Securities Class Actions Research Articles

Underestimation of Securities Fraud Aggregate Damages Due to Inter-Fund Trades

Abstract Aggregate damages in class action securities cases estimated using standard methodologies and public volume data may be understated due to the frequent occurrence of inter-fund trades. Inter-fund trades are internal crossing trades between funds within the same fund family and are one of the few instances of trading transactions that are not reported publicly. Consequently, while inter-fund trades show up in submitted claims they are omitted from the public trade volume data generally used to estimate aggregate damages. Using actual claims data obtained from a claims administrator in a recent case, we find a significant number of damaged shares attributable to inter-fund trades, for which traditional damage estimation models do not account without an adjustment to the models' trading volume input. Our findings have implications for how aggregate damages should be estimated and call for policy reform in the reporting of inter-fund trades.

Multicriteria decision aid models for the prediction of securities class actions: evidence from the banking sector

In recent years, there has been an increase in the number and value of securities class actions (SCAs), attracting the attention of various stakeholders such as investors, managers, policy makers, lawyers, etc. The present study extends the literature, by investigating for the first time the development of a classification model to forecast SCAs filed against US banks. Our results show that the proposed multicriteria decision aid model achieves a satisfactory accuracy, by classifying correct around 80 % of the banks in an out-of-sample testing. We obtain similar results when we use a walk-forward approach, instead of a tenfold cross-validation technique, for the estimation and testing of the model. Further analysis indicates that the classification accuracies can improve further by the inclusion of a corporate governance indicator that relates to executive and director compensation and ownership.

<I>Amgen</I> and the Fraud-on-the-Market Class Action: Frozen in Time?

In November 2013, the Supreme Court granted certiorari in the Halliburton litigation to reconsider, and perhaps overrule, its seminal decision in Basic Inc. v. Levinson. Basic legitimated the fraud-on-the-market presumption of reliance, making securities class actions for claims of false corporate publicity viable, and such cases have become the central mechanisms for private securities fraud litigation. This move came after last Term’s Amgen decision, where four justices signaled their doubts about Basic. This essay looks at the connection between Amgen and the continuing viability of fraud-on-the-market litigation. How Halliburton comes out will likely depend on how the Court views the Private Securities Litigation Reform Act of 1995 — was there an implicit Congressional endorsement of fraud-on-the-market as part of a broader political bargain to make such class actions harder (but not impossible) to bring? My essay considers that question along with others that are raised in the effort to overturn Basic.

Global Deterrence of Wrongful Behaviors: The Quest for a Single Forum in Cross-Border Consumer’s Disputes

This paper aims at analyzing current developments in transnational class actions and class arbitration by assessing whether it is currently possible to aggregate cross-border consumer’s disputes in a single forum. The work begins by justifying the quest for a single forum with the positive effects of an effective global deterrence, before turning to U.S. and Europe. The trend in the U.S. seems to go along two paths: limiting foreign plaintiffs and foreign class actions; and allowing mandatory bilateral arbitration agreements in standard consumer’s contracts. In this sense, U.S. courts are diminishing their appeal as sorts of ‘global courts’ for the world’s wrong. Europe, on the contrary, is slowing and gradually discovering the notion of ‘private attorney general’, starting to focus on the private dimension of the enforcement of public interests. However, redress mechanisms modeled on the U.S. class action are still relatively new and in an initial phase, while class arbitration does not seem a likely development in the foreseeable future.Cautious hopes have been recently raised by the broad scope of a handful Canadian securities class actions and some applications of the Dutch Collective Settlement of Mass Claims (WCAM), but in the meantime the quest for a single forum in cross-border consumer’s disputes will have to continue.

The Pricing Effects of Securities Class Action Lawsuits and Litigation Insurance

The price reactions to corrective disclosures often serve as a benchmark for settlements in securities class action lawsuits. When the firm bears litigation costs, this benchmark creates a feedback effect that exacerbates the price reaction to news that contradicts managers’ earlier reports. Litigation insurance provides value in this setting by reducing the need for investors to price the effects of anticipated litigation. Insurance also affects how changes in the litigation environment impact the firm, with some changes having opposite effects on the frequency of lawsuits against uninsured and insured firms. The pricing behavior of rational investors eliminates the valuation impact of the portion of settlements paid to the investors, similar to dividends. The valuation impact of litigation arises from transaction costs, such as attorney fees, which the firm can mitigate by constraining misreporting and by purchasing insurance. (JEL G14, G30, K22, M41).

