The resolution of many securities class action lawsuits would benefit from an economic assessment early in the case process. In the following guest post, Assen Koev argues in favor of a standardization of the initial economic assessment analysis as a way to provide the parties and concerned insurers with a clearer picture of the securities lawsuit at an earlier point in the case. Assen is an economic consultant and founder of SCA iPortal. A version of this article previously was published on Law360. I would like to thank Assen for allowing to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Assen’s article.
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Initial case assessment in securities class action litigation refers to a preliminary internal investigation by defense counsel in the earliest stages of a case. Such an investigation, which includes legal and economic analyses, is advocated by a number of prominent securities class action litigators as an important step in planning the defense strategy. Yet, it is far too often not undertaken.[1]
In this article, I focus narrowly on the economic analysis portion of the initial case assessment, which I refer to as an initial economic assessment.
There is no agreement on what an initial economic assessment should include. Some suggest using this time to perform a damages estimate and determine which areas will be addressed in later stages of the case.[2] Settlement estimates should be on the list as well.
What is generally agreed upon is that an initial economic assessment is a review of a wide range of fundamental economic questions and is, therefore, a limited high-level analysis by necessity.
An initial economic assessment, just like an initial case assessment, is rarely performed to address the full range of those questions. If and when economic consultants are retained before the motion to dismiss, the questions are often targeted based on some salient features of the case. Thus, potentially strategically important questions remain unaddressed until much later stages of the case.
In this article, I argue that a simple standardization of the initial economic assessment analysis can significantly improve its effectiveness and increase the likelihood of its implementation, thus providing counsel, clients and insurers with a much clearer view of the case at the early planning stage.[3]
The Importance of the Initial Damage Assessment on a Current Case
A comprehensive illustration of an initial economic assessment is the subject of a separate write-up. In this section, I provide an example of the importance of initial damage assessment only.
On Feb. 20, after market close, cybersecurity company Palo Alto Networks announced earnings and significantly reduced its guidance. The steep daily stock price decline on Feb. 21 triggered immediate and numerous notifications of investigations for securities law violations.
For example, Block & Leviton LLP announced an investigation noting that Palo Alto Networks’ announcement “[wiped] away tens of billions of dollars of shareholder value.”[4] While the statement itself is correct — the company’s market capitalization declined by over $33 billion — it provides an inaccurate perception of the size of the case that was filed five days later.
A preliminary damages analysis shows that supportable damage claims in the Palo Alto Networks litigation would likely not exceed $3 billion, a tenth of the staggering loss of value on Feb. 21!
This estimate is driven by the short class period of the filed case, large institutional holdings not traded in the class period and the increasing trajectory of the stock price during the class period.[5] The estimate is even lower if potential defense-side loss causation analyses are applied.
Reasons for the Infrequent Use of Initial Economic Assessment
There are a number of reasons for the infrequent use of economic assessment at the outset of a securities class action. Some of them are the reasons hindering the initial case assessment in general. Others are specific to economic research itself.
For example, Doug Greene, the leader of BakerHostelter’s securities and governance litigation team, wrote in 2022 that the infrequent use of initial case assessment — and by association, initial economic assessment — can be attributed to
a low cap or budget offered to secure the engagement; the (incorrect) view that a motion to dismiss is mostly a matter of identifying what the complaint does not allege, as opposed to an affirmative narrative that sticks up for the defendants’ honesty and good faith; and understandable backlash over some firms’ use of the background review to do a full-blown internal investigation.[6]
The infrequent use of initial economic assessment is also driven by reasons unique to the economic research in securities class action litigation. The very high stakes in securities class actions inevitably demand exhaustive, careful, highly customized and, ultimately, expensive economic analyses.
Even preliminary and internal analyses follow this trend because these results form the basis of counsel’s and client’s expectations, and affect the broader defense strategy. Expert economists are weary of producing limited preliminary analyses with strategic implications. Reputational concerns alone result in strong incentives for any limited analysis to snowball into full-blown investigations closer to those typically performed at the later stages of the case.
Exhaustive high-cost research projects are, of course, unjustifiable at the outset of many cases for a number of reasons.
First, approximately 50% of all filed securities class actions are dismissed at the motion to dismiss stage. It is hard to justify significant expenditure on early analyses of damages, class certification or loss causation, when these stages have less than — and for some, much less than — a 50% chance of being reached.
Second, with the increase in the number of cases against smaller companies, detailed economic analyses are rarely undertaken because the total cost of litigation becomes an important deterrent.
