crisis-related cases have yet to be resolved, the study’s authors expect the volume of class-action litigation to rise over the next several years.
Simmons
“What we saw in 2009 is something that we expect to be the beginning of an upward trend in settlements that will result from the volatility of the stock market that we saw in 2008,” says Laura Simmons, senior research adviser at Cornerstone Research and a professor at the College of William & Mary Mason School of Business.
While the number of cases increased only slightly, the total dollar value of settlements soared from $2.75 billion in 2008 to $3.8 billion in 2009. The report attributes this increase partly to a whopping $925.5 million settlement in 2009 (against UnitedHealth for lawsuits over backdated stock options), where the largest single settlement in 2008 was $750 million.
In the last two years, no single class-action settlement has topped $1 billion. That’s in sharp contrast to 2005 through 2007—a period where lawsuits filed after the collapse of Enron and WorldCom reached their conclusions—which saw eight settlements of more than $1 billion.
The median settlement amount for cases settled in 2009 remained unchanged at $8 million, although a few large settlements inflated the average settlement from $28.4 million in 2008 to $37.2 million last year.
Grundfest
“The classic litigation risk factors continue to run true to form,” Grundfest said. “If a lawsuit is prosecuted by a large public pension fund, involves a parallel SEC proceeding, and alleges accounting violations, then defendants can be expected to pay higher amounts.”
Mind the GAAP
Complaints related to violations of Generally Accepted Accounting Principles were included in more than 65 percent of settled cases last year, and they continue to be resolved at higher settlement prices than lawsuits that don’t involve accounting allegations.
McLaughlin
No company is immune from those lawsuits, says John McLaughlin, a senior managing director for LECG, because any company “can get in that situation where they have to restate their financials because of some misinterpretation of GAAP.” The more difficult situation, he adds, is a dispute with shareholders over risk management and the overall effort to run the business well. “What [companies] are struggling with is this whole concept of enterprise risk management.”
To defend themselves against such lawsuits cases, companies “should be demonstrating that they are doing the right thing as best as they can,” he says. That means having a tangible approach to ERM—one that demonstrates that even when a mistake happens, the company takes risk management seriously, has evaluated its risks, and developed strategies to deal with them, he says.
“Those companies demonstrating genuine or effective ERM programs would certainly have a positive impact … from the defendant standpoint of reducing the amount of the settlement.”
—John McLaughlin,
Senior Managing Director,
LECG
McLaughlin predicts that having an ERM program would also help a settlement amount. “Those companies demonstrating genuine or effective ERM programs would certainly have a positive impact … from the defendant standpoint of reducing the amount of the settlement,” he says.
Aside from complaints about bad accounting, institutional investors also continue to play a large role in driving settlements. Such investors served as lead plaintiffs in nearly 65 percent of settlements last year, the highest proportion to date since the passage of the Private Securities Litigation Reform Act in 2005. “It just took several years before they actually began to become very active,” she says.
Some industries saw more settlements last year than others. Of the 103 settlements in total, 19 involved financial firms, closely followed by pharmaceutical and tech businesses, involved in 16 and 15 cases, respectively. (Of the cases involving financial firms, all 19 settlements were for shareholder suits unrelated to the credit crisis, the report noted.)
Across all sectors, however, cases are taking longer to settle. Historically, settlements have been reached on average about three years after filing. But since 2006, the average time from filing to settlement approval has climbed to four years.
One factor is “the increase in the complexity of these cases,” driven by the increase in investor losses and more cases involving accounting issues, Simmons says. But, she adds, today’s poor economy might also be pushing plaintiffs or defendants to delay the resolution of cases, presumably in hopes of a better outcome.
The SOX Effect
Approximately 45 percent of settlements involved restatements of financial results, compared with slightly more than 30 percent for cases prior to the passage of the Sarbanes-Oxley Act in 2002. That presumably reflects the surge in restatements after SOX, when companies were forced to re-examine their internal controls over financial reporting—and the percentage may change again over time, since restatements have fallen sharply since 2007, as companies have gained more mastery over their financial reporting processes.
TOTAL SETTLEMENT DOLLARS
The chart below from Cornerstone Research shows class-action settlements in 2009 and gives a breakdown of total settlement dollars for 2000 through 2009. (“N” equals the number of settlements in each year.)
Cornerstone Class Action Settlement Analysis (2009)
Prior to SOX, independent auditors “may not have been sitting as high or as forward in their saddle,” McLaughlin says. “It has certainly reduced the number of restatements, because of the amount of work that the independent auditors, as well as management, are doing,” he says.
The report noted that improvements in corporate governance as a result of SOX may ultimately lead to a decrease in restatement-related class actions, but stressed that it is too early to determine what the full effect of SOX might be.
“Surprisingly, we haven’t yet found an increase in these cases accompanied by SEC actions, even though we know the SEC has become more active in pursing these actions,” Simmons says. Because many of those complaints have yet to be resolved, it’s likely that more will be settled in the future, she says.
The report also listed the law firms most active in serving as lead counsel. In first place was Coughlin Stoia, representing the plaintiffs in 26 percent of the cases that settled in 2009; Barroway Topaz represented 12 percent, and Bernstein Litowitz represented 10 percent of the cases. The two other firms that ranked high were Milberg and Labaton Sucharow, with 9 and 7 percent of cases, respectively.
No comments yet