As I have noted in prior posts, a number of commentators have proposed that companies filing with the SEC to complete IPOs ought to be able to include in their bylaws a mandatory arbitration provision requiring shareholder claimants to submit claims – including even claims under the federal securities laws – to arbitration. This idea, which has been percolating for years, received a significant boost in a statement last summer from outgoing SEC Commissioner Michael Piwowar, in which he suggested that the SEC would favorably view submissions by IPO companies that included bylaw provisions requiring mandatory arbitration of securities claims. As detailed in an April 23, 2018 paper from Elisa Mendoza of ISS Securities Class Action Services entitled “The Uncertain Role of IPOs in Future Class Actions” (here), this idea has its critics. But what might this kind of mandatory arbitration proposal, if put into action, actually mean for securities class action litigation going forward? Mendoza’s paper helpfully takes a statistical look at this question in light of historical securities litigation involving IPO companies.
As might be expected from a paper from one of the arms of Institutional Shareholder Services, the paper stakes out a position opposed to the introduction of mandatory shareholder arbitration. The paper acknowledges at the outset that allowing mandatory arbitration would “effectively give credence to the contention by advocate of mandatory arbitration that the burdens and expense of securities class action lawsuits are among the factors that led to the decline [in the number of IPOs] in recent years.” However, the report cites Jeff Lubitz, the head of ISS Securities Class Action Services, as saying that other reasons may explain the decline in IPOs, including the fact that an increasing number of companies are choosing to remain private based on the availability of capital and the robust economy. The benefits of going public, Lubitz says by way of explanation for the lower number of IPOs in recent years, are outweighed by the negatives that come with additional regulation, added public disclosures and being driven by quarterly expectations.
Even if, as some argue, allowing mandatory arbitration might arguably encourage more companies to go public, it would “do considerable damage to the rights and abilities of investors to recoup their losses if fraudulent activities were to occur.” The problem is that each investor might lack the economic incentive to bring an individual case, even if the collective losses of multiple investors would justify the costs of litigation.
In order to take a deeper look at what the impact of mandatory arbitration might be, the paper takes a look at the track record of IPO-related lawsuits over the last ten years. The paper analyzes securities class action lawsuits filed in federal and state court between 2008 and 2018, using ISS Securities Class Action Services data. Her review showed that of the 5,282 cases filed in the last ten years, only 220, or 4% involve IPO companies. However, a timeline review of the filings also shows that the percentage of cases involving IPOs increased incrementally from 2009 to 2017, from just below 2% in 2009 to nearly 7% in 2017.
The paper also finds that “smaller companies disproportionately see IPO-related litigation.” Only two settled IPO-related class action lawsuit during the past ten years involve large capital, S&P 500 companies. The two are Prudential Financial, which was sued in 2009 and settled for $16.5 million (or 0.30 percent of the company’s 2009 market capitalization), and Genworth Financial, which was sued in 2014 and settled for $20 million (representing just 0.25 of its 2014 market capitalization).
The paper notes that the absence of more IPO settlements involving S&P 500 companies is reflects that fact that S&P companies largely have been public for many years; are “more prudent about valuation and pricing”; and, with respect to the absence of settlements, “were able to defeat any class action litigations brought against them in the past decade.”
However, while there have been relatively few S&P 500 IPO-related settlements over the last ten years, there have been a number of IPO-related securities suits involving high-priced tech companies. Of the top six high-priced IPO tech companies over the past decade, five were named as defendants in an IPO class action lawsuit – Alibaba, Facebook, Groupon, and Snap faced federal securities suits, and Twitter is a defendant in a California state court action. However, even though these top tech companies have faced IPO-related litigation, “the settlement funds (for those that settled) have been a small percentage of the market cap of the company.”
In terms of the aggregate amount of money paid in settlements, IPO-related case settlements represent only a small percentage of total settlement amounts. Disbursements in IPO cases “only make up less than two percent of the total monies disbursed for securities class action litigations over the last 10 years.” The IPO settlement disbursements total about $1.1 billion, while the total disbursements were more than $43.4 billion.
IPO related case settlements averaged about $5 million per case during the period 2008-2018, while the average disbursement in all other securities class actions totaled about $8 million.
