Largely as a result of the number of suits filed against smaller companies, the number of securities class action lawsuits filed in 2015 increased for the third year in a row, to the highest level since 2008, according to a new report from PwC. The April 2016 report, entitled “Small Companies, Big Targets: 2015 Securities Litigation Study,” can be found here. The numbers in the PwC report differ slightly from the figures reported in previously released annual securities class action litigation studies by Cornerstone Research (here) and NERA Economic Consulting (here), but the reports are directionally consistent. My own analysis of the 2015 securities litigation filings can be found here.
The Number of Securities Suit Filings: According to the PwC report, there were 195 securities class action lawsuits filed in 2015, representing an increase of 15.4% over the 169 new lawsuits that in 2014. The number of securities lawsuits filings in 2015 represented the third annual increase in a row. The 195 securities suits filed in 2015 represents the highest annual number of securities lawsuits filings since the peak financial crisis year of 2008, when there were 209 securities suit filings.
The Inverse Relationship Between Equity Markets and Securities Lawsuit Filings: According to the report, the 2015 filing levels confirm the “inverse relationship” between the relative performance of equity markets and the number of securities suit filings. As the S&P 500 performance decreased from 2013 to 2015, the number of federal securities class action lawsuit filing increased each year. (Just a side note here to observe that the report uses the S&P 500 as the measure of market performance, while at the same time, as discussed in the next paragraph, the bulk of securities litigation increasingly involves smaller companies that are not a part of the S&P 500 index.)
The Increased Prevalence of Litigation Involving Smaller Companies: The report notes an “emerging trend” of the increased involvement of smaller companies in securities litigation. Two thirds of cases filed in 2015 were filed against micro-cap (market capitalization under $300 million) and small-cap (market capitalization between $300 million and $2 billion).
More Cases Against Smaller Companies Alleging Accounting Irregularities: Accounting-related allegations were asserted in only 26% of the cases. However, in cases alleging accounting fraud, plaintiffs named micro-cap and small-cap companies much more frequently than larger cap companies. A total of 70% of the 2015 accounting-related cases named smaller companies as defendants. The majority of these cases involving allegations of improper revenue recognition and inadequate internal controls.
Disclosure Allegations and Non-Accounting Cases: Of the 195 securities suits filed in 2015, 145 did not involve accounting issues; of these non-accounting cases, 60 cases involved false or misleading disclosures concerning business operations or future financial prospects; 37 cases involved allegedly late disclosure of negative information, such as investigations or poor product performance; 25 cases involved M&A transactions; and 23 involved IPOs.
Increase in the Number of Cases Involving IPO Companies: With an increase of companies completing IPOs since the enactment of the JOBS Act in 2012, there has been an increase in the number of companies completing IPOs, with many of these companies taking advantage of the JOBS Act’s provisions for Emerging Growth Companies. This “influx of new, mostly small, companies into the capital markets has led to a rise in IPO-related litigation.” There were 23 IPO-related securities suits filed in 2015 (representing 12% of all securities suits), compared to 19 IPO-related securities suits in 2014 (11% of all cases). The report notes that the 23 IPO cases filed in 2015 “centered on pre-IPO financial disclosures – precisely the disclosures that the JOBS Act targeted in reducing the burden to market entry.” The JOBS Act’s reduced disclosure requirements “may be fueling increased litigation.”
More IPO-Related Litigation Ahead?: The report also notes that at the end of 2015, nearly 95% of the 738 companies that completed IPOs between 2013 and 2015 have not been the subject of a federal securities class action lawsuit, “yet still fall within the statute of limitations,” suggesting that the heightened levels of litigation activity involving IPO companies could continue for some time, even if the IPO drought we have experienced so far in 2016 continues.
Heightened Level of Activity Involving Foreign Issuers: Forty-three of the 195 securities suits filed in 2015 involved foreign issuers, representing 22% of all securities suits, the highest annual percentage of cases involving foreign issuers since 2011 (the year of the influx of suits involving Chinese reverse merger companies, when suits against foreign issuers represented 33% of all filings).
Aggregate and Average Settlement Amounts Increased in 2015: Excluding “outlier settlements,” the total value of all settlements in 2015 was at its highest level since 2008. The aggregate value of all securities class action lawsuits settlements in 2015 was $3.97 billion, up from $2.89 billion, but below the $5.2 billion in 2012. The average securities suit settlement in 2015 was $51.5 billion, compared to $38.5 billion in 2014. The median securities suit settlement in 2015 was $9.8 million, up from $6.5 million in 2014. The figures reported in the PwC report may differ from those reflected in other studies, as the PwC study uses the year in which a settlement is announced as the year of settlement; other studies use the year in which the settlement was approved.
Lessons for Smaller Companies: The lessons for smaller companies from the findings in the 2015 report are “clear” – that is, a small market capitalization “does not shield a public company from the large attention of a shareholder suit,” nor do reduced disclosure and attestation requirements for Emerging Growth Companies represent a “defense to inadequate internal controls.” Any accounting issue or disclosure issue “no matter how small,” may attract the unwanted attention of the plaintiffs’ attorneys. As a result all companies, including small companies, must be “open and transparent regarding their business operations,” and must “continuously evaluate the effectiveness of their accounting controls and financial reporting and disclosure procedures.”