Corporate Fraud, External Debt and Corporate Cash Policy

This paper explores the financial implications of corporate fraud by examining the impacts of corporate fraud on fraudulent firms’ external financing cost and internal cash holdings. Using a sample consist of 184 fraudulent firms that experience material litigation in securities class action, we find that firms’ cost of debt significantly increases associated with corporate fraud incident. In response to the costly external finance, fraudulent firms retain more cash to better cope with adverse shocks. Consistent with the precautionary motive argument, the value of cash increases after corporate fraud. In addition, corporate fraud contributes to financial constraints in the sense that fraudulent firms display a positive cash flow sensitivity of cash after corporate fraud. Our result indicates that corporate fraud can have a real impact on corporate outcomes by affecting the external financing cost and internal cash holdings.

The Future of Securities Class Actions against Foreign Companies: China and Comity Concerns

In Morrison v. National Australia Bank Ltd., the U.S. Supreme Court limited the application of U.S. securities fraud law in transnational situations. The Supreme Court noted that its decision was influenced by international comity considerations. In this Article, we evaluate the availability of class actions in China in cases involving alleged securities fraud. Because we find that the availability of those actions is too limited to fully protect U.S. shareholders, we argue that U.S. investors should be permitted to bring securities fraud class actions against non-U.S. companies whose securities are traded on a U.S. exchange regardless of where those investors entered into the relevant securities transactions.

Auditors’ Multi-Layered Liability Regime

The proposals to limit auditor liability, principally aimed at protecting the Big-4 from the risk of a catastrophic exposure to damages, are grounded on the assumption that auditors are generally over-deterred. The 2008 EC Commission Recommendation on auditor liability relies heavily on this assumption and the economic rationale that underpins it, which is entirely focused on liability towards investors and the US narrative concerning securities class actions. However, the case is much more complex. Any discussion about auditor liability must investigate the following questions: who the auditor’s principals are; whether they are in a position to negotiate in order to design the optimal liability regime; whether and at what stage market failures prevent contractual negotiation; what kind of positive (or negative) interferences stem from multiple negotiations and a multi-layered liability regime; how such a multi-layered regime might be designed. This article covers these issues. It conducts a step-by-step analysis of each layer and considers the potential interactions amongst them. Its conclusion is that it is impossible to assess the optimal level of deterrence in multi-layered liability regimes of such complexity. From a wealth perspective, the case for a mandatory limitation of liability can be argued exclusively with regards to liability towards secondary market investors, albeit subject to numerous qualifications that the conventional wisdom too easily overlooks.

Strategic Conservative Earnings Management of Technology Firms: Evidence from the IPO Market

In this paper, we investigate the conservative earnings management strategies of technology firms in the IPO market. We hypothesize that technology IPOs, due to their fewer tangible assets, more information asymmetry, and higher uncertainties of future cash flows, tend to have higher litigation risk. At equilibrium, technology firms are more motivated to strategically employ conservative earnings management during the IPO process, to mitigate their higher litigation risk. Using a sample of U.S. IPOs, we find that technology IPOs, on average, involve significantly more conservative earnings management, especially during the bubble periods. Our results also show that the conservative earnings management strategies of technology firms tends to have a greater impact on their underpricing than for non‐tech firms, and thus effectively reduce their risk of being a target in the securities class action lawsuits.

Can Shareholder Litigation Discipline CEO Bonuses in the Financial Sector? - The Role of Securities Class Actions

The dynamics of executive compensation represents a critical issue, especially in the financial industry. There is evidence that even during the recent financial crisis CEOs were rewarded with disproportionate bonuses, a phenomenon that stands in vivid contrast with the wave of securities litigation that took place in that period as a consequence of managerial misbehaviour. This paper empirically investigates the relationship between securities class actions and the growth of CEO bonuses for financial intermediaries included in the S&P500 index in the period 1999-2010. We use an instrumental variable related to court behaviour in order to address problems arising from the endogenous nature of securities class actions with respect to CEO compensation. The analysis shows that the former are likely to moderate the dynamics of the latter, although the effect does not seem to persist through time.

