Securities Fraud Class Actions Research Articles

Paying for Performance? Attorneys’ Fees in Securities Fraud Class Actions

Paying for Performance? Attorneys’ Fees in Securities Fraud Class Actions

Price Inflation and Price Maintenance in Securities Fraud Class Actions

Price Inflation and Price Maintenance in Securities Fraud Class Actions

증권관련집단소송 사건 중 집단소송허가절차에 관한 한국과 미국 법리 비교연구

The U. S. Supreme Court has decided four judgments in the past 10 years on the issues of the securities class action certification. Securities class action cases under Section 10(b) and Rule 10b-5 are actively filed in the United States. Under Basic Inc. v. Levinson, the plaintiffs are no longer required to prove individual reliance. This rule allowed the U.S. investor class to be more easily certified in a Rule 10b-5 securities class action.
 In Korea, the Securities-related Class Action Act was enacted.
 Although securities-related class actions were not actively filed, there were some cases where the Supreme Court of Korea interpreted the rule on class action certification. Under the rule interpreted by the Supreme Court of Korea, the requirements to be certified as a class are different from that of the United States.
 In the United States, plaintiffs in a securities fraud class action frequently submit event studies at the class certification stage. However, Korean plaintiffs are not required to submit an event study at the class certification stage in a typical stock price drop class action.
 This is because, as the article discusses, the substantive securities law and the class certification rule differs from that of the United States.

Coalitions among Plaintiffs’ Attorneys in Securities Class Actions

Abstract This article examines contests among plaintiffs’ law firms to become lead counsel in securities fraud class actions. We study lead counsel appointments in all federal securities class actions from 2005 to 2016. Although the typical class action has several lead plaintiff motions, many of these motions will either withdraw or combine before the judge chooses the lead plaintiff and lead counsel. We find that law firms’ decisions to combine correspond primarily with the existence of relationships between law firms rather than case characteristics. When motions combine, the number of selected lead counsel typically increases. We also find that the correspondence of prior relationships between law firms on decisions to withdraw or combine does not increase with our proxies for the importance of synergies between law firms.

Short Sellers, Short Squeezes, and Securities Fraud

The modern securities fraud class action lawsuit rests on a legal fiction. Plaintiffs are able to bring claims together and avoid proving individual reliance because over thirty years ago, the Supreme Court assumed that almost all investors purchase and sell securities based on their belief that the market price is accurate. In today's world of short sellers, options traders, algorithmic traders, and institutional investors with more valuation tools than the issuers themselves, that assumption cannot hold. These atypical traders, particularly short sellers, are becoming more and more visible in class actions as lead plaintiffs and lead plaintiff candidates, and sometimes as defendants. Courts have not decided exactly what to do with short sellers in securities fraud cases, and this Article is one of the first to create a theoretical and normative framework for atypical investors in the securities fraud paradigm. Building on a dataset of all 10b-5 cases filed in federal court in 2017, this Article explores the questions of when and whether short sellers and other atypical traders should benefit from the securities fraud class action structure.

Rule 10b-5 Meets Wagon Mound: A New Perspective on Loss Causation

In a classic securities fraud class action materially false or misleading information is disseminated into an efficient marketplace, resulting in an artificial market price that causes an investor to purchase securities at an inflated price. A corrective disclosure eventually signals the truth to the market and the investor suffers a loss when the share price declines. To prevail on a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission, the defrauded plaintiff must prove loss causation, defined as a causal connection between a defendant's fraud and the plaintiff's economic loss. The analysis in this Article shows that loss causation does not exist, and the defendant escapes liability, if scientists could not ex ante predict the disclosure event that revealed the fraud and corrected the inflated market price. There is no liability, even if all other Rule 10b-5 elements are satisfied. This theory may be relevant in cases where a false or misleading statement that distorted a company’s stock price is corrected by an event such as an unpredictable drug reaction or a novel computer security threat.

What's a Nice Company like Goldman Sachs Doing in the Supreme Court?

