According to Accounting Class Action Filings and Settlements—2011 Review and Analysis, a new report by Cornerstone Research, securities class action filings that involve accounting allegations increased in 2011 from 2010, which had the lowest number of accounting case filings in recent years. Of the 188 securities class actions filed in 2011, 70 included accounting allegations, compared with 46 in 2010. This increase can be attributed in part to the number of Chinese reverse merger filings in 2011, which are significantly more likely to involve restatements of financial statements and, as a result, include alleged violations of generally accepted accounting principles.
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The number of accounting case filings involving financial statement restatements also increased, reversing a four-year trend of declines. In 2011, 20 accounting case filings included restatements, compared to 12 case filings in 2010. Declines in the number of financial statement restatements had been widely attributed to improved corporate governance practices as a result of the Sarbanes-Oxley Act (SOX). In 2010, however, the number of restatements by public companies increased, which may have contributed to the increase in case filings involving restatements.
For the second consecutive year, more than 60 percent of accounting case filings included allegations of internal control weaknesses. Only 17 percent of initial filings with these claims were accompanied by company announcements reporting the presence of internal control weaknesses over financial reporting. During 2006 to 2011, accounting cases with internal control allegations that were accompanied by announcements of internal control weaknesses by the company tended to settle for higher amounts.
In addition to the 188 new class actions, plaintiffs also filed amendments to 164 cases during 2011. Amendments frequently resulted in changes in class periods to include accounting-related announcements, including investigations of accounting irregularities by regulators, auditor resignations, or announcements of restatements of financial statements. For cases in which the class period was extended, 56 percent included new accounting allegations. Amendments also added accounting-related defendants, most often members of the audit committee. Of complaints amended in 2011, one in four named audit committee members, up from less than one in 10 in the corresponding initial filings.
A sharp decline in the number of settlements occurred in 2011, and in contrast to the prior five years, accounting cases constituted less than half of the total volume of settlements. However, accounting cases continued to represent a disproportionately higher share of total settlement values. As in past years, accounting cases resulted in higher settlement outcomes, particularly for cases in which companies faced SEC actions.
Dr. Elaine M. Harwood, Vice President of Cornerstone Research:
- As we approach the tenth anniversary of the passage of SOX, it is interesting to observe the increase in allegations related to SOX 404 reporting in recent years. This trend suggests that plaintiffs believe that including allegations of internal control weaknesses will bolster their position in litigation, regardless of whether material weaknesses were actually present, but settlements in recent years do not support that position.
- Amended filings in 2011 resulted in the addition of accounting-related defendants and allegations, likely increasing the complexity of these cases. The added complexity of accounting cases may explain why they are still less likely to be dropped or dismissed and settle for a disproportionately higher total settlement value than non-accounting cases.
Additional Key Findings
- Accounting cases continue to be dismissed less frequently than non-accounting cases. For example, of the securities class actions filed in 2006, only 38 percent of accounting cases were dismissed by the end of 2011, compared with 46 percent of non-accounting cases.
- For cases filed during 2006 through 2011 that reached disposition by the end of 2011, only 8 percent of accounting cases were voluntarily dismissed, compared with 27 percent of non-accounting cases. A relatively low percentage of both accounting and non-accounting cases reached a ruling on summary judgment.
- Cases involving write-downs settle for higher values than cases not involving write-downs (even when compared with cases involving restatements). Cases involving financial statement restatements, however, settle for a significantly higher percentage of “estimated damages.” This suggests that the higher settlement values associated with cases involving write-downs are due in part to the higher investor losses involved with these cases.