Capital Markets

Securities-fraud Lawsuits Decline

Measured both by number of filings and by claimed investor losses, 2005 represented a decline from the previous year and from historic averages; ''...
Stephen TaubJanuary 3, 2006

The number of securities fraud class actions decreased to 176 filings in 2005 from 213 a year earlier, according to a report released by Stanford Law School and Cornerstone Research. The 2005 filing rate is nearly 10 percent below the 1996-2004 average of 195, the report noted.

Investor losses related to these lawsuits decreased, too, to $99 billion last year from $147 billion in 2004.

Further, 2005 saw a reduction in what Stanford calls “mega filings.” Last year there was just one filing with a disclosure loss of $10 billion or more, compared with three such filings in 2004; there were six lawsuits with a disclosure loss exceeding $5 billion, compared with seven a year earlier.

“The pig may have moved through the python,” said Joseph Grundfest, a professor at Stanford Law School, the director of the school’s Securities Class Action Clearinghouse, and a former commissioner of the Securities and Exchange Commission, in a press release.

Grundfest’s statement cited two factors for the decline. First, lawsuits arising from the post-1990s bust are largely in the past, and second, improved governance in the wake of major corporate scandals may have reduced the actual incidence of fraud.

The report also speculated that the decline in stock-market volatility in 2005 may be another factor. “Our observations over the past decade indicate that lower market volatility tends to be associated with a lower number of filings,” explained John Gould, vice president of Cornerstone Research and contributor to the study, in the press release.

Charges of misrepresentation in financial reporting and allegations of false forward-looking statements were made more frequently in 2005 than in the past. The percentage of filings alleging misrepresentation increased to 89 percent in 2005 from 78 percent a year earlier; charges of false forward-looking statements increased to 82 percent, from 67 percent.

The percentage of filings alleging GAAP violations and insider trading remained relatively stable, according to the study.

“This trend suggests that the securities litigation market is now even more focused on the validity of financial results and forecasts presented in financial documents, such as SEC filings and press releases,” stated Gould.

Meanwhile, as the late 1990s bubble fades into the distance, lawsuits against the technology and communications sectors are tumbling; filings were down more than 32 percent from 2004 levels and 36 percent from historic averages. The most litigation is centered around the consumer non-cyclical sector, which includes biotechnology, commercial services, cosmetics/personal care, food, health-care products and services, and pharmaceuticals.

The most active federal circuits in 2005, measured by the number of issuers sued, were the Second Circuit (New York) with 44 filings, the Ninth Circuit (California) with 38, and the Third Circuit (Delaware/Pennsylvania) with 18. Ranked by claimed investor losses, the top three were the Second Circuit with $38 billion, the First Circuit (Massachusetts) with $17 billion, and the Third Circuit with $10 billion.

The data reflects a dramatic 41 percent decline from 2004 in the number of securities-fraud lawsuits filed in the Ninth Circuit, the report pointed out — which tracks the decline in litigation against high-tech firms that tend to be based in California.