Securities Class Actions Research Articles

Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation*

AbstractA heated debate exists as to whether discontinuities in earnings distributions are indicative of earnings management. While many studies attribute discontinuities in earnings distributions to earnings management, other studies argue that earnings discontinuities are artifacts of sample selection and research design. Overall, there is limited direct evidence of a connection between earnings discontinuities and earnings management. In this study, we provide direct evidence linking earnings management to earnings discontinuities for a sample of firms that settle securities class action lawsuits and restate earnings from the alleged GAAP violation period. We compare the distribution of restated (“unmanaged”) earnings to originally reported (“managed”) earnings. We find that discontinuities are not present in the distribution of analyst forecast errors and earnings changes using unmanaged earnings but are present using managed earnings. The discontinuity in the earnings level distribution is attenuated, but not eliminated, on an unmanaged basis. These shifts among our sample of firms are caused by earnings management and cannot be explained by sample selection or research design issues. Our findings are important because many studies use earnings discontinuities as a proxy for intentional earnings manipulations and we provide the first direct evidence of a link between these two phenomena.

Institutional Activism Through Litigation: An Empirical Analysis of Public Pension Fund Participation in Securities Class Actions

The PSLRA's lead plaintiff provision enlisted institutional investors to monitor class counsel in order to curb the agency costs endemic in securities class actions. This article uses a sample of 731 settlements to examine the efficacy of this provision. It finds that, even when controlling for institutional self‐selection of potentially easier or higher‐quality cases, cases with public pension lead plaintiffs have larger recoveries and lower fee requests and fee awards than cases with other lead plaintiff types. The article also finds evidence consistent with the existence of a significant positive externality associated with public pension participation. Over time, fee requests and fee awards have on average declined significantly even in cases without such lead plaintiffs. These findings suggest that public pensions act as more effective monitors of class counsel than traditional plaintiffs and that the lead plaintiff provision has substantially reduced the transactions costs associated with securities class actions.

A brief overview of securities class actions and risk management for pension fund trustees

The history of securities class actions and their importance for pension funds is reviewed along with the risk factors that need to be managed by pension trustees including the nature of claims, factors for determining court jurisdiction, legal cost awards, litigation funding and insurance, fiduciary obligations and the need for community of interest.

Can Shareholder Litigation Discipline CEO Bonus? An Empirical Analysis on Securities Class Actions in the Financial Sector

Can Shareholder Litigation Discipline CEO Bonus? An Empirical Analysis on Securities Class Actions in the Financial Sector

Securities Class Actions and Bankrupt Companies

Securities Class Actions and Bankrupt Companies

Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions

Measuring the efficiency of the market for a stock is important for a number of reasons, but such measurements have been widely utilized in securities class action litigation, particularly to justify certification of cases as appropriate for class action treatment. We provide a general methodology to measure the arbitrage risk, which is a negative proxy for the market efficiency, of a stock for any relevant period. We apply this methodology to calculate the arbitrage risk of each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the Capital Asset Pricing Model of the stock (positively). These findings seem inconsistent with “conventional wisdom” and with the understanding that courts use in applying notions of market efficiency to class certification decisions, but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative) and institutional ownership (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.

Securities Class Actions: Anglo-American Comparison and Cross-Border Implications

Securities Class Actions: Anglo-American Comparison and Cross-Border Implications

Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions

Measuring the efficiency of the market for a stock is important for a number of reasons, but such measurements have been widely utilized in securities class action litigation, particularly to justify certification of cases as appropriate for class action treatment. We provide a general methodology to measure the arbitrage risk, which is a negative proxy for the market efficiency, of a stock for any relevant period. We apply this methodology to calculate the arbitrage risk of each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the Capital Asset Pricing Model of the stock (positively). These findings seem inconsistent with “conventional wisdom” and with the understanding that courts use in applying notions of market efficiency to class certification decisions, but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative) and institutional ownership (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.

Rules-Based Accounting Standards and Litigation

Some claim that rules-based accounting standards shield firms from litigation, while others argue that violations of detailed rules give plaintiffs a “roadmap” to successful litigation. We inform this debate by investigating whether rules-based standards are associated with the incidence of securities class action litigation. Overall, our results suggest that rules-based accounting standards are associated with a lower incidence of litigation. These results are of interest in the debate regarding the switch from a more rules-based U.S. GAAP to a more principles-based IFRS.