This essay considers the issues raised in the latest securities fraud class action to reach the Supreme Court – Goldman Sachs v. Arkansas Teacher Retirement System – and finds that the claims asserted therein against Goldman Sachs on behalf of open-market buyers of its common stock are claims that should have been asserted on behalf of Goldman Sachs (by means of a derivative action) and against the individuals who caused the losses at issue. The losses suffered by individual buyers of Goldman Sachs stock during the extraordinarily long forty-month alleged fraud period are minimal if they exist at all. Moreover, the law is quite clear that claims on behalf of the company arising from the same constellation of facts should take precedence over any claims on behalf of individual buyers. Yet the practice that has evolved is the opposite: Class claims take priority and company claims are settled for non-monetary governance reforms of dubious value rather than for real money. The forces that have led to this classic example of market failure are both fascinating and sinister. But the bottom line is that ordinary investors – such as investors in well-diversified mutual funds and index funds – end up losing far more than they gain from class actions. Indeed, index fund investors effectively pay out about twenty dollars for every dollar they recover. Thus, the best hope for reforming the system is for index funds to step up and intervene to assert the interests of diversified investors in favor of litigating such claims as derivative actions rather than as class actions.

Working Hard or Making Work? Plaintiffs’ Attorney Fees in Securities Fraud Class Actions

In this article, we study attorney fees awarded in the largest securities class actions: “mega‐settlements.” Consistent with prior work, we find larger fee awards but lower percentages in these cases. We also find that courts are more likely to reject or modify fee requests made in connection with the largest settlements. We conjecture that this scrutiny provides an incentive for law firms to bill more hours, not to advance the case, but to help justify large fee awards—“make work.” The results of our empirical tests are consistent with plaintiffs’ attorneys investing more time in litigation against larger companies, with the largest potential damages, particularly when there are multiple lead counsel firms. We find a similar pattern with relative efficiency, with more hours per docket entry for the largest‐stake cases with multiple lead counsel firms. Overall, our results suggest that plaintiffs’ attorneys are receiving windfall fee awards in at least some mega‐settlement cases at shareholders’ expense.

Coalitions among Plaintiffs’ Attorneys in Securities Class Actions

This paper examines contests among plaintiffs’ firms to become lead counsel in securities fraud class actions. We study lead plaintiff appointments in all federal securities class actions involving a disclosure claim from 2005 to 2016. We find that law firms’ decisions to combine correspond primarily with the existence of relationships—either with clients or between firms—rather than case characteristics. In the case of initial motions, the presence of a relationship between attorney firms and certain institutional investor movants for lead plaintiff corresponds with motions that propose multiple lead counsel. We also find that although the typical class action has several lead plaintiff motions, many of these motions will either withdraw or combine before the judge chooses the lead plaintiff and lead counsel. When motions combine, the number of selected lead counsel typically increases. The existence of prior relationships between law firms corresponds with the decision to withdraw or combine. Finally, we find that the correspondence of prior relationships between law firms on decisions to withdraw or combine does not increase with our proxies for the importance of synergies between law firms.

OOPs! The Inherent Ambiguity of Out-of-Pocket Damages in Securities Fraud Class Actions

Most securities fraud class actions under SEC Rule 10b-5 involve revelation of negative information about the defendant company that should have been disclosed earlier – bad news that (allegedly) has been covered up by company agents. The standard remedy in such cases is out-of-pocket damages (OOPs). But this measure of harm is inherently ambiguous. Some courts interpret it as price inflation at the time of purchase. Others interpret it as the difference between the price paid and the price at which a stock settles after corrective disclosure. Although it might seem that these formulations are synonymous, the latter includes not only the difference in price that would have obtained if the truth had been known at the time of purchase but also any additional difference that might be caused by revelation of the truth. For example, the market may conclude that the company is likely to become the target of an SEC enforcement action or private securities litigation. Either way, the company is likely to suffer increased legal expenses. In addition, the company may suffer an increased cost of capital because the market perceives added risk that information about the company may be unreliable. These additional factors and possibly others – herein dubbed collateral damage – will be reflected in the decrease in price that occurs immediately upon corrective disclosure. But such collateral damage is harm suffered by the company that should be the subject of a derivative action – for the benefit of all stockholders – and not a direct (class) action. The clear implication is that OOPs should be measured as price inflation at the time of purchase– that is, price inflation narrowly defined net of any collateral damage. Indeed, because FRCP Rule 23 – which governs class actions – requires that a class action for damages be superior to any other means of resolving a dispute, Rule 23 itself requires that collateral damage be addressed in a derivative action simply because it can be so addressed. As demonstrated here, state corporation law is perfectly congruent with federal securities law such that a derivative action for collateral damage will lie whenever a meritorious claim can be stated under Rule 10b-5. Aside from simplifying the litigation process by providing for unitary corporate recovery, derivative actions avoid the circularity inherent in class actions while also addressing the problem of excessive deterrence by providing a perfectly tailored action against individual wrongdoers. Finally, because derivative actions quite clearly address corporate internal affairs, a corporation can assure that claims for collateral damage will be so addressed by adopting a bylaw to that effect.

