Federal securities fraud class action activity increased in the second half of 2010, according to Securities Class Action Filings—2010 Year in Review, a semiannual report prepared by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research. A total of 104 federal securities class actions were filed in the second half of the year compared with 72 filings in the first six months of the year. For the full year of 2010, there were 176 filings, a 4.8 percent increase from 168 filings in 2009, but 9.7 percent below the annual average of 195 filings between 1997 and 2009.
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The number of lawsuits alleging disclosure violations in merger and acquisition (M&A) transactions increased to 40 filings in 2010 from the seven observed in 2009. These claims are typically generated by alleging violations of Section 14 of the Securities Exchange Act of 1934, which forbids solicitation of proxies in violation of rules and regulations, and making state law fiduciary claims. The 20 percent increase in underlying M&A activity seems insufficient to explain fully the almost sixfold increase in M&A filings, an increase that may largely be a result of changes in plaintiff law firm behavior rather than changes in underlying market factors.
The data also indicate a spike in filing activity against Chinese companies. In 2010 Chinese issuers were named in 12 filings, or 42.9 percent of all filings against foreign issuers. Filings against foreign issuers accounted for 15.9 percent of all filings, which is among the highest rate ever observed.
Professor Joseph Grundfest, Director of the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research, observed:
- “The sharp increase in federal litigation alleging disclosure violations in M&A transactions suggests that plaintiff lawyers are scrambling for new business as traditional fraud cases seem to be on the decline. There is little reason to believe that this trend will reverse or slow down; if anything, plaintiff lawyers may well bring an increasing percentage of these claims in federal court in an effort to control the litigation and to share in any fees that might result.”
- “The spike in litigation against Chinese issuers presents an interesting challenge for investors and regulators alike. It’s impossible to deny China’s ascending importance as a global market force, but tensions may well arise as some Chinese issuers struggle to conform to Western market norms and others might engage in outright fraud.”
Filings related to the credit crisis were sharply lower for the year, with 13 such filings in 2010, a 76.4 percent decrease from the 55 filings in 2009. Credit-crisis filings in 2010 represented just 7.4 percent of all filings compared with 32.7 percent in 2009. New analysis shows that settlement rates are lower for credit-crisis filings compared with non-credit-crisis filings, while the dismissal rates are similar between the two types. The difference in settlement rates appears to be driven by filings in the Second Circuit.
Filings against financial companies also continued to decrease. The Heat Maps of S&P 500 Securities Litigation™ show that 10.3 percent of S&P 500 companies in the Financials sector were named defendants in a class action in 2010 compared with the 10-year historical average of 11.8 percent. Filings in the Health Care sector spiked after a lull in 2009 and made Health Care the hottest sector on the Heat Maps for the year. In 2010 15.4 percent of the companies in the Health Care sector, representing 33.7 percent of the sector’s market capitalization, were named defendants in a class action.
The report also introduces a new analysis of the litigation exposure following initial public offerings (IPOs). This analysis shows that exposure to securities class actions is highest during the first few years after an IPO. The incremental litigation exposure decreases over time as companies mature and the volatility of their stock price decreases. Companies bore the highest risk in the second year after an IPO when they faced a 4.1 percent chance of being sued. A newly public company has a 28.7 percent chance of being subject to at least one securities class action in the 11 years after its IPO.
Dr. John Gould, Senior Vice President of Cornerstone Research, commented:
- “This year we took a close look at how often firms that had initial public offerings were defendants in securities litigation. We found that there is more than a 10 percent chance that firms would be targeted within three years of an IPO, and firms face the highest risk of being sued in their second year of public trading.”
- “With the wave of credit-crisis filings behind us, the industry focus for class action filings shifted to Health Care, where more than one out of every seven S&P 500 companies was involved in a class action.”