For just about any business, the thought of costly and potentially reputation-damaging securities litigation is, at the very least, disconcerting. Since 1997, on the average, 95 companies per year go to court to face class action securities filings and lose billions in trial costs and market capitalization in the process.
The good news for businesses is that in 2013, securities litigation filing levels declined to the lowest they’ve been since before the financial collapse. The rub, however, is that just having a general decrease in the amount of cases going to court doesn’t necessarily mean your company is in the clear. Depending on the industry, the size of the organization, and what tactics the plaintiffs’ bar decides to use in their case, the likelihood of being sued may not be any lower.
Following what was a sluggish 2012, the first half of 2013 has yet to show any material increase in the volume of securities litigation class action cases brought to federal courts. Numbers are up from where they were in the second half of 2012, but if filings for the second half are the same as the first, this will be the second slowest year for securities class actions since 1997.
Evan Chesler, chair of Cravath, Swaine and Moore, has over 30 years of litigation experience in securities and is recognized as one of the best litigators in the country by a number of publications and organizations. According to Chesler, “Very often in a bull market like this you’ll see something of a decline of the levels of securities litigation. Generally a period of recovery albeit slower than people would like, but directionally a recovery in the economy, in that kind of environment it's not unusual to see sort of a down turn in the volume of securities cases.”
With the great recession of the last decade fading in the rear-view mirror and an admittedly less volatile market gaining traction, it would make sense that there would be less “classic” securities litigation going to court. The ebb and flow of securities litigation seems to be cyclical, but given the extremely depressed figures, one must ask if this is a sign of something more.
The numbers game
Seventy-four class action securities cases were filed in the first six months of 2013, down 16 percent from the first half of 2012, but 16 percent higher than the second half of 2012, according to a Cornerstone research report. The reduction of suits also means a reduction in market capitalization loss, with a total disclosure dollar loss of $25 billion in the first six months of 2013. Compare this figure to the semiannual average of $63 billion from 1997 to 2012. At less than half of the average semiannual market cap loss, securities litigation's impact on the market has been very quiet this year.
Although the results of the Cornerstone report were released in June, Alexander Aganin, vice president of Cornerstone, revealed in early October that there had still been no marked increase in the amount of litigation filed ahead of the year-end results release.
“We did not see much of an uptick after the midyear,” Aganin notes. “Sometimes filings come in waves but it would appear that based off filings we are observing, we are roughly at the same level of intensity as the first six months.”
While the number of filings has yet to budge very much, what is continuing to trend up in intensity is the rate at which smaller companies are being sued. For example, 2013 has seen an increase in litigation activity against those companies on OTCBB and Pink Sheets, versus organizations on larger exchanges like the S&P 500. Companies traded on these markets generally do not have the market capitalization for larger exchanges. The increasing levels of litigation against companies trading on the smaller markets is likely due to the scarcity of investment opportunities in more lucrative cases on the larger markets.
In addition to a plaintiff's bar acting more aggressive towards smaller companies, trends also suggest an increase of filings made against the technology industry. The uptick in filings from the second half of 2012 to the fist half of 2013 is due almost exclusively to litigation in the high-tech and bio-tech industries.
This scenario is typical and these industries receive renewed focus when litigation rates drop, according to Tim Hoeffner, a partner at DLA Piper with complex securities, professional malpractice and business litigation experience.
“In the intervening time-frames typically the plaintiffs’ bar will focus on the tech companies because they tend to be more volatile and product focus,” Hoeffner explains. “This is especially true for smaller biotech firms that have one or two products, if one of those gets held up due to a regulation issue or anything else, it can really wreak havoc on the stock of that company, and therefore result in litigation.”
Along with the lower number of filings, the Cornerstone report showed a lower than average settlement figure for the year. This is likely a direct function of a plaintiff bar being more willing to go after smaller companies with smaller market cap. But the actual settlement figure trends are probably not a strong indicator of what those going to court should expect to pay, notes Chesler.
“In my experience settlement really tends to be a function of the particular cases” he says. “It's down to a level of how strong your witnesses are, how weak your witnesses are, what the documents look like. Do you have proactive statements in the relevant documents or not?”
While the legal system is seeing a decrease in the number of filings against the big household names that typically make up the Fortune 500 who's who of class action securities litigation every year, what legal departments should keep in mind is that even with fewer filings, there is no reason to assume there is any less risk of being suited. Companies will need to remain aware of the types of industries currently going to court, and the size of the companies being targeted.
Even keeping an eye out for those trends doesn’t excuse a company from its fiduciary duty. As the old adage goes, “an ounce of prevention is worth a pound of cure.” While being aware of your surroundings is important in any context, law departments should be less attentive to defining trends that will help them to see why they’ll be sued, as well as the quality of statements that will reduces their losses if they get suited.
“It's not uncommon for a company to face securities litigation in which their judgments about disclosures around the risk are second guessed in light of the fact that there was a drop in stock price. So I think the most important thing that law departments need to be aware of is making sure they have a good grasp on what the risks are and that the disclosures around those risks and the way the company is conducting its business are focal,” Chesler says. “Even If you can’t necessarily prevent lawsuits when the risk turn against you and the stock price drops, you can maximize the chances that your company will be successful if the disclosures have taken adequate account of what the risk looked like.”
In other words, even with figures down, it is not a time to sit idle on the quality and intensity with which your company treats financial statements and disclosures. Being dutiful about the prevailing atmosphere of the securities litigation space can give insight into what you can expect, but is not always a direct indicator. Perhaps the best option for companies trying to “read the tea leaves” in securities litigations is to be aware of regulations and laws and tactics within the space and vastly affecting the number of cases coming to bear.
Marc Sonnenfeld, partner at Morgan & Lewis, has practiced for over 30 years with a concentration on shareholder class action under federal law. He says there are other forces at play that are holding the amount of securities litigation down.
“I would say it's a combination of factors, one of those is certainly the economy and how the market is doing, I would say another factor that's maybe driving this is that the reforms of the Private Securities Litigation Reform Act of 1995 an act by Congress, have worked and they have been a deterrent to some of the abusive securities litigations that we saw before that statute was enacted,” Sonnenfeld says.
In addition to the PLSRA, which has been frequently pointed to as a potential source for the reduction of securities lawsuits since the mid-1990s, a more aggressive Securities and Exchange Commission could also potentially affect the figures.
“I think the plaintiff's bar follows on the heels of what the regulators focus on, so if the regulatory are focusing now on valuations and accounting issues that to me signals a trend that is going to trigger something down the line,” Hoeffner adds.
Pending decisions that would allow defenses to challenge the “fraud on the market” theory could also potentially reduce the number of cases coming to bear. Up until now, cases dealing with fraudulent or misleading statements have not required individuals of a class to show that they actually relied on financial statements in making their investment decisions; the presumption is that they didn’t actually use the statements but instead relied on the integrity of the market. If plaintiffs need to prove reliance for all members of the case, there could be a further decrease in 10b-5 litigation due to difficulty in providing such evidence.
Regardless of the trends at play, chief legal officers and other legal professionals need to keep in mind that timely and quality financial reporting is essential to being prepared in the event of a suit. Keeping an eye on the trends in the space may help to prepare you when your industry is being targeted, but the in this space, the trends are easily bucked.