Private Securities Litigation Reform Act Research Articles

Should SPAC Forecasts be Sacked?

In 1995 Congress passed the Private Securities Litigation Reform Act (PSLRA), which grants public companies a safe harbor from liability for forward-looking statements (FLS). Because investors cannot reasonably assess the legitimacy of forward-looking information for initial public offerings (IPOs), these companies are excluded from the act’s provision. However, companies that go public through a special acquisition company (SPAC) are defined as merger targets of an already-public firm, and as such, their FLS are protected under the PSLRA safe harbor. In this paper, we offer the first large-scale study on revenue forecasts disclosed in investor presentations given by SPAC targets. We document a positive association between the compound annual growth rate (CAGR) in projected revenue and both market returns and abnormal retail trading during the five-day event window around the investor presentation. We also show that higher revenue growth projections are more likely to be optimistically biased and that firms with higher projections tend to underperform comparable firms during the two-year span following the SPAC merger. Overall, our results attest to the recent concerns expressed by both the SEC and the financial press, that SPAC firms’ aggressive revenue projections compel retail investors, who end up faring worse on their investment.

Disclosure and the outcome of securities litigation

We examine the impact of disclosure by defendant firms on the outcome of securities fraud class actions. We hypothesize that firms issuing a higher quantity of disclosure will experience more adverse litigation outcomes, given the strict pleading standards of the Private Securities Litigation Reform Act (PSLRA). Using broad measures of disclosure derived from press releases issued during the class period, we find that more disclosure increases the likelihood that the judge will allow a lawsuit to proceed rather than dismissing it. Our results provide new insights to the literature on disclosure and litigation by studying the outcome rather than incidence of litigation, or the plaintiffs’ decision to sue. We strengthen the inference that the features of the PSLRA create a positive relationship between overall disclosure and the likelihood of settlement by showing that the relationship holds when controlling for forward-looking disclosure and ex ante litigation risk, and by providing evidence that more public disclosures allow plaintiffs to present more extensive cases.

Auditor Litigation and the Penalties on U.S. Client Firms after the Private Securities Litigation Reform Act

This study examines the relation between auditor litigation and the market and legal penalties imposed on sued audit clients after the private securities litigation reform act (PSLRA). A sample of accounting-related lawsuits is used in the regressions of three-day cumulative abnormal returns, settlement amount, and probability of settlement on auditor litigation and other variables. The results indicate a negative relation between auditor litigation and the 3-day cumulative abnormal returns around the announcement of litigation against the client firm. Another result from the study is a positive relation between auditor litigation and the legal penalty on the client firm. Specifically, the results indicate higher likelihood of settlement and larger settlement sizes for securities lawsuits in which the auditor is also sued. Our study contributes to the debate on the merit of litigation against auditors after the PSLRA. The findings imply that lawsuits against auditors appear to be a signal of audit failure and higher financial reporting risk. As audit failures erode investor confidence in the capital markets, the present study provides valuable evidence on the market and legal system’s perception of the merit of auditor litigation. The findings should be of interest to regulators and market participants given the increase in securities lawsuits against audit firms and the substantial reputational consequences of such lawsuits on audit firms and client firms.

Accountability and Competition in Securities Class Actions: Why 'Exit' Works Better than 'Voice'

The rules of litigation governance class actions are diametrically different from the rules of corporate governance, large part because the former works off an rule while the latter employs an in rule. This results higher agency costs the former context. To address this problem, reformers have long favored remedies such as the lead plaintiff provision of the Private Securities Litigation Reform Act (PSLRA), which theory give class members a stronger voice. Empirically, however, such voice-based reforms appear to have had no more than a modest impact. But an alternative remedy appears to be more promising: exit-based reforms that seek to provoke greater competition between class counsel and attorneys soliciting class members to opt out of the class and file individual actions with them state court. Unnoticed by academics, a major trend towards institutional investors opting out of securities class actions has developed over the past five years. More importantly, these opt outs appear to be recovering per share amounts that are a multiple of the class per share recovery. This development poses a variety of issues that this paper examines: (1) Why do opt outs do better?; (2) Do the opt outs gains come at the expense of those who remain the class?; (3) Can defendants feasibly restrict opt outs and how should courts respond to such attempts?; (4) Are pension funds and other institutional investors under a fiduciary or ERISA-based duty to opt out?; and (5) Will greater competition produce greater accountability?

