Securities Litigation Is A Predictable Market, Study ShowsSean Griffith in Forbes, July 30, 2012
A study of more than 1,000 securities-fraud lawsuits shows that while stock-market returns are essentially random, plaintiff lawyers are fairly predictable when it comes to which cases they’ll file and how much they’ll settle them for.
The paper examined fraud suits according to the precise legal claim at issue, the amount of money shareholders claim to have lost, the size of the company, the court the case is filed in, and a subjective measure of “sexiness” based on how much notoriety the case got in the news. The study found a predictable relationship between the type of case and whether and how much it settled for, with suits involving big companies with ugly facts around them generally garnering the biggest settlements.
When it comes to securities class actions, “there’s a settlement market that sort of works,” said Thomas Baker of the University of Pennsylvania Law School, a co-author and specialist on medical malpractice litigation. “The fact we can make the model we made shows there’s consistency out there.”
The paper, Predicting Securities Fraud Settlements and Amounts, was written by Blakeley B. McShane of Northwestern University, Oliver P. Watson of Juridigm, Baker and Sean J. Griffith of Fordham University School of Law. Their results could be of great interest to corporations and insurance companies, which constantly wrestle with how much to offer to settle securities suits. Securities class actions represent 35-40% of all class actions and 75% of all money paid out to settle such cases, running to billions of dollars a year.
Medical malpractice litigation is similar, in that it is prompted by events that are highly predictable in general — bad outcomes in hospitals and medical clinics — and frequently settled by insurance companies. The difference is many more malpractice cases go to trial, offering an objective reference point for how much juries tend to award for different types of injuries.
Securities class actions virtually never go to trial, because the potential damages are so high relative to the amount plaintiff lawyers are willing to settle them for. Unlike med-mal plaintiffs, the “clients” in securities cases are thousands of shareholders who usually can’t be bothered to fill out the paperwork to claim a damage check for a few dollars per share owned. Congress changed the law to require courts to appoint an institutional shareholder with larger losses to lead the litigation, but that is frequently either a labor-union pension fund or state or municipal pension fund where plaintiff lawyers can curry favor by providing campaign contributions.
The study found that lawyers gravitate toward cases with large potential damages, such as when a large-cap company’s stock falls a lot relative to the market and its industry group. These cases also have a higher rate of dismissal, showing that lawyers will make the rational choice to pursue an iffy case if the stakes are high enough, Baker said.
Cases where the target is smaller settle for less, even if the facts are good, and lawyers eschew cases where both the facts and the amount of money at stake are unfavorable.
The study found cases with the highest likelihood of settling involved non-durable goods manufacturers in the 10th federal circuit based in Denver, while the least likely were utility cases in the Fifth Circuit based in New Orleans. The highest settlement amounts came with “utilities” in the Fifth Circuit, however, perhaps reflecting the multibillion-dollar settlements surrounding the Enron litigation.
Most securities lawsuits are settled within the limits of companies’ director and officer insurance policies, curious given that the largest policy available is only $300 million and many cases settle for less than $10 million. Baker said based on his anecdotal research for other papers, he believes companies have no interest in fighting these lawsuits given they can get rid of them through insurance and concentrate on running their businesses instead.
The research should find a market with insurers, Baker said, since they now tend to estimate reserves for securities litigation either by taking an arbitrary amount of the shareholder loss, say 2%, or relying lawyers to come up with an estimate.
“Our research shows it’s a rational settlement marketplace,” he said.