The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

Securities class action lawsuits involving accounting allegations are less likely to be dismissed, take longer to resolve, and make up a much greater proportion of total securities suit settlement dollars than non-accounting cases, according to a new report from Cornerstone Research. The report, entitled “Accounting Class Action Filings and Settlements: 2012 Review and Analysis,” and which can be found here, shows that the number of securities cases involving accounting allegations declined in 2012, both in absolute numbers and as a percentage of all securities suit filings. However, a number of factors suggest that the number of accounting cases could increase in the months ahead. Cornerstone Research’s April 10, 2013 press release regarding the report can be found here.

The report defines a securities suit as an “accounting case” if the lawsuit involves allegations of Generally Accepted Accounting Principles or weaknesses in internal control over financial reporting. The alleged GAAP violations vary widely, but include allegations of accounting irregularities, restatement of financials, and asset write-downs.

During 2012, new accounting case filings decreased both in number and in proportion of new securities class action filings, to the lowest levels in six years. The number of accounting cases decreased from 78 in 2011 to 45 in 2012, and the proportion of total filings that accounting cases represented decreased from 42 percent to 30 percent. As a result of declines during 2012 in the number of cases involving Chinese reverse merger companies, as well as a general decline in the number of securities class action lawsuit filings in the second half of the year, the number of securities suit filings overall declined during 2012. The drop in Chinese reverse merger cases alone accounted for approximately two-0thirds of the drop in new accounting cases from 2011 to 2012

The total number of accounting restatements actually increased in 2012. However, the total number of accounting cases involving financial restatements decreased during 2012, returning to levels seen in 2009 and 2010, after a significant increase in 2011. Perhaps many of the 2012 restatements did not result in lawsuits because the “many of the restatements during 2012 did not have a significant effect on stock price.” It is also possible that a time lag between the time of the restatement and an eventual filing may result in more restatement related filings in 2013.  

For the third consecutive year, the majority of accounting cases included allegations of internal control weaknesses. Over the past three years, nearly two out of three accounting cases included allegations relating to internal controls, a much higher proportion than during the period 2007 through 2009.

Accounting cases typically are less likely to be dismissed than non-accounting cases. Of the securities class action lawsuits that were filed in 2007, only 35 percent of accounting cases were dismissed by the end of 2012, compared with 52 percent of non-accounting cases. In addition, 60 percent of accounting cases filed in 2007 settled by the end of 2012, compared to 41 percent of non-accounting cases. Of all cases filed during the period 2007 to 2010, only five percent of accounting cases were voluntarily dismissed, compared with 24 percent of non-accounting cases.

Accounting cases continue to represent a substantial portion of the total dollar value of all settlements. While accounting cases represented less than 70 percent of the number of 2012 securities lawsuit settlements, accounting cases represented over 90 percent of the total value of the settlements.

Both average and median settlement amounts are higher for accounting cases compared with non-accounting cases. During 2012, the average and median settlement amounts for accounting cases were approximately $73 million and $15 million respectively, compared with $16 million and $6 million for non-accounting cases. This difference is due in part to the fact that accounting cases often involve other factors associated with higher settlement amounts, such as an accompanying SEC action. The report also notes that cases in which the company has announced internal control weaknesses are associated with both higher median settlement amounts and a higher settlement share of “estimated damages.”

The report notes that factors such as the Dodd-Frank whistleblower program, a recent increase in the number of restatements by accelerated filers, and the JOBS Act’s extension of the exemption from auditor reports on internal controls for emerging growth companies are all factors that could contribute to an increase in the number of securities class action lawsuit filings involving accounting allegations.

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Securities class action lawsuit filings were down “sharply” in 2012 compared to the prior year and to historical average, according to Cornerstone Research’s annual report. The study, published in conjunction with the Stanford Law School Securities Class Action Clearinghouse and entitled “Securities Class Action Filings: 2012 Year in Review,” can be found here.  A short, single-page graphic summary of the report’s conclusions can be found here. The two organization’s January 23, 2013 press release discussing the report can be found here. My own analysis of the 2012 securities suit filings can be found here.

According to the report, there were 152 securities class action lawsuits filed in 2012, which is below both the number of filings in 2011 (when there were 188) and the 1997-2011 annual average number of filings (193). The 152 filings in 2012 represents a 19 percent decrease from 2011 and a 21 decrease from the 1997-2011 annual average.

