Decreased credit crisis-related filings partially offset by an influx of new filings related to M&A transactions or involving Chinese companies resulted in slightly decreased overall levels of securities class action litigation filings during the first half of 2011, according to a recent report entitled “Securities Class Action Filings: 2011 Mid-Year Assessment,” jointly published by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. The report can be foundhere and the accompanying July 26, 2011 press release can be found here. My own analysis of the first half filings can be found here.
According to the report, there were 94 securities class action lawsuit filings during the first half of 2011, compared to 104 in the second half of 2010. The 94 first half filings annualizes (using calendar days rather than months) to 190 filings, which is slightly below the 1997-2010 annual filing average of 194. (Cornerstone’s lawsuit count may differ slightly from other published tallies because, among other things, it counts multiple complaints against the same defendants only once and because it does not count state court filings.)
The report notes that the quarterly number of filings has generally declined during the past twelve months. Quarterly filings decreased from 56 in the third quarter of 2010 to 48 in the fourth quarter of 2011, 46 in the first quarter of 2010 and 48 in the second quarter of 2011.
One factor driving the first half 2011 filings was the upsurge in lawsuits against Chinese companies. There were 24 securities class action lawsuits against Chinese companies in the first half of 2011, with 23 of those actions involving reverse merger companies, up from 12 filings against Chinese companies, nine involving reverse merger companies, in all of 2010. By the same token there were 21 M&A-related filings in the first six months of 2011, “continuing a new pattern” that emerged in the second half of 2010, when there were 27 M&A-related lawsuits.
The lawsuits involving Chinese companies and M&A-related activity collectively represent a very substantial part of all securities class action lawsuit filings in the first six months of 2011. These two groups of lawsuits together represented 46.8 percent of all filings in 2011’s first half, up from 32.7 percent in the second half of 2010. Excluding these two categories, there were otherwise only 50 securities class action lawsuits in the first half of 2011, 70 in the second half of 2010 and 57 in the first half of 2010. These figures, the report notes, are “similar to the low number of filings seen in 2006 and 2007.”
The report notes that the its own annualized projection for the 2011 year-end number of securities class action lawsuit filings assumes that the pace of new filings against Chinese companies seen in the year’s first half will continue in the second half. However, the report notes, the number of U.S.-listed Chinese reverse merger companies is finite, and the current level of new filings involving Chinese companies is unlikely to continue indefinitely. The report reckons, “at one extreme,” that if there were no new lawsuits involving Chinese companies in 2011’s second half and other filings continue at the same pace as in the year’s first half, there would be only a total of 166 filings this year, “making 2011 the second lowest year in filings activity during 2006.”
The report contains some interesting analysis of the frequency of new lawsuit filings involving S&P 500 companies. The report notes that only 8.5 percent of the first half of 2011 filings named companies in the S&P 500 index, down from 15.4 percent in the second half of 2010. Overall, eight companies, or about one out of every 63 companies in the S&P 500 Index, were defendants in a class action filed in the first half of 2011, compared with about one out of every 19 S&P 500 companies during the full year of 2010. Only one out of 81 companies in the S&P 500 Financials sector was named as a defendant in the first half of 2011, compared to an average of 11.7 percent of Financials sector firms named in class actions between 2000 and 2010.
The losses in market capitalization associated with adverse disclosures at the end of the class periods remains low compared to historical levels. The total disclosure loss during the first half of 2011 of $48 billion is well below the historical average of $64 billion occurring between 1997 and 2010. The market cap declines during the class periods also remained low during 2011.
The report clearly substantiates that the number of lawsuits against Chinese companies and involving M&A transactions were a significant factor driving securities class action litigation activity during the first half of 2011. The report’s exploration of the counterfactual question of what the litigation levels might have looked like without these two categories of litigation activity is interesting. But the report’s implicit suggestion that – but for the anomalous Chinese company and M&A transaction lawsuits – securities litigation filings are actually trending toward the lower levels that prevailed during the “lull” years of 2006 and early 2007 warrants scrutiny.
The lawsuits involving Chinese companies and M&A-related transactions may reflect short term filing patterns. But it has long been the case with securities class action lawsuit filings that they are substantially driven by short term filing patterns. For years, class action lawsuit filings have been reflected sector slides, contagion patterns, or industry events. The Internet bubble was followed by the telecom industry crash and that was filed by the era of the corporate scandals, which was followed by the mutual fund industry market timing scandal, and then came options backdating scandal and after that the subprime meltdown and then the credit crisis. Each one of these events involved an associated influx of securities class action lawsuits.
So while it is true that the current litigation activity is largely being driven by short-term trends, there is nothing unusual about that. There always seems to be something driving securities class action litigation activity and it seems likely that even after the current round of securities lawsuits involving Chinese companies winds down, the plaintiffs lawyers will find something else to agitate about. (And as for whether the pattern of lawsuits against Chinese companies is going to wind down soon, I note that there have already been four new securities class action lawsuits filed against U.S.-listed Chinese companies already this month, so there is no current suggestion that the filing phenomenon has started to slow down.)
The other thing about the “lull” period, from about mid-2005 to mid-2007, is that while securities class action lawsuit filings may have declined compared to historical norms during that period, overall litigation levels did not decline. The options backdating scandal unfolded during that period, and many more of the options backdating lawsuits that were filed during that period were filed as shareholder derivative suits (over 160) than were filed as securities class action lawsuits (only about 40). So while there may have been a decline in new securities lawsuits during that period, overall litigation levels remained at or near historical norms. It is important to keep this fact in mind when attempting to discern filing patterns over time, especially when considering the possibility that filing levels are or are not actually trending toward a putative lower level.
My own view, which is substantially dependent upon the assumption that the plaintiffs’ lawyers will always find the next new category of lawsuits to pursue, is that securities class action lawsuit filings are not trending toward some lower level. More specifically, I do not think that the mid-2005 to mid-2007 filing levels represent some sort of “new normal” to which filings levels are generally trending but for short-term anomalies that obscure the overall pattern. To the contrary, I think the lower securities class action filing levels during the 2005 to 2007 period represent the anomaly, and it is an anomaly that is entirely explainable by the plaintiffs’ bar’s temporary diversion into shareholders derivative lawsuit filings during the options backdating scandal.
As I have said before, fish gotta swim, birds gotta fly, and plaintiffs’ lawyers have to file lawsuits. The fish and the birds can be counted upon to continue their traditional activities, and so can the plaintiffs’ lawyers.
An important consideration to keep in mind along those lines is that going forward the lawsuit filings driving corporate and securities litigation may or may not involve securities class action lawsuits. As the insurance advisory firm Advisen has well documented in its periodic reports on corporate and securities litigation (refer for example here), securities class action lawsuits increasingly represent a declining percentage of all corporate and securities litigation. So it may happen, as was the case during the so-called “lull” period, that securities class action lawsuit filings may decline while overall litigation levels remain unchanged or even continue to increase.
Responding to Negative Say on Pay Vote: Although only a very small companies experienced a negative say on pay vote during this past proxy season (as detailed here), a number of the companies that did sustain negative votes wound up in litigation. For companies that find themselves in this position, the question arises of how the company and its board should respond.
In an interesting July 24, 2011 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here), Paul Rowe of the Wachtell Lipton law firm examines the question of the how companies that have experienced a negative say on pay vote should respond.