The Indian Securities Fraud Class Action: Is Class Arbitration the Answer?

In 2013, India enacted one of the most robust private enforcement regimes for securities fraud violations in the world. Unlike in most other countries, Indian shareholders can now initiate securities fraud lawsuits on their own, represent all other defrauded shareholders unless those shareholders affirmatively opt out, and collect money damages for the entire class. The only thing missing is a better financing mechanism: unlike the United States, Canada, and Australia, India does not permit contingency fees, so class action lawyers cannot front the costs of litigation in exchange for collecting a percentage of what they recover. On the other hand, the 2013 law enacted a public financing regime for securities fraud class actions and it is possible third-party financing will be permitted; these mechanisms may make up some of the loss in effectiveness caused by the lack of contingency fees. It is still too early to tell. Yet, commentators are very pessimistic that the Indian securities fraud class action will do much good because the Indian court system is glacially slow. For example, it takes over six years on average to resolve some civil appeals. The solution to this problem in the 2013 law was to channel the securities fraud class action to a special tribunal, the National Company Litigation Tribunal (“NCLT”). Yet, this type of solution has been tried before in India: special tribunals tend to quickly take on the negative characteristics of the general courts. This may be why very few securities fraud lawsuits have been filed since the 2013 law was enacted. We propose a different solution to the problem of the Indian court system: class arbitration. As we explain, although class arbitration is not perfect, it may better facilitate robust private enforcement than the Indian court system.

Working Hard or Making Work? Plaintiffs' Attorneys Fees in Securities Fraud Class Actions

In this paper, we study attorneys’ fees awarded in the largest securities class actions: “mega-settlements.” Consistent with prior work, we find larger fee awards but lower percentages in these cases. We also find that courts are more likely to reject or modify fee requests made in connection with the largest settlements. We conjecture that this scrutiny provides an incentive for law firms to bill more hours, not to advance the case, to help justify large fee awards – “make work.” The results of our empirical tests are consistent with plaintiffs’ attorneys investing more time in litigation against larger companies, particularly when there are multiple lead counsel firms. Using a difference-in-difference analysis, we show that “make work” increased in cases with multiple lead counsel after the Supreme Court validated a “price impact” defense in the Halliburton II case. We find a similar pattern with relative efficiency, with more hours per litigation day. We also find that courts award higher multipliers in cases with pre-litigation observable characteristics that indicate a lower risk of dismissal – and a correspondingly higher probability of settlement – particularly against larger companies. Overall, our results suggest that plaintiffs’ attorneys are receiving windfall fee awards in mega-settlement cases at shareholders’ expense.

Loss Causation and the Materialization of Risk Doctrine in Securities Fraud Class Actions

