D&O Litigation Trends in 2007 - 2008
January 2009
2007 - 2008 marked a rebound in the number
of securities action filings, while the median size of settlements continued
to increase.
by John
E. Black Jr.
Boundas, Skarzynski,
Walsh & Black, LLC
The rate at which securities actions were filed in 2007–2008 returned to
annual post-Private Securities Litigation Reform Act of 1995 (PSLRA) levels,
dramatically reversing the drop in filings in 2006. Only 131 securities class
actions were filed in 2006, prompting widespread speculation on whether the
drop was a turning point or an aberration. In every year from 1997 to 2005,
the average number of securities complaints filed against directors and officers
of publicly traded corporations had ranged from 189 to 270, averaging approximately
230 actions filed each year. Filings in 2007 increased substantially over filings
in 2006, totaling 198. In 2008, securities class action cases were filed at
the highest rate since 2002—totaling over 255 by mid-December 2008.1
The median value of securities claim settlements continued to increase, due
in part to the backlog of very large securities cases built up in prior years.
In 2007, the median settlement value reached a new high in the post-PSLRA era—$9.4
million. In 2008, the median settlement value was $7.5 million, a drop from
2007 but still the second highest median settlement value in the past 13 years.
These and other trends that appear to be continuing into 2009 are discussed
below.
The Rebound in Securities Class Action Filings
The rebound in filings commenced in the second half of 2007, which was marked
by significant stock market volatility. One hundred companies were sued in the
second half of the year, nearly 1½ times the number of companies sued in the
first half of the year.2 Out of the 100 filings
in the second half of 2007, 23 involved credit crisis matters. However, even
if credit crisis filings are excluded, the number of filings increased from
the first half of 2007 to the second half of 2007 by over 16 percent. Options
backdating—which gave rise to far more shareholder derivative suits than securities
class action suits—not surprisingly accounted for only a handful of securities
class action filings in 2007 (9) and in 2008 (5).
Credit crisis problems accounted for approximately 17 percent of the securities
class action suits filed in 2007, but over 40 percent of the securities suits
filed in 2008. Half of the credit crisis filings in 2007 and 2008 were in the
Second and Ninth Circuits. Given the nature of the crisis, not surprisingly
nearly 50 percent of the 2008 filings were against companies in the financial
sector. Contributing to the number of credit crisis filings in 2008 was the
influx of auction rate securities lawsuits, 21 of which were filed in 2008.
The number of "mega" filings in 2007 and 2008 also increased dramatically.
For several years, Cornerstone has termed those filings involving a $5 billion
or greater disclosure dollar loss as "mega" filings and has separately tracked
"mega" filings.3 Cornerstone identified 8 mega-filings
in 2004, 5 in 2005, and just 1 in 2006. The number of "mega" filings in 2007
jumped to 9 and, within the first 6 months of 2008, 7 more "mega" cases were
filed.
Consistent with this, the maximum disclosure dollar losses for all filings
in 2007 more than doubled the maximum disclosure dollar loss claimed for all
filings in 2006, going from $293 billion to $674 billion. This continued into
the first half of 2008, when maximum disclosure dollar losses for securities
class action filings totaled $587 billion.4 Notably,
the maximum disclosure dollar loss for all filings in the first half of 2008
was higher than the maximum disclosure dollar losses for all filings in the
last half of 2007.
Although the number of filings against companies in the financial sector
increased in the last 2 years, filings against companies in the electronic technology
and technology services sector has decreased. Between 1996 and 2006, the average
number of securities class actions filed against companies in the electronic
technology and technology services sector was 32—the sector with the third highest
annual filings in that period. Since then, the annual average number of filings
brought against companies in that sector has dropped. However, the number of
filings against companies in the health technology sector has increased in the
last 3 years, so that the health technology sector saw more filings in 2008
than the electronic technology and technology services sector.5
According to Cornerstone, the higher level of filings from mid-2007 through
mid-2008 coincided with a "marked increase in stock market volatility."6
At the same time, stock market volatility doubled securities class action filings
increased from 119 in the period of June 2006 - 2007 to 217 in the period of
June 2007 - 2008.
