The pace of federal court securities class action filings during 2018 was “the highest since the aftermath of the 2000 dot-com crash,” according to a recent report from NERA Economic Consulting. Not only were the filings during the year at significantly elevated levels, but the filings “accelerated over the second half of the year, with the fourth quarter being one of the busiest on record.” As noteworthy as the filing trends are, the elevated filing pace “masked fundamental changes in the filing characteristics,” including the shift toward significantly higher amounts of investor losses. Average and median settlement levels also jumped significantly during the year, compared to the year prior. The January 29, 2019 report, entitled “Recent Trends in Securities Class Action Litigation: 2018 Full-Year Review” can be found here. NERA Economic Consulting’s January 29, 2019 press release about the report can be found here. My analysis of the 2018 federal court securities class action lawsuit filings can be found here.
The Number of Filings: According to the report, there were 441 new federal court securities class action lawsuits in 2018, representing a 1.6% increase over the 434 federal court securities lawsuits NERA tallied in 2017. (Please see my notes in the Discussion section below about counting methodologies and differences in counting tallies.) These filing figures for the last two years contrast sharply with the 2013-2017 average annual number of filings of 280, and are well above the post-PSLRA annual average of approximately 253. The number of federal court securities suit filings in 2018 (441) was more than double NERA’s tally for the number of filings in 2014 (218).
Merger Objection Lawsuits: Of the 441 federal court securities class action lawsuits that NERA tallied in 2018, 210 (or 47.6%) were merger objection lawsuits, while 214 were “traditional” securities class action lawsuits (alleging violations of Section 10 of the ’34 Act and/or Sections 11 and 12 of the ’33 Act). The number of 2018 merger objection suits was roughly even with the number in 2017. The report suggests that the “stagnant” level of federal court merger objection lawsuit activity in 2018, after years of growth, is “likely driven by relatively stagnant M&A activity.”
The Litigation Rate: While the number of federal court securities class action lawsuit filings over each of the last two years has been impressive, the rate of litigation (that is, the number of lawsuit filings relative to the number of listed companies) is even more significant. The 441 securities suits filings during 2018 means that during the year about 8.4% of the U.S. listed companies were hit with securities suits; the overall rate has “increased substantially” since early in the decade, when only about 4.0% of public companies on the U.S. exchanges were subject to a securities class action.
In explaining this growth in the litigation rate, the report notes that “the long-run trend toward fewer listed companies coupled with more class actions” means that the likelihood of a listed company getting hit with a securities suit has increased from about 2.6% after the passage of the PSLRA to 3.7% over the last five years and 8.0% over the last two years. Much of this growth is attributable to the rise in the number of federal court merger objection suits. The average probability of a company getting hit with a standard securities suit was about 4.0% in 2018, higher than the average probability of about 2.6% following the PSLRA and 3.5% between 2013 and 2017.
Filings Against Non-U.S. Companies: In recent years, plaintiff shareholders have targeted non-U.S. companies with greater frequency than these companies percentage of listings on U.S. exchanges might suggest. For example, in 2018, non-U.S. listed companies represented about 17.7% of all U.S.-listed companies but lawsuits filed against non-U.S. companies represented 20.1% of all securities suit filings. The figures for filings against non-U.S. companies are down slightly as a percentage matter from the levels of more recent years; for example, in 2017, the filings against non-U.S. companies represented 25.7% of all securities suit filings during the year. There were 56 securities suit filings against non-U.S. companies in 2017, compared with 43 in 2018. The report notes that the relative decline in the number of filings against non-U.S. firms reflects a larger slowdown in filings following-on in the wake of regulatory allegations.
Place of Filing: In terms of the place of filing, the 2018 filings, as has been the case for many years, were concentrated in the Second Circuit (which includes New York) and the Ninth Corcuit (which includes California). The concentration of the filings in these circuits increased in 2018, during which these two circuits alone accounted for 64% of filings, up from an average of 57% in the prior two years.