In the context of a claim for securities fraud under SEC Rule 10b-5, most federal circuit courts have ruled or recognized that loss causation can be proven by an event that demonstrates an earlier statement by a defendant company to be false. In other words, corrective disclosure need not take the form of speech. Rather, a statement can be shown to be false by the materialization of a risk that was concealed by the company, and investors can be compensated for any losses they suffer as a result. Although this materialization doctrine is well established, it is the thesis here that its ultimate effect is to over-compensate investors, thus encouraging excessive securities litigation and chilling voluntary disclosure. The point is graphically illustrated by the securities litigation that followed the Deepwater Horizon explosion and spill. There, plaintiffs argued that BP (the operator of the rig) had misrepresented its safety practices. Assuming the allegations to be true, the pre-event market price of BP stock would have been a bit lower, reflecting additional risk. If plaintiffs had paid that lower price, they would have had no claim as a result of the explosion and spill. So if plaintiffs recover an amount equal to pre-spill price inflation, they will be in exactly the same financial position as if they had bought knowing the truth. But most of the price decline following the event came from the prospect of cash outflows resulting from clean-up, repairs, fines, settlements, and possibly an increase in the cost of capital. To compensate buyers for these consequential losses is excessive. The risk of such losses is one that can be diversified away by investors. Moreover, if these consequential losses are actionable at all, they constitute a claim of mismanagement belonging to the company that should be pursued in a derivative action. To generalize: In cases in which loss causation can be shown only by materialization, the bulk of the claim is almost always more properly characterized as one on behalf of the company that should be resolved by a derivative action instead of by a class action on behalf of individual investors. Moreover, to recharacterize such claims as derivative carries significant collateral benefits: Because the company stands to recover (rather than to pay), derivative actions avoid the circularity problem endemic in class actions while providing a remedy that is perfectly tailored to the true (undiversifiable) loss suffered by investors. It is difficult to overstate the significance of this insight: It implies that much of securities litigation, as we know it must be recast as derivative rather than direct.

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.

Sense and Nonsense About Securities Litigation

In We Have a Consensus on Fraud on the Market – And It’s Wrong, James Spindler has attempted to defend securities fraud class actions (SFCAs) and the fraud-on-the-market (FOTM) doctrine by purporting to refute two arguments that have been cited by numerous scholars: (1) the circularity (feedback) critique and (2) the diversification critique. In essence, Spindler’s gist is that SFCAs are both workable and necessary. But in the end, Spindler exposes weaknesses in the usual arguments against SFCAs that point the way to still stronger arguments against SFCAs. Regarding circularity, Spindler argues that SFCAs are workable because it is possible even with circularity for investors to be compensated in full even though compensation is funded by a reduction in the aggregate value of the defendant company and thus the wealth of its stockholders (including those who are compensated). But he fails to recognize that because feedback magnifies buyer claims, it induces investors to spend that much more on precaution and increases already excessive deterrence. Moreover, it effects a transfer of wealth from diversified investors to stock-picking investors even though the law should encourage investors to diversify. Regarding diversification, Spindler argues that SFCAs are necessary because one cannot diversify away fraud. But as shown here, the loss from securities fraud is a mixture of diversifiable losses that someone will suffer one way or the other (when the truth comes out) and undiversifiable losses that derive from the cover-up of bad news. Bad things happen to good companies. Sales decline. Risks increase. But such losses can be diversified away because unexpectedly good things happen to other companies. In contrast, if an ordinary loss is exacerbated by a cover-up leading to a loss of investor trust (and an increased cost of capital) or cash outflows (from litigation expenses or fines), such additional losses cannot be offset by unexpected gains. There is no potential for gain from the absence of fraud. The only losses that really matter are the losses that cannot be diversified away. But these are losses suffered by the corporation that should give rise to a derivative action. Moreover, it turns out that derivative actions are perfectly tailored to compensate investors and to provide perfectly calibrated deterrence without the collateral damage caused by feedback.