Litigation risk and institutional monitoring

According to the existing literature, institutional investors have a significant impact on the litigation risk of publicly traded companies. This should be particularly true after the Private Securities Litigation Reform Act (PSLRA) of 1995 that encourages institutional investors to serve as lead plaintiffs in securities class actions. Using a large sample of securities class action lawsuits, we distinguish between different types of institutional investors based on their investment horizon and ownership structure and find that both factors significantly affect a firm's litigation risk. Short-term institutional investors are more likely to monitor firms through ex-post litigation, whereas long-term institutional investors prefer to monitor firms internally. Further, we document a nonlinear relation between the stock ownership of the largest institutional investor and a firm's litigation risk. In particular, as measures of long-term (short-term) ownership increase, the likelihood of litigation declines (increases). In summary, shareholder litigation may be an effective external monitoring device for short-term investors that serves as a substitute for internal corporate governance mechanisms.

Lead Plaintiffs and Their Lawyers: Mission Accomplished, or More to Be Done?

This chapter, written for the Research Handbook on Shareholder Litigation, surveys empirical work studying the lead plaintiff provision of the Private Securities Litigation Reform Act (PSLRA). That work finds that the lead plaintiff provision has encouraged institutional investors to participate in securities class actions, and that those institutional investors have negotiated lower attorneys' fees. Those benefits from the lead plaintiff provision are undercut, however, by political contributions made by plaintiffs' lawyers. We suggest additional reforms to promote transparency and competition among lawyers for lead plaintiffs. We also suggest reforms to the lead plaintiff provision intended to enhance the screening effect of the PSLRA.

Regulation, Auditor Litigation and Settlements

This paper aims to understand the determinants of lawsuits against auditors in securities class action litigation and the settlement pattern by auditors when the suit is not dismissed. The issues we consider are: (i) when are auditors named as defendants (ii) when do auditors choose to settle and (iii) what proportion of the settlement do auditors pay in relation to the settlement by all the other parties; and (iv) differences in settlement strategies among the big-n firms. We also want to understand how these suit and settlement patterns have changed following the enactment of major regulation such as the Private Securities Litigation Reform Act (PSLRA), Sarbanes Oxley Act (SOX). Following prior literature, we first establish that auditors are more likely both to be named and to settle in cases involving restatement of earnings, accusations of violation of GAAP or accounting improprieties. We then show that the likelihood of suit and settlement increase in a measure that we construct measuring the complexity of litigation. We then examine differences in settlement patterns across periods preceding and after the passage of PSLRA and SOX. We find that auditors are named less often in the post PSLRA period (relative to the pre-PSLRA period), settle with the same frequency in both periods but pay less proportional damages. The same set of comparisons show that auditors are just as likely to be sued post-SOX as pre-SOX, but settle with lower frequency and pay the same proportion of damages. Overall this study documents the beneficial role of both PSLRA and SOX on reducing the litigation burden on auditors. With regard to settlement strategies, we document the varying strategies employed by the Big-n firms that settle at different rates, vary in their aggressiveness and time to settle signaling the willingness to fight or cooperate in the settlement.

Disclosure and the Outcome of Securities Litigation

We examine the impact of disclosure by defendant firms on the outcome of securities fraud class actions. We hypothesize that firms issuing more disclosures will experience more adverse litigation outcomes, given the strict pleading standards of the Private Securities Litigation Reform Act (PSLRA). Using broad measures of disclosure derived from press releases and conference calls, we find that more disclosure by the defendant firm does indeed lead to a higher likelihood of settlement rather than dismissal. We strengthen the inference that the features of the PSLRA create a positive relationship between overall disclosure and the likelihood of settlement by showing that the relationship holds when controlling for forward-looking disclosure and ex ante litigation risk, and by providing evidence that more public disclosures allow plaintiffs to present more extensive cases.

Resolution of restatement-induced lawsuits after the Private Securities Litigation Reform Act

Using a sample of 185 restating firms that were sued between 1997 and 2005, we examine the role of accounting irregularity, other restatement characteristics and the Sarbanes Oxley Act in the resolution of litigation after the Private Securities Litigation Reform Act (PSLRA). The empirical results indicate that restatement due to an accounting irregularity and investigation of accounting misstatement by the Securities and Exchange Commission (SEC) are associated with a higher probability of settlement. Furthermore, the more negative the investor reaction to a restatement, the higher the probability that a lawsuit will be settled. Finally, we do not find any evidence that the Sarbanes Oxley Act is associated with the probability of a settled lawsuit. Our findings suggest that restatement-induced lawsuits with strong inference of fraud are settled in the period after the PSLRA. The results also highlight the importance of making a distinction between dismissed and settled restatement-induced lawsuits.

