Let's Get the Facts Right

Posted on February 9, 2009 by Kevin LaCroix

The numbers are unambiguous – there were more securities lawsuits filed in the second half of 2008 than there were in the first half. Nevertheless commentators and observers continue to repeat the mistaken conclusion that there were fewer lawsuits filed in the second half, and even to try to discern some significance from a decline that never, in fact, occurred.

 

Here are the facts. As reflected on the Stanford Law School Clearinghouse Securities Class Action Clearinghouse website, which helpfully indexes the securities class action filings by quarter (here), there were 112 securities lawsuits filed in the first half of 2008 and 114 in the second half.

Not only were there more lawsuits filed in the second half of the year, but there were more lawsuits filed in the fourth quarter (65) than any other quarter during the year. Indeed, there were more lawsuits filed in December (30) than any other month during the year.

 

 

Clearly, the fact that securities lawsuit filings in fact accelerated at the end of 2008 potentially has far different implications for the future than the mistaken impression that lawsuit filings were declining.

 

 

The source of the impression that there were fewer lawsuits in the second half of 2008 is the year-end securities lawsuit filing Report jointly published by the Stanford Law School Clearinghouse and Cornerstone Research. The Report, which can be found here, considered only lawsuit filings through December 15, 2008. As I noted at the time the Report was first published (here), by omitting the last two weeks’ lawsuit filings, the Report not only excluded at least 12 lawsuit filings from its analysis, but it also reached a conclusion, inconsistent with the actual aggregate year-end data, that lawsuit filings had declined in the year’s second half. When lawsuit filing data through December 31 are considered, it is clear that the number of filings did not decline in the year’s second half.

 

 

What difference does it make whether or not lawsuit filings declined in the second half? Well, a discussion of the reasons for a lawsuit filing decline is a far different conversation that a debate over the reasons why lawsuit filings accelerated in the year’s final quarter and month. The repetition of the impression that lawsuit filings were declining when in fact they were accelerating not only perpetuates a misunderstanding of what actually happened, but it also allows the possibility that decisions could be made or conclusions reached based on a faulty premise.

 

 

Unfortunately the conclusion that securities lawsuit filings declined in the second half of 2008 continues to be repeated. As reflected in a February 9, 2009 Business Insurance article (here), industry observers continue to distract themselves and perhaps others as well debating the reasons for a lawsuit filing decline that never happened, when in fact the actual discussion ought to be the reason why lawsuit filings actually accelerated at the end of the year.

 

 

The danger from this mistaken conclusion is apparent in the remarks of one leading industry observer at a recent conference. As quoted in the Business Insurance article, the observer noted, in apparent reliance on the Cornerstone report, that “in this last quarter, there were actually fewer cases filed. It got better, not worse at the end of the year.” The world certainly looks a lot different if you think things recently “got better”; unfortunately, they didn’t get better, they got worse.

 

 

The D&O insurance industry has a hard enough time behaving rationally and making sense of what has actually happened. It would be extremely unfortunate if the industry were to become even further confused by a conclusion that unsupported by full-year data.

 

 

I entreat readers to do everything they can to make sure that the misimpression about securities lawsuit filing activity levels is not perpetuated. The industry faces too many other challenges to have to deal with the added burden of laboring under misimpressions.

 

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Class Action Opt-Outs: The Impact of Competition on Securities Lawsuit Resolution

Posted on April 20, 2008 by Kevin LaCroix

I have previously noted (most recently here) the increasing significance of opt-out actions as a part of securities lawsuit resolution. Columbia Law School Professor John Coffee, in a March 27, 2008 paper entitled “Accountability and Competition in Securities Class Actions: Why ‘Exit’ Works Better Than ‘Voice’” (here) examines the opt-out phenomenon and concludes that while the increased recoveries in opt-out actions compared to class recoveries will encourage competition among plaintiffs’ counsel, shareholder litigation could become even costlier to resolve.

Coffee also concludes, contrary to what others have “prematurely predicted,” that shareholder class action lawsuits “will not die or whither away, but that the current system of shareholder class action lawsuits may be abandoned in favor of a “two-tier system,” in which “the largest investors will opt-out and sue in state court individual actions, with the class action becoming the residual vehicle for smaller investors.” These possibilities have enormous implications for the future of securities litigation, which Coffee’s paper explores.

