Why Event-driven Securities Litigation Has Become A Thing—and A Lucrative One Too – Corporate/Commer…

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If Matt Levine has a mantra in his “Money Stuff”
column on Bloomberg, it’s this: everything is
securities fraud. “You know the basic idea,” he often
says in his most acerbic voice,


“A company does something bad, or something bad happens to it.
Its stock price goes down, because of the bad thing. Shareholders
sue: Doing the bad thing and not immediately telling shareholders
about it, the shareholders say, is securities fraud. Even if the
company does immediately tell shareholders about the bad thing,
which is not particularly common, the shareholders might sue,
claiming that the company failed to disclose the conditions and
vulnerabilities that allowed the bad thing to happen. And so
contributing to global warming is securities fraud, and sexual
harassment by executives is securities fraud, and customer data
breaches are securities fraud, and mistreating killer whales is
securities fraud, and whatever else you’ve got. Securities
fraud is a universal regulatory regime; anything bad that is done
by or happens to a public company is also securities fraud, and it
is often easier to punish the bad thing as securities fraud than it
is to regulate it directly.” (Money Stuff, 6/26/19)

(See 
this PubCo post
.)  But should everything really be
securities fraud? An interesting new
paper
 examines the phenomenon.

Much securities fraud litigation involves allegations of company
conduct such as cooking the books or inflating the company’s
prospects-conduct that, if true, causes direct harm to
 shareholders.  Some securities litigation, however, is
based on events such as oil spills or product defects-conduct that
causes direct injury primarily to a different set of constituents,
but only indirect injury to shareholders. Yet, when the stock drops
after the event, shareholders sometimes sue the company, contending
that the company provided inadequate disclosure about the risks
related to the event.  This type of litigation, often referred
to as “event-driven securities litigation,” has become
increasingly common.

SideBar

In 2020, the U.S. Chamber Institute for Legal Reform and the
Center for Capital Markets Competitiveness of the U.S. Chamber of
Commerce filed a 
rulemaking petition
 asking the SEC to use its authority
under the Private Securities Litigation Reform Act to take on
event-driven securities litigation arising out of the COVID-19
pandemic. In particular, petitioners asked the SEC “to bar
liability for statements about a company’s plans or prospects
for getting back to business, resuming sales or profitability, or
other statements about the impacts of COVID-19, whether
forward-looking or not-as long as suitable warnings were
attached.” Petitioners argued that securities litigation has
been predicated on “wildfires, oil spills, product recalls, a
plane crash, and a dam collapse.” However, Petitioners
considered these cases to often be of “dubious merit,”
filed to “extract a quick settlement.” They indicated
that securities class actions based on COVID-19 have already been
filed, and predicted that “pandemic-related events will be
seized upon as the basis for additional securities
litigation.”

Petitioners considered the recent increase in securities
litigation to be driven in large part by the growth of event-driven
claims, citing in support Professor John Coffee of Columbia Law
School:

“Once, securities class actions were largely about
financial disclosures (e.g., earnings, revenues,
liabilities, etc.). In this world, the biggest disaster was an
accounting restatement. Now, the biggest disaster may be a literal
disaster: an airplane crash, a major fire, or a medical calamity
that is attributed to your product.. The expectation of major
losses from the disaster sends the issuer’s stock price down,
which in turn triggers securities litigation that essentially
alleges that the issuer failed to disclose its potential
vulnerability to such a disaster.” 

In these cases, Coffee argued, plaintiff’s counsel do not
spend months building a case to plead scienter with particularity;
rather, these cases are filed quickly, and “that may be
because ‘some plaintiff’s counsel are less concerned about
surviving a motion to dismiss because they expect an early (and
cheap) settlement.'” The characteristics of this
event-driven litigation, petitioners argued, are just like the
those that led Congress to pass the PSLRA.  Although the
“legitimacy of these lawsuits is highly suspect,” the
litigation creates “a large potential exposure. The defense
costs are high, and few companies want to risk the reputational
damage that could result from prolonging the litigation of such
claims.”

Is
Everything Securities Fraud?
, by Emily Strauss, a
professor at Duke Law School, examines the prevalence and
attributes of event-driven securities litigation.  The author
looked at approximately 400 securities class actions against public
companies during the period 2010 to 2015.  The author found
that about 16.5% of securities class actions “arise from
misconduct where the most direct victims are not
shareholders.”

