Securities class action lawsuit filings have been going crazy. Securities suit filings during the first quarter 2017 set a pace that if continued would mean an unprecedented number of securities lawsuit by year end. But even more significant than the sheer number of lawsuits is the rate of litigation. The percentage of listed companies sued in the first quarter, if annualized, would mean that U.S. public companies are being sued at four times the long-term historical rate. As discussed below, three factors account for much of the upsurge in securities suit filings.
Total YTD Securities Suits and Annualized Projections: There were 125 securities class action lawsuit filings during the first quarter of 2017. A larger number of these lawsuits – 44 — are merger objection lawsuits, which as discussed further below, also need to be considered separately. If we annualize the YTD number of suits (including the merger objection lawsuits), that would imply a total of 500 lawsuits by year end, which would be by far the highest annual number of securities class action lawsuits during the modern era. (The only annual period with remotely close to this number of lawsuits was in 2001, when the wave of IPO laddering cases led to 498 securities suit filings that year).
YTD Filings Compared to 2016: By way of comparison, during 2016, a year that everyone considered to be a record-setting, there were “only” 270 securities class action lawsuits. After the year’s first three months, we are nearly half way to last year’s record-setting annual total. The projected year-end total of 500 securities lawsuit filings, were it to materialize, would represent more than two-and-a-half times the 1995-2015 annual average number of lawsuits of 188.
The Impact of Merger-Related Suits: One factor driving the feverish filing pace in the year’s first quarter was the significant number of federal court merger objection securities class action lawsuits. Of the 125 securities suits filed in the first quarter, 44 (35.2%) of them were federal merger objection suits. Even if we disregard the merger objection suits, however, there were still as astonishing number of lawsuits filed in the first quarter. The 81 non-merger related lawsuits filed in 1Q17, if annualized, project to 326 lawsuits by year end, which still would represent the highest annual number of securities lawsuit filings since 2001, and by far the highest in the modern era if 2001’s IPO laddering lawsuit-distorted figures are disregarded.
The Litigation Rate: While the number of lawsuits filed during the first quarter can only be described as alarming, the rate of litigation is even more disturbing. Using Cornerstone Research’s 2016 year end number of U.S. listed companies (4593) for purposes of calculation, and annualizing the number first quarter 2017 filings (inclusive of the merger objection suits) to a projected year -end total of 500, what we can determine is that during the first quarter of 2017 U.S. publicly traded companies were being sued at an annualized rate of nearly 11% — 10.88% to be precise. In other words, the pace of litigation in the first quarter viewed on an annualized basis means that the companies were being sued during the first quarter at an annualized pace of more than one out of ten.
Litigation Rate Compare to Last Year’s and Long-Term Rates: By way of comparison, the comparable rate of litigation for the full year 2016 was 5.6%, which was itself a disturbing rate, given that the average annual litigation rate during the period 1996 through 2015 was only 2.5%. Just to put this comparison to the 2016 litigation rate into perspective, keep in mind that Cornerstone Research noted in its 2016 annual review of securities class action lawsuit filings with respect to the 2016 litigation rate, “the litigation exposure of U.S. exchange-listed companies was greater [in 2016] than in any prior year” – and the litigation rate for the first quarter of 2017 was nearly double the 2016 rate!
Indeed, the annualize pace of the first quarter’s litigation rate of 10.8% is more than four times the 1997-2015 litigation rate of 2.5%. In other words, at the current filing pace, if continued for the rest of the year, U.S. publicly traded companies would face a likelihood of getting hit with a securities suit four times greater than the average annual likelihood of a securities suit during the last two decades.
The Litigation Filings Pace: Here’s another way to look at this. There were 62 business days between January 1, 2017 and March 31, 2017 (that is, excluding Saturdays, Sundays, and federal holidays). With 125 securities suits filed during that period, that means that the lawsuits were arriving at a pace of over two a day. Even if the merger objection suits are disregarded, the lawsuits were still getting filed at a rate of over one a day.
Federal Court Merger Objection Lawsuit Filings Considered Separately: The merger objection lawsuits do represent something of a distinct phenomenon, and possibly even a short term phenomenon. As I have noted elsewhere, as a result of the Delaware Chancery Court’s hostility to the disclosure-only type settlement by which many of the merger objection lawsuits often are resolved, claimants in these actions have since early 2016 been filing these lawsuits in federal court rather than state court. However, even with respect to just the merger objection lawsuits, the numbers of lawsuit filings in the year’s first quarter were significantly elevated. As noted above, there were 44 merger objection lawsuit filings in 1Q17, which, if this pace were to continue for the rest of the year, would project to 176 merger objection suits. Last year, there were 80 federal court merger objection lawsuits, and only 17 the year before.
It may be that the increasing numbers of federal court merger objection lawsuits do not necessarily represent overall increased numbers of lawsuits; it may just be that lawsuits that previously would have been filed in state court are now being filed in federal court, without an increase in the overall total numbers of lawsuits. Just the same, the rising numbers of federal court merger objection lawsuits are having some interesting impacts. For example, there were an unusually larger number of federal securities class action lawsuits filed in the federal District Court of Delaware in the first quarter; there were 10 securities suits filed there in the year’s first three months, all of them merger objection lawsuits. The same or nearly the same thing is true of several other federal district courts (for example, the District of Massachusetts, where five of eight securities suits filed in the first quarter were merger objection suits). I suspect that the judges in those courthouses could quickly going to grow every bit as tired of these kinds of cases as did the judges on the Delaware Chancery Court.
