Risk & Compliance

Record High for Class-Action Settlements

Even excluding WorldCom and Enron, the value of cases settled during 2005 totaled $3.5 billion. However, ''estimated damages'' actually decreased, ...
Stephen TaubFebruary 7, 2006

Last year was a record-breaker for securities class-action settlements, according to Cornerstone Research, which found that companies paid $9.6 billion to shareholders.

Even excluding the $6.1 billion agreement by WorldCom (as well as the $7.1 billion settlement by Enron that has yet to be finalized), the value of cases settled during 2005 totaled $3.5 billion — still the highest ever, reported Cornerstone. The total comprised 124 cases with an average settlement of $28.5 million, including 9 settlements of more than $100 million. For 2004, the total of $2.9 billion comprised 113 settlements averaging $26.4 million.

Looked at another way, in 2005 the median settlement was $7.5 million; historically, through 2004, the median settlement was only $6.3 million. “While in recent years we have been observing an increasing number of very large settlements, never before have we observed such a large single-year increase in the median settlement amount,” said Laura Simmons, a Cornerstone principal and an author of the new study, in a statement.

Accounting-related settlements played a major role. The percentage of cases involving restatements grew to 40 percent in 2005, almost double the figure for 2004, according to the report. The median settlement amount for these cases was $7.5 million, compared with $5.8 million for all other cases.

The rising role of institutions as plaintiffs also contributed to the larger size of the settlements. Cornerstone found that in 2005, more than 35 percent of settlements involved an institutional investor as the lead plaintiff, compared with only 20 percent in 2004. Institutions typically lose more money than other, smaller investors, and indeed, the study found that the median settlement when an institution was the lead plaintiff came in at $10.7 million, compared with $5 million for cases without an institutional lead plaintiff.

The most important determinant of settlement amounts, noted Cornerstone, is “estimated damages.” For purposes of its study, the research firm based them on a simplified version of a model often used by plaintiffs to estimate the number of shares damaged and the amount of alleged share-price inflation.

Cornerstone found that estimated damages actually decreased, year-on-year, to $2.2 billion in 2005 from $2.3 billion in 2004. The firm also suggested that the trend is toward lower damages, largely due to last year’s landmark Supreme Court decision in Dura Pharmaceuticals v. Broudo. In Dura, the court ruled that plaintiffs must show a causal link between the alleged misrepresentations and the subsequent actual losses suffered by plaintiffs.

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