Risk Management

Fewer Class-Action Suits Cite Accounting Issues

Two-year trend especially notes cases alleging financial-restatement problems have fallen, but the numbers suggest a decline in other areas as well.
Stephen TaubApril 1, 2008

For the second straight year, allegations of financial-restatement issues were found in a declining percentage of 2007 settled class action lawsuits — appearing in only 30 percent of settlements, according to a new report. Still accounting-related issues of all kinds continued to appear in more than 55 percent of all securities class action cases settled last year.

The latest results appear in a new report from Cornerstone Research. Taken together with an earlier report from Cornerstone Stanford Law School Securities Class Action Clearinghouse, however, the trends seem to suggest that alleged accounting violations — not just from restatements, but from other issues as well — will be playing a smaller role in litigation.

The earlier report said that the percentage of new complaints accusing companies of violating generally accepted accounting principles made up only 42 percent of federal filings last year, down from 66 percent in 2006. “This decline seems to suggest a movement away from the focus in recent years on the validity of financial results and accounting treatment,” the earlier report’s authors wrote.

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Taken together, the number of securities class action cases settled last year rose 21 percent, to 111 from 92 in 2006, according to the latest report. However, the total value of these settlements plummeted 60 percent, from the all-time high of $17.2 million reported in 2006 to $7 billion in 2007, according to Cornerstone.

Beware of drawing too many lessons from the statistics, though. Cornerstone pointed out that recent comparisons are skewed by major settlements from high-profile frauds uncovered earlier in the decade.

For example, more than 70 percent of the drop in 2007 was due to the largest settlement in history, the now $7.2 billion Enron case settlement, the majority of which was approved in 2006.

Cornerstone also pointed out that aggregate settlements in 2007 are dramatically influenced by the $3.2 billion Tyco International settlement, which accounts for almost 45 percent of the total value of settlements approved in 2007, and is the third largest case settlement in history behind Enron and WorldCom ($6.2 billion).

In fact, Tyco was the only settlement approved in 2007 to exceed $1 billion, compared with four in 2006, excluding Enron, and is only the seventh settlement in history above $1 billion.

Overall, Cornerstone counted nine settlements in 2007 in excess of $100 million, down from 14 in 2006.

Interestingly, the study found that middle-range settlements — defined as those of $10 million to $20 million — increased significantly in 2007, accounting for nearly a quarter of the total number. In 2006 these kinds of settlements accounted for just over 10 percent. Moving down the magnitude scale, in 2007 settlements for less than $5 million declined to about 35 percent of the total.As a result, the median settlement jumped to $9 million, the highest amount to date.

“For the past several years a relatively small number of settlements in excess of $100 million have been the focus of attention in analyses of securities case settlements, even though more than half of securities cases continued to settle for less than $10 million,” said Dr. Laura Simmons, a senior advisor to Cornerstone Research and an author of the report. “What will be interesting going forward is to see whether the upward shift emerging from the 2007 data for more typical cases persists into future years.”

Added Stanford Law School Professor Joseph Grundfest, director of the Securities Class Action Clearinghouse: “It seems clear that the aggregate dollar value of settlements over the next two or three years is likely to decline significantly because the inventory of large cases in the pipeline just isn’t there.” He is also co-director of the Rock Center on Corporate Governance, and a former commissioner of the Securities and Exchange Commission.

He said that the big open question is whether the subprime crisis will cause an uptick in securities fraud settlement activity that might, given settlement cycles in the litigation industry, only become apparent three to five years from now.