Settlement Size Continues To Increase
2007 and 2008 saw securities class-action litigants continue to work through
the large pipeline of significant cases from prior years. According to Cornerstone
and NERA Economic Consulting, the average size of securities class-action settlements
continued to increase.7 Eliminating settlements
over $1 billion, the average settlement in 2007 was $31 million and the average
settlement in 2008 was $29 million. Both of these average figures exceeded the
annual average settlement for every year since 1996.8
The median settlement size in 2007 increased to $9.4 million, due partly
to a higher percentage of cases that settled in the $10 - 20 million range—almost
25 percent. However, the median settlement value dropped in 2008 to $7.5 million,
which still represented an increase over 2004 and 2005.9
2007 offered up only one settlement in excess of $1 billion, in contrast
to 2006 in which four cases settled above this level. The excess billion dollar
settlement was the $3.2 billion settlement of Tyco International, which was
the third largest securities class-action settlement in history. However, due
to the greater number of excess billion dollar settlements in 2006, the average
settlement actually fell from $179 million in 2006 to $62.7 million in 2007.
Settlement size often is largely a function of the magnitude of alleged investor
losses and the ability to pay. Average investor losses of settling cases in
2004, 2005, and 2006 were $1.7 billion, $2.6 billion and $7.5 billion, respectively.
Increased Enforcement Activity
The increase in the total number of shareholder class actions in 2007 - 2008
was more than matched by the increase in the total number of actions brought
by the Securities and Exchange Commission (SEC) in 2007 and 2008. In fiscal
year 2007, the SEC Enforcement Division brought a record number of investigations
and proceedings, increasing the number of investigations and proceedings brought
in fiscal year 2006 by over 10 percent. The SEC initiated 1776 investigations
and brought 394 administrative proceedings and 262 civil actions.10
The SEC was even more active in 2008, with the SEC bringing the second-highest
number of enforcement actions in agency history in fiscal year 2008. The SEC
brought 671 enforcement actions, with the number of insider trading cases up
more than 25 percent and market manipulation cases up more than 45 percent over
the prior year. In both 2007 and 2008, the SEC returned more than $1 billion
to harmed investors through Fair Fund distributions.11
The SEC also sought more bar orders against directors and officers in fiscal
year 2007 than in 2006. In 2007, the SEC sought orders to bar 125 directors
and officers, more than a 25 percent increase over the number of bar orders
sought in 2006. Bar order statistics for 2008 are not yet available.
The SEC and the Department of Justice (DOJ) were also much more active in
2007 and 2008 in pursuing foreign bribery by directors and officers. The Federal
Corrupt Practices Act (FCPA) prohibits providing money or anything of value
to foreign government officials to try to obtain or retain business. In 2006,
the SEC and DOJ brought 15 actions to enforce the FCPA. In 2007, the number
of enforcement actions brought by the SEC and the DOJ shot up to 38.12
This trend continued through the first half of 2008, with the DOJ bringing more
FCPA prosecutions than in the first 6 months of 2008 than in any other full
year prior to 2007.13
While the number of investigations and administrative proceedings may have
increased, there has been a significant decline in the number of securities
fraud cases brought during the first 11 months of the 2008 fiscal year according
to a new study by Syracuse University using Department of Justice data. The
data reportedly showed there were 133 prosecutions for securities fraud during
that time, substantially below the number of prosecutions in prior years. In
contrast, there were 437 securities fraud cases prosecuted in 2000 and as many
513 prosecuted in 2002.14
Judicial Developments
The most significant court decision in 2007 concerning securities litigation
was the Supreme Court decision on June 21, 2007, in
Tellabs, Inc. et al. v. Makor Issues and Rights, Limited, et al. The
Supreme Court considered the PSLRA requirement that plaintiffs plead with particularity
facts giving rise to a "strong inference" of scienter. The Seventh Circuit Court
of Appeals had interpreted this language as requiring the plaintiff to plead
facts "from which, if true, a reasonable person could infer that the defendant
acted with the required intent."15 By an eight
to one vote, the Supreme Court rejected this approach, holding that "an inference
of scienter must be more than merely plausible or reasonable, it must be cogent
and at least as compelling as any opposing inference of non fraudulent intent."
The Court noted that "motive can be a relevant consideration," but that "the
absence of a motive allegation is not fatal." The Supreme Court observed that
the court's task "is not to scrutinize each allegation in isolation but to assess
all the allegations holistically."
Although a number of commentators have hailed the
Tellabs opinion as a significant defense victory, the extent to which
the opinion will actually increase the rate at which securities class actions
are dismissed is unclear. So far two circuit courts since Tellabs—the
First and Sixth Circuit Courts of Appeal—have issued opinions indicating that
Tellabs actually lowered the pleading standards
in those Circuits.16Tellabs
will clearly shape the issues to be addressed at the pleadings stage in future
securities litigation.