On the other hand, the dismissal rate for IPO cases is lower than for other kinds of securities class action lawsuits. Over the past decade, 32 percent of IPO class actions have, on average, been dismissed, compared to 49 percent to all other securities class actions. On average, “a higher percentage of IPO cases last from initial filing to disbursement as compared with the average other securities class actions.”
The report concludes that “even if IPO-related class actions have only filled a small space in the class action arena,” the IPO class action “is still a paramount opportunity for shareholders to enforce their basic rights.” Shareholders, the paper argues, “should continue to have the ability and means to recoup lost assets in a public fraudulent actors and chills fraud from occurring in the future.”
The ISS Securities Class Action Services paper provides a useful statistical overview of securities class action litigation involving IPO companies, particularly with relation to the securities litigation arena as a whole.
The relationship of the number of IPO companies involved in securities suits compared to the total number of securities class action lawsuits filed, as discussed in the paper, represents an interesting statistic. However, there are other comparisons that might be even more interesting. For example, in addition to comparing the number of lawsuits involving IPO companies to the number of lawsuits in total, it might have been interesting to compare the number of lPO lawsuits to the number of companies completing IPOs – that is, what percentage of companies completing IPOs experience a securities class action lawsuit in the first three years after the offering?
With respect to the conclusion that IPO-related lawsuits represent only a small percentage of the overall number of securities lawsuits, this is to be expected given the relative low number of IPO companies each year compared to the number of existing listed companies. Over the last ten years, there have been only around one or two hundred IPOs each year, while there are thousands of existing public companies. Even though there are now fewer public companies than there once were, there are still many more existing public companies than IPO companies. All else equal that would seem to suggest that of course there will be many fewer lawsuits involving IPO companies than involving existing public companies.
With respect to the aggregate and average amount of IPO-related lawsuit recoveries, the numbers themselves provide much of the explanation. There are many fewer IPO-related lawsuits, so of course recoveries in IPO lawsuit will be only a small percentage of the aggregate recoveries in securities lawsuits as a whole. And as the paper itself notes, relatively few larger companies are involved in IPO-related lawsuits, so it would be expected that average recoveries in settlements involving all other companies (including the kind of larger companies that are not involved in IPO-related lawsuits) would be greater than the average recoveries in IPO-related lawsuits. Even the five high-price high tech IPOs mentioned by named in the report are not enough to offset this overall effect. Perhaps a more useful comparison would be average recoveries as a percentage of claimed investor-style losses.
The lower percentage dismissal rate in IPO cases is consistent with the general view that Section 11 actions (the kind of liability lawsuit plaintiffs typically would filed against an IPO company) are more favorable for plaintiffs, because the IPO entity is said to be “strictly liable” for misrepresentations and omissions in the offering documents, whereas Section 10 cases (the kind of lawsuit typically filed against established listed companies) require plaintiffs to plead and prove scienter, which represents a higher initial pleading burden. For that reason, a lower dismissal rate for IPO-related lawsuit should be expected.
The paper was focused on IPO-related companies because the mandatory arbitration proposals circulating generally focus on companies including mandatory arbitration provisions in the IPO registration papers. One concern about restricting the statistical analysis of this situation to IPO companies is that there is nothing about the proposed arbitration requirement that limits it exclusively to IPO companies. Indeed, if the idea were to become broadly accepted for companies when they first float their shares, there is nothing that would inherently restrict established listed companies from adopting mandatory arbitration bylaws as well. In other words, there is nothing inherent in the idea that says that the spread of these kinds of bylaws would be limited just to IPO companies, that is just where these kinds of provisions seems likeliest to get a start.
It may be that some of the gas has gone out of the balloon on the mandatory arbitration bylaw. As I noted at the outset, part of the reason this idea has gained momentum and attention in recent months is the advocacy of the idea of mandatory arbitration clauses by SEC Commissioner Michael Piwowar. However, on May 7, 2018, Piwowar issued a statement saying that he intends to resign his position on the earlier of July 7, 2018 or the date his successor is sworn in. Piwowar was the leading advocate within the SEC for the idea of mandatory arbitration. As discussed in detail here, in an April 2018 letter, SEC Chair Jay Clayton made it clear that he does not view the mandatory arbitration initiative as a priority item (although he did suggest that it is an idea warranting further study). It may be that with Piwowar’s departure, the momentum this idea had gained may diminish – of course, much also may depend on the views of his replacement, as well.