Class-Action Suits: The Number of Filings is Down...but the Cost of Settlements Sets a Record
1 May 2007
While it's probably still too early to take your attorney's number off speed dial, 2006 may have seen the start of a trend that will give directors reason to celebrate. The number of classaction shareholder lawsuits filed during the year fell to 110, a 38% drop from 2005, according to a report by Stanford Law School's Securities Class Action Clearinghouse and Cornerstone Research in Boston.
Former Securities and Exchange commissioner Joseph Grundfest, a professor of law and business at Stanford and the clearinghouse's principal directorinvestigator, advances three theories to explain the decrease in filings. The first two: the strength of the stock market (happy investors are less likely to sue) and the criminal prosecution of Milberg Weiss (by far the most aggressive plaintiffs' law firm).
Grundfest's third explanation for the drop? "The hypothesis that makes the most sense is that there is actually less fraud," he says. "In the wake of the Enron and WorldCom events, the price of fraud has gone up, and just like in any other market, when the price goes up people want less of it."
If he's right, the number of lawsuits may stay down. Grundfest says the life of a class-action suit is typically two to three years, and "if you assume that executives' willingness to engage in fraud went down in '02-'03, looking at the normal lags in this market you would expect to see a decline in filing behavior sometime around '05-'06. And that's exactly what we've seen."
Even though the number of filings fell, the average size of settlements increased from $73.6 million in 2005 to $86.7 million, according to NERA Economic Consulting, a unit of Mercer Specialty Consulting.
Last year's average was pushed up by a small number of mammoth agreements that companies reached with shareholders, among them promised payouts of $2.7 billion by what was then AOL Time Warner and $6.2 billion by WorldCom. (The year's average did not include the $7.2 billion Enron settlement.) Given that the likes of Coca-Cola Enterprises, General Motors, and Home Depot are facing other big suits, 2007 could also see some huge settlements, which might keep the average up.
Will the size of these agreements begin to shrink thereafter? Maybe. "If you keep in mind the length of time for a case to be filed and resolved, we're still looking at cases that were filed when the market began to decline in 2000," says Laura Simmons, a principal with Cornerstone Research. "So once losses come down because of a more stable market, we expect that the settlements might come down as well. Fortunately, most of the large cases in the pipeline have been settled. I think we're either near or at the peak of these very large settlements."
This article has been reproduced with permission from the publisher. Copyright May/June 2007, Corporate Board Member. All Rights Reserved.