Claim Character and Class Conflict in Securities Litigation

The loss suffered by buyers in a typical securities fraud class action may come from several distinct sources including lower expected return or a higher cost of capital or one-time outflows of cash or a combination thereof, all of which are quickly impounded in market price even though prospective. Under federal securities law (Rule 10b-5), a buyer may recover the entire difference between purchase price and market price after correction. But some of this loss should properly give rise to a derivative claim on behalf of the corporation (and all stockholders) rather than a direct claim on behalf of a buyer class. In addition, some sources of stock price decrease are losses that would happen even in the absence of fraud. Thus, for buyers to recover for such a loss is to restore them to a better position than if there had been no fraud, resulting in over-deterrence. Moreover, investors can protect themselves against such losses through diversification. In contrast, the extra loss that derives from fraud or misconduct – loss over and above the loss from bad business luck – cannot be diversified away because such losses can result only in a decrease in stock price. Although stock price may sometimes increase because of good business luck, there is no potential for gain from the absence of fraud or misconduct. The bottom line is that the only losses that really matter are those that are non diversifiable – which losses also happen to be derivative. The question is why the courts have failed to characterize investor claims properly. The answer is a combination of historical factors, conflicts of interest, and market failures. The most promising solution seems to be for index funds acting on behalf of investors to intervene to oppose certification. Index investors who trade infrequently – and only for purposes of portfolio balancing – lose more as holders (because the corporation pays) than they recover as buyers. They should oppose a direct class action remedy in favor of a derivative remedy by which the corporation recovers to the extent of actionable losses that give rise to a decrease in stock price. The same is true for diversified investors in general who comprise a large majority of investors. And because it is impossible to sort out investors who would thus oppose a direct buyer remedy from those who may favor such a remedy, the courts should decline to certify securities fraud class actions on grounds of class conflict. Rather, such actions should be recast as derivative actions, which constitute a superior form of class remedy under established rules of civil procedure, because they benefit all stockholders proportionally and only for non-diversifiable losses.

Securities fraud and corporate board turnover: New evidence from lawsuit outcomes

We examine the relationship between outcomes of securities fraud class action lawsuits (SFCAs) and corporate board turnover rates. Our results indicate that turnover rates for board members are higher when a firm settles a lawsuit than when a suit is dismissed. Outside director turnover is most sensitive to SFCA outcomes, perhaps reflecting reputational effects. Results demonstrate that involvement in securities fraud is costly for corporate board members.

Market Efficiency and Fraud on the Market: The Promise and Peril of Halliburton

This spring, the Supreme Court will hear Halliburton v. Erica P. John Fund, the most important securities law case in a quarter century. The Court will reconsider Basic v. Levinson and the fraud-on-the-market doctrine, the doctrine that has made the modern securities fraud class action possible. I argue that — contrary to the claims of the parties and of several of the Justices — the Court need not pass judgment on the efficient capital markets hypothesis in order to pass judgment on the fraud-on-the-market doctrine. It is possible to accept the efficient capital markets hypothesis and reject the fraud-on-the-market doctrine, or to reject the efficient capital markets hypothesis and accept the fraud-on-the-market doctrine. I further demonstrate that it is not only unnecessary, but would also be profoundly unwise for the Justices to wade into the debate over market efficiency. While market efficiency is of little relevance to the debate over the fraud-on-the-market doctrine, it is central to numerous other contemporary legal debates, many of which are of far more fundamental importance than the fraud-on-the-market doctrine. Any Supreme Court pronouncements on market efficiency would be certain to resurface in these debates in ways the authors would not intend.

Audit Firm Reputational Consequences of Alleged Non-Accounting Misconduct by Clients

This study examines whether U.S. audit firms experience reputational damage when clients are accused of misconduct that does not affect auditor litigation risk. Auditors have minimal, if any, responsibility related to non-GAAP securities fraud class actions, our proxy for such misconduct, but bounded rationality suggests that auditors could still incur reputational damage from these suits. In the year after suit filing, fees are lower for the auditor’s clients in the same city-industry as the sued client, but are unchanged for clients of other auditors in the same city-industry. This effect is stronger (1) for new engagements, suggesting auditors must provide incremental discounts to win new clients, and (2) when suits are severe, likely because the negative information is more salient. Overall, these results provide evidence that reputation is an important incentive for U.S. audit firms. This study also contributes to mounting archival evidence of systematic biases and cognitive errors by corporate decision-makers.

The Role of Directors’ and Officers’ Insurance in Securities Fraud Class Action Settlements

AbstractBecause of previous data unavailability, it is unclear how important directors’ and officers’ (D&O) insurance is in securities fraud class action settlements. Using a unique data set of US D&O policies, we find that D&O insurance coverage is a less significant determinant of settlement amounts than estimated damages and proxies for the merits of cases. Limits on D&O insurance are related to settlements in only the weakest cases (those without allegations of accounting violations or institutional lead plaintiffs) where proxies for cases’ merits play a minimal role. Our findings suggest that most securities fraud class action settlements are meritorious and that accounting-related cases are a reasonable proxy for fraud.