The Pricing Effects of Securities Class Action Lawsuits and Litigation Insurance

The price reactions to corrective disclosures often serve as a benchmark for settlements in securities class action lawsuits. When the firm bears litigation costs, this benchmark creates a feedback effect that exacerbates the price reaction to news that contradicts managers' earlier reports. Litigation insurance provides value in this setting by reducing the need for investors to price the effects of anticipated litigation. Insurance also affects how changes in the litigation environment impact the firm, with some changes having opposite effects on the frequency of lawsuits against uninsured and insured firms. The pricing behavior of rational investors eliminates the valuation impact of the portion of settlements paid to investors, similar to dividends. The valuation impact of litigation arises from transaction costs, such as attorney fees, that the firm can mitigate by constraining misreporting and by purchasing insurance.

The Financial Implication of Corporate Fraud

This paper explores the financial implications of corporate fraud by examining the impact of corporate fraud on fraudulent firms’ external financing cost and corporate cash holdings. Using a sample consist of 184 fraudulent firms that experience material litigation in securities class action, we find that firms’ cost of debt significantly increases associated with corporate fraud incident. In line with the costly external financing evidence, fraudulent firms accumulate more cash to keep liquidity and avoid underinvestment issues. Consistent with the precautionary motive argument, the value of cash increases after corporate fraud. In addition, corporate fraud contributes to financial constrains in the sense that fraudulent firms display a positive cash flow sensitivity of cash after corporate fraud. Our result indicates that corporate fraud can have a real impact on corporate outcomes by affecting the external financing cost and internal cash holdings.

Securities Litigation Risk for Foreign Companies Listed in the U.S.

We study securities litigation risk faced by foreign firms listed on U.S. exchanges. We find that U.S. listed foreign companies experience securities class action lawsuits at about half the rate as do U.S. firms with similar levels of ex ante litigation risk. The lower rate appears to be partly attributable to higher transaction costs in uncovering and pursuing litigation against foreign firms. However, once a lawsuit triggering event like an accounting restatement, missing management guidance, or a sharp stock price decline occurs, there is no difference in the litigation rates between a foreign and comparable U.S. firm. This evidence suggests that effective enforcement of securities laws is constrained by transaction costs, and the availability of high quality information that reveals potential misconduct is an important determinant of litigation risk for foreign firms listed in the U.S.

How well do measures of judicial ability predict judicial performance?: A case study using securities class actions

Abstract Diverse measures are used as proxies for judicial ability, ranging from the college and law school a judge attended to the rate at which her decisions are cited by other judges. Yet there has been little examination of which of these ability measures is better or worse at predicting the quality of judicial performance – including the management and disposition of cases. In this article, we attempt to evaluate these measures of ability by examining a rich group of performance indicators. Our innovation is to derive performance measures from judicial decisions other than case outcomes (which are inherently difficult to evaluate): the decisions to preside over a securities class action, to reject a motion for lead plaintiff, to dismiss the complaint with prejudice, and to reject a request for fees. In each case, an affirmative decision requires more work from the judge, and thus may be an indicator that the judge works hard and, all else equal, performs well. Using a database of securities class action cases, we find that judges who publish frequently and are highly cited are more likely to dismiss with prejudice but no more likely to make the hard choice in the other cases. Other proxies for judicial ability (attended top law school, judicial experience, earlier position as judge, prior private practice, heavy business caseload, and senior status) are more mixed in terms of their predictive power.

The Way Forward after Wal-Mart

The Supreme Court's decision denying certification of a class action in Wal-Mart Stores, Inc. v. Dukes elicited a strong dissent from Justice Ginsburg, and widespread criticism in liberal circles, but in several important respects, the decision was unanimous. All the Justices agreed that a class action could not be certified under Federal Rule of Civil Procedure 23(b)(2), the rule which governs class actions in which injunctive relief is appropriate respecting the class as a whole. The holding that divided the Justices concerned the failure of the plaintiffs’ case to meet the requirement of Rule 23(a)(2) that there were questions of law or fact common to the class. Yet even on this issue there were points of apparent agreement, and one of them was the need to inquire into the merits to determine whether the prerequisites to certification were satisfied. This article begins by situating this widely accepted observation in the context of perennial disputes over substance and procedure in class actions. It then turns to the question of where to put certification decisions in the structure of pretrial litigation: in pleading, discovery, or summary judgment. That inquiry, in turn, leads to the larger question of how to reform class action procedure. Looking to the merits provides a way to differentiate among class actions, both in fine-grained analysis of particular claims and in broad terms defined by different areas of law. The cases and commentary on class actions presume that class actions must be divided into conventional categories, such as mass torts, consumer class actions, civil rights claims, and securities class actions, but they provide little more than a pragmatic justification for this division. A look at the merits was tacitly accepted as the premise of most analyses of class actions before Wal-Mart. This article provides a theoretical justification for doing so -- at the level of legal doctrine, based on the relationship between the substance of a claim and the requirements of Rule 23, and at the level of optimal enforcement, by identifying cases in which the expense of aggregate litigation yields gains in the basic goals of compensation, deterrence, and efficient litigation.

