Shareholder Class Action Settlements Expected to Set Record Highs in 2005, Driven in Part By $6.1 Billion Record-Breaking WorldCom Settlement
18 July 2005
Shareholder class action settlements are at all-time highs, according to the latest research by NERA Economic Consulting, which tracks securities class action cases. The latest growth is being fueled by settlements in the WorldCom and Enron cases, which are setting new standards for shareholder compensation.
Topping $6.1 billion, the WorldCom shareholder class action settlement is close to double the previous record of $3.5 billion established five years ago in the Cendant Corp. settlement. The record-breaking WorldCom settlement compensates record-breaking investor losses far larger than in any other settled case filed since 1991. The WorldCom case is also striking in that it was financed almost entirely by outside co-defendants, including ten investment banks and former auditor Arthur Andersen. Company directors also contributed to the settlement from their personal assets, a rare outcome, in addition to a contribution by their D&O insurers.
Meanwhile, the settlement expected at the conclusion of Enron's shareholder class action may be even larger, with preliminary settlement agreements already approaching $5 billion, according to the NERA Economic Consulting study released today, Recent Trends in Shareholder Class Action Litigation: Are WorldCom and Enron the New Standard?
Settlement of the WorldCom and Enron shareholder class actions will bring to an end two of the cases that epitomized the alleged mega-frauds that occurred during the stock market bubble of the late 1990s. However, according to the study, such large settlements are likely to continue as lawsuits filed during the bear market of 2000-2002 progress toward settlement.
"Our projection rests on our analysis of median investor losses by end-of-class-period year for settled cases... Median investor losses for cases with class periods ending in 2000-2002 are $397 million -- more than 80% higher than the maximum for any prior end-of-class-period year," the study notes. Because half of cases that settle do so within five years of the filing date, the authors expect it will take until 2007 for most of the shareholder class actions filed after the collapse of the stock market bubble to reach settlement.
NERA's economists have established investor losses as "the single most powerful, publicly available determinant of settlements."
A sharp decline in "nuisance" settlements of under $3 million, say the authors, is also fueling new highs in median settlements. In the first six months of 2005 alone, the median settlement value of securities class action cases jumped nearly 30% to $6.8 million from $5.3 million last year, according to the report's co-authors, NERA Economic Consulting economists Elaine Buckberg, Todd Foster, and Ronald I. Miller. Coupled with the substantial increase in dismissal rates since the Private Securities Litigation Reform Act of 1995 (PSLRA), the authors consider the possibility that "cases that formerly settled for small sums are instead being dismissed."
According to the study, bigger settlements yield lower percentage fees for plaintiffs' counsel. However, as settlements have climbed, so have plaintiffs' attorneys' total fees. The average settlement in 2005 will yield over $6 million in fees to plaintiffs' counsel, compared to $3.6 million five years ago.
In terms of new actions, the NERA study found that federal class action filings are down by 17 percent for the first half of 2005. If filings continue at the rate of the first six months of the year, NERA projects 201 filings in 2005, compared to 241 filings in 2004. However, according to the authors, the slowdown may be temporary and may be reversed by an above-average pace of filings in the second half of the year. After the Supreme Court reversed the Ninth Circuit's decision in Broudo v. Dura Pharmaceutical in April, the authors anticipate that "Ninth Circuit plaintiffs' firms may file an unusually high number of cases in the remaining months of 2005, including cases that they would otherwise have filed earlier in the year" now that the Supreme Court has established the criteria to plead loss causation.
Among other findings of the NERA study:
- In the first six months of 2005, the mean settlement value for securities class action reached $25.8 million, exceeding the prior high of $23.5 million in 2002; these statistics exclude the WorldCom, Enron, and Cendant settlements.
- Trends in investor losses explain both the blockbuster settlements of recent years and the rise in average settlements. On average, a 1.0% increase in investor losses results in a 0.4% increase in the size of the expected settlement.
- There has been no statistically significant change in settlement values following the passage of the Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002.
- Cases with accounting allegations continue to result in higher settlements. The presence of accounting irregularities, restatements, or other accounting issues in a shareholder class action will raise average settlement values by approximately 20%.
- One of Congress's major goals for the PSLRA was to increase involvement of institutional investors as lead plaintiffs in securities class action cases with the expectation that they would play a more active role in litigation and generate better outcomes for class members. Findings from NERA's proprietary model indicate that cases with an institutional investor as lead plaintiff settle for one-third more on average.
- Settlements are also about a third higher if an IPO took place during the class period.
- Dismissal rates nearly doubled after PSLRA and account for 39.3% of dispositions of cases filed 1996-2002. Dismissal rates vary substantially by judicial circuit. Both the Second and Ninth Circuits, which together receive the majority of cases, dismiss roughly 25% of cases within two years of the filing date. The Fourth Circuit has the highest rate, dismissing nearly 45% of filings within two years. Higher dismissal rates offset the 10% probability that the average public corporation will face at least one shareholder class action lawsuit in any five-year period. As a result, the annual probability of a company facing a suit that survives a motion to dismiss has remained roughly constant over time at 1.2%.
About NERA
NERA Economic Consulting is an international firm of economists who understand how markets work. We provide economic analysis and advice to corporations, governments, law firms, regulatory agencies, trade associations, and international agencies. Our global team of more than 500 professionals operates in 19 offices across North and South America, Europe, Asia, and Australia.
NERA provides practical economic advice related to highly complex business and legal issues arising from competition, regulation, public policy, strategy, finance, and litigation. Our more than 40 years of experience creating strategies, studies, reports, expert testimony, and policy recommendations reflects our specialization in industrial and financial economics. Because of our commitment to deliver unbiased findings, we are widely recognized for our independence. Our clients come to us expecting integrity; they understand this sometimes calls for their willingness to listen to unexpected or even unwelcome news.
