Exposure in securities class actions down slightly, size of settlements up

The frequency of class action suits seems to be fairly manageable. However, that good news does not carry over to the severity side. Dramatic settlement increases have occurred during the past five years, panelists told the 18th Annual Professional Liability Underwriting Society (PLUS) International Conference attendees.

The first year after the Enron debacle, in 2002, there were 231 classic security actions filed, according to Dan Bailey of Bailey of Cavelleri LLC. Bailey, who moderated the PLUS panel discussion, noted that in 2004, the number dropped to 214. “If you project out the filing for 2005, it looks like it will come in somewhere around 190, a pretty significant decrease from 2004 and 2002,” he said.

Bailey said that some of the reasons may include:

“We don’t know for sure, and whether it’s going to stay down at that level is anyone’s guess,” he said. That good news doesn’t carry over to the severity side of the picture, however.

More settlement money
Bailey noted that there have been dramatic increases in the size of settlements in security class actions during the past four to five years. According to the recent survey by Nuera Communications, the average settlement in a classic security class action case is at an all-time high of $25.8 million.

“The median drops to around $7 million, which says there are a lot of real big settlements, and there are still a number of small cases that go away with no dollars at all. That explains why the median number is so much lower,” Bailey said. “The big driver for the dramatic increase in severability is the emergence of institutional investors taking control of this litigation.”

According to Bailey, the Neura survey indicates that if an institutional investor is a lead plaintiff in a case, the settlement of that case will increase by one-third over the amount if the person was an individual.

Price inflation
Looking at securities class action cases, specifically the Dura Pharmaceuticals case, Daniel Standish, partner at Wiley, Rein & Fielding, touched on the broad holdings in the Supreme Court, specifically why the decision is so important and has garnered so much attention. He also discussed the open issues that are playing themselves out in the wake of the decision.

According to Standish, the plaintiff in the Dura Pharmaceuticals case alleged in the complaint that he had purchased his shares at an inflated price; that was the sole extent of the allegations regarding the damages the plaintiff had suffered.

“The issue that made its way to the Supreme Court after the 9th Circuit had allowed that case to proceed was whether or not this price inflation approach was a sufficient allegation under the federal securities laws,” he said. “The Supreme Court held that it was not an adequate allegation of loss causation.” Loss causation is the requirement that a securities plaintiff be able to show that the alleged fraud or misrepresentation caused harm to the investor, Standish explained.

The Supreme Court held that the bare allegation that the purchased shares were inflated in value is not enough to show that somebody was damaged, Standish said. “You could purchase a share at an inflated value and sell it at an equally inflated value; it doesn’t necessarily translate into harm to the investor,” he said. “The Court also said the 9th Circuit Holding was completely inconsistent with long-standing precedent requiring a more exacting showing of harm to a particular investor. It also raised the concern that by allowing a price inflation approach to proceed, it in essence would transform the federal securities fraud laws into market loss insurance, rather than a mechanism to remedy alleged fraud in the marketplace.”

The decision was significant, according to Standish, because it imposes on the plaintiffs an affirmative obligation in the complaint to allege facts that show that they were harmed by the purported misrepresentation or omission in a section 10B case. That is important in the dynamic of a section 10B case because the motion to dismiss is an important event.

Under the Private Securities Litigation Reform Act of 1995 (PSLRA), no discovery occurs prior to the disposition of the motion to dismiss. If the case is allowed to proceed, the costs associated with the case increase dramatically, he said.

“There’s increased pressure on both defendants and carriers to settle in that context, so the fact that the Supreme Court has endorsed a threshold pleading requirement that plaintiff’s are obligated to address in the context of their complaint, gives the defense bar and insurance carriers one more arrow in their quiver in order to raise threshold defenses,” he said

A second important aspect of the decision, Standish said, is that the Supreme Court embraced a concept of loss causation that is frequently discussed in section 10B cases, as well as other cases that proceed under federal securities laws.

“The concept of loss causation can be important in the context of damages analyses,” Standish said. “Oftentimes, the experts that are hired by the defense to address the plaintiff’s alleged harm give a very detailed look at the various factors that affect a particular stock’s price and that can explain movements in a stock price. We now have a Supreme Court decision that embraces that type of analysis.”

“While the Supreme Court focused on the context of a motion to dismiss, that analysis is going to play out not only in the damages analysis, it can also play out in the context of class certification — whether the harm that has been suffered by the proposed class plaintiff is similar to the alleged harm that would apply across the lines to the class,” Standish added. “It’s conceivable that it also could be used in the context of summary judgment pleadings as well.”

Costly derivatives
Looking at derivatives, Wayne E. Borgeest of Kaufman Borgeest & Ryan LLP noted that there is a fair amount of concern that derivative actions are taking more capital to resolve. “The numbers might be as much as triple what they were five years ago,” he said.

“There are many kinds of derivative actions, and all are resolved in different kinds of ways; sometimes costing companies a lot of money, sometimes not. In tag-alone claims, one of the things we are seeing is that it’s less and less certain that you can assume the ability of the class to bring the derivatives in the room when you are mediating a case. In the past, we’ve had very good luck saying to those parties, ‘let’s get everyone in the room and settle the case.’ But more and more, we have derivatives saying they are not coming to the mediation. That would suggest that some of the folks prosecuting have their own agendas. Lawyers are in competition with other lawyers.”

Looking at settlements, Borgeest said the Disney case is an important decision to read. “It was an extremely expensive litigation,” he said. The court came down on the board’s side, although it was critical of many people on the board and pointed out their shortcomings and failure to be involved in the hiring, negotiation and termination process, he said. “What came out of the Disney decision is whether and how judges draw the line differently between negligence and gross negligence, and the extent to which the board educates itself and directors involve themselves in the decision-making process,” he said.

Carol A.N. Zacharias, counsel at ACE USA, looked at the underwriting process after the corporate debacles of WorldCom and Enron, and noted there is an increased sensitivity as to whether there should be coverage for the true “black hat,” how to define a black hat, who is going to define a black hat and when to make that determination. According to Zacharias, that should be addressed in conduct exclusions.

“Conduct exclusions are becoming more and more the focus, as we get into things like non-rescindability and full severability, because now we can’t look at the application for the relatively rare rescission cases,” she said. “The coverage issues will be determined based on the policy and what is in the policy are two exclusions — the profit exclusion and dishonesty exclusion. Deliberate fraud and deliberate dishonesty is a synonym for intent, which triggers the dishonesty exclusion.”

PLUS is an international, non-profit association that provides information and educational opportunities and programs on professional. For more information, visit www.plusweb.org. Phone: (800) 845-0778 or (952) 746-2580.

Topics Lawsuits Fraud