Does Syndicate Pressure Affect Analysts’ Incentive to Produce Information? Evidence from Recommended Firms’ Securities Class Action Lawsuits

We propose that syndicate pressure distorts unaffiliated analysts’ incentive to produce information. To examine this newly proposed conflict of interest problem, we separate unaffiliated analysts into two types. The first type is the analysts employed by syndicate banks, which do not have direct underwriting relationships with the recommended firms but have participated in the affiliated main banks’ syndicates (the underwriters of recommended firms). The second type is independent banks, which do not have underwriting relationships with the recommended firms or syndication relationships with the main banks. Syndicate pressure refers to syndicate banks’ analysts being cooperative or acting like main banks’ analysts so as to enhance their banks’ chance to participate in future underwriting syndicates. We further distinguish syndicate bank types by their roles as co-managers or co-lead syndicate members because co-managers tend to be smaller underwriters and do not have the same capacity to organize their own syndicates as co-lead syndicate banks. Therefore, co-manager partners are more susceptible to syndicate pressure than co-lead syndicate banks. Using a novel event, the securities class action lawsuits, we are able identify unique private information production periods prior to the public’s knowledge of the wrongdoings. Therefore, we can examine the timeliness of private information dissemination by various types of analysts. Consistent with the “syndicate pressure” hypothesis, we find that unaffiliated analysts employed by co-manager syndicate banks issue downgrade revisions no sooner than those employed by the affiliated main banks. On the other hand, unaffiliated analysts employed by co-lead syndicate banks and independent banks issue downgrade revisions significantly more promptly than those of main banks. In addition, we document that Global Settlement appears to improve analysts’ independence, particularly among main banks, which are subject to the greatest level of conflicts of interest, and co-manager syndicate banks, which are susceptible to syndicate pressure from main banks.

A Critical Analysis of Databases used in Financial Misconduct Research

An extensive accounting and finance literature examines the causes and effects of financial misreporting or misconduct based on samples drawn from four popular databases that identify restatements, securities class action lawsuits, and Securities and Exchange Commission (SEC) Accounting and Auditing Enforcement Releases (AAERs). We show, however, that the results from empirical tests can depend on which database is accessed. To examine the causes of such discrepancies, we compare the information in each database to a detailed sample of 1,243 case histories in which the SEC brought enforcement action for financial misrepresentation. These comparisons allow us to identify, measure, and estimate the economic importance of four characteristics of each database that affect inferences from empirical tests. First, these databases contain information on only the event that is used to proxy for misconduct (e.g., restatements), so they omit other relevant announcements that affect a researcher’s interpretation and use of the events. Second, the initial public revelation of financial misconduct occurs, on average, months before the initial coverage in these databases, leading to discrepancies in event study measures and pre/post comparison tests. Third, most of the events captured by these databases are unrelated to financial fraud, and efforts to cull out non-fraud events yield heterogeneous results. Fourth, the databases omit large numbers of events they were designed to capture. We show the extent to which each database is subject to these concerns and offer suggestions for researchers seeking to use these databases.

Does Syndicate Pressure Affect Analysts’ Incentive to Produce Information? Evidence from Recommended Firms’ Securities Class Action Lawsuits

Does Syndicate Pressure Affect Analysts’ Incentive to Produce Information? Evidence from Recommended Firms’ Securities Class Action Lawsuits

Die Us-Amerikanische Class Action: Struktur und Rechtsökonomischer Hintergrund

Abstract The article is dealing with the new German legal regulation concerning so called securities class actions. Th e author sees the new possibilites to bind together claims which arose from false information in capital market as a followor of the US class actions, therefore the article explains with the aim to simplify the intepretation of the new German legal rules the current American legal regulation of class actions. Th is means it analyses mainly the article 23 of the Federal Rules of Civil Prodecure and brings opinions of the author whether its particularities may function in Germany or not.

The Price of Pay to Play in Securities Class Actions

We study the effect of campaign contributions to lead plaintiffs—“pay to play”—on the level of attorney fees in securities class actions. We find that state pension funds generally pay lower attorney fees when they serve as lead plaintiffs in securities class actions than do individual investors serving in that capacity, and larger funds negotiate for lower fees. This differential disappears, however, when we control for campaign contributions made to officials with influence over state pension funds. This effect is most pronounced when we focus on state pension funds that receive the largest campaign contributions and that associate repeatedly as lead plaintiff with a single plaintiff's attorney firm. Thus, pay to play appears to increase agency costs borne by shareholders in securities class actions, undermining one of Congress's principal goals in adopting the Private Securities Litigation Reform Act.

In search of responsible CEOs: The case of CEOs with non-profit experience

We advance, and test, two competing hypotheses that relate prior non-profit experience to mismanagement and/or negligence against the null of no relationship. The evidence supports the hypothesis that the bureaucratic and chaotic culture of many non-profits often attracts and/or molds individuals with subpar managerial habits. We find that firms headed by CEOs with non-profit experience are more likely to restate financial statements than other firms, even after controlling for variables that have been shown to affect restatements, and that the returns around announcements of class action securities litigation are more negative for firms with “non-profit” CEOs.

