NERA Economic Consulting Releases Update on Trends in Shareholder Class Action Litigation

13 September 2007

NEW YORK/13 September 2007 -- Headline-grabbing record shareholder class action settlements and low filings continued through the first half of 2007, but there are also several indications that these trends may be reversing, according to NERA Economic Consulting's semi-annual benchmark study, released today.

The report, "Recent Trends In Shareholder Class Action Litigation: Filings Stay Low and Average Settlements Stay High -- But Are These Trends Reversing?" is authored by NERA economists Todd Foster, Ronald I. Miller, Stephanie Plancich, Brian Saxton, and Svetlana Starykh, and includes data on filings and settlements through 30 June 2007.

Have Average Settlement Values Peaked?

Average settlements hit record highs once again through the first half of 2007, and top settlements continued to dominate the news as additional partial settlements were finalized in the Enron and McKesson litigation, and a near-$3 billion tentative settlement was announced by Tyco. For the first time, every one of the top 10 shareholder class action settlements exceeded $1 billion. Before 2006, only three settlements had ever exceeded $1 billion.

However, there is evidence to suggest this trend may be poised to reverse direction. High average settlement values in 2006 and 2007 are primarily the result of resolutions for cases filed between 2002 and 2004. An examination of cases filed since 2005 by the authors reveals the following indicators:

  • Median Investor Losses Declining. Investor losses are a strong predictor of settlement values, and median investor losses for cases filed in 2006 and 2007 are lower than the median values in 2005.
  • Filings with Accounting Allegations Declining. NERA's settlement prediction model reveals that filings with accounting allegations have historically been associated with higher settlements. In 2006, the percentage of cases involving accounting allegations was 57%. However, through 30 June the percentage of 2007 filings with such allegations has declined to 26%.

 

These trends indicate that recent filings may not lead to a continued increase in average settlement values in the future, though it is still too early to know which of the recently filed cases will result in settlement as opposed to dismissal.

Filings on the Rise Again -- Did They Bottom Out in 2006?

Although overall federal class action filings remain well below levels from 1998-2005, they are on pace to rise above 2006 totals. There were 136 cases filed during 2006; with 76 cases filed through the first half of 2007, the projected total of 152 would mark a 12% increase. However, these totals include options backdating cases, which emerged in 2005 and spiked 2006 but have fallen off sharply in 2007 (only four cases filed in the first half of the year, compared with 22 in 2006). The increase in 2007 filings becomes far more pronounced based on standard federal filings and comparing six-month intervals.

In fact, standard filings in the first half of 2007 jumped 47% from the second half of 2006, and are at their highest level since the second half of 2005. This sharp rise combined with the decline in backdating cases suggests that the trend in filings may in fact be changing directions.

The Ninth Circuit: Bellwether for Filing Trends?

The authors also suggest that another indicator of this apparent increase may be revealed through an analysis of filings by Circuit. The majority of shareholder class action cases are filed in the Second and Ninth Circuits. Filings fell in both jurisdictions from 2004-2006, although the Ninth Circuit had a much sharper decline than the Second. However, while just 17 standard cases were filed in the Ninth Circuit in 2006, there have already been 20 such cases through the first half of 2007. Given that the Ninth Circuit previously led the downward trend in filings, this may be a signal that other jurisdictions could also experience a rebound in filings in the months to come, note the authors.

Filings against Non-US Companies on the Rise

The NERA report also examines the pattern of shareholder class action filings against non-US companies. Historically, the percentage of all class action filings made against non-US companies has been lower than the proportion of non-US company listings. For example, in 2000 only 5% of filings were against non-US companies, even though this group accounted for over 12% of listings.

In recent years, however, the authors note that this gap has been narrowing: through the first half of 2007, the percentage of filings against non-US companies had increased to 12%; but through the first half of 2006 they accounted for 14.4% of listings.

Trends for 2007 and Beyond: Will Filings Start To Rise?

Although the stock market has performed relatively well in recent years, a substantial market downturn could lead to an increase in filings. For example, if significant losses are sustained by stakeholders in the subprime meltdown, this could lead to a rise in shareholder class actions going forward. With seven subprime related claims filed through 30 June, this suggests that the subprime fallout may be the source of a significant number of filings in the near future.

Among other findings in the NERA study:

  • With the drop in filings, the average corporation now faces a 6.4% probability of being the target of at least one shareholder class action suit over a five-year period. The annual likelihood of a suit has fallen 27% since the period of 1993 to 1995, from 1.8% to 1.3%, prior to the PSLRA.
  • Chances are also greater that shareholder class action cases will be dismissed. More than 39% of class action cases filed between 2001 and 2005 were dismissed. Dismissal rates have nearly doubled since the PSLRA.
  • Dismissal rates vary widely by Circuit. The percentage of cases dismissed within two years of filings ranges from a low of 7% in the Tenth Circuit to 41% in the Fourth. The Second and Ninth Circuits -- with the most filings -- are both around 22%. Circuit-specific patterns have been relatively steady in recent years.
  • Eight of the top 10 settlements of all time have resolved in 2006 and 2007, or are ongoing, with Enron remaining at the top with $7.2 billion. Tyco's announced tentative agreement of $2.975 billion would be the largest amount ever paid by a single settling defendant. All of the top 10 settlements are associated with enormous investor losses, the single most powerful predictor of settlement size.
  • Average settlements continue to rise, even excluding mega-settlements. Excluding the top 10, average settlement values more than doubled in the 2002-2007 period to $23.2 million, compared with $11.5 million from 1996-2001.
  • Including the top 10 settlements, the average settlement value from 2002-2007 is $40.5 million. If the top settlements in 2006 and 2007 such as Tyco are finalized, the average for 2007 could surpass $100 million.
  • Median settlements, which are more descriptive of typical cases, also reached a new high in the first half of 2007, at $9 million. This reflects a rise of more then 20% over the 2006 median of $7.3 million, and continues an upward trend. In 2004, nearly half (47%) of cases resolved for under $5 million, but in the first half of 2007 just 32% of settlements were resolved for under $5 million.
  • Investor losses constitute the single most powerful publicly available determinant of settlements, explaining approximately 50% of their variation. Average investor losses have ballooned from $134 million in suits settled in 1996 to approximately $7 billion in 2006. To date, average losses for cases settling in 2007 are approximately $2 billion.
  • Other factors helping to determine the size of settlements are the number of classes of securities involved (bonds and options boost the size of settlement values), the depth of defendant's pockets, and whether accounting improprieties are alleged. According to the report, the mere existence of allegations concerning accounting improprieties leads to an increase in the expected settlement of more than 20%.

 

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 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 deliver unbiased findings, we are widely recognized for our independence. Our clients come to us expecting integrity and the unvarnished truth.

NERA Economic Consulting (www.nera.com), founded in 1961 as National Economic Research Associates, is a unit of the Oliver Wyman Group, an MMC company.

 

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