Consider, for example, that 31% of all cases between 2014 and 2022 settled for less than $4 million.[7] That is one of the reasons defense counsel is often interested in early settlement projections for small cases. The expected settlement in these cases is a threshold for sizing up the entire litigation budget. Setting aside strategic considerations, low expected settlements provide strong disincentives to undertake costly litigation and perform extensive economic analyses upfront.[8]
Third, customized economic analyses, by definition, change with the changing nature of cases. Those with a long tenure in economic consulting are familiar with various waves of litigations like the initial public offering cases, the options backdating cases, the financial crisis cases, the special-purpose acquisition company cases, the merger objection cases, the opioid cases, and so on.
Each of these litigation waves came with its own set of economic facts and logic. The differences in the economic underpinnings across these case types make customized analysis an ever-moving target, thus contributing to persistently high consulting costs.
Defining “Standardized Analyses” in Securities Class Action Litigation
As the prior section points out, an initial economic assessment may be infeasible in many cases if it is performed in the typical exhaustive and customized format as most securities class action economic research is. In this section, I list some methodologies that (1) have been widely accepted, (2) can be implemented in a highly efficient manner, and (3) are highly informative for the initial economic assessment stage. I refer to them as standardized analyses.
- Market-efficiency analysis — Cammer factors, Krogman factors, autocorrelation;[9]
- Price impact and loss causation — event chronology (event study, daily and/or intraday price charts, and news headlines);
- Damages analysis — “plaintiff-style damages”; and
- Settlement analysis — settlement prediction models.
The simple fact is that every major line of inquiry in a securities class action litigation has some standardized methodologies associated with it, alongside innumerable unique or cutting-edge ones. This should not be a surprise. After all, the legal framework of Section 10(b) of the Exchange Act and Section 11 of the Securities Act is over 90 years old. The Private Securities Litigation Reform Act is almost 30 years old. The event study — the “workhorse” in securities class action analysis — is over 55 years old. The efficient markets hypothesis is over 50 years old.
Basic v. Levinson, the landmark U.S. Supreme Court case that allowed securities class action plaintiffs to rely on a rebuttable presumption of market efficiency in demonstrating reliance, is over 35 years old.[10] So is the U.S. District Court for the District of New Jersey‘s 1989 decision in Cammer v. Bloom, which, along with the U.S. District Court for the Northern District of Texas‘ 2001 ruling in Krogman v. Sterritt, are, by far, the most commonly used precedent cases for determining the efficiency of the market for a security in a securities litigation.
So, while legal interpretations, research techniques and technology continue to evolve, we have more than enough experience to provide standardized answers to most economic questions in securities class action litigation.
The list above is typical, though neither complete nor unique. In fact, the “standardized analysis” for any particular securities class action question will depend on the approach that counsel and their consultants typically use and can produce in the most efficient manner.
The Advantages of Standardization at the Initial Economic Assessment Stage
Standardized analyses have a lower expected cost.
Standardization of analyses can lower the expected cost of producing the initial economic assessment analysis by either standardization of the research tasks or outright automation.
Automation is a possibility for many standardized analyses. Take, as an illustrative example, the event study — the most ubiquitous and still-considered gold standard tool in securities class action analysis. The implementations of event studies in securities class actions are fairly similar in most cases, and not very different from the methodology published in the seminal 1969 paper, “The Adjustment of Stock Prices to New Information,” that formalized the event study in its current form.[11]
This conclusion is not lost on researchers and practitioners. A simple online search shows a number of commercial event study tools available for researchers and practitioners. The legal profession has benefited from the introduction of automation and artificial intelligence in many standardized workflows, such as document review or case law research. Standardized economic analyses are no different.
Even without automation, a standardization of the research tasks generates efficiency by building experience. It is far more efficient for consultants to deliver results on, say, market efficiency, based on the Cammer and Krogman factors, than on other rarely used and custom-designed tests. The experience accumulated by the consulting staff translates into higher-quality results, a better understanding of the results and fewer hours billed.
Standardized analyses have lower cost uncertainty.
Standardization reduces not only the expected costs but also the cost uncertainty. A standardized analysis is, by definition, a well-defined analysis. The cost of its implementation is not only relatively lower but also less variable than that of open-ended exploratory analyses.
Understandably, many questions in securities class action litigation are open-ended and exploratory. The analysis of loss causation, for example, depends on the facts of the case and the discovery materials that are reviewed as part of the analysis.
Open-ended analyses carry a justifiable risk of snowballing into more exhaustive or wider research projects with ever-increasing costs.
However, if counsel and consultants agree on a standard set of analyses with a prespecified scope for the initial economic assessment stage, expectations become manageable. The cost and delivery schedule uncertainty decline significantly for the client and counsel. The consultant, on the other hand, has fewer incentives to explore more side questions or delve deeper to prevent potential future surprises.
Standardized analyses capture core results.
The standardized preliminary analysis is not a small piece of the comprehensive research required later in the case. In fact, it often contains the core of the complete analysis. Loss causation analyses, for example, involve a review of the news, analyst reports, U.S. Securities and Exchange Commission filings, discovery materials, and other case-specific materials.