A significant factor in the reduced number of filings in 2012 was the decline in filing activity during the year’s second half, particularly during the fourth quarter. There were only 64 filings in the second half, compared with 88 in the first half. The filing level in the second half of 2012 was “lower than all semiannual periods other than the historic low observed in the second half of 2006.” The 25 filings in the year’s fourth quarter was “the lowest number of filings in any quarter in the last 16 years.” The report notes that these observations are consistent with “a declining trend since the first half of 2010.”

The report states that the decrease in 2012 filings was “largely due” to declines in federal mergers and acquisitions objection litigation and in the number of lawsuits involving Chinese companies (particularly Chinese companies that obtained a U.S. listing through a reverse merger transaction). According to the report, on a year-over-year basis, M&A filings decreased 70 percent (as plaintiffs appeared to prefer state court forums for this type of litigation) and filings related to Chinese reverse merger companies decreased by 68 percent. The report also noted that for the first time since 2007 there were no new securities class action lawsuit filings related to the credit crisis.

The number of filings against foreign issuers dropped from 61 in 2011 to 32 in 2012 (a 48 percent drop). Though filings against foreign issuers represented only 24 percent of all 2012 filings, compared to 32 percent in 2011, the 2012 percentage “reflects a level that is greater than al prior years other than 2011.” The continued elevated level of filings against foreign issuers in 2012 is largely due to filngs related to Chinese firms. There were a total of 18 filings against Chinese companies in 2012 (including Hong Kong companies) compared to 40 in 2011.

Larger companies were less likely to be the target of a securities suit in 2012 compared to recent years. 3.4% of S&P 500 companies were named in securities suits in 2012, compared to an annual average of 6.1% for S&P 500 companies during the period 2000 to 2011. The 2012 level is comparable to the 13-year low observed in 2011 (3.2%).

The most targeted industrial sector in 2012 was Consumer Non-Cyclical, representing 32% of all filings. Health care and life sciences companies comprised 67 percent of all Consumer Non-Cyclical filings (33 filings), compared to 62 percent (28 filings) in 2011. Filings against companies in the financial sector continued a declining trend with 15 filings in 2012, compared with 43 in 2010 and 25 in 2011.

As I noted in my own analysis of the 2012 securities suit filings, it is too early to tell whether the late-year decline in filings represents a trend or just a temporary dip in the general ebb and flow of securities suit filings. The report noted that the previous low semiannual filing level was in the second half of 2006, which was quickly followed by the onslaught of the subprime meltdown and credit crisis-related litigation wave.

One obvious factor in the overall 2012 decline was the absence of any episodic even driving filing levels. Indeed, Dr. John Gould, one of the report’s authors, is quoted in the press release as having said that “the absence of a filings trend…influenced the total number of new cases,” by comparison to recent years when filing levels have been dominated by “observable filings types,” such as, more recently, the M&A related litigation and litigation involving U.S.-listed Chinese companies.

While it is hard to know whether the trend will continue, the press release identifies at least one development that could result in a possible increase in future securities lawsuit filings. The press release quotes Stanford Law School Professor Joseph Grundfest, who notes that the upsurge in SEC whistleblower reports raises the questions whether the SEC will translate these reports into enforcement actions, and, if so, whether “private-party plaintiffs will be successful in prosecuting ‘piggyback’ claims that copy the Commission’s complaints.”

One factor that could also explain the declining number of 2012 filings is the plaintiffs’ securities bar’s continuing shift to diversity their inventory. Going back to the options backdating cases in 2006, the plaintiffs lawyers have been pursuing types of litigation other than securities class action litigation (in part due to unfavorable U.S. Supreme Court decisions). While the Cornerstone Report notes the absence of any new credit crisis-related securities class action lawsuit filings in 2012, there were a host of credit crisis-related lawsuits filing as individual actions in 2012. It is hard to tell, but it seems likely that this diversifying trend will continue.

Finally, it is worth noting that, as one reader observed in a comment to my blog post analyzing the 2012 securities suit filings, Superstorm Sandy could have had an impact on fourth quarter filings, since the storm basically closed New York’s downtown business district for several weeks during the fourth quarter.

Jan Wolfe's January 22, 2013 Am Law Litigation Daily article about the Cornerstone Research report can be found here.

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On July 25, 2012, Cornerstone Research in conjunction with the Stanford Law School Securities Class Action Clearinghouse release it report entitled “Securities Class Action Filings: 2012 Mid-Year Assessment” (here). By contrast to other mid-year securities litigation reports, the Cornerstone Research study reports that securities class action litigation filings decreased by 6 percent in the first half of 2012,  compared to both the first half and second half of 2011. I discuss below possible explanations for the differences in the conclusion between the Cornerstone Report and other published studies of first half filings. Cornerstone Research’s July 25, 2012 press release about the report can be found here. My own analysis of the first half 2012 filings can be found here.

