Signs of Life: Securities Suits Rise

Despite scrutiny and a crackdown on fraud, securities class-action litigation filings are rebounding.

When William Lerach, the class-action lawyer who won more than $7 billion for Enron investors, pleaded guilty this week to criminal conspiracy charges, plaintiffs’ attorneys everywhere felt a chill run up their spine. The investigation into his former law firm, Milberg Weiss LLP, for allegedly participating in a scheme to secretly pay individuals to serve as plaintiffs in more than 150 lawsuits created what some called the “Milberg effect,” deterring lawyers from suing companies whenever stock prices sag.

To be sure, class-action lawyers have filed fewer lawsuits during the past two years, although they have been winning bigger settlements. The recent decline in the number of shareholder class-action lawsuits has shown that tighter financial regulations are working, but shaky financial markets and the lure of ballooning settlements could change that. A report this month by NERA, an economic consultancy, finds that after bottoming out in 2006, shareholder class-action filings were on the rise in the first half of 2007.

After just 136 cases were filed last year, 76 were filed in the first six months of 2007. The 12 percent projected increase is particularly meaningful, NERA says, as options-backdating cases — a boon in 2005 and 2006 — have all but vanished this year. “The bottom is starting to rise again,” says Ronald Miller, an author of the NERA report. “It looks like we have a turnaround in the rate of filing.”

The apparent reversal comes as each of the top 10 shareholder class-action settlements exceeded $1 billion for the first time: previously, just 3 settlements exceeded the $1 billion mark. The median settlement in the first half of 2007 reached a high of $9 million. “High settlements are mostly driven by the investor loss measure,” Miller told CFO.com. “The scale of these suits for settlement has been big.”

Some of the high settlements represent a “hangover,” say observers, as headline settlements from a few years ago are finalized. Meanwhile, NERA finds that median investor losses have declined from 2005, and that cases involving accounting allegations — which notoriously yield the highest settlements — are down to 26 percent from 57 percent in 2006.

According to PricewaterhouseCoopers, which calculates a 20 percent decline in cases with accounting allegations, the drop is largely due to a decrease in charges of fraudulent revenue recognition. PwC finds such allegations declined from 41 percent in 2006 to 17 percent so far in 2007. Of the accounting allegations, however, 70 percent involved internal controls in 2007 compared with 48 percent in 2006.

Despite the turnaround, Grace Lamont, a partner in PwC’s securities-litigation practice, says she does not expect shareholder class-action filings to reach the 10-year average of 189. Although she acknowledges a “Sarbanes-Oxley effect,” the markets may have the most impact on the rate of filings. “What are moving these numbers are the general economy and the volatility of the stock market,” avers Lamont. “What will happen will depend on what happens with the debt crisis and what happens with the volatility of the stock market going forward.”

Lamont notes that there were four cases specifically related to the subprime-mortgage sector in the first six months of the year, and that there have been an additional eight during the past three months. Turmoil in the subprime sector could lead to other types of litigation beyond class action, but its effect on the markets is likely to spur more lawsuits.

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