In the following guest post, Doug Greene and John McCarrick take a look at the way that securities class action lawsuits settle and make a suggestion of a way for D&O insurers and defense counsel to try to improve settlement outcomes. Doug is the leader of BakerHostetler’s firmwide Securities and Governance Litigation Team. John is the chair of White and Williams’ firmwide Financial Lines Group. A version of this article previously appeared on Law 360. I would like to thank Doug and John for their willingness to allow me to publish their article as a guest post. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Doug and John’s article.
Our careers are devoted to securities and governance litigation defense – Doug on behalf of public companies and their directors and officers, and John on behalf of directors and officers (D&O) insurers and also directors and officers themselves from time to time. With great dismay, we both have watched securities class action litigation become routine over the past 10 years, and it rarely involves analysis that allows anyone to understand the actual merits or real risks a case poses. This makes securities cases an outlier; in all other types of significant commercial litigation, the parties litigate high-stakes cases and sometimes go to trial.
Yet in securities cases, a case that survives a motion to dismiss settles soon after. We no longer test whether a case meets the requirements to be a class action, defend the allegations through discovery, or give the defendants the chance to defend the truth of what they said in a deposition. We don’t litigate the case far enough to even make a motion for summary judgment – a central feature of all other types of litigation. And trial is virtually unheard of. At the end of the day, an outsider could reasonably conclude that securities class action settlement negotiations have more in common with hostage negotiations than with risk-based valuation negotiations – because we don’t know the real risks.
From one perspective, it’s understandable that securities class actions have developed this unique resolution structure. They are often spoken of as “bet the company” cases because they typically involve a loss of market capitalization in excess of the resources of the company or of their directors and officers and their D&O insurance limits.
But here’s the thing: Securities class actions are highly winnable. To start with, the dismissal rate for securities class actions across all industry classes approaches 50%. And even if a case survives an early motion to dismiss, a good defense lawyer can defeat class certification or win at summary judgment – or even at trial.
How do we know? Well, for one thing, it’s no secret that the smaller plaintiffs’ firms operate primarily on a volume model and could not withstand a full-blast defense by even a modest fraction of the number of companies they sue. To be sure, larger plaintiffs’ firms have more resources to litigate cases more aggressively, but even those larger firms are not structured to strenuously litigate more than a handful of securities class action cases at once.
What’s the fix? We have been doing a lot of thinking recently about damages analysis. (We know this is eyes-glazing-over stuff, but bear with us.) The problem, as we see it, is not so much whether damages claims can be whittled down by economic analysis but when.
In an early mediation, the parties have not done damages discovery or rigorous analysis – much less the work required to analyze price-impact issues under the Supreme Court’s 2014 decision in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (Halliburton II), in which the Supreme Court held that defendants may seek to rebut the fraud-on-the-market presumption of reliance, and thus defeat class certification, through evidence that the alleged false and misleading statements did not impact the market price of the stock. Indeed, despite tremendous fanfare, defendants have rarely used Halliburton II, given the need to settle early to avoid high defense costs.
Instead, the parties typically come to the mediation only with a preliminary damages estimate that neither side has thoroughly analyzed, much less tested through intensive work with the experts and expert discovery. Rigorous expert work often significantly reduces realistic damages exposure. For example, stock drops that lead to a securities class action are often the result of multiple negative news items. A rigorous damages analysis parses each item from the total stock drop to isolate the portion caused by the revelation of the allegedly hidden truth that made the challenged statements false or misleading.
Once the mediation process starts, settlement momentum often develops on the defense side. While defendants would prefer to continue to defend the litigation and not just throw in the towel – if they have sufficient insurance proceeds – they come to accept the wisdom of early settlement to avoid being left without enough insurance to settle later. Defense counsel’s job thus becomes to get the settlement done – a task at odds with rigorous damages analysis that the plaintiffs will contest. Instead, defense counsel uses a basic, plaintiff’s-style damages analysis with a large bet-the-company damages figure to pressure the insurer into settling for an amount that the plaintiffs will take. A defense lawyer might say, “Our economist says that damages are $1 billion, so the $40 million the plaintiffs are demanding is a reasonable settlement.” But expert analysis and discovery may well push the $1 billion number down to a much lower number, which in turn would dramatically reduce a reasonable settlement amount.
To allow us to better calibrate what is actually at stake in each case, we propose to move securities class action damages expert reports and discovery ahead of fact discovery. Expert damages analysis and discovery really should be the first things we do after a motion to dismiss is denied. This will help us know whether the case is really a big case, or is a small case that just seems big.
Everyone would benefit. Plaintiffs and defendants would be able to reach a settlement, one based on true risk and reward, more easily. Defendants would not settle for bloated amounts that create a perception that they did something wrong. Insurers would know that they are funding a settlement that reflects the real risk in terms of damages exposure. And courts would feel more comfortable that they are approving (or rejecting) settlements based on a litigated assessment of damages. Indeed, placing damages expert work first would help serve the core policy of our system of litigation: “to secure the just, speedy, and inexpensive determination of every action and proceeding.” Federal Rule of Civil Procedure 1.
There is no rule or procedural reason why parties cannot accomplish damages discovery ahead of fact discovery. Courts should be willing to stay fact discovery for a limited period of time to allow the parties to better understand the realistic size of the case from a damages standpoint. Moreover, early expert discovery can be accomplished relatively quickly and efficiently, whereas fact discovery can be immediately and wildly expensive – which is primarily what drives very early settlements. And although plaintiffs and defendants often disagree about the relevance of fact discovery to damages, the absence of fact discovery for consideration in damages analysis is a factor the parties can weigh in evaluating the damages experts’ opinions.
Unless and until defense costs become more manageable, continuing the fact discovery stay while expert damages discovery proceeds would strike the right balance. Even if fact discovery blows up from time to time or defendants need to acquiesce to limited fact discovery that the plaintiffs persuasively argue is relevant to damages, everyone would be better off with a system that emphasizes early damages discovery and does not default to full fact discovery first.
Accelerating the timing of damages expert discovery would align it with the work required by damages experts to analyze price-impact issues under Halliburton II. Unifying these two overlapping economic expert projects would create efficiencies for the lawyers and economists. Completing both of them before fact discovery starts would avoid unnecessary discovery costs if the Halliburton II opposition defeated or limited class certification or if the damages analysis facilitated early settlement.
We plan to do our part to push economic analysis toward the front of the line after a motion to dismiss is denied. But we can do only so much, and we call on our fellow defense counsel and D&O insurers to join us. This one small change would make a big difference in making the merits matter again.
The views expressed in this article are those of the authors and not necessarily those of BakerHostetler, White and Williams, or the firms’ clients.