NERA Economic Consulting Releases Annual Survey of Trends In Shareholder Class Action Litigation
2 January 2007
NEW YORK -- January 2, 2007: Despite a surge in lawsuits alleging options backdating, shareholder class action filings were down dramatically in 2006, even as settlements of existing cases soared past last year's record levels, according to NERA Economic Consulting's annual benchmark study, Recent Trends In Shareholder Class Action Litigation: Filings Plummet, Settlements Soar, released today.
Class action settlements paid by corporations to shareholder plaintiffs rose by some 37% -- an increase driven by more "mega-settlements" exceeding $100 million. Four multi-billion-dollar settlements occurred in 2006. They were: the $2.7 billion settlement paid to shareholders in the AOL Time Warner class action, the $1.1 billion Royal Ahold NV settlement, and two separate $1.1 billion settlements resulting from two Nortel Networks class action cases. These four settlements are in addition to the partial settlement of $7.1 billion paid to shareholder plaintiffs in the Enron class action -- which began in 2005 and continued into 2006. The largest payout to date in a shareholder class action, the Enron settlement is expected to grow even larger after the final payments are made to shareholders.
"This is an astonishing development given that before 2006 only three settlements had ever exceeded $1 billion," write NERA economists Todd Foster, Ronald I. Miller, and Stephanie Plancich, co-authors of the report. Settlement size is influenced by variety of factors, including the class of securities involved, whether there are allegations of accounting improprieties, and whether the case concerns an IPO. "The single most powerful" determinant of settlement size, according to the study, is the losses experienced by investors.
The NERA study also noted that, despite some 22 lawsuits in 2006 over the issue of options backdating, shareholder class action filings are projected to plunge 36% (the data for the study tracks 2006 filings through December 15). This decline in filings continues a trend that began in the second half of 2005, and represents a 44% decline from the average rate of filings after the Private Securities Litigation Reform Act (PSLRA), passed in 1995 to curtail excessive securities litigation.
According to NERA, only 129 federal shareholder class actions were filed from January 1 through December 15, 2006. A total of 135 are expected by year's end -- in contrast with 211 filings in 2005.
"It is not yet clear what is driving this precipitous decline. One hypothesis is that Sarbanes-Oxley (SOX), passed in July of 2002, has now had enough time to cause improvements in corporate governance that have limited fraud and resulting class actions," the authors write. However, for a number of reasons, they call this scenario "unlikely."
"Another possibility is that the decline is the result of distraction on the part of some of the largest plaintiffs' law firms," such as Milberg Weiss, due to federal indictment and personnel changes. They conclude: "If limitations in the resources of the plaintiffs' bar turn out to be the cause of the trend in filings then we would expect filings to return to higher levels in the future."
Among other findings in the NERA study:
- The largest drop in filings occurred in the Ninth Circuit, despite its reputation for being friendly to plaintiffs. Filings plunged from 68 in 2004 to only 27 through December 15, 2006. The smallest decrease took place in the New York-centered Second Circuit, which represents a substantial portion of the financial sector. The Second Circuit "has seen fully 87% of the filings it typically received over 1998-2004," according to NERA. However, every circuit court but two is expected to see filings decline by at least one third this year.
- With the drop in filings, the average corporation now faces less than an 8% probability of being the target of at least one such suit over a five-year period. The annual likelihood of a suit has fallen 9% since the period of 1993 to 1995, from 1.8% to 1.6%, prior to PSLRA reform.
- Chances are also greater that shareholder class action cases will be dismissed. More than 38% of class action cases filed between 1999 and 2004 were dismissed. Dismissal rates have nearly doubled since PSLRA reforms.
- A significant portion of shareholder class action cases are dismissed within the first two years. The Second and Ninth Circuits, which together receive the most cases, dismiss approximately 20% within this time period. The Fourth Circuit has the highest rate, dismissing 31% of cases within two years, while the Tenth Circuit has the lowest, at 5%.
- Seven of the ten largest settlements occurred between 2005 and 2006. Enron's $7.1 billion partial settlement exceeds last year's record-setting $6.2 billion WorldCom settlement, which dwarfed the mammoth $3.6 billion Cendant settlement in 2000.
- The average shareholder class action settlement, including this year's largest billion dollar cases, is $86.7 million -- up from the average of $73.6 million in 2005. [These numbers do not take Enron into account.] If cases exceeding $1 billion are excluded, the average is $34 billion, according to NERA numbers through December 15.
- More than 10% of shareholder class action settlements were "mega-settlements" of over $100 million, in contrast with an average of 3% reaching this threshold in prior years.
- Median settlements, which are more descriptive of typical cases, continued to rise in 2006, hitting a new peak of $7.3 million.
- There were also fewer class action settlements of $3 million or less. They made up 22% of 2006 settlements, compared with 26% in 205 and 44% in 1996.
- Investor losses constitute the single most powerful publicly available determinant of settlements. Average investor losses have ballooned from $140 million in suits settling in 1996 to $2.5 billion in 2003.
- Other factors helping to determine the size of settlements are the class of securities involved (bonds and options boost the size of settlement values), the depth of defendant's pockets, and whether accounting improprieties are suspected. According to NERA, "The mere existence of allegations concerning improprieties leads to an increase in the expected settlement of more than 20%."
- Settlements increase by approximately one-third if an IPO is involved.
- Corporations in the health services sector pay significantly higher class action settlements than defendants in other industries, a possible consequence of billing fraud allegations resulting from the federal False Claims Act.
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 22 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 45 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 delivering 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.
NERA Economic Consulting (www.nera.com), founded in 1961 as National Economic Research Associates, is a unit of Mercer Specialty Consulting, an MMC Company.
