Securities lawsuits seen at 10-year low this year, a trend expected to continue through 2007
Financial Week
October 16, 2006
Jeff Nash
As the Dow Jones industrial average reaches for new highs, the number of securities fraud lawsuits is hitting record lows. In fact, 2006 is shaping up to have the fewest fraud class actions in a decade.
This year just 123 securities class actions are expected to be filed, down 31% from last year and the lowest number since 1996, according to a recent study by Cornerstone Research.
Likewise, market-cap losses—the decrease in value of the defendant firms—from securities class-action lawsuits are expected to top out at $255 billion this year, a 44% decline from the $456 billion in 2005.
The trend is likely to continue into 2007, said Joseph Grundfest, author of the study and a professor at Stanford University Law School.
“We don’t see any market forces likely to change it,” he said. Mr. Grundfest forecast just 103 securities class-action suits being filed next year.
The cause of the steep decline in securities lawsuits, say industry watchers, is twofold.
For starters, the bull market has reduced the number of earnings disappointments—and the subsequent stock-price decreases—that typically trigger securities lawsuits.
“In any strong, robust market like this, you’d expect to see fewer class-action cases being filed,” said David Balser, a partner at Atlanta law firm McKenna, Long & Aldridge.
Observers also say improvements in corporate governance following the high-profile blowups of Enron and WorldCom—and passage of the Sarbanes-Oxley Act of 2002—have made many companies less susceptible to fraud charges.
“Many companies have already thrashed out their problems,” said Joseph Weinstein, an attorney at Cleveland law firm Squire Sanders & Dempsey. “They’ve made mistakes, and don’t want to go through those experiences again.”
Some have wondered if the trend is due in part to the decline in filings by Milberg Weiss, the law firm that filed 91 of the 179 suits in 2005. Milberg Weiss was indicted in May for allegedly paying individuals to serve as lead plaintiffs in class-action suits.
But Mr. Grundfest dismissed the idea. “The market for representing plaintiffs in this area of litigation is highly competitive,” he said, “and the barriers to entry are very low.”
Few options cases
The study notes that only eight federal class-actions had been filed alleging illegal backdating of stock options among executives.
The main reason for so few cases, Mr. Grundfest explained, is that many instances lack a sizable stock-price decline—a key requirement for a federal class-action lawsuit.
Therefore, most backdating cases are being filed in state court through actions in which a price drop is not needed to justify bringing a legal action.
Mr. Grundfest also noted that it may be easier to allege a violation of fiduciary duty in state court than to claim fraud in federal court.
And while the forecast for 2007 looks rosy, industry watchers do not expect securities class actions to disappear from the legal landscape anytime soon.
“As long as companies have problems—and you’re never going to have a company that’s perfectly compliant with all the rules and regulations—you’re going to have hiccups in stock prices,” said Mr. Weinstein.
“And someone out there is going to claim it’s tantamount to securities fraud.”FW