Has the two-year lawsuit lull ended?

Was the two-year letup in class action lawsuit filings too good to be true?

In July 2007, Cornerstone Research released its mid-year 2007 study of securities class action filing trends, in which it noted that the first half of 2007 “marked the fourth consecutive six-month period with below average securities class action filings.” The Cornerstone report went on to note that the average filing rate since June 2005 was “40 percent below the average observed during the preceding nine-year period.”

Stanford Law Professor Joseph Grundfest, commenting in the Cornerstone report on the two-year decline, speculated that as a result of post-Sarbanes Oxley governance improvements, we may have experienced a “permanent shift” to a lower level of securities class action filings. The Cornerstone study also contained additional analysis suggesting that historically lower levels of stock market volatility might alternatively explain the recent lower filing levels, and that securities class action filings might return to historical levels if normal levels of stock market volatility were to return.

NERA Economic Consulting issued a separate mid-year 2007 report of securities class action activities in September 2007. While the observations in the NERA report were consistent with the findings in the Cornerstone report, the NERA report added the observation that “filings in the first half of 2007 increased 47 percent from the second half of 2006, indicating that the trend in filings may be changing direction.”

The NERA study focused on the six-month period that ended on June 30, 2007, but it is clear that the filing levels since June 30 have continued the upward trend noted in the NERA report, particularly since Aug. 1, 2007.

By my count, during the two-month period beginning on Aug. 1, 2007, 37 publicly traded companies were sued for the first time in securities class action lawsuits. If this filing rate were extrapolated over a 12-month period, the resulting annualized filing rate would be 222 lawsuits, which is both well above the filing rates between June 30, 2005 and June 30, 2007, and also consistent with historical norms. By way of comparison, according to Cornerstone, the average number of securities class action filings during the nine-year period between 1996 and 2004 was 202, compared with 116 filings for the full year 2006.

The increased securities class action filing activity during August and September was to a certain extent attributable to the growing wave of subprime lending-related litigation. Many of the lawsuits filed during that period involved companies directly involved in subprime lending or whose businesses were disrupted by the subprime meltdown. But it is significant that the subprime litigation wave is not all or even most of the story; the lawsuits are arising in a diversity of sectors and involve a variety of allegations. Most of them have nothing to do with subprime lending.

The apparent upward trend in securities class action filings during 2007 when compared to the 2006 filing level is particularly striking when the specifics of the 2006 filing activity is taken into account. The number of filings during 2006 was significantly inflated by the number of options backdating-related securities class action filings during 2006. Almost all of the 33 options backdating-related securities class action lawsuits were first filed during 2006. So, the options backdating cases represent a significant portion of the total of 116 class action lawsuits filed in 2006. The influx of options backdating cases did not continue into 2007, so the fact that the 2007 numbers have increased over 2006, although the 2006 numbers were increased by the short-term effect of the options backdating scandal, is significant.

Clearly part of what is going on is that volatility has returned to the financial marketplace. A disrupted credit market and a more volatile securities environment have stressed a number of companies, resulting in litigation in some cases.

It now appears that, contrary to Professor Grundfest’s suggestion that class action had experienced a permanent shift to lower filing levels, the two-year lull in securities lawsuits filings was simply a side-effect of an unusually stable financial marketplace. While we would all like to believe Professor Grundfest’s optimistic assessment that as a result of corporate reforms there is now less fraud, it seems that his proclamation of a permanent shift to a lower level of securities class action activity may have been premature, at best.

To be sure, a two-month period may prove to be too short of a time from which to generalize. But based on securities class action activity during August and September 2007, it appears that we may be headed back to historical class action filing levels.

Topics Lawsuits