 

According to the Cornerstone Research report, there were 88 filings in the first half of 2012, which annualizes to 176 filings. This annualized figure is below the 1997 to 2011 average number of filings of 193, but in line with the 2009 to 2011 average of 177.

The slight decrease in the number of filings is due to the “substantial decline” in Chinese reverse merger filings and also to a decline on mergers and acquisitions related filings. Chinese reverse merger filings were down 79 percent in the year’s first half, compared to the first six months of 2011, and M&A related filings were down 67 percent. The press release quotes Stanford Law Professor Joseph Grundfest as saying with respect to the M&A related filings that in the second quarter of 2012, “the aggregate deal flow count reached the lowest level since the third quarter of 2009,” which obviously was a factor in the decline the federally-filed M&A litigation in the first half of 2012.

While litigation related to Chinese reverse merger companies and M&A activity declined in the first half, “traditional filings” increased 23 percent, offsetting the decline in the number of nontraditional filings. Filings against non-U.S. companies decreased in the first half of 2012 after a sharp increase in 2011 (when there were significant numbers of Chinese reverse merger filings) but remained above historical levels. In the first six months of 2012, 26 percent of all filings involved non-U.S. companies, compared to 36 percent in 2011, but also compared to 9 percent for the period 1997 to 2010.

Of the 88 securities class action lawsuits filings in the first half of 2012, 10 involved S&P 500 companies, compared to eight in the first half of 2011.

In terms of looking ahead, the press release quotes Professor Grundfest as saying that “the Libor-litigation industry is clearly a sector to watch for years to come.” Both the size of the potential exposures and the complexity of the claims mean that the Libor-scandal will “likely generate large amounts of litigation activity in may geographies.” Interestingly, Grundfest suggests that “much of the litigation activity will occur away from the U.S. class action securities sector, but more lawsuits are virtually assured.”

Discussion

The Cornerstone Research reports on securities litigation activity are unique, in that it is possible to go to the Stanford Law School Class Action Securities Class Action Clearinghouse website and identify exactly what their reports are “counting.” By comparing the filings listed on their website, it is possible to determine what they are – and more importantly, what they are not – counting in their tally. By comparing the list of cases on the website with my own list of cases, it is a simple matter to determine why the Cornerstone Research tally is lower than other published tallies, and why Cornerstone Research is report that filings are declining, which other observers are reporting that filings are holding steady or increasing.

Simply put, the difference has to do with the M&A related filings.  Further review reveals that Cornerstone Research is not including federal court merger objection cases that do not include a claim based on an alleged violation of the federal securities laws. For example, if a federal court merger objection suit contains only a claim for breach of fiduciary duty, but no claim for breach of the federal securities laws, it is not included in the Cornertone list.The exclusion of these cases accounts for a significant part of the differences between the Cornerstone Research tally and other published figures.

Another difference between the Cornerstone Research tally and other published figures is that, as the Cornerstone Research report states on the inner page following the title page of the report, in counting filings, the Cornerstone Research report takes the following approach: “Multiple filings related to the same allegations against the same defendant(s) are consolidated in the database through a unique account indexed to the first identified complaint.” Other published reports take a different approach, counting separate complaints in separate judicial districts separately, at least until formally consolidated in a single action or proceeding. These differences in counting methodology also account for apparent differences between the Cornerstone Research report and other published reports.

One final observation I have is that the discussion about filing activity and whether filings are up or down often relates exclusively to the absolute number of filings. In my view, the absolute numbers of filings alone, considered without respect to the changing numbers of public companies, can lead to some misleading conclusions. The fact is that the absolute numbers of annual filings over the last 17 or so years has remained within the same very narrow band, while the numbers of publicly trade companies has declined dramatically. The key fact that should not be lost sight of here is that for any given company with shares trading on the U.S. exchanges, the chances of getting hit with a securities class action lawsuit are much higher now than they were, for example, in the late 90s. Focusing solely on the absolute numbers of lawsuit filings is not sufficient to fully understand what is going on.

Professor Grundfest’s comments about the likely Libor-scandal litigation are very interesting. Because so many of the events and so many of the prospective defendants are located outside the United States, it does seem more likely that lawsuits would be brought outside the United States -- except for the fact that there are so many procedural advantages to pursuing claims in the U.S. It will be very interesting to see if, as Professor Grundfest has suggested, Libor-related litigation outside the U.S. will be a significant factor.