In January 2008, the U.S. Supreme Court in Stoneridge
Inv. Partners, LLC v. Scientific-Atlanta, Inc.,17
dismissed the theory of "scheme liability," ruling that securities fraud claims
against third parties who did not directly mislead investors but were business
partners with those who did are not sustainable. According to the Court, investors
may only sue those who issued statements or otherwise took direct action upon
which investors relied in buying or selling stock, whether such action involved
public statements, omissions of material facts, manipulative trading or conduct
that was itself deceptive. Without such direct action, the market would not
know of the defendants' participation in the fraud, thereby precluding any showing
of reliance and making a potential claim too remote to justify the imposition
of liability. The significance of the Stoneridge
decision is that it removes a pleading tool that plaintiffs having been trying
to utilize in recent years.
Other Notable Developments—Opt Outs and Trials
One of the most notable trends concerned opt outs from securities class action
settlements. On November 21, 2007, two state pension funds, Colorado Public
Employees Retirement Association and the Alaska Permanent Fund Corporation announced
settlements with Qwest in action separate from the class action litigation after
they had elected to "opt out" from the Qwest Securities class action settlement.
The Colorado Public Employees Retirement Association reported that had it participated
in the class, it would have recovered $400,000. Instead, its opt out settlement
was for $15.5 million, more than 28 times greater than the settlement it would
have received had it participated in the class. Similarly, the Alaska Permanent
Fund Corporation reported that its opt out settlement was $19 million, more
than 45 times greater than the $422,000 it would have received if it had participated
with the class. These settlements, along with other opt out settlements in the
Qwest litigation, total $411 million, exceeding the class action settlement
of $400 million.
Another notable development was that of securities class action cases going
to trial. Since 1996, 6 cases were tried involving conduct prior to the adoption
of the PSLRA, and 12 cases have been tried involving post-PSLRA conduct. Moreover,
it appears that more cases are increasingly being tried, with 6 cases going
to trial since the beginning of 2005. In a closely watched case, the securities
class action against JDS Uniphase and 4 of its former executives went to trial
in October 2007. On November 27, 2007, JDS Uniphase announced that, following
a month-long trial, the jury returned a unanimous verdict in favor of all defendants.18
In another closely watched case, the securities class action Apollo Group,
Inc., and its former CEO and CFO proceeded to trial in late November 2007, although
the trial did not conclude until January 2008. In that case, the jury returned
a verdict in favor of the plaintiffs. Based on the plaintiffs' estimate, the
damages were expected to range between $166.5 million and $277.5 million. The
defense cost totaled $25 million. However, the judge overturned this verdict
in August 2008 on the ground that the plaintiffs had failed to prove the company's
action caused any harm.
While the defense verdict in JDS Uniphase and the overturning of the verdict
in the Apollo Group case provide encouragement to defense counsel, corporate
defendants, and their insurers, the amount of the Apollo Group verdict nonetheless
highlights the substantial risk presented by a trial of a securities class action
law suit—both from potential damages and defense costs.
Possible Trends for 2009
Following the failures of Wall Street institutions in 2008 and the Bernard
Madoff scandal, the SEC has come under increasing scrutiny. With this backdrop,
President Barack Obama has promised a tougher regulatory and enforcement approach,
and the new administration is expected to work to increase the effectiveness
of SEC enforcement.
Stock prices continue to be volatile. Indeed, prices were nearly twice as
volatile in the last 6 months of 2008, with a volatility index of approximately
40, than in the first 6 months, when the volatility index was approximately
23. In the first few days of 2009, stock prices continue to be volatile. If
the apparent correlation between stock price volatility and securities filings
continues to hold, it seems very possible that securities class-action filings
will continue at the present pace or may even increase, at least in the first
half of 2009.
Finally, in light of the large disclosure dollar losses in the securities
class actions filed in 2007 and 2008, it also seems likely settlement amounts
will continue to increase. This may be somewhat mitigated, however, if companies
that are the subject of the actions continue to struggle or enter bankruptcy
and therefore have limited resources to contribute to settlements above the
amount of available insurance.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. Expert Commentary articles
and other IRMI Online content do not purport to provide legal, accounting, or other
professional advice or opinion. If such advice is needed, consult with your attorney,
accountant, or other qualified adviser.