There have been a number of important developments in class action securities litigation case filings in the recent years. In the following guest post, Michael Klausner, Professor of Law, Stanford Law School, and Jason Hegland, Executive Director, Stanford Securities Litigation Analytics, using the Stanford Securities Litigation Analytics database, identify and review several of these developments. As their guest post explains, there have been a number of interesting changes with respect to the kinds of cases that are being filed, as well as with respect to who is filing them. I would like to thank Mike and Jason for their willingness to publish their guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this site. Please contact me directly if you would like to submit a guest post. Here is Mike and Jason’s guest post.
NERA and Cornerstone have recently published annual reports showing that the volume of securities class actions has increased from 2006 to 2015, with a low in 2009 and a steady rise since then. In this blog we use the more detailed data of the Stanford Securities Litigation Analytics database to dig deeper into this trend and expose some interesting drivers. As we will explain, the increase in case volume has come with a decrease in average case quality, measured a few different ways. In addition, low quality cases appear to have been litigated disproportionately—though not exclusively—by a group of firms that until 2009 had a relatively small share of the federal securities class action market but whose share has increased substantially since then.
Much of the data we provide here will be presented in charts, though some is just in text. For readers who want to see a full set of charts with interactive features, we have provided those charts in an interactive form on the SSLA blog, which can be found here.
Figure 1 shows the annual volume of securities class action filings from 2006 to 2015 with a breakdown of those cases into those involving allegations of financial misstatements and those involving allegations of only non-financial misstatements. Financial misstatements are misstatements in a company’s financial statements. Non-financial statements are all other misstatements, which as explained below, can have a financial element as in the case of overly optimistic financial projections. This distinction and the large increase in non-financial cases is a central theme in the explanation that follows.[i]
Figure 1: Filings by Year
As Figure 2 shows, the dismissal rate for securities class actions has risen since 2006, with a low of 38% in 2008, a high of 58% in 2013, and a rate of 51% in 2015. Most of the dismissals occur in non-financial cases which, as shown in Figure 1, have increased. Cases involving alleged non-financial misstatements have always been dismissed more often than cases involving alleged financial misstatements. For the entire 2006 to 2015 period, the dismissal rate for non-financial cases was 60%. Thus, it is not surprising that the increase in the volume of these cases has been associated with a higher rate of dismissal overall. But in addition, the rate at which non-financial cases were dismissed was higher in the second half of that decade than in the first half—63% compared to 56%.
Figure 2: Dismissal Rate by Resolution Year
Looking more closely at non-financial cases helps us pinpoint the nature of their weakness in more detail. Figure 3 breaks non-financial cases down by the nature of the misstatements alleged. The most common type of non-financial case involves a situation in which a defendant’s earnings guidance overshoots actual earnings or its more general projections of success end up missing the mark, and a plaintiff alleges that the earlier statements were materially false. The second most common type of non-financial case alleges misstatements regarding products or operations, which, for biotech and pharmaceutical firms, typically means allegedly unrealistic statements regarding ongoing clinical trials. Both missed earnings cases and product and operations cases accounted for most of the increase in non-financial cases over the 2006 to 2015 period, while other non-financial case types decreased slightly. Dismissals of both missed earnings cases and product and operations cases increased substantially over this decade—from 52% in the first half of the decade to 64% in the second half. During this same period, the dismissal rate for other nonfinancial cases actually declined slightly.
Figure 3: Nature of Alleged Misstatements in Non-Financial Cases
Another underlying change that occurred in non-financial cases from 2006 to 2015 was a change in the industries targeted. Healthcare and technology companies have been targeted with increasing frequency between 2006-2015. Dismissal rates for cases against companies in these sectors have also increased in the second half of the decade in in both non-financial cases and financial cases). This change is related to the change in the nature of alleged misstatements in cases filed between the first and second half of the decade, as cases against firms in these sectors often involve allegations of misstatements regarding missed earnings and products and operations.
In sum, both the increased volume of cases and the increased rate of dismissal over the 2006 to 2015 period is largely explained by a change in the composition of the cases toward more non-financial cases, and more specifically, missed earnings cases and product and operations cases, largely in the technology and healthcare industries. The related trends of higher volume and lower quality cases raises the question why plaintiffs’ law firms are filing these relatively low quality cases.
Emerging Plaintiffs Law Firms
Although we cannot definitively answer the question with which the prior section ends, yet another pattern emerges when we look at the details in the data. Beginning in 2009, a group of plaintiffs’ law firms that we will call “emerging firms” increased their volume of cases substantially, in both absolute and percentage terms.[ii] Figure 4 shows this increase in market share over time—from 6% of cases filed in 2008 to 43% of cases filed in 2015.
Figure 4: Emerging Firms as Lead Counsel
As shown in Figure 1, cases alleging non-financial misstatements have increased in absolute number and as a percent of total filings between 2006 to 2015. Figure 5 illustrates the role of emerging firms in this shift. Between the periods 2006-10 and 2011-15, total non-financial cases increased 60% (201 cases). Plaintiffs firms that have maintained a high volume of cases throughout the past decade—a group of firms we will refer to as “established firms”[iii]—increased their targeting of non-financial cases by 16% (25 cases), while emerging firms increased their filing of non-financial cases by 396% (95 cases). Moreover, among the non-financial cases, emerging firms filed a disproportionate number of cases alleging missed earnings and cases alleging product and operational problems—the types of cases shown above to account for both the increase in case volume over the decade and the increase in dismissals.