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A decline in the number and size of settlements in 2011 led to a drop in aggregate and average securities class action settlement figures during the year, according to the annual study of securities suit settlements from Cornerstone Research. According to the study, entitled “Securities Class Action Settlements: 2011 Review and Analysis” (here), the number and total value of all securities suit settlements reached a ten-year low during 2011. Median and average settlements were also well below historical levels. Cornerstone Research’s March 14, 2011 press release regarding the study can be found here.

According to the study, there were 65 court-approved securities class action lawsuits settlement during 2011, representing a total of $1.4 billion in settlement funds. (The study uses the year in which a settlement receives court approval as the year of the settlement, rather than the year in which the settlement was first announced.) The number of 2011 settlements is 25 percent below the prior year’s number and 35 percent below the average of the preceding 10 years. The aggregate settlement amount represents a 58 percent decline from 2010’s total of $3.2 billion.

The median settlement amount declined nearly 50 percent in 2011, from $11.3 in 2010 to $5.8 million in 2011. The 2011 median represents the lowest annual median settlement figure during the post-Reform Act era. The average settlement also declined from $36.3 million in 2010 to $21 million in 2011. The 2011 average is well below the 1996-2010 average of $55.2 million. The 2011 average of $21 million is even below the 1996-2010 average if the three largest settlements during that period are removed from the equation (the adjusted 1996-2010 average is $39.9 million). The 2011 average is the lowest average settlement in the last decade.

The relatively low 2011 average is largely attributable to the absence of very large settlements during the year. In addition, the average for settlements of $100 million or greater declined more than 27 percent from 2010 to 2011.

The report reviews several possible explanations for the decline in the number of settlements and in aggregate settlement funds during 2011. First, the report attributes the decline “largely to the drop in traditional securities class actions that began in 2006.” This decline in filings was partially offset by credit crisis cases, but the credit crisis cases tend to take longer to settle than traditional cases.

Another factor in the ten-year low in average and median settlements is that the 2011 settlements involved cases with lower “estimated damages” than prior years. The “estimated damages” for 2011 settlements declined 40 percent compared to 2010.

The 2011 settlements also lacked the involvement of factors that often are associated with larger settlements. There was a substantial decline during 2011 of settlements involving accounting-related allegations, overlapping SEC actions and companion derivative actions. There was also a reduction in the number of settlements involving third-party defendants (such as auditors). As these factors “tend to be associated with higher settlement amounts,” the drop in the number of cases with these characteristics “may explain the lower 2011 settlement values.”

The factors that contributed to the lower settlement figures during 2011 may only be temporary. Indeed, the report notes that in light of the $725 million AIG settlement that was approved in February 2012, “it appears likely that the total dollar amount of settlements will return to more typical levels in 2012.”

The report contains a number of interesting observations, including one that will be of particular interest to readers of this blog. The report states that nearly 80% of settlements with identifiable D&O insurance contributions “were funded 100 percent by such policies,” compared with about 60% in 2010. The report suggests that this increase in the proportion of the settlement amounts covered by D&O insurance “may be a function of the lower overall settlement amounts in 2011 and an increase in the level of D&O coverage carried by firms.”

The report also contains some interesting analysis about the cumulative distribution of all post-Reform Act settlements. According to the report, more than half of the post-Reform Act settled cases have settled for less than $10 million, about 80 percent have settled for less than $25 million, and only 7 percent have settled for $100 million or higher.

Discussion

One factor that may have a considerable impact on the analysis is the report’s use of the year of settlement approval as the settlement year, rather than the year of announcement. While this factor is at one level simply a timing issue, it does have an impact. Just to pick one settlement by way of illustration, the $725 million AIG settlement noted above may not have been approved by the court until 2012, but it was first announced in 2010 (refer here). By the same token, there are a number of credit crisis related settlements that were announced in 2011 (for example, the $417 million Lehman Brothers underwriters’ settlement), but that will not receive final court approval until 2012 or later.

To be sure, it makes sense to only include settlements that have actually been approved and as they are approved.  My point is just that the use of this methodology distributes the settlements in a way that could affect the overall settlement figures, include overall aggregates, medians and averages. A different methodology might produce different conclusions about settlement trends. This is not just an idle observation; practitioners, for instance, pay keen attention to settlement announcements, and their perceptions of settlement trends are based on the most recent settlement announcements, not the most recent settlement approvals.