The Morrison Case as a Window to Institutional Investors’ Motives in Securities Class Actions

A growing body of legal literature suggests that securities litigation in the United States has little economic benefit, both from the perspective of compensation and with respect to deterrence. In light of the costs entailed with securities class actions and the transfer of losses to innocent group of shareholders, one would expect that financial institutions would seek to limit the scope of these suits. However, a recent study conducted by the Securities and Exchange Commission (the “SEC”) with respect to the Morrison case reveals that the inclination of institutional investors is quite the opposite. The paper analyzes the puzzling comments of institutional investors to the SEC’s study and suggests possible explanations to their support of broader class action regime.

Efficient Markets and the Law: A Predictable Past and an Uncertain Future

This article analyzes the manifold situations in which the efficient-market hypothesis (EMH) has influenced—or has failed to influence—federal securities regulation and state corporate law, and the prospective roles for the EMH in these contexts. In federal securities regulation, the EMH has offered a theoretical construct to accompany the general belief in the value of accurate and complete information that has animated the US Securities and Exchange Commission (SEC) since its creation. Specific applications of the EMH have been straightforward and predictable: For instance, its tenets as to market processing of public information helped motivate the streamlining of procedural requirements as to corporate disclosures and, more controversially, as to private securities class action lawsuits. In state corporate law, the EMH has influenced developments as to takeovers and the corporate objective. In contrast, the EMH and related learning have failed to sufficiently inform governmental actions to address financial illiteracy. Belief in the EMH and the value of efficient markets has weakened in the face of recent market anomalies and stress. The May 2010 flash crash is not easily reconciled with the EMH, and related phenomena such as high frequency trading involve an equity market microstructure far different from the microstructure at the time the EMH emerged. Actions motivated by the global financial crisis (GFC), such as the SEC short-selling ban in September 2008, arguably suggest a greater willingness to subordinate market efficiency in favor of other governmental goals. A range of important EMH-related issues loom beyond those associated with financial illiteracy, the equity market microstructure, and governmental goals. Foremost are those relating to the informational predicate on which market efficiency rests. One key aspect of the informational predicate relates to the disclosure challenges associated with financial innovations (such as asset-backed securities) and business entities heavily involved in financial innovation activities (such as certain money center banks). The “intermediary depiction model” that the SEC has always used is inadequate in financial innovation–related contexts. Another key aspect relates to the massive amounts of information that the Dodd-Frank Act requires to be provided to governmental bodies.

Predicting Securities Fraud Settlements and Amounts: A Hierarchical Bayesian Model of Federal Securities Class Action Lawsuits

This article develops models that predict the incidence and amount of settlements for federal class action securities fraud litigation in the post‐PLSRA period. We build hierarchical Bayesian models using data that come principally from Riskmetrics and identify several important predictors of settlement incidence (e.g., the number of different types of securities associated with a case, the company return during the class period) and settlement amount (e.g., market capitalization, measures of newsworthiness). Our models also allow us to estimate how the circuit court a case is filed in as well as the industry of the plaintiff firm associate with settlement outcomes. Finally, they allow us to accurately assess the variance of individual case outcomes revealing substantial amounts of heterogeneity in variance across cases.

SEC Investigations and Securities Class Actions: An Empirical Comparison

Using actions with both an SEC investigation and a class action as our baseline, we compare the targeting of SEC-only investigations with class action-only lawsuits. Looking at measures of information asymmetry, we find that investors in the market perceive greater information asymmetry following the public announcement of the underlying violation for class action-only lawsuits compared with SEC-only investigations. Turning to sanctions, we find that the incidence of top officer resignation is greater for class action-only lawsuits relative to SEC-only investigations. Our findings are consistent with the private enforcement targeting disclosure violations at least as precisely (if not more) than SEC enforcement.

Rules-Based Accounting Standards and Litigation

ABSTRACT 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 and outcome of securities class action litigation. Overall, our results suggest that rules-based standards are associated with a lower incidence of litigation but are not associated with litigation outcomes. 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. JEL Classifications: K22, K41, M41.