The extraordinary levels of securities litigation filings during 2017 have been the subject of numerous commentaries, including on this blog. In a March 19, 2018 post on The CLS Blue Sky Blog, Columbia Law School Professor John Coffee adds his observations to the discussion about the 2017 securities suit filings. In his article, entitled “Securities Litigation in 2017: It Was the Best of Times, It Was the Worst of Times” (here), Coffee’s commentary about last year’s securities suit filings is consistent with prior reports and analyses. One specific aspect of his commentary – relating to the phenomenon of event-driven securities litigation – is particularly noteworthy, as discussed below.
As I have noted before, the phenomenon of event-driven litigation has recently emerged as a significant factor in the level of securities class action filings. I distinguish this category of litigation from the kinds of allegations that in the past characterized securities litigation – that is, allegations based on financial misrepresentation or financial omissions. As restatements have become less common than in prior years, the plaintiffs’ lawyers (or at least some of them) have shifted their focus to adverse developments in company operations. Something goes wrong at the company, its share price declines, and the company gets hit with a securities suit.
In his article, Coffee duly notes many of the factors that were significant in the 2017 filings, including the shift of merger objection lawsuits from state to federal court, and the substantial volume of new lawsuits involving life sciences companies.
Coffee then turns to analyze event-driven class actions, which he describes as a “new trend.” In these kinds of cases, he notes, “an adverse event will trigger a securities class action: an explosion, a crash, a mass torts episode.” In these circumstances, the “first suits were by injured consumers, workers, or others with tort claims, but the caboose of the train is the securities class action, which will claim that investors were injured by the defendant company’s failure to disclose its misconduct.” Coffee comments that “sometimes this reasoning seems strained.” He also notes that the largest securities class action lawsuit settlement in 2017, the $175 million settlement of the BP Deepwater Horizon securities suit.
Coffee’s analysis helps explain the rise of this phenomenon. He points out that two recent Supreme Court cases — Matrixx Initiatives, Inc. v. Siracusano (2011) and Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund (2015) – the Court upheld the materiality of the defendant companies’ respective failure to disclose the risks that might arise from adverse developments.
These cases, Coffee says, “establish only that an adverse event (whether a criminal misdeed or a harmful side effect) can be the basis of a securities fraud class action.” The cases in 2017, by contrast, “push the envelope on this principle to the limit.”
As an example, Coffee cites the securities suit that was filed against Arconic last summer in the wake of the Grenfell Tower fire in London (a case that I discuss at length here, as an example of an event-driven lawsuit). Coffee cites several other cases filed in 2017 as examples, including the suits filed against Johnson & Johnson (about which refer here) and the case filed against RYB Education (refer here).
The trend in “event-driven” litigation, Coffee notes, appears to be to file early, soon after the stock drop, and without more elaborate investigation that the larger established plaintiff’s firms today employ in securities litigation.”
This development is a reflection of the fact that “securities litigation has recently seen a number of new plaintiff’s firms enter the field.” These new entrants lack connections to large institutional investors and so have little hope of winning the fight for control of a major securities suit involving financial irregularities.
As a result, a “two-tier plaintiff’s bar is emerging,” in which the older, more established firms focus on the financial irregularities cases, because they can win control of the cases, while the new entrants are likely to focus on event-driven cases because that is what is left to them. (Please see more about the plaintiffs’ bar in the additional item below, following the discussion section.)
Coffee notes that in light of two other emerging securities litigation trends, the scope of event-driven litigation could “expand rapidly.” The two trends are cybersecurity and Harvey-Weinstein-style sexual harassment allegations. These kinds of cases, Coffee notes, may be the event-driven cases of the future.
As readers of this blog know, I have been sounding the alarm on event-driven cases for some time now. While on the one hand, these cases often lack merit (for example, they often are fatally deficient on scienter or causation allegations), on the other hand, their sheer volume means cost and vexation for companies and their insurers. The fact is that in the ebb and flow off day to day business, many companies face setbacks or hit unexpected operational hurdles. It is bad enough that these companies must deal with the adverse circumstances; increasingly they must also deal with a resulting securities lawsuit as well.
The fact that these rise kinds of cases can be explained by changes in the plaintiffs’ bar suggests that these kinds of cases are going to continue; these firms have a business model built on finding cases that allow them to avoid the bigger, more-established firms. The “new entrants” pursuing this business model are not likely to go away any time soon and they don’t seem likely to change their business model either. (At least some of the members of the plaintiffs’ bar appear to agree, as noted in the additional item below.)
