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Securities Suits Down in 2005, Study Says

January 04, 2006|Molly Selvin | Times Staff Writer

The flat stock market of 2005 helped bring at least one benefit to corporate America: a decline in securities class-action suits, according to a study released Tuesday.

The number of such suits dropped 17% to 176 last year, the lowest total since 1997, according to an annual report by Boston-based Cornerstone Research and Stanford Law School. The highest number in recent years, 239 suits, came in 1998.

The stock price volatility that came with the tech boom of the late 1990s contributed to big claims by investors who alleged mismanagement, the study's authors said. Tighter corporate governance laws and a quieter market also might have played a role in last year's drop in litigation, they said.

The findings are good news for American businesses and investors, said Stanford's Joseph Grundfest. But he cautioned that "we won't know for another two or three years" whether the decline will become a trend.

More significant than the drop in the number of suits was an even steeper dive in total alleged losses, Cornerstone economist John Gould said.

Those losses -- defined as the combined decline in market capitalization suffered by defendant firms the day after restating earnings or taking another corrective action that led to a suit -- fell by a third in just one year, from $147 billion in 2004 to $99 billion in 2005. This may reflect more rigorous corporate accounting practices, some observers said.

John C. Coffee, a securities expert at Columbia Law School, pointed to "a sharp and continuing increase in financial statement restatements" last year. The restatements were not necessarily evidence of more fraud, he said, but might indicate that accountants have become more conscientious since the passage of the 2002 Sarbanes-Oxley corporate reform law.

Coffee also said there were "overlapping explanations" for the filings drop, adding that it was "hard to say that Sarbanes-Oxley has solved everything."

San Francisco class-action lawyer Robert Lieff said fewer class actions were being filed in part because some institutional plaintiffs concluded that they would fare better against corporations by going it alone, not diluting their claims with lesser ones filed by smaller investors.

In some cases, Lieff said, investment funds represented by his firm won full restitution while class members who sued the same corporation recovered only 10% of their alleged losses.

Some observers said last year's relatively stable stock market probably contributed to the drop in securities suits because litigation tends to soar with increased volatility.

"When people are not losing money, they don't get as upset about allegations of fraud," said Mark Gitenstein, a securities lawyer in Washington.

Rising markets also could spur litigation, said Lynn Stout, who teaches securities law at UCLA.

"Financial scandals are historically associated with ... bubbles," she said. "People may get so swept up in enthusiasm for the market that they'll buy things they normally wouldn't buy with a 10-foot pole."

In the recent market, she said, "fraud is much less tempting because there aren't as many suckers out there." Even without Sarbanes-Oxley, she said, "we still would have seen a decline in fraud allegations."

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