Lawsuits Against Pharmaceutical Companies: Beyond the rise of federal court merger objection lawsuits, there are at least two other factors that might explain the surge of securities suit filings in the first quarter, at least in part. First, there were a significantly high number of suits filed in the first quarter against companies in the 2834 SIC Code category (Pharmaceutical Preparations). 22 of the 125 lawsuits (17.6%) filed in the year’s first quarter were filed against companies in the 2834 SIC Code category; no other SIC Code category had more than four lawsuits.
The concentration of cases in this one category appears even more pronounced if the merger objection lawsuits are disregarded. Only two of the 22 first quarter lawsuits against companies in the 2834 SIC Code category were merger objection lawsuits. The remaining 20 lawsuits against companies in this category represented nearly a quarter (24.7%) of all first quarter non-merger objection lawsuits. Whatever the reason for the huge upsurge in securities suit filings during the first quarter, it clearly has meant a disproportionately high number of lawsuits against companies in this one SIC Code category. I hasten to add that companies in this category have long been a particular securities litigation target, but these cases often fare poorly (as discussed here).
Lawsuits Against Foreign Companies: Another possible reason for the uptick in securities suit filings in the year’s first quarter is the continued high numbers of lawsuits filed against non-U.S. companies whose shares are listed on U.S. exchanges. There were 18 non-U.S. companies hit with securities suits during the first quarter. None of the lawsuits filed against foreign companies were merger objection lawsuits. So, disregarding the merger objection suits, the lawsuits against non-U.S. companies represented 22.2% of the first quarter filings. Since foreign companies only represent about 13.4% of all U.S. listed companies, the non-U.S. companies are experiencing a greater rate of litigation than their presence on the U.S. exchanges might otherwise suggest.
The Combined Impact: If you add up the first quarter’s federal court merger objection lawsuits (44), the non-merger related suits against companies in the 2834 SIC Code category, and the suits against foreign companies, the total is 82, meaning that these three categories together represented almost two thirds (65.6%) of the first quarter securities suits. The 2834 SIC Code company cases and the lawsuits against foreign companies together account for about 47% of the non-merger related securities suits.
Why is this happening? The best theory I can come up with is that this is largely due to the rise of the “emerging firms.” As Michael Klausner and Jason Hegland of Stanford Law School detailed in their June 2016 guest post on this blog (here), since 2009, a significantly larger number of securities class action lawsuits (both in terms of absolute numbers of lawsuit filings and in terms of percentage of all lawsuits filed) are now being filed by a group of small plaintiffs’ firms that were not previously active in filing securities lawsuits. These firms, which Klausner and Hegland call “emerging” law firms, have not only been responsible for the gradually increasing numbers of annual lawsuit filings, but they are also disproportionately responsible for the decrease in “average case quality” as measured a number of different ways. The surge of securities suits in early 2017 in large part seems to be the work of these emerging firms; the “average case quality” of the 2017 lawsuits also seems to reflect the emerging firms’ handiwork.
It is important to note that the numbers of securities suit filings ebbs and flows over time. The quarter-long time frame of the year’s first three months is in the grand scheme of things a relatively period within which to try to analyze securities suit filing trends. There is nothing that says that the frantic pace of securities suit filings in the year’s first quarter will continue. It is entirely possible that by the time we get to the end of the year, the filings rates and trends will have settled down to more typical numbers and patterns.
On the other hand, what happened in the first quarter arguably is just a continuation of trends from last year. As I noted about last year’s filings in my annual survey of securities suit filing trends (here), the securities suit filing started the year last year at an elevated pace in the year’s first six months, and in the second half of the year, the pace increased. This rising trend continued in the first quarter of this year, albeit at accelerated levels.
Some readers may recall that toward the end of January, I published a post in which I remarked even at that early date that the securities lawsuits were certainly coming in at a startling pace in the first few weeks of 2017. At that point, based on the number of securities suits that had been filed in the first few weeks of the year, I calculated that the YTD filings then projected to a year- end total number of lawsuits of 492. I hastened to add that I was not predicting that that many lawsuits would be filed this year, and I noted the likelihood that the filing rate in the first few weeks was unlikely to continue. As it turns out, I was right, the filing rate up to that point did not continue; instead, it has increased.
Whether or not the filing rate continues at its current blistering pace, the numbers of lawsuits already filed represent a disruptive development. Neither D&O insurers nor their policyholder (nor the policyholder’s insurance advisors) assume anywhere the current level of securities class action litigation frequency. If the litigation rate continues at anywhere near its current levels, there is going to have to be a massive recalculation of fundamental assumptions in the D&O insurance industry.
A Final Note about the Data and Methodology: My information about the securities class action lawsuit filings is drawn from a number of resources including in particular Justia and Law 360, as well as other Internet resources like Yahoo Finance and the Stanford Law School Securities Class Action Lawsuit Clearinghouse. I only count each defendant once regardless of the number of separate complaints that are filed. I only count federal court securities lawsuits. I only count merger objection lawsuits if they are filed as class actions and if they allege a violation of the federal securities laws (that is , I don’t count individual’s lawsuits and I don’t count lawsuits that, for example, allege only breaches of fiduciary duties). Readers will undoubtedly note that my tally differs from information reflected on some publicly available sites, at least as of today. Over time these differences will diminish or even disappear.