Cornerstone Research: Securities Suits Involving Accounting Allegations Less Likely to Be Dismissed, Costlier to Settle
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.