In most cases, however, the analysis integrates many of these into an event study to test the materiality of the misstatements. Hence, a preliminary implementation of a standardized event study, particularly if combined with a preliminary review of news headlines, would provide a considerable portion of the loss causation results that a more exhaustive analysis would produce at a later stage.
This approach is also observed in practice. Many economic consultants and experts routinely include standardized chronologies — event studies combined with news headlines — in expert reports.
Of course, experts perform exhaustive reviews of the news contents at the report preparation stage. However, a chronology and price charts, depicting the daily or intraday prices and major news headlines, provide counsel with an almost complete picture of the information environment during the class period.
Standardized analyses make the overall consulting process more efficient.
From a purely mechanical standpoint, once an important step or analysis is standardized for the purposes of an initial economic assessment, it will be performed more efficiently at the later stage when a complete, in-depth and customized analysis is performed. Investing in the standardization of an event study, trading model or other analysis implies that all future uses of these analyses will be performed more efficiently as well.
Any economist who has been through the process of writing an expert report knows that multiple iterations, scenario analyses and robustness checks are all but guaranteed in that process. Having some of these steps standardized can make a big difference to the full-blown research effort.
From a strategic viewpoint, both counsel and economists benefit from having preliminary results while planning legal and research strategies. Preliminary results can guide the planning process, and pinpoint important areas for research and weaknesses in the complaint or the defendant’s position. Without a preliminary analysis, these processes are driven by experience and assumptions.
Standardized analyses reduce the learning cost of the audience.
Any customized analysis inevitably puts noneconomist audiences — counsel and clients — at the bottom of a potentially steep learning curve associated with that specific analysis. Producing a new custom-built analysis at the outset of a case adds a learning cost for counsel to what could be an already substantial consulting bill.
A standardized analysis, on the other hand, allows counsel to build up an understanding of the analysis with every implementation, across cases and even through continuing legal education credits built on the standardized framework. This is not a trivial advantage considering the trend of less specialization and less efficiency due to the fact that most defense counsel handle only a few cases.[12]
Concluding Remarks
As noted earlier, different counsel and their consultants can apply different standardized analyses depending on their usual practice. Standardization also provides an extra level of flexibility in implementation. A very initial analysis can be performed using fully automated or AI-assisted tools.
The benefit of starting with automated standardized analyses is that (1) they are usually extremely fast and cost-effective, and (2) counsel can always refer any interesting results to their consultants for deeper probing. Other standardized — and if needed, nonstandardized — analyses can be added based on the generated results.
The important point is that when the initial assessment starts with standardized, rather than customized, tools, counsel and consultants can now choose how exhaustive they want to be.
[1] Doug Greene, “The State of Securities Litigation: Good Communication is Key to Improving Securities Litigation Outcomes | D&O Discourse (dandodiscourse.com).”
[2] Id.
[3] Under “standardization,” I only mean the use of widely accepted and frequently used analyses like event studies, damages models, settlement prediction models, and others. The article should not be interpreted as advocating the “standardization” of IEA analyses across firms or even across cases for a particular law firm.
[4] https://www.morningstar.com/news/globe-newswire/9041389/shareholder-alert-recent-purchasers-of-palo-alto-networks-who-have-lost-money-may-be-able-to-recover-damages-block-leviton-is-investigating.
[5] For examples where an upward price trajectory can significantly curb damage claims, see J. Schreiber and J. Tschirgi (2020), “Market Rebound May Curb Securities Class Actions, Damages”, Law360, July 31, 2020.
[6] Doug Greene, “The State of Securities Litigation: Good Communication is Key to Improving Securities Litigation Outcomes | D&O Discourse (dandodiscourse.com).”
[7] Cornerstone Research, “Securities Class Action Settlements: 2023 Review and Analysis”.
[8] See also discussion of the cost concerns in litigation against small companies by Doug Greene in “Putting ‘Litigation’ Back in ‘Securities Litigation’ | D&O Discourse (dandodiscourse.com).”
[9] “Market Efficiency” refers to the “Efficient Markets Hypothesis (EMH”) which posits that all value relevant information is incorporated in the stock price very quickly. See Fama, Eugene F. “Efficient capital markets.” Journal of finance 25.2 (1970): 383-417. See also, Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) and Krogman v. Sterritt, 202 F.R.D. 467, 474 (N.D. Tex. 2001).
[10] Basic Inc. v. Levinson: 485 U.S. 224 (1988).
[11] See Fama, E. Fisher, L., Jensen, M. and Roll, R. “The Adjustment of Stock Prices to New Information.” International Economic Review 10, 1-21, (February 1969).
[12] See, “Putting ‘Litigation’ Back in ‘Securities Litigation’ | D&O Discourse (dandodiscourse.com).”