That said, the time of settlement approval does have important practical significance, because it dictates when investors receive their money. It also dictates when the plaintiffs’ lawyers get paid as well. Given the relative decline in the number of aggregate value of settlements in 2011, it seems that 2011 was an off year for the plaintiffs’ bar.

The report’s observation about the percentage increase in D&O insurance contribution toward settlement is also very interesting. This observation might suggest that even if the aggregate, averages and medians may be dropping, the equivalent figures for the insurers themselves might actually be increasing.

There are a couple of important considerations to keep in mind with respect to Cornerstone Research’s analysis. The first is that the report considers only class settlements. The figures in the report do not include any amounts related to settlements with other claimants that opt out of the class action settlement, which can be a significant factor in connection with at least some settlements. The settlement amounts in the report also do not include amounts incurred in defending against these lawsuits. The defense costs often are enormous, and typically are borne in whole or in part by the D&O insurers, which adds the overall costs this litigation imposes on the D&O insurers.

Finally, the settlements analyzed in the Cornerstone Research report related solely to securities class action lawsuits. Settlements in association with other types of corporate and securities litigation are not included. In most past years, the absence of consideration of other types of litigation would not have been worth noting, as the securities class action suits represented by far the most significant corporate and securities litigation threat. However, as I have noted on this blog (refer here), litigation relating to mergers and acquisitions activity is becoming an increasingly serious problem – and it is a problem that involves both increased frequency and severity, as large settlements in the M&A cases, previously unknown, have become increasingly common. In other words, the consideration of the trends noted in the Cornerstone Research report represent only a part of the serious corporate and securities litigation exposure that companies face.

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Securities class action filings rise slightly in 2011 compared to the prior year but remained below historical averages according to the annual study of Cornerstone Research, prepared in conjunction with the Stanford Law School Securities Class Action Clearinghouse, which was released today. A copy of the report can be found here, and Cornerstone Research’s January 19, 2012 press release can be found here. My own analysis of the 2011 securities class action lawsuit filings can be found here.

According to the report, there were 188 securities class action lawsuit filings in 2011, compared to 176 in 2010, and compared to the 1997 to 2010 average annual average number of filings of 194. The two largest factors in the number of 2011 filings were the heightened number of M&A-related filings (43) and the elevated number of filings involving U.S.-listed Chinese companies. (33).

The Cornerstone Research report contains a number of insights about the 2011 filings beyond those that have appeared in previously published analysis of the filings. Among other things, the report notes that three percent of companies listed on the three major U.S. exchanges (NYSE, NASDAQ and Amex) were sued in securities suits in 2011. This represents the highest annual percentage since 2004 and is above the 1997 to 2010 annual average percentage of 2.4 percent.

On the other hand, in 2011 only 3.2 percent of S&P 500 companies were sued, “making it the least litigious year for S&P 500 companies since 2000.” Historically, larger companies have been more likely to be sued in a securities class action lawsuit, and that trend continued in 2001. Thus, while only 3.2 percent of the S&P 500 companies were sued in 2011, those companies represented 5.1% of the S&P 500 market capitalization.

This year’s Cornerstone Research report also contains a number of new analyses, including an analysis of the number of private securities class action lawsuits filed between 1996 and 2011 involving Foreign Corrupt Practices Act allegations. The report shows that there were four such filings in 2011, the highest annual number of filings since 2006 (when there were also four filings).

The report also contains a new analysis of the experience of the judges handling securities class action lawsuits during the period 1996 to 2011. The analysis shows that while there are a relatively small number of judges that handled more than ten cases during that period (65), a much larger number of judges (329) handled only one case, and the vast majority of judges (582) handled only three or fewer cases. The inference is that many securities cases are being handled by judges who are relatively inexperienced with securities cases – although there is also a smaller number of judges that are very experienced with these types of cases.

The report also reflects some interesting insight about the plaintiffs’ law firms’ involvement in these cases. The report sets out which law firms are selected most often as lead counsel in securities class action cases that do not involve M&A related allegations and then separately lists the firms most often selected as lead counsel in the M&A cases. The interesting thins is that the lineup of law firms leading the M&A cases looks very different than the lineup for the other cases. These differences shed some light on the changing mix of corporate and securities lawsuits and the growth in the number of M&A cases, suggesting that among other things the rising M&A related litigation activity may reflect dynamics within the securities’ plaintiffs’ bar.

Speaking of M&A related cases, Cornerstone Research has also recently released a separate companion report specifically focused on M&A related litigation, which can be found here.

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