Could New Regs Bring More Lawsuits?

Proposed regulatory reforms in Congress could reverse the recent dip in securities class-action filings.

The number of securities class-action claims made in 2009 declined 24% from the previous year, according to a recent study by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research. A total of 169 claims were made in 2009, compared with 223 in 2008. However, the dip could be short-lived, depending on the outcome of regulatory-reform bills working their way through Congress.

For instance, a bill introduced in November by members of the Senate Banking Committee would expand the liability of a fraudulent company’s accounting firms, suppliers, and banks, increasing the likelihood that these business partners could be sued. Tucked into the bill is a provision allowing civil action to be brought against a third party that “knowingly or recklessly provides substantial assistance” to anyone who has violated securities laws. If the provision survives, such so-called secondary actors to fraud would no longer be protected by Supreme Court decisions that have dismissed shareholder claims aimed at expanding the types of parties considered primarily responsible for securities fraud.

By opening up claims against aiders and abettors of fraud — who until now have largely been shielded from private litigation — the bill could “build up a whole new class of targets for plaintiffs,” says K. Stewart Evans, a senior partner at law firm Pepper Hamilton.

Investors harmed by market losses because of fraud may be especially keen on suing accounting firms if the bill becomes law. The percentage of claims that cite auditors as defendants increased last year, according to Cornerstone. Auditors were pinged in 7% of claims in 2009, compared with 3% in 2008. However, allegations of violations of generally accepted accounting principles were at their lowest level since 2005, with just 34% referencing accounting problems. Accounting firms may have become bigger targets because of their “deeper pockets,” notes Tracy Coenen, a fraud examiner and forensic accountant. “The auditors want to protect their reputation and to get rid of the issue, so they may be more willing to settle.”

Other changes on the regulatory front could make plaintiffs’ lawyers busier in the year ahead. Reforms proposed in Congress (which have yet to be seriously worked on by the Senate) would bolster the authority of the Securities and Exchange Commission. The regulator’s enforcement division may prove to be more active this year after spending 2009 repairing its reputation and adjusting to its new director, Robert Khuzami. News of enforcement actions or investigations can often trigger more lawsuits from the plaintiffs’ bar than significant dips in a stock’s price can, notes Donald Chase, a partner at law firm Morrison Cohen.

Meanwhile, the plaintiffs’ bar has been digging through older cases to keep active, contends Cornerstone, which attributes the decline in shareholders’ claims to less volatility in the stock market. (The 169 filings in 2009 included 71 claims related to the credit crisis or Ponzi schemes.) The research firm saw a higher number of cases that had longer lag times between the date the alleged fraud was disclosed and the date the related suit was filed.

Cornerstone connects many of the longer-lag-time filings to plaintiffs’ law firm Coughlin Stoia Geller Rudman & Robbins, where William Lerach was once a partner before he was imprisoned for his role in a kickback scheme. Lerach served as a symbol for the plaintiffs’ bar during its heyday in the 2000s, when he led a successful case against Enron. Last year Coughlin was disproportionately busy compared with other firms in filing claims on behalf of shareholders, says Cornerstone, accounting for 39% of the filings made. What’s more, more than 63% of the filings with longer lag times came from the firm, according to Cornerstone. A Coughlin spokesman did not respond to CFO‘s request for comment.

To be sure, few securities class-action cases ever go to trial. Only 20 of the 2,682 federal class-action shareholder lawsuits filed between 1995 and 2008 made it to the trial phase instead of being resolved through a settlement agreement, according to RiskMetrics Group. Indeed, 2009 will stand out because it had 2 trials (involving Household International and Vivendi), notes NERA Economic Consulting in its annual review of class-action litigation. Like Cornerstone, NERA also calculated a decline in securities-fraud filings last year, but it came up with different figures because it uses a different methodology for tracking cases. NERA most recently said 235 cases were filed last year, marking a 7% decrease from 2008.

 

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