The financial crisis has prompted a surge in class-action securities lawsuits—although the surge seems largely confined to businesses in the financial services sector for now.
Two widely respected scorekeepers—NERA Economic Consulting and Stanford Law School Securities Class Action Clearinghouse—say the number of such lawsuits filed last year was up sharply from 2007 and earlier in the decade. NERA counts 255 lawsuits filed in 2008, up 37 percent from the year before; Stanford is counting 210, a jump of 19 percent. And both say nearly half the lawsuits are related to players in the financial crisis.
Grundfest
Joseph Grundfest, head of the Stanford Clearinghouse, notes that firms representing roughly two-thirds of the financial sector as measured by market capitalization were the subject of a class-action lawsuit by the end of the year. “We have never had a concentration like that,” he says.
The volume of class-action lawsuits can affect companies in many ways, from higher premiums on director-and-officer insurance to greater litigation risks should a judge somewhere set a new precedent others might follow. A drop in class-action lawsuits in the middle of the decades is credited for a concomitant dip in D&O insurance. And lower courts will be applying two new U.S. Supreme Court standards on class-action lawsuits (the Stoneridge and Tellabs decisions) in their jurisdictions this year, which should clarify how far class-action suits can proceed.
Of the 110 new cases NERA attributes to the financial crisis, 20 stem from failures in the auction-rate securities market; most of those were filed in the first half of 2008, after the ARS market went into the deep freeze and then died an ignominious death in February. And while the initial cases were filed against the banks and broker-dealers selling auction-rate securities, at least one was filed against a non-bank company: NextWave Wireless, which held these securities in its portfolio.
“The nature of the cases has expanded,” says Stephanie Plancich, co-author of the NERA study. “It is not just linked to sub-prime lenders. It may also be companies that held sub-prime mortgages in their portfolios.”
“This shift is driven by the credit crisis, because a number of these cases relate to alleged failures of financial products to perform as promised.”
— NERA
Most cases filed in 2008 were concentrated in the Second and Ninth circuits, which encompass New York and California, respectively. The Second Circuit in particular—home to legions of financial companies in New York, Connecticut, and Vermont—saw 97 cases filed in its jurisdiction, including 47 related to the financial crisis.
NERA also pointed out that roughly one-quarter of the allegations in cases filed in 2008 are related to accounting. More than 40 percent of the allegations involve product and operational defects. “This shift is driven by the credit crisis, because a number of these cases relate to alleged failures of financial products to perform as promised,” the NERA study says.
The Stanford Clearinghouse, meanwhile, says the pace of lawsuit filings started to accelerate as far back as the latter half of 2007. There were 317 class-action lawsuits filed in the last 18 months, a 71 percent increase over the 185 filings in the prior 18-month period.
But John Gould, a vice president at Cornerstone Research, which compiles the class-action data with Stanford, notes that lawsuit filings did not spike in the latter half of 2008 as market volatility soared and the stocks went down the tubes. Why did that happen? Nobody is quite sure yet.
KEY FINDINGS
Some key findings from Cornerstorne Research’s securities class actions report, “2008: A Year in Review.”
Of the companies included in the S&P 500 index, 9 percent were sued in a federal securities class action in 2008, compared to only 5 percent in 2007.
The sub-prime/liquidity crisis was associated with 97 federal securities class actions, with 21 of these filed on behalf of holders or purchasers of auction rate securities.
Disclosure Dollar Losses (DDL) increased 48 percent from 2007 and were 75 percent higher than the annual average for 1997–2007. Totaling $227 billion, these losses were the second highest ever recorded and fell just short of the 2000 level.
In 2008, DDL for sub-prime/liquidity crisis securities class actions totaled $92 billion, or 41 percent of the total, and MDL for those class actions totaled $456 billion, or 53 percent of the total.
There were 12 “mega” DDL complaints—complaints associated with a DDL of $5 billion or more—filed in 2008, the largest number of mega DDL filings for any year in the database. These mega DDL complaints alone accounted for 72 percent of total DDL in 2008 ($163 billion).
There were 26 “mega” MDL complaints—complaints associated with an MDL of $10 billion of more—filed in 2008. This is the second highest number of mega MDL filings ever, accounting for 80 percent of total MDL in 2008 ($682 billion).
The consumer non-cyclical and industrial sectors had the second and third highest levels of litigation activity with 37 and 17 complaints filed, respectively.
Many more companies listed on the NYSE and Amex exchanges were sued than firms listed on the NASDAQ in 2008, breaking from the historical pattern. In 2008, 111 class actions were filed against firms listed on the NYSE/Amex compared to 68 against firms listed on NASDAQ.
The Second Circuit (which includes New York) had the most securities class-action complaints filed in 2008 with 92, followed by the Ninth Circuit (which includes California) with 28, and the Eleventh Circuit (Florida/Georgia/Alabama) with 17. These three circuits were also the most active in 2007 for securities class-action litigation.
Class actions filed in the last two years tend to have more Section 11 and 12(2) allegations, fewer Section 10-b claims, and more frequently name underwriters as defendants compared to previous years. In complaints alleging specific accounting violations, there has been a shift in emphasis from allegations related to traditional income statement line items to allegations related to balance sheet components.
Source
Cornerstone Research: “2008: A Year in Review.” (2008).
“A new dynamic may be at work in the litigation marketplace,” Gould says. “One possible explanation is that market volatility has been so large that plaintiffs found it difficult to isolate company-specific stock movements from the broader noise … It will be interesting to see whether the historical relation between stock market volatility and the number of class-action filings will re-emerge in 2009.”
Stanford’s study noted a few other interesting trends over the last few years:
the percentage of lawsuits related to traditional Rule 10b-5 claims dropped to 75 percent of all filed lawsuits in 2008, down from 91 percent just three years ago;
lawsuits related to Section 11 (that is, a false registration statement) have surged from 9 percent of all lawsuits filed three years ago to 23 percent of the total in 2008; and
many more companies listed on the New York Stock Exchange and American Stock Exchange were sued in 2008 (111 class actions filed) than firms listed on Nasdaq (68 class actions filed), breaking from the historical pattern.
Grundfest speculates that the rise in Section 11 complaints may be stemming from the drop in Rule 10b-5 complaints. “Lawyers have long known that plaintiffs have an easier time making claims under Section 11 versus 10b-5,” he says. “You just have to demonstrate materiality, not scienter [willful intent to commit fraud].”
Hecht
In fact, Steven Hecht of the law firm Lowenstein Sandler says this trend underscores the significance of the recent Tellabs and Stoneridge rulings from the Supreme Court; many say those rulings make Rule 10b-5 cases harder to pursue. “They may have had an impact on filings,” he says.
Hecht, though, is even more interested to see how many of these new lawsuits make it through the motion to dismiss stage. He adds: “You can make a headline claim,” he says. “But a lot of the filings will not get past the pleading stage.”
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