I agree completely with Professor Coffee that cybersecurity and the current #MeToo movement are likely to contribute to an increase of event-driven litigation going forward. Indeed, in my post last week about the new Facebook securities lawsuit, I specifically noted that the case represents an example of an event-driven securities suit. In that regard, however, I would slightly amend Professor Coffee’s prognostication about cybersecurity cases to expand the trend to include all types of data security issues, and not just cybersecurity or breach-related issues. We have also already seen a flurry of suits arising in the wake of the current sexual misconduct scandals, including the lawsuits filed against 21st Century Fox (refer here) and Wynn Resorts (refer here). We are likely to see more of these kinds of suits in the months ahead.
The only thing I would add to Professor Coffee’s analysis, based on a legal development subsequent to the publication of his article, is that the effect of this event driven litigation could be amplified by the U.S. Supreme Court’s recent holding in the Cyan case. As discussed here, the Court held that state courts retain concurrent jurisdiction for liability suits under the ’33 Act. These ’33 Act suits typically involve IPO companies. Newly public companies have always been particularly susceptible to securities suits. Based on the event driven litigation phenomenon, these IPO companies arguably are even more vulnerable to securities litigation; any IPO company hitting any kind of obstacle or setback, whether or not based on the company’s financial report, can expect a lawsuit. And now, in addition in light of the Cyan lawsuit, IPO companies could face the possibility of parallel lawsuits in federal and state court, or even in multiple state courts.
To pick up on the theme in the title of Professor Coffee’s article, it is definitely the “worst of times” for companies and their insurers. With the advent of event-driven litigation phenomenon, and the increasing activity of the “new entrants” to the plaintiff’s bar, both companies and their insurers will have to expect continued elevated levels of securities class action frequency, in which all companies face heightened risk of securities litigation. The Supreme Court’s recent Cyan decision even further magnifies these effects for IPO companies.
More About the Plaintiffs’ Bar and Event-Driven Litigation: A March 26, 2018 Law 360 article entitled “The Rise in Event-Driven Securities Class Actions” by Steve Berman and Mike Stocker of the Hagen Berman Sobol Shapiro law firm (here) provides an interesting take on the rise of event-driven litigation from the perspective of plaintiffs’ attorneys.
The authors note that event-drive cases pose “distinct challenges” for plaintiffs’ securities attorneys as “they usually require extensive and detailed background in scientific and technical practices specific to a defendant company’s area of business.” The defendants’ counsel can rely on their clients to learn this background but the plaintiffs’ attorneys may be “forced to seek time-consuming and very expensive help from retained industry experts.”
Just the same, the event-driven cases may have some benefits for the plaintiffs’ counsel. The authors note in light of the requirement for claimants to plead scienter with specificity, plaintiffs’ attorneys must usually rely on confidential witnesses to show that defendants knew what they were saying was wrong. The challenge in a financial fraud case is that there usually are only a very small number of persons who have direct access to information showing that the company was cooking the books. In an event-based case, by contrast, “the number of former insiders with knowledge of nonpublic negative developments in a company’s core business can be much larger” which can “increase the odds that a thorough and careful investigation can turn up information critical to pleading and proving the case.”
The authors suggest that in the competitive plaintiffs’ securities bar “the edge will go to firms that have close familiarity with presenting scientific and technical issues and share investigators” rather than the knowledge of GAAP and conventional accounting fraud.” The resulting “shakeup,” the authors suggest, may “upend the roster of firms pursuing these cases.”
New York County Lawyers’ Association Webinar About the U.S. Supreme Court’s Cyan Decision: As I noted in my blog post about the U.S. Supreme Court’s March 20, 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, the Court’s ruling has serious implications for IPO companies and for their D&O insurers. On Thursday March 29, 2018 from 12:15 pm EDT to 1:30 EDT, I will be participating as a panelist in a New York County Lawyers’ Association webinar discussing the Cyan decision and “What it Means; What We Can Expect.” The other panelists in the webinar will include Giovanna Ferrari of the Seyfarth Shaw law firm and Jeroen Van Kwawegen of the Bernstein Litowitz law firm. Greg Markel of Seyfarth Shaw will be moderating the event. Information about the webinar including instructions on how to register can be found here.