Industry Sectors Hit: The 2018 filings were once again concentrated in the three historically dominant sectors, which include firms in the health care, technology, and financial services sectors. The share of filings in these sectors increased to 62% in 2018 from about 54% in 2017, primarily due to a surge of filings against firms in the technology sector.
Firms in the technology sector were particularly susceptible to allegations involving accounting issues, misleading earnings guidance, or firm performance issues. The industry with the highest percentage of companies targeted with such allegations was the Computer and Equipment SIC Code group (SIC Code 357), with more than 9% of listed companies subject to litigation. 6% of the firms in SIC Code Group 367 (Electronic Components and Accessories) and 5% of firms in the SIC Code Group 283 (Drugs) also were targeted.
Motions to Dismiss and for Class Certification: Of the cases in which courts ruled on motions to dismiss, 45% of the motions were granted with or without prejudice; 30% were granted in part and denied in part; and 25% were denied.
In only 27% of all cases were motions for class certification filed; of these, courts ruled on only 55% of the class certification motions, meaning that in only 15% of cases reach a ruling on class certification motions. Of these, class certification motions were granted in part or in full in 89% of the cases. About 64% of class certification decisions were reached within three years of the date of the filing of the original complaint. The median time for a class certification motion was about 2.5 years.
Number of Cases Pending: The increased numbers of case filings in recent years means that there are now more cases pending. Looking just at the standard securities suits, the number of pending cases has increased to 660 cases, up 6% from 2017 and up 31% from 2012. About 50% of the long-term growth in pending case can be explained by recent filing growth, since the most recently filed cases have not been resolved. Delayed resolution of older filings explains the other 50% of growth in pending litigation since 2011.
Case Resolution: Looking at all securities class actions filed between 2011 and 2014, about 39% are resolved within two years and about 61% are resolved within three years. The median time to resolution for cases filed in 2016 (the most recent year with sufficient data) was 2.3 years, similar to the resolution pattern over the preceding five years.
Investor Losses Surged in 2018 Filings: NERA-defined Investor Losses is a variable that compares the aggregate amount investors lost by buying the defendant’s stock rather than investing in the broader market during the class period. This variable is not a measure of plaintiffs’ damages, however it is, according to NERA, an predictor of settlement size.
Under this gauge, the Investor Losses associated with the cases filed during 2018 surged during the year. The aggregate investor losses reached nearly $1 trillion, well over the $334 billion in 2017 and much greater than the preceding five year average of $245 billion. Even if the effect of the case filed against GE (which represents about 45% of the 2018 aggregate investor losses) is disregarded, the 2018 investor losses are well above that of prior years. Several large cases account for much of this effect, including the cases filed against Johnson & Johnson, Facebood, NVIDIA, Bristol-Myers Squibb and Celgene. The report suggests a “systematic shift toward larger filings.”
Because of the correlation measured in the past between investor losses and settlement amounts, the significant upswing in investor losses in 2018 “may be a prelude to higher settlements in the future,” especially as investor losses have increased for three consecutive years.
Average and Median Settlements: The average securities class action settlement during 2018 surged to $69 million, compared to only $25 million in 2017, largely as a result of the impact of the massive $3 billion settlement in the Petrobras case. Excluding Petrobras, the average securities class action settlement was about $30 million, about average for the post-PSLRA era when adjusted for inflation.
The median securities class action lawsuit settlement in 2018 was a “near-record” $13 million, more than double the $6 million median in 2017. The increased median in settlements during 2018 was due largely to the high number of settlements of moderately sized cases (as measured by NERA’s Investor Losses measure). Also, unlike in 2017, there were relatively few very small settlements.
Aggregate Settlements: The aggregate settlement amount in 2018 was nearly $5.3 billion, well more than double the $1.8 billion in aggregate settlements during 2017. However, more than 80% of the growth in aggregate settlements from 2017 to 2018 is attributable to the $3 billion Petrobras settlement. If Petrobras and the $480 million Wells Fargo settlements are disregarded, the aggregate 2018 settlements were near the 2017 low, “reflecting a persistent slowdown in overall settlement activity.”