In a conclusion that may seem counter-intuitive, the author
found that regular securities cases, where shareholders are the
primary victims, are almost 20 percentage points more likely to be
dismissed (55%) than event-driven securities cases (36%). 
What’s more, the average shareholder settlement in event-driven
securities litigation (where the misconduct most directly harms
victims other than shareholders) is $24.3 million compared to $7.2
million for regular securities litigation where the primary victims
are shareholders. The author noted that these correlations
“persist even when controlling for firm size, class period
duration, court expertise, and indicia of merits of the lawsuit,
such as institutional investors as lead plaintiffs, earnings
restatements within the class period, and whether the complaint
cited an SEC investigation.” In addition, defendant companies
in event-driven securities cases are larger on average ($29.6
billion in total assets), compared to regular securities class
actions on average ($8 billion in total assets). And, almost 70% of
event-driven securities cases were brought by pension funds and
other institutional investors, compared with only 42% of regular
securities litigation.  That’s notable because
“institutional investor lead plaintiffs are associated with
lower dismissal probability and dramatically higher settlement
values. They also generally appear to sue much larger
firms.”

The author concluded that these event-driven securities class
actions are “big-ticket cases.” Why is that? According to
the author, probably because, in these cases, the “shareholder
plaintiffs almost universally benefit from government
investigations into the defendant firms’ misconduct against
third parties.” That is, plaintiffs “piggyback” on
the government’s factfinding; work already performed by
regulators such as the EPA, the FDA and the NHTSA means that
“the bad facts are already public,” making these cases
prime vehicles for litigation-or, depending on your point of view,
piling on by opportunistic plaintiffs. The author viewed the
incidence of government investigations as “the most striking
difference”: although SEC investigations were cited in both
types of complaints with similar frequency, over 70% of
event-driven securities class actions cited only inquiries or
actions by non-SEC regulators, but only 4% of regular securities
class actions cited these types of inquiries. Nearly 90% of
complaints in event-driven securities lawsuits cited some
government investigation.

But do these cases have merit?   The answer, according
to the author, “is that in practice, there is usually
extraordinary ambiguity in these cases about whether the
shareholders were defrauded.” The author contended that,
although the characteristic “low dismissal rates, high
settlement values, government investigations and institutional lead
plaintiffs” are often considered indicia of merit, with
event-driven securities litigation, that is not necessarily the
case. She argued that the intense pressure to settle these
cases-because of the size of the claims, the battle’s being
fought on several fronts and uncertainties of success, rather than
merit-could account for the relatively high settlements.  In
addition, institutional investors, which are often the lead
plaintiffs, may “cherry-pick” these cases, “not
because there was clearly investor fraud, but because, thanks to
the government investigations that accompany the vast majority of
them, bad facts are already public, and the defendants tend to have
deep pockets.”  Finally, the investigations performed by
regulators outside of the SEC may not really provide “hard
evidence of investor fraud” as compared with SEC
investigations: “the fact that non-SEC regulators discover
that something went wrong does not necessarily mean that investors
were defrauded.”

While the real solution, the author observed, would be for
companies to adopt better mechanisms to prevent the underlying
event that caused the injury altogether, the author offered what
she considered to be a more doable policy prescription: two
“targeted mechanisms that might help shareholders and the
general public better monitor firm conduct that externalizes costs
to third parties: more specific catastrophic risk disclosures.and
mandatory ESG disclosures.”  (With regard to catastrophic
risk disclosures, some might point out that many companies already
include in their SEC filings 40- or 50-page risk factor sections
that seek to do just that.)  With regard to ESG disclosures,
she argued that the absence of mandatory uniform requirements has
made ESG disclosures difficult to evaluate and compare and
allowed companies to engage in greenwashing.  However, the
author suggests, if companies “undertake, in measurable terms,
to be responsible citizens, there may be less leeway for them to
maintain operational risks that could result in harm to third
parties.”  Accordingly, she contends, providing better
information  about the “measures firms take to be
responsible corporate citizens.would enable shareholders and the
general public to better monitor these risks.”

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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