Recent Developments in Securities Law Class Actions
Federal securities law class actions remain a significant risk for public companies. It is useful to step back from time to time to look at trends in these filings, even though, on a company by company basis, what matters most is careful attention to financial reporting and other disclosures in order to minimize the risk of a suit that can be costly, even if dismissed at an early stage.
Two organizations publish statistical compilations of filings, dispositions and settlements, which provide a perspective on both long-term and short-term trends in securities class action litigation. The source for what follows is the most recent report by NERA Economic Consulting. (The full report can be found at http://www.nera.com/67_7799.htm.) The other major periodic report is prepared by Cornerstone Research in association with the Stanford Law School Securities Class Action Clearinghouse.
Cases raising federal securities law challenges to announced mergers constitute a major portion of total filings, as they have since 2010. These are often parallel to cases in state court claiming a breach of fiduciary duty because the deal price is too low. These cases almost invariably settle, so that the merger can proceed, with the federal case often being dropped and the counsel in that case joining the attorneys who pursued the cases in state court to achieve a global settlement.
The overall pace of filings has been relatively stable in the last few years, though the nature of the cases changes over time. For example, in 2011, many cases focused on the financial crisis late in the last decade and challenging Chinese reverse mergers in 2011. One notable development is that in the first six months of 2012 no federal securities class action was filed where an accounting firm was a defendant. This is most likely due to the recent Supreme Court decision in Janus Capital Group, Inc. v. First Derivative Traders, which held that under Rule 10b-5 the defendant must be a person who made a deceptive statement or controlled the making of the statement. This effectively limits claims against accounting firms to liability for their audit reports. At the same time, claims against companies and their management for deficiencies in financial reporting remain a frequent basis for securities class actions. The most common allegations in recently filed cases, however, related to product defects and operational shortcomings. There has been a substantial decline in the number of cases that allege insider selling in order to plead corporate or individual scienter. Those allegations appeared, for example, in more than half of the cases filed in 2007 but in only 14% of the cases filed in the first half of 2012.
The NERA report included a retrospective analysis of motion practice in cases filed beginning in 2000 that were eventually settled. Motions to dismiss were filed in nearly 90% of the cases that ultimately settled; the remaining cases settled even before a motion was filed. More than half of the cases that settle do so before there is a motion for class certification. Where such a motion has been filed, nearly half settled before that motion was resolved. Most of the remaining cases resulted in certification of a class, usually followed by a settlement.
In a separate analysis NERA assessed the ultimate dispositions of all filed cases. The rate of dispositive dismissals in favor of the defendants, on a motion to dismiss or for summary judgment, is increasing, with the rate approaching 50%. A very small number of cases have gone to trial. According to NERA, since enactment of the Private Securities Litigation Reform Act in 1995 there have only been 30 securities class action trials, compared to more than 3900 cases filed; six of the 30 settled during trial.
As always, the NERA report contains comprehensive information regarding settlement amounts categorized in various ways. The smaller the amount at stake, the greater the settlement as a percentage of apparent investor losses. Cases with hundreds of millions of potential damages tend to settle in the single-digit percentage of those losses. This uses a very rough measure of investor losses that would be compensated in a federal securities law at trial, however.
Finally, the trend for lead plaintiffs to be institutional investors continues. The percentage of cases with institutional lead plaintiffs passed the 50% level in 2007 and remains above that, with more public pension plan plaintiffs than private institutional plaintiffs.
That is a look at history. What does the future hold? There may be a significant change in the landscape for class actions under Rule 10b-5 after the Supreme Court rules later this term in Amgen v. Connecticut Retirement Plans and Trust Funds, No. 11-1085, which was argued on November 5, 2012. Ever since Basic Inc. v. Levinson was decided by the Supreme Court in 1988 (following a predominant line of authority in the courts of appeal), a class action plaintiff has been able to satisfy the element of reliance required in an action under Rule 10b-5 by relying on the rebuttable fraud-on-the-market presumption of reliance where the defendant made materially deceptive statements and the stock traded in an efficient market. There is currently a split in the circuits, however, whether in order to obtain class certification using that presumption the plaintiff must prove, rather than merely allege, the materiality of the deception claimed and whether the defendant must be allowed to rebut the application of the fraud-on-the-market presumption at the class certification stage, such as by showing that the market was not deceived (truth-on-the-market). Stated another way, can materiality be litigated at both the class certification stage and then on the merits, that is, at trial or on summary judgment? (On the same day that Amgen was argued the Court heard argument on another important class action case with a potential bearing on securities class actions, Comcast Corporation v Behrend, which addresses whether a district court may certify a class action without resolving whether the plaintiff class has introduced admissible evidence to show that the case is susceptible to awarding damages on a class-wide basis.)
If the court decides in favor of the defendants in Amgen, requiring proof of materiality at the certification stage and affording defendants the opportunity to establish at that stage that the “market” was not deceived, with the battle of experts that would ensue, the likelihood of a case being certified would inevitably be diminished. Because certification of a class gives the class enhanced settlement leverage, if materiality can be contested at the certification stage that phase of the case will become a more comprehensive and complex proceeding than it already is.
Perhaps more important, Amgen affords the Supreme Court an opportunity to look even more closely at the viability of the fraud-on-the-market presumption itself. Basic, after all, was a 4 to 2 plurality ruling with three conservative justices not participating. Tea leaf readers who are poring over the oral argument transcript — available at http://www.supremecourt.gov/oral_arguments/argument_transcripts/11-1085.pdf — must take into account, however, that, while in recent years the Court has often narrowed the scope of Rule 10b-5 private actions (as in Stoneridge Investment Partners, LLC v. Scientific-Atlantic, Inc. and Janus), some of its recent decisions have sided with the plaintiff (Merck & Co., Inc. v. Reynolds on the statute of limitations defense, Matrixx Initiatives, Inc. v. Siracusano on whether statistically insignificant facts are necessarily immaterial and Erica P. John Fund, Inc. v. Halliburton on whether loss causation must be established at the class certification stage). The oral argument did not focus on the continued viability of the fraud-on-the-market theory, but its underpinnings were questioned by Justices Scalia and Kennedy.