A larger number of settlements approved in 2004 as well as an increase in
the average settlement size contributed to the increase in the total value
of cases settled. In 2004, there were 118 cases settled, compared to 96 in
2003, a 23 percent increase. The average settlement size increased by more
than 25 percent from $19.2 million for settlements through 2003 to $24.6
million in 2004.
A rise in the calculation of "estimated plaintiff-style damages" in 2004 was
a likely contributor to the increase in the average settlement.
Average "estimated plaintiff-style damages" increased by more than 45
percent to $2.5 billion in 2004 from only $1.7 billion in 2003, representing
the seventh consecutive yearly increase. In 2004, the median
(midpoint) "estimated plaintiff-style damages" was $329 million while in
2003 the median was $184 million. For purposes of the study, "estimated
plaintiff-style damages" are calculated based on a simplified version of a
model often used by plaintiffs to estimate the number of shares damaged and
the amount of alleged stock price inflation.
Underlying the rise in the calculation of average "estimated plaintiff-style
damages" in 2004 was a 40 percent increase in the length of the average
class period (from 1.2 years in 2003 to 1.7 years in 2004), as well as an
increase in the dollar amount of market capitalization losses by defendant
companies.
"On average, cases tend to settle approximately three years after they are
filed," explained Dr. Laura Simmons, a principal in Cornerstone Research's
Washington, DC office and an author of the study. "Therefore, many of the
cases that settled in 2004 were filed during the bear market that began in
2000 and thus involved losses associated with a period of significant market
decline."
However, Cornerstone Research's analysis reveals that the trend in larger
damages is likely to continue. This in part reflects the overall expansion
in the market capitalizations of publicly traded firms through 1999 and
early 2000. With recent market fluctuations and the return of the U.S.
securities markets to mid-1999 levels, Dr. Simmons believes that increases
in the calculations of "estimated plaintiff-style damages" are likely to
persist into the future.
"These trends warrant careful attention from executives and directors at all
publicly traded firms," observed Joseph A. Grundfest, Esq., a professor of law and
business at Stanford Law School and a former Commissioner of the Securities
and Exchange Commission. "Especially coming on the heels of news that
outside directors at Enron and WorldCom have been asked to reach into their
own pockets to fund settlements — and not to rely on insurance and
indemnification — it makes sense for firms to redouble their efforts to
avoid liability for securities fraud."
Interestingly, even though "estimated damages" increased, settlement values
expressed as a percentage of those damage estimates actually declined
significantly from a median of 4.0 percent for settlements through 2003 to
2.1 percent for settlements reached in 2004. For example, for 2004
settlements with "estimated damages" in the range of $50 million to $125
million, the median class recovery was 4.1 percent of "estimated damages."
Settlements in the same range during 2003 were 5.7 percent of "estimated
damages." The largest lawsuits with "estimated damages" in excess of $1
billion saw median settlements decline to only 0.8 percent of estimated
damages in 2004, a settlement rate that is slightly less than half the rate
of 1.7 percent observed through 2003. Although the largest cases receive the most media attention, more than 65
percent of all settlements in 2004 were for less than $10 million and
approximately 80 percent were for less than $30 million.
Analyzing the 620 cases that have settled since the passage of the Reform
Act, the study found several leading factors that tend to influence
settlement amounts. For instance, settlements were higher in cases where
institutional investors were lead plaintiffs ($10.1 million median
settlement value with them vs. $4.9 million without), where the SEC also
took action against the defendants ($10 million vs. $5.3 million), and, most
significantly, where corresponding derivative actions (i.e., suits filed
against officers and directors on behalf of the defendant
corporation) were filed, ($17.7 million vs. $5.1 million).
"Companion derivative actions tend to be associated with larger class action
cases, as well as cases involving accounting allegations, SEC actions, and
institutions serving as lead plaintiff. However, even considering these
factors, they are still associated with higher class action settlements,"
noted Simmons.
Also significant, accounting issues were included in the allegations of
nearly 55 percent of all post-Reform Act cases settled to date, and these
cases settle for a significantly higher percentage of "estimated damages"
relative to cases not involving accounting allegations. Settlements in
cases alleging violations of GAAP settled for 4.3 percent of estimated
damages while cases not alleging such violations settled for 3.2 percent.
Settlements in cases alleging financial restatements settled for 5.3 percent
of estimated damages while case without such allegations settled for 3.4
percent. Settlements in cases that named an accountant as a defendant were
5.3 percent of estimated damages while cases without accountant defendants
settled for 3.4 percent.
A full copy of Cornerstone Research's Post-Reform Act Securities
Settlements: Updated Through December 2004 is available at http://securities.cornerstone.com/pdfs/Settlements_2004.pdf. Additionally, Dr. Simmons is available
for interviews.
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