The Private Securities Litigation Reform Act (PSLRA), Sarbanes Oxley & Large Firm Risk

This study empirically evaluates the impact of the Private Securities Litigation Reform Act of 1995 (PSLRA) and the Sarbanes Oxley Act of 2002 upon the (equity) risk of the largest US firms, the backbone of the US economy. Drawing from the literature, hypotheses are developed and empirically evaluated using an extensive data set: daily return data between 1993 and 2009 from a representative sample of the largest European and US firms. This represents one of the first studies to evaluate the risk implications of the PSLRA, while research on Sarbanes Oxley has produced inconclusive — at times contradictory — findings. Strong evidence is provided that the PSLRA had no significant risk impact, and that Sarbanes Oxley significantly reduced firm risk — measured as mean equity variance. Findings also suggest that Sarbanes Oxley’s risk impairment effect may be enhanced for the largest 2.5% of US firms.

Whistle Blowing and CEO Compensation: The Qui Tam Statute

A purported dark side to powerful equity-based incentives is that they may induce a CEO to manipulate stock prices. With this in mind, recent theoretical models predict that firms will grant more equity-based compensation to their CEOs when the detection of any information manipulation is more likely. We provide confirming empirical evidence using three different tests. First, we use the qui tam statute as an experimental setting to test this prediction. This statute gives whistle blowers in the healthcare industry large financial incentives to reveal corporate fraud. Controlling for characteristics that might vary between the healthcare and other industries, we find that the proportion of equity-based compensation to total annual compensation is around 9% higher in the healthcare industry. Second, as third parties, such as the press, focus their investigative efforts towards large firms, we use an indicator variable to identify the largest firms in our sample and find that these firms are granted more equity-based compensation than others firms. Third, we use the passage of the Private Securities Litigation Reform Act (PSLRA) as an exogenous shock that increased the frequency of meritorious lawsuits. We find that equity-based compensation increased significantly after the passage of PSLRA. Using a difference-in-difference specification, we document that the effect of PSLRA on equity-based compensation is more pronounced for the healthcare industry and for the largest firms. The collective evidence appears consistent with theoretical models that predict that the detection likelihood of information manipulation affects the structure of CEO compensation.

The Screening Effect of the Private Securities Litigation Reform Act

Prior research shows that the Private Securities Litigation Reform Act (PSLRA) increased the significance of merit‐related factors in determining the incidence and outcomes of securities fraud class actions (Johnson et al. 2007). We examine two possible explanations for this finding: the PSLRA may have reduced the incidence of nonmeritorious litigation, or it may have changed the definition of merit, effectively precluding claims that would have survived and produced a settlement pre‐PSLRA. We find no evidence that pre‐PSLRA claims that settled for nuisance value would be less likely to be filed under the PSLRA regime. There is evidence, however, that pre‐PSLRA nonnuisance claims would be less likely to be filed under the PSLRA regime. The latter result, which we refer to as the screening effect, is particularly pronounced for claims lacking hard evidence of securities fraud or abnormal insider trading. We find only limited evidence of a similar screening effect for case outcomes.

Pleading scienter after Tellabs in Section 10(b) cases generally and in the “subprime” context

PurposeThe purpose of this paper is to examine the impact the US Supreme Court's Tellabs decision has had on Section 10 (b) cases generally and on cases related to subprime mortgage‐backed securities.Design/methodology/approachThe paper provides background including provisions of Section 10(b) of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act (PSLRA) of 1995. Analyzes the decision in Tellabs, Inc. v. Makor Issue & Rights, Ltd, recent decisions since Tellabs by the the Second, Seventh, and Ninth Circuits, and decisions in two recent subprime securities cases in which defendants moved to dismiss pursuant to Tellabs; and draws preliminary conclusions from cases that have applied Tellabs so far.FindingsThe PSLRA raised the bar for pleading scienter by requiring a “strong inference”, but the courts of appeals have differed in applying the standard. The Tellabs decision asserted that the PSLRA requires consideration of competing inferences in determination of whether scienter is adequately pleaded. The Supreme Court's “prescription” said the inference of scienter must be more than merely “reasonable” or “permissible”; it must seem to a reasonable person to be at least as cogent and compelling as any opposing inference. One lesson of Tellabs and the Seventh Circuit's decision on remand is that the “plausibility” of scienter allegations requires a fact‐specific inquiry. The Ninth Circuit court found that “deliberate recklessness” is sufficient to allege scienter. In one of the subprime cases, In re 2007 Novastar Financial, Inc., a district court found that a deterioration of a company's business was not evidence of wrongdoing. It is difficult – and premature – to draw firm conclusions from cases that have applied Tellabs so far, but requiring courts to consider competing inferences, requiring the pleadings in question to satisfy more “adjectives”, and requiring the “weighing” of inferences at the pleadings stage would all appear to help defendants. However, Tellabs could help plaintiffs by reversing previous practice in which a “tie” between competing inferences automatically resulted in a victory for the defendant.Originality/valueThe paper offers practical guidance by experienced securities lawyers.