The report contains a number of other interesting observations, including with respect to the relation between investor losses and settlement amounts, dismissal rates (including voluntary dismissals), and plaintiffs’ counsel’s fees. The report is well worth reading at length and in full.
The NERA report’s federal securities class action filing rate varies from other published tallies, including my own. There are a number of factors that explain the difference.
For example, in compiling its tally, NERA counts separate cases filed in separate judicial circuits separately unless and until the cases are consolidated. Other tallies (including my own) counts suits against the same defendant and involving the same allegation only once, even if separate suits are filed in separate judicial circuits. This factor of counting suits in separate circuits separately could explain at least in part why NERA’s tally is higher than some other published tallies (including my own).
As reflected in the graphic on page 5 of the NERA report, NERA includes in its tally a category of cases it calls “Other.” I am told by NERA that this group includes cases that “1) do not allege violations of Rule 10b-5, Section 11, and/or Section 12 of the Securities Act of 1933, and 2) are not merger objections.” This group includes cases involving “fraudulent initial coin and cryptocurrency offerings, manipulation of derivatives (e.g., VIX products and metals futures), and breaches of fiduciary duty (including client-broker disputes involving churning and improper asset allocation).” Many if not most of these kinds of cases may not be included in others’ tallies; other than perhaps some of the cryptocurrency cases, I do not include many of these kinds of cases in my tally. The inclusion of these cases may also explain at least in part why the NERA tally is higher than other published tallies (including my own).
Another important consideration to keep in mind with respect to the NERA tally is that, like many published tallies, including my own, the NERA tally includes only federal court securities class action lawsuit filings. As the NERA report notes, under the U.S. Supreme Court’s March 2018 decision in the Cyan case, plaintiffs may filed securities class action lawsuits alleging violations of the Securities Act of 1933 in state court. Since the Supreme Court handed down its Cyan decision, there have been a number of state court lawsuits filed. These state court suits are more difficult to track than federal court lawsuits.
In many instances, these state court suits are accompanied by parallel federal court lawsuits. In some instances, the cases are filed only in state court without parallel federal court filings. The NERA tally, like my own tally, does not reflect these state court filings. To that extent, it could be argued that a tally reflecting only federal court securities lawsuit filings does not describe the full level of securities class action filing activity. To that extent, securities class action litigation filing activity during 2018 may well have been (and in fact almost certainly was) more significant than even than the elevated levels reflected in the NERA report.
Readers who closely follow the annual securities litigation filing reports to try to glean public company D&O insurance underwriting information will want to closely read the report’s section on which industries were hit with securities suits. The report not only details what percentages of the year’s lawsuits were filed against companies in various industrial sectors but the report also all too briefly hints at what percentages of the companies in a particular industry were hit. For anybody that has tried to work out a sector specific pricing model, this industry specific frequency information is the Holy Grail. There are of course ways to work out industry specific frequencies but it requires a lot of number-crunching – not just of the industries of the companies that were hit with lawsuits but of the numbers of companies in each of the industries. Only by doing that kind of number crunching can you figure out what percentage of the companies in a particular industry got hit, which is an indispensable step in trying to figure out industry-sensitive pricing.
If you look, in a few very brief statements, the report identifies (on page 15) the industry frequencies for a few key industries. Not enough to figure out a comprehensive pricing model by any means but enough to provide some food for thought about relative pricing. The interesting point, and one that should not be overlooked, is that the most dangerous industries may not be the ones that have the most lawsuits – there may be a lot of companies in those industries relative to the number of lawsuits. No, the most dangerous industries are the ones that have the most lawsuits relative to a fewer number of companies. A lot of lawsuits and relatively fewer companies make for a more dangerous combination. Interesting reading, for sure, for anyone that wants to read it.