Though the number of securities class action lawsuit containing accounting allegations remained essentially the same in 2013 compared to 2012, the market capitalization losses associated with the 2013 suits were more than double the losses associated with the 2012 suits, according to a new report from Cornerstone Research. The report contains a brief analysis of the ways SEC enforcement practices and priorities could lead to an increase in the number of accounting cases in the future The report, entitled “Accounting Class Action Filings and Settlements: 2013 Review and Analysis,” can be found here. Cornerstone Research’s April 29, 2014 press release about the report can be found here.
The report examines filing and settlements during 2013 in securities class action lawsuits containing accounting allegations. Securities suits are considered “accounting cases” if they include allegations related to Generally Accepted Accounting Principles (GAAP), auditing violations or internal control weaknesses.
According to the report, 47 of the 166 securities class action lawsuits filed in 2013 contained accounting allegations, compared to 46 (out of 152) filed in 2012. The 28 percent of all securities class action lawsuits filed in 2013 that involved accounting allegations represents a ten year low. By way of comparison, in 2011 43% of all class securities lawsuit filings contained accounting allegations, and in 2012, 30% of all filings had accounting allegations. No single industry sector accounted for a significant proportion of 2013 accounting cases; rather, the filings were evenly distributed across the seven industry sectors the report tracked.
At 40 percent of all accounting cases, the proportion of filings in 2012 involving restatements is higher proportion than any of the prior five years. However, in absolute numbers there were more restatement cases filed in 2011, when there 27 restatement cases representing 34% of all accounting cases, compared to the 19 restatement cases filed in 2013.
In addition, the proportion of accounting cases involving allegations of internal control weaknesses was also higher in 2013 than in any of the prior five years. There were allegations of internal control weaknesses in 28 percent of all accounting cases in 2013, compared with only 6 to 8 percent between 2008-2010.
The market capitalization losses associated with the 2013 accounting cases increased significantly compared to the accounting cases filed in 2012. In reaching this conclusion, the report examines what it calls the “disclosure dollar losses’’, or DDL, which the report describes at the dollar value change in the defendant company’s market capitalization between the trading day immediately proceeding the end of the class period and the trading day immediately following the end of the class period. Based on this analysis, the market capitalization losses associated with the 2013 cases are $44.8 billion, compared to only $17.6 billion in 2013, representing a 155 percent in market capitalization losses.
Even though the number of accounting case filings in 2013 was essentially the same as in 2012, the number of accounting case settlements increased in 2013 compared to 2012. In 2013, there were 44 settlements in securities class action lawsuits involving accounting allegations, representing about 66% of all securities suit settlements during the year, compared to 38 representing about 67% of all securities lawsuit settlements. 14 of the 2013 settlements of accounting cases involved Chinese companies that had obtained their U.S. listing through a reverse merger with a publicly traded shell.
Historically, accounting cases have represented the vast majority of the annual aggregate dollar value of securities class action lawsuit settlements. However, in 2013, in contrast to prior years, accounting cases represented only 25 percent of the total value of cases settled. However, this unusual result is largely due to the presence of one very larger non-accounting case settlement in 2013 that by itself represented fifty percent of the total value of all securities lawsuit settlements. Excluding this one enormous settlement, accounting cases represented just over 50 percent of the value of all securities lawsuit settlement during the year.
Another reason that accounting settlements were lower than for non-accounting cases in 2013 was the large number of Chinese reverse merger lawsuit settlements, which tend to be smaller in size.
In part due to the presence of the Chinese reverse merger lawsuit settlements, the median and average accounting case settlements were lower than for non-accounting case settlements in 2013. During, 2013, the median accounting case settlement was $4.2 million and the average was $26.6 million, compared to a median of $15.3 million and an average of $156.7 million for non-accounting cases. However the majority of the total value of non-accounting cases during 2013 was attributable to that one large settlement. Without that case, the median and average of non-accounting case settlements in 2013 were $14.4 million and $53.6 million, respectively.
The report notes that overall accounting cases tend to involve substantially higher median “estimated damages” than cases without accounting-related allegations, a factor that is generally associated with higher settlement amounts. In addition, cases involving accounting issues tend to be associated with accompanying SEC actions and accompanying derivative actions, both of which are also associated with higher median settlement values.
The proportion of cases involving auditor defendants has recently been lower than in the immediately after the PSLRA was passed, largely due to the changes in the case law making it more difficult to pursue securities claims against a company’s outside auditor. In 2013, 12 (or 27%) of the accounting case settlements involved auditor defendants, compared to only 8 (representing 21% of all accounting settlements) in 2012. The increase in the number of settlements involving auditor defendants in 2013 is largely a reflection of the number of settlements in Chinese reverse merger cases, which have tended to have auditors named as defendants more frequently than in other accounting cases. Cases involving auditors as named defendants tend to settle for higher amounts.
Though the report notes that the annual number of securities class action lawsuit filings containing accounting allegations was basically level between 2012 and 2013, the report notes a number of factors involving SEC enforcement practices and priorities that could lead to an increase in the number of accounting case filings in the future. The report notes that the SEC’s July 2013 formation of the Financial Reporting and Audit Task Force and the agency’s use of analytic tools such as the Accounting Quality Model, together with the agency’s efforts to facilitate whistleblower tips are “generally expected to increase SEC enforcement actions.”
These efforts could also “have significant potential consequences for private securities litigation involving accounting issues.” The report states that “it is conceivable that the SEC”s current focus could provide an opportunity for plaintiff counsel to make accounting-related cases a future wave in securities class action litigation.”