Removal of class actions filed in state court alleging federal securities law violations

PurposeThe purpose of this paper is to survey the landscape of recent federal securities class actions filed in state court and explore arguments for removal of those cases to federal courts under the Securities Litigation Reform Act (SLUSA) or the Class Action Fairness Act (CAFA).Design/methodology/approachThe paper discusses: US Congressional legislation designed to bring the bulk of securities class actions back into federal courts, including the Private Securities Litigation Reform Act (PSLRA) and SLUSA; CAFA, another law designed to redirect class action litigation away from state courts; recent cases that have tested the limits of SLUSA and CAFA for removal from state to federal courts; and arguments for removal under SLUSA and CAFA.FindingsLegislative history for both SLUSA and CAFA suggests that these statutes should be read as evidence of Congressional intent to return most securities class actions to federal court. Nonetheless, plaintiffs have continued to devise legal schemes to litigate class actions in what they perceive to be friendlier forums in state courts.Originality/valueAlthough the arguments discussed in this paper are not exhaustive, they are a starting point for defendants seeking removal once litigation arises.

PSLRA and Litigation Backed Investor Speculation

Following sharp drops in securities prices, newer investors may allege they purchased their shares based on fraudulent information from management in order to recover their losses in court, albeit at the expense of current and long-term shareholders. Inherently, following the release of information, the stock is worth more to new investors who have the option to sue, than it is for existing shareholders who do not; with the option value dependent on the uncertainty surrounding the information's accuracy. We examine how changes to this option, through the passage of the Private Securities Litigation Reform Act (PSLRA) in 1995, affected investors' incentive to speculate and drive up prices. While previous studies have documented a positive reaction to the proposed legislation, we found that the reaction was significantly negative for firms with higher market to book ratios, even when scaled by each firms' average market to book. Furthermore, we find that the reaction of firms in the highest valuation quartile was significantly more negative than the returns in the other quartiles, even after controlling for other factors previously found to be significant factors in explaining the markets' response to the changes.

What Counts as Fraud? An Empirical Study of Motions to Dismiss Under the Private Securities Litigation Reform Act

This article presents the findings of a study of the resolution of motions to dismiss securities fraud lawsuits since the passage of the Private Securities Litigation Reform Act (PSLRA) in 1995. Our sample consists of decisions on motions to dismiss in securities class actions by district and appellate courts in the Second and Ninth Circuits for cases filed after the passage of the Reform Act to the end of 2002. These circuits are the leading circuits for the filing of securities class actions and are generally recognized as representing two ends of the securities class action spectrum. Post‐PSLRA, the Second Circuit applies the least restrictive pleading standard to securities claims and the Ninth Circuit applies the most restrictive. The Ninth Circuit's post‐PSLRA reputation as being a tougher venue in which to win securities fraud class actions is borne out by a significantly higher dismissal rate. The differences between the two circuits are also reflected in factors that correlate with dismissal. For example, allegations of violations of accounting principles other than revenue recognition correlate negatively with dismissal in the Second Circuit. This coefficient, however, is insignificant in our regressions for the Ninth Circuit. Allegations of revenue recognition violations are insignificant in both circuits, regardless of whether the issuer has been forced to restate those revenues. The circuits part ways on other factors as well: the Second Circuit is significantly less likely to dismiss cases with allegations of false forward‐looking statements, a surprising result given the stringent standards for such statements imposed by the PSLRA. The Ninth Circuit is significantly less likely to dismiss complaints with allegations of ‘33 Act violations, and the Second Circuit is more likely to dismiss cases brought by the Milberg Weiss firm. When it comes to insider trading, however, both circuits are skeptical, and the allegations correlate with dismissal in both circuits.

