Expert Commentary

D&O Litigation Trends in 2007–2008

2007–2008 marked a rebound in the number of securities action filings, while the median size of settlements continued to increase.

Professional, D&O, and Fiduciary Liability
January 2009

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.

1 2008 Trends in Shareholder Class Actions, December 2008, Plancich and Starykc, NERA ("2008 NERA Report"). Kevin LaCroix, in, tallied 224 new securities lawsuits filed in 2008—a 30 percent increase over the 172 securities lawsuits he tallied as filed in 2007 (January 2, 2009).

2Cornerstone Research tallied only 116 "traditional" securities class action filings in 2006, but in 2007, the number of "traditional" securities class action filings increased to 166. This represented a 43 percent increase in filings from 2006. The number of filings in 2007 was still below the average for the prior 10 years. Companies listed on the New York Stock Exchange, NASDAQ, and Amex were defendants in 2.19 percent of the traditional class action lawsuits filed in 2007, substantially more than the 1.57 percent filed in 2006 per issuer and very close to the prior 10 year average, which was 2.27 percent. See Securities Class Action Settlements—2007 Review and Analysis, Cornerstone Research.

3Cornerstone defines "disclosure dollar loss" as the total decline in the market capitalization of the defendant company from the trading day immediately preceding the end of the class period to the trading day immediately following the end of the class period.

4Securities Class Action Filings—2008 Mid-Year Assessment, Cornerstone Research ("2008 Mid-Year Assessment").

52008 NERA Report.

62008 Mid-Year Assessment

7Securities Class Action Settlements—2007 Review and Analysis, Cornerstone Research; 2008 NERA Report.

82008 NERA Report.


10Select SEC and Market Data—Fiscal 2007; Select SEC and Market Data—Fiscal 2006. Note that the fiscal year statistics are through September of the applicable calendar year.

11SEC Announces Fiscal 2008 Enforcement Results, Release 2008-254, Oct. 22, 2008.

122007 Year-End FCPA Update, Gibson Dunn & Crutcher LLP.

132008 Mid-Year FCPA Update, Gibson Dunn & Crutcher LLP,

14"Federal Cases of Stock Fraud Drop Sharply," N.Y. Times (Dec. 24, 2008).

1547 F.3d 588, 602 (2006).

16ACA Financial Guaranty Corp. v. Advest, Inc., 512 F.3d 46 (1st Cir. 2008) (equally strong inferences for and against scienter no longer result in a win for defendants); Frank v. Dana Corp., 2008 WL 4923012 (6th Cir. Nov. 19, 2008) ("most plausible" standard no longer good law).

17128 S. Ct. 761 (2008)

18JDS Uniphase declined to indicate the amount of its defense fees. Moreover, in a January 4, 2008 statement, the Apollo Group provided "clarification of certain matters in regard to the verdict." The company noted that it did not expect to receive "material amounts of insurance proceeds from its insurers to satisfy any amounts ultimately payable to the plaintiff class." The company noted that if the judgment were not stayed or discharged, it would constitute an event of default under the company's credit facility.

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