On the eve of the tenth anniversary of the enactment of The Sarbanes Oxley Act, Cornerstone Research has released a study of the filing trends and settlements of securities class action lawsuits involving accounting allegations. The May 2012 report entitled “Accounting Class Action Filings and Settlements: 2011 Review and Analysis” can be found here. A summary of the report’s findings can be found here.
According to the report, the share of securities class action lawsuit filings involving accounting allegations increased in 2011, compared to the prior year. In 2011, the number of accounting cases increased in both number and as a proportion of all securities lawsuit filings, compared with 2010. The number of accounting cases increased to 70 in 2011, compared to only 46 in 2010, and the proportion of total case filings represented by accounting cases increased from 26 to 37 percent.
This increase in the number of accounting cases in 2011 was largely driven by the increase in Chinese reverse merger cases during 2011. The Chinese reverse merger cases “are significantly more likely to involve restatements of financial restatements, and as a result, plaintiffs are more likely to allege violation of generally accepted accounting principals” in those cases compared to other securities class actions.
For similar reasons, the number of accounting case filings involving financial restatements increased in 2011 compared to 2010, reversing a four-year trend of declines. For the second consecutive year, more than 60 percent of accounting case filings included allegations of internal control weaknesses. However, in 2011, only 17 percent of the internal control deficiency claims were accompanied by company announcement of internal control weaknesses, which suggests that “plaintiffs may believe that including these claims will bolster their position in litigation, regardless of whether material internal control weaknesses were actually present.”
Cases with accounting allegations are less likely to be dismissed than non-accounting cases. For example, of cases filed in 2006, only 38 percent of accounting cases were dismissed by the end of 2011, compared to 46 percent of non-accounting cases. Accounting cases are also more likely to settle than non-accounting cases. 56 percent of accounting cases filed in 2006 had settled by the end of 2011 compared with only 50 percent of the non-accounting cases. These same patterns on dismissal and settlements held with respect to the 2007 and 2008 filings as well.
During 2011, there was a sharp decline in the number of securities class action settlements (measured with reference to the date on which the settlement was approved), compared to prior years. There was also a drop in the percentage of settlements in 2011 involving accounting cases. In the five years preceding 2011, more than 60 percent of all settlements involved accounting cases, but in 2011, less than half of the settlements involved accounting cases. Nevertheless, even though the accounting cases represented less than half of the total number of settlements, these cases represented more than 70 percent of the total 2011 settlement value. The report notes that accounting cases typically involved substantially higher settlement amounts compared to non-accounting cases.
For cases settled during 2006 to 2011, median settlements were higher both in dollar amounts and as a percentage of “estimated damages for cases involving internal control weaknesses with accompanying company announcements. However, when internal control weakness allegations are made without any corresponding company announcement, settlements are not higher either in dollar value or as a percentage of estimated damages, compared with cases with no internal control allegations.
Cases involving asset valuation write-downs settle for higher dollar values than cases not involving write-downs (even when compared to cases involving financial restatements). Cases involving financial restatements “settle for a significantly higher percentage of ‘estimated damages’ compared with cases involving write-downs,” which suggests that the higher settlement dollar values for cases involving write-downs are “due in part to the higher investor losses involved with those cases.”
From 2006 to 2011, about 34 percent of all accounting cases involved accompanying SEC actions, compared to only about 10 percent for non-accounting cases.
SOX Party: And speaking of the tenth anniversary of SOX, Broc Romanek has an interesting post on his CorporateCounsel.net blog (here), recognizing the anniversary of the legislation, His post contains a number of links to interesting articles about the tenth anniversary of SOX.