Risk & Compliance

The Class Action Resurgence Is Just Beginning

After a year-long lull, subprime woes fueled a sharp rise in 2007 suits, and a study says we should look for the surge to continue — and to boost D...
Roy HarrisFebruary 21, 2008

A 43-percent surge in securities class action lawsuits in 2007 — after a year-long lull — likely will continue, growing into a “perfect storm” of swelling litigation by this year, a study by The Corporate Library predicts.

Among the results from the continued rise, which the study links strongly to a plaintiffs viewing executive compensation as excessive: renewed upward pressure on directors and officers insurance premiums, which have fallen recently to reflect industry competition for business.

In a study titled “Predicting Securites Litigation: 2007 Year-end Report,” the corporate governance research group noted that the rise in 2007 suits listed by the Stanford Securities Class Action Clearinghouse reflected many subprime mortgage-related cases and complementary real estate and homebuilder suits, along with suits reflecting risk exposure in foreign business — especially China — and failed stock offerings and mergers.

With D&O insurance now at low levels because of the previous fall-off in litigation, and the new reasons for suing even more attractive to litigants now, the research group asked, Is there such a storm brewing? It answered, “The Corporate Library believes there is, and that 2008 will be a year of significant activity in securities litigation in general and securities class action … cases in particular.”

Cases related to stock-option backdating are growing rarer, while 38 cases, or 23 percent of all those filed, reflected subprime connections. At least five involved IPOs, and one a failed merger, with most companies involved being in the financial services sector. “Given the softness and volatility of the current U.S. economy, [that] industry will face increasing exposure,” to suits, the Corporate Library said, with the pending subprime-related cases “just the tip of a significantly larger — and potentially more damaging — iceberg.”

Among specific cases noted were some against Moody’s and Standard & Poor’s parent McGraw-Hill, along with at least 10 cases already involving Chinese and other emerging market liabilities. Among the subjects, lead paint in toys was only the beginning, the report noted.

While most class actions “continue to be triggered by precipitous drops in share prices, more and more are being triggered by first announcements of potentially damaging regulatory and other investigations,” the report said.

By way of “predicting” new class actions, the Library continues to favor “excessive CEO compensation” as “the single most important indicator of governance risk,” with base pay and annual bonus levels the key ingredients, compared to long-term incentive payouts. The reason CEO pay is so important, the Corporate Library suggests, is that litigants are attracted to that metric in choosing targets.

Other variables in predicting the likelihood of suits include the constituency of the board (and especially lack of independence); a high ownership by institutional investors, industry-specific risks, market capitalization of at least $400 million, and trading volume during the prior 52 weeks of at least two billion shares — “though never more than 25 billion shares.”