Coffee opens his paper comparing the changes wrought by the opt-out phenomenon with prior legislative efforts to reform class action litigation. Specifically, Coffee notes that unlike legislative efforts to give the class greater control, such as the lead plaintiff provision of the PSLRA, the increasingly utilized opt-out option may offer true oversight, actual competition, and even lead to better results for the plaintiff class.

In analyzing these developments, Coffee adopts terminology from the writings of economist Albert O. Hirschman. Hirschman describes two ways in which organizational behavior may be modified: (i) participants can be given greater “voice”; or (ii) participants can be given increased ability to “exit” the system. Coffee contrasts the legislative reforms, such as the lead plaintiff provision, designed to give class members greater “voice,” with the alternative of “exit” offered by the opt-out option. Coffee concludes that “ ‘exit’ works better than ‘voice,’” at least within realm of securities class actions.”

A critical component of Coffee’s analysis is that “when institutional investors exit the class and sue individually, they appear to do dramatically better – by an order of magnitude!” Coffee views this as an “optimistic development” because the opt-out outperformance can “kickstart active competition” among plaintiffs’ attorneys, by contrast to the PSLRA reforms which have had the perverse effect of reducing competition.

As Coffee notes, these developments have significant implications for the future of class litigation, as large institutional investors increasingly may conclude that their interests are better served by proceeding separately. Coffee specifically notes that the current wave of subprime-related cases are “particularly likely to produce a high rate of opt-outs,” because of the predominance of institutional investors among purchasers of the kinds of asset-backed securities that are at the heart of many of these lawsuits.

Coffee speculates that defendants (and indeed all class litigants) may seek to employ adaptive practices to offset these developments. Among other possibilities Coffee reviews are such practices as advancing the time of the opt-out decisions before the settlement is reached; structuring the settlement in a way to give class members “priority” over individual recoveries, such as given them a security interest in company assets to the extent of the settlement amount; including a “most favored nation” provision in class settlements so that class members are entitled to increase their recovery if opt-outs reach a higher settlement; or even reducing the settlement amount in respect of each opt-out.

In the final analysis, each of these potential adaptations has shortcomings. Over the long run, Coffee anticipates, “increased opting out will place class counsel under increased competitive pressure to improve the class settlement.” For that reason, Coffee concludes that “greater competition is coming.”

I very much agree with Professor Coffee that the emergence of significant opt-out settlements represents a watershed development in securities class action litigation, with the potential to have an enormous impact. However, I think it does still remain to be seen how widespread the opt-out phenomenon will prove to be.

The increased recovery percentages (so far) in the high profile opt out actions do provide obvious incentives for institutional investors to become more focused on their opt-out opportunities. But so far the significant opt-out activity has been limited to “mega” cases where the aggregate recoveries, for both the class and the opt-out litigants have run into the hundreds of millions and even the billions of dollars. It is entirely possible that rather than becoming a universal phenomenon affecting all, most, or even many securities class actions, significant opt-out activity will be limited only to a small handful of cases where the dollars involved reach this rarified range. Without more, it seems premature to project that shareholder litigation is about to enter a two-tier system where institutional litigants have abandoned class resolutions altogether.

That said, even if the phenomenon proves to be limited only to a small subset of securities cases, the opportunities and incentives involved could still affect the overall outcome of many securities cases. Just the threat of material opt-outs could affect the class action settlement dynamic. As Professor Coffee notes, some adaptive behavior is likely, as litigants seek to suppress or minimize the prospects for opt-outs. The likeliest adaptive behavior is that class settlements overall could be driven upward, as all class settlement participants seek to remove the incentive to opt out by improving the class settlement itself.

We are already in an era of increasing average claim severity. The emergence of the opt-out phenomenon can only amplify these trends. In any event, the developments related to opt-outs also present important implications for D&O insurers’ severity assumptions and for insurance purchasers’ assumptions about limits adequacy. The direct and indirect impacts from the emergence of significant opt out activity could make historical assumptions in this regard obsolete.

Very special thanks to Professor Coffee for his permission to cite and quote his paper, which, he emphasizes, is preliminary only.

Hat tip also to Werner Kranenburg of the With Vigour and Zeal blog (here) for the link to Professor Coffee’s paper.

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