Securities class action filings in the United States appear to be settling down, yet general counsel should not drop their guard.
Based on 2014 data, Cornerstone Research reported that the number of securities class action filings “remained essentially flat” and the size of the filings as seen by “dollar losses” has “decreased dramatically.” In fact, during 2014, companies listed on the Standard & Poor's 500 “were less likely to be targeted by a securities class action … than in any year measured (2000 through 2014),” Cornerstone reported in “Securities Class Action Filings 2014 Year in Review.”
Of the S&P 500, those companies with the largest market capitalizations were less likely than smaller companies to be named in a class action suit. Also, plaintiffs filed 170 new class action securities cases in 2014. That is 10 percent lower than the historical average of 189 seen between 1997 and 2013.
Down, down, down
Considering trends in securities class action litigation, Joseph A. Grundfest, a law professor at Stanford University and founder of the Stanford Securities Class Action Clearinghouse, says they are “down, down, down.”
“Measured from the peak, the number of filings is down, the value of settlements is down, and the dollar risk of the exposure in unresolved litigation is down,” he explains.
Also, Cornerstone Research's “maximum dollar index,” which shows the largest amount plaintiffs may claim, dropped to its lowest level since 1997. To explain that trend, Grundfest speculates that “several factors are likely at work.”
“First, the number of companies being sued has declined. Second, the number of mega-cases (cases with potential exposure in excess of $5 billion) has also declined. As for the reasons for the decline, the confluence of two other factors are likely at work: The stock market has … been strong for several years, and the incidence of large-scale accounting frauds has declined precipitously. There simply haven't been any Enron or WorldCom-style frauds in the last several years,” Grundfest says. He also adds, “In my view, companies are indeed paying more attention to the integrity of their financial reports.”
John Stigi, a partner at Sheppard, Mullin, Richter & Hampton, further points out that a lot of the securities class action litigation affecting the economy over the last couple of years finally “petered out” and has returned to a “more ordinary” situation.
On the other hand, Stephanie Scharf, a partner at Scharf Banks Marmor, says that just because the “stock market is going up,” it may not impact the number of securities class actions much. In fact, it could mean that more deals are being made. Often, class actions come about in response to deals or transactions, Scharf says. There also can be more shareholder litigation coming as a result of mergers and acquisitions, especially if there is a challenge on the value of the price of shares.
One other interesting issue is how the Securities and Exchange Commission (SEC) or other regulators can undertake investigations and that information is released, thus prompting plaintiffs’ lawyers to become interested in filing litigation.
Another important question is whether there will be smaller recoveries for the plaintiff class. “If the Cornerstone numbers show lower MDLs [maximum dollar losses] and DDLs [disclosure dollar losses], then there will likely be a lower recovery for the class, all other factors equal,” Grundfest says. In 2014, MDL was at its lowest level since 1997, and DDL was its lowest level since 2006. Also last year, there were no mega DDL filings [over $5 billion] for the first time since 1997.
On another front, in 2014 there was a decision from the Supreme Court on the Halliburton v. Erica P. John Fund case, which relates to whether investors can recover damages in a securities fraud action as it relates to misrepresentation. The Erica P. John Fund filed a class action claiming a misrepresentation was made by the company in order to inflate Halliburton's stock price.
The Halliburton decision by the U.S. Supreme Court means defendants in securities fraud class actions were given an opportunity to rebut fraud at a class certification stage with testimony from economists, statisticians or other experts.
“It happens earlier in the case,” Scharf says, which makes it good for defendants. A judge can decide whether the case can proceed. Scharf said the decision may have an impact on the length of time to resolve securities fraud class actions.
Yet, Grundfest says the impact from Halliburton was “very small,” and, he explains, “As many observers suggested when the opinion issued, the narrow nature of the ruling would likely have little effect.”
Another notable, recent decision from the Supreme Court was Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund. The Supreme Court ruled that a statement of opinion can be a basis for a securities fraud claim. Stigi advises inside counsel that any time a CEOs and chief fiscal officers want to make a statement of opinion, they should review the factual basis for the opinion. Stigi suggests asking if making the opinion is worth it, and if any other facts need to be disclosed.
When it comes to advice to general counsel, Scharf says companies can get out from under shareholder class action suits by showing strong compliance programs. She recommends legal departments keep their kitchens “clean.” For instance, corporate compliance programs should be up-to-date, and they need to be enforced, Scharf says. That means companies should have policies on Big Data, data security, global transactions, confidentiality and social media, among other areas.
An example of the importance of compliance was seen a few years ago, when Dow's compliance program was cited by a Delaware court as a reason why a shareholder suit related to bribery allegations was dismissed. “I have seen companies work very hard to make sure compliance programs are implemented in the right way—including global companies,” Scharf says.
Also, global companies have a complex task to implement and monitor compliance activities. If companies understand the value of compliance programs, they readily implement them and update them. “Good compliance policies are good business,” Scharf says.
Generally, larger companies often have several compliance programs in place. But smaller companies may not have as many compliance programs—even though they may be at risk for a lawsuit.
As far as sectors more at risk, the Cornerstone study showed that plaintiffs’ lawyers are increasingly targeting firms in the pharmaceutical and biotechnology industries. One reason why this is taking place is because of “market price volatility,” Grundfest says. “Another factor is that these industries have volatile information disclosure patterns because of the drug development and FDA approval process,” he adds.
Stigi agrees, saying that “pharma is always going to be attractive” for plaintiffs’ lawyers.
Looking ahead, there may be a new trend related to globalization of class actions. That means that plaintiffs’ lawyers can file lawsuits on behalf of investors related to other nations’ exchanges if a U.S. company is on multiple exchanges. This may take place in Canada, the Netherlands and other locations as well.
And more litigation may be brought in the United States—in locations such as Delaware—by institutional and activist investors. “They are absolutely getting more aggressive,” Stigi says.
Even if data suggest that class action litigation is lessening, corporations need to be careful. Being proactive means companies will be more prepared for whatever litigation may come their way.