Figure 5: Change in Filing Volume Between Periods 2006-10 and 2011-15
As shown in Figure 6, the cases that the emerging firms have filed have been dismissed at a higher rate than cases brought by the established firms—56% compared to 44%. (As stated above, the dismissal rate for all cases for the 2006-20015 period was 53%.) Moreover, the dismissal rate for emerging firms increased as the volume of their cases increased from the first to the second half of the decade.
Figure 6: Dismissal Rates of Established and Emerging Firms
Another indicator of the quality of a case can be the timing of settlements. Although this is not a perfect indicator—some strong cases settle early and some weak cases settle late—the combination of settlement timing and settlement size is a reasonable indicator of case quality. Cases that settle early for small amounts can reasonably be assumed to be relatively weak.
In order to analyze settlement timing, we divide the litigation process into three periods: (a) the “early pleading” stage is the period between the filing of a complaint and a court’s ruling on the first motion to dismiss; (b) the “late pleading” stage is the period between a dismissal of the first motion to dismiss without prejudice and a final ruling to deny a later motion to dismiss an amended complaint; and (c) the “discovery” stage is the period after a motion to dismiss has finally been denied.) Figure 7 compares settlement timing for emerging firms to that of established firms.
Figure 7: Settlement Timing by Firm Type
Among cases that settled across the entire time period from 2006 to 2015, 22% of cases settled during the early pleading stage—before the ruling on the first motion to dismiss. But as Figure 7 shows, the emerging firms settle in the early pleading stage in 34% of their cases. In contrast, 16% of established firms’ cases settle in the early pleading stage. Moreover, Figure 8 shows the settlements the emerging firms reached at this early stage were relatively small. The mean and median settlements were $3.8 million and $2.6 million, respectively. These same figures for the established firms that settled early were $46.7 million and $8.75 million.
Figure 8: Median Settlement Size by Timing
Conversely, the emerging firms settle late much less often than the established firms do—in 55% of their cases compared to 68% for the established firms. Here too, the settlement sizes are dramatically different. The mean and median for the emerging firms are $7.9 million and $3.1 million, compared to $101 million and $13.9 million for the established firms.
In part, the difference in settlement size could be attributable to another difference between cases brought by emerging and established firms. Emerging firms target corporate defendants that are substantially smaller than the defendants that established firms target. For example, median and mean market cap of cases that emerging firms have targeted are $362 million and $1.6 billion, respectively. This compares to $1.59 billion and $11.5 billion for established firms. This substantial difference is present with respect to non-financial cases, and cases involving alleged misstatements related to earnings guidance and operations. Market cap is directly related to the size of a stock drop in response to a misstatement, and stock drop is related to settlement size. Nonetheless, when we hold market cap and stock drop constant, settlements in cases filed by emerging firms are still smaller than settlements filed by established firms.
In sum, there is more than initially meets the eye in the increase in the volume of securities class actions over the past decade. This increase in volume has been associated with an increase in dismissals and other indicators of low quality cases, which in turn is linked to a change in the nature of the lawsuits that have been filed between the beginning and end of the decade. Cases involving only non-financial misstatements are the source of the increased volume—specifically cases alleging misstatements related to missed earnings and product and operational matters, largely in the healthcare and technology sectors. This new set of cases have been filed by firms that we have termed “emerging firms”—firms that increased their filings and their share of the securities class action market over the course of the past decade.
NOTE: In addition to the interactive version of the charts used above, our developers had some fun experimenting with a bubble chart illustrating the differences between emerging firm and established firm settlements reached in 2015 alone. This chart shows settlement size by relative area of the circles. The shade of color for each circle represents settlement timing, with the lightest shades representing cases that settled during early pleading and the darkest shades representing cases that settled during discovery. Following the link will direct you to the Stanford Securities Litigation Analytics site, where rolling over a particular settlement will reveal additional information collected by SSLA about each case. We will continue refining this chart, including it’s functionality and design for use in future posts and welcome any feedback with respect to this chart or any others on our site.
[i] If we were to include merger objection class actions brought under Section 14(a) of the Securities and Exchange Act, the pattern would be the same, with 209 cases in 2015 compared to 170 for example, but the analysis would be unchanged.
[ii] These firms were The Rosen Law Firm, Pomerantz LLP and Glancy Prongay & Murray LLP. The firms with the next largest increase in volume were Kahn Swick & Foti LLC, Scott & Scott LLP and Motley Rice LLC, but these firms had less than one half volume of lowest volume “emerging firm” over the same year period, and with annual filing numbers declining from 2006 to 2015.
[iii] Established firms are defined as the top 10 in lead counsel volume from 2000 –2015 and at least 5 settlements on the Institutional Shareholder Services Top 100 Settlements list. The following firms meet that definition of “established”: Barrack Rodos & Bacine, Berman DeValerio, Bernstein Litowitz Berger & Grossman LLP, Grant & Eisenhofer P.A., Kaplan Fox & Kilsheimer LLP, Kessler Topaz Meltzer & Check LLP, Kirby McInerney LLP, Milberg LLP, Labaton Sucharow LLP and Robbins Geller Rudman & Dowd LLP.