Leaving Money on the Table: Do Institutional Investors Fail to File Claims in Securities Class Actions?

In this paper, we examine the role of institutional investors in securities fraud class actions. We begin by surveying the first five years of experience with the Lead Plaintiff provision of the Private Securities Litigation Reform Act (PSLRA). In particular, we look at those cases where the lead plaintiff position has been contested and the outcome of those disputes. We find that institutional investors have been very successful in obtaining the position of lead plaintiff where they have sought it, but that there are a number of cases where they were unsuccessful. In part two of the paper, we dissect institutional investors' fiduciary obligations in petitioning to become lead plaintiffs and in filing claims in securities fraud settlements. For each major type of institution, we analyze their legal obligations under different legal standards in an effort to answer the question what obligation do they have to act in these areas. We conclude that institutional investors have a duty to file claims in settlements, except what we believe are rare instances where their cost-benefit calculations show filing to be unjustified. The case for becoming lead plaintiffs in securities fraud class actions is much more tenuous, though, as the costs of such a course of action may be substantial and the benefits are less certain. The remainder of the paper focuses on the question of filing claims in settled securities fraud cases. Beginning with a discussion of the process of notifying claimants, we move to an empirical analysis of whether institutions actually file claims in these cases. We use a sample of 53 settlements. Our tentative findings are that only 25-33% of institutions that we can identify as having claims to file in these settlements are actually filing claims.The last section of the paper offers several theories as to why institutions are not filing claims. Among the theories proposed, we focus on three as the most likely candidates: first, that the institutions are making cost-benefit analyses of whether to file such claims, and concluding that they are not worth filing; second, that there are no internal personnel at the institutions that are responsible for filing the claims, and thus they never get made; and third, that the institutions may not be receiving notice of the settlements and claims forms from the banks and brokers that hold their shares for them. Each of these theories may explain some portion of the institutions' failure to file claims in securities fraud cases.

Securities Price Consequences of the Private Securities Litigation Reform Act of 1995 and Related Events

The Private Securities Litigation Reform Act (PSLRA) increases restrictions on private litigation for securities fraud. We examine stock price reactions on legislative-event-related days of firms in four high-litigation-risk industries. Two other studies on this issue, Spiess and Tkac (1997) (ST) and Johnson et al. (2000) (JKN), conclude that shareholders considered PSLRA beneficial. While we find largely similar daily abnormal returns for event-related days that they examine, we present evidence that the timing of multiple confounding events makes the interpretation of these daily returns ambiguous. Results from additional analyses beyond those conducted by ST and JKN (market price reversal tests, analysis of additional legislative-event-related days, cumulative abnormal returns over the legislative period, and analysis of other events affecting investors' ability to bring securities-related lawsuits), are largely inconsistent with their interpretation, suggesting instead that shareholders in the four high-litigation-risk industries react negatively on average to PSLRA's restrictions on their ability to bring securities-related lawsuits.

Securities Price Consequences of the Private Securities Litigation Reform Act of 1995 and Related Events

The Private Securities Litigation Reform Act (PSLRA) increases restrictions on private litigation for securities fraud. We examine stock price reactions on legislative-event-related days of firms in four high-litigation-risk industries. Two other studies on this issue, Spiess and Tkac (1997) (ST) and Johnson et al. (2001) (JKN), conclude that shareholders considered PSLRA beneficial. While we find largely similar daily abnormal returns for event-related days that they examine, we present evidence that the timing of multiple confounding events makes the interpretation of these daily returns ambiguous. Results from additional analyses beyond those conducted by ST and JKN (market price reversal tests, analysis of additional legislative-event-related days, cumulative abnormal returns over the legislative period, and analysis of other events affecting investors' ability to bring securities-related lawsuits), are largely inconsistent with their interpretation, suggesting instead that shareholders in the four high-litigation-risk industries react negatively on average to PSLRA's restrictions on their ability to bring securities-related lawsuits.

When your auditor blows the whistle: How to deal with a 10A crisis under the new private securities litigation reform act

AbstractA new federal law greatly expands the scope of external auditors' investigations. That can mean big trouble. The author, an attorney, explains how CFOs should respond if an auditor blows the whistle including guidelines for forming a crisis management team.