Why Do U.S. Securities Laws Matter to Non-U.S. Firms? Evidence from Private Class-Action Lawsuits

A continuing controversy is whether U.S. securities laws are enforced against foreign firms, since public enforcement actions by the SEC are infrequent and often result in insignificant penalties. We examine private enforcement actions of U.S. securities laws and find that 269 securities class-action lawsuits were filed against foreign firms from 1996 to 2008. We document the severity of the penalties imposed on foreign firms and show that while firms paid a total of $9 billion to settle lawsuits brought against them, the monetary penalties levied by the market are even larger. During the three-day period surrounding the lawsuit filing date, there is a significant negative stock price reaction of -6.16%, which translates to an average loss of $392 million dollars. Aggregating over all firms, the total dollar loss is $73 billion. Even foreign firms without significant U.S. assets experience significant valuation losses. Moreover, insiders of the firm bear direct financial losses through their shareholdings. Our results provide evidence that enforcement actions of U.S. securities laws against foreign firms are neither uncommon nor economically insignificant events.

Internal and external discipline following securities class actions

Companies are sometimes accused of misleading the market. The SEC can punish this with enforcement actions. Alternatively, shareholders can seek redress through a shareholder class action (SCA). While some literature has examined SEC actions, it has not examined SCAs, and has not examined external discipline and the managers's future employment prospects after either action. Thus, using a sample of 416 securities class actions, this paper shows that SCAs are a catalyst to promote disciplinary takeovers, CEO/CFO turnover and CEO/CFO pay-cuts, and harm CEOs future job-prospects. This suggests that even if the law governing SCAs is sub-optimal, they can still induce internal and external discipline.

Developments in United States Securities Class Actions: The Status of ‘Fraud on the Market’ Causation and Implications for Australia

In 1988 the United States Supreme Court handed down the judgment of Basic Inc v Levinson which recognized the ‘fraud on the market’ theory of causation of investor loss in a securities class action. More recently, legislative reform and the US Supreme Court's decision in Dura Pharmaceuticals v Broudo have circumscribed somewhat the permissive approach to such claims by creating more stringent requirements at the pleading and certification stage. The development of behavioural finance also questions somewhat the theory of efficient capital markets on which the ‘fraud on the market’ causation theory partly rests. In Australia meanwhile, market based causation has not been tested yet in their courts. To the extent that causation of loss through the effects of non-disclosures on the market is accepted by Australian courts it is not clear that the gloss developed in Dura would necessarily have application here.

Earnings quality and Rule 10b-5 securities class action lawsuits

This study examines the earnings quality of firms sued under accounting-related Rule 10b-5 securities fraud class action lawsuits, following a decline in their stock prices, relative to earnings quality of a return-matched control sample of firms. Our analysis is conducted in pre- and post-Private Securities Litigation Rule Act (PSLRA) periods. We measure accruals (earnings) quality using the Dechow and Dichev (2002) model, and provide evidence of significantly lower quality earnings (earnings overstatement) in both the pre- and post-PSLRA periods, for the test sample firms in the four quarters immediately prior to the sued quarter, followed by a sharp decline in the level of earnings of the sued quarter and subsequent four quarters. These consistent results in the pre- and post-PSLRA suggest that lower earnings quality is merit-related indicia of evidence of fraud and that accounting based securities class action lawsuits target only firms with lower earnings quality. Our findings suggest that further policy reforms making it more difficult for shareholders to file an accounting based securities class action lawsuit would be unwarranted.

The Supreme Court's Impact on Securities Class Actions: An Empirical Assessment of Tellabs

How does Supreme Court precedent affect lower court decisions when there is asymmetric probability of appellate review? We study the impact of Tellabs, Inc. v. Makor Issues & Rights, Ltd., which clarified the law of securities fraud on pleading scienter. Tellabs reversed a lenient standard for pleading scienter but replaced it with a standard that is nonetheless relatively generous to plaintiffs. Would the Supreme Court's directive cause the dismissal rates in the lower courts to converge? We find that Tellabs correlates with a significantly lower dismissal rate on scienter grounds in circuits previously applying a higher preponderance standard for scienter. In contrast, we find no significant shift in the courts previously applying the lower reasonableness standard in our basic model. Overall, we conclude that Tellabs led to increased uniformity in how lower courts apply pleading standards, but its effect is muted by the asymmetry of the right to appeal. The Author 2011. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oup.com, Oxford University Press.