The Litigation Storm

Boards were just beginning to bask in the milder securities class-action litigation climate. After record numbers of suits in the early part of the decade, the number of cases was dwindling to the point that directors wondered if a permanent change had occurred. There were numerous reasons for such optimism. Courts were holding plaintiffs to higher standards in their allegations of securities fraud. The stock market was fairly steady, and instances of accounting fraud and insider trading were decreasing. To top it all off, Milberg Weiss—enemy number one to many corporate defense lawyers—was being torn apart by its own scandal and fraud case. In other words, things were good.

Then something happened in the second half of 2007 to break the relative calm. The subprime-mortgage crisis unfolded, and concerns about the economy caused stock-market volatility— a chief accelerant to securities class actions—to pick up. More than 100 companies were sued for securities-related allegations in the second part of the year, compared to 116 in all of 2006, reversing a downward trend of eight consecutive quarters of below-average litigation activity.

The reversal of fortune has many board members wondering if this augurs a return to days when an onslaught of securities cases put many companies on the defensive. They are asking: What’s causing the shift in litigation? What are the issues being litigated? And what should they be on the lookout for?

Surprisingly, there is some cause for optimism. Experts, including Joseph Grundfest, a professor at Stanford University School of Law and director of its Securities Class Action Clearinghouse, believe that the recent increase is a temporary blip rather than the beginning of a trend. They cite a number of positive developments in litigation that favor corporate defendants over the long-term. In fact, Grundfest says that if you rule out specific events, such as stock-options backdating or subprimerelated cases, the downward trend in class-action litigation might continue. Corporate officers are possibly just behaving better, he suggests. “Most corporate managers are not engaging in risky behavior the way they used to be. Accounting is more precise. Books are better kept, the probability of getting caught is much higher than it used to be, and the price you pay is much greater.”

Going the Distance

One of those positive developments was the jury verdict in favor of JDS Uniphase Corp. following five years of shareholder litigation. Last November in U.S. District Court in Oakland, Calif., a jury, citing insufficient evidence to show wrongdoing, ruled that four former executives were not guilty of insider trading and securities fraud.

The defendants’ victory may embolden other companies to proceed to trial. This is “an important landmark in modern securities litigation,” says Grundfest, a former commissioner of the Securities and Exchange Commission (SEC). “These cases rarely go to trial, and for the defendants to win a total victory in a case that claimed $20 billion in damages demonstrates that not every case that makes it past summary judgment has merit. The interesting question is how and whether this trial result might cause plaintiffs to modulate their settlement demands or embolden defendants to take cases to trial.”

In its year-end report, the Securities Class Action Clearinghouse cited the JDS Uniphase case as one of the defining events in class-action litigation, along with the guilty plea of former Milberg Weiss Bershad & Schulman partner William Lerach, and the surge in filings related to the subprimemortgage market crisis. A fourth development that bears note was the Supreme Court decision in Tellabs v. Makor that requires plaintiffs to show stronger evidence of fraud than previously sought.

"The scandal and indictments at Milberg Weiss may have had the greatest effect no reducing class-action litigation, especially securities class action." --Steven Hantler, American Justice Partnership 

Experts such as Grundfest believe the reasons for the decline over the last few years stem from better accounting practices, a more stable stock market, and increased federal enforcement activity.

The nature of class actions is also changing. The Stanford report found a “moderate decline” in the percentage of filings that allege misrepresentations in financial statements and a notable drop in the number of alleged insider-trading cases. The recent surge in new securities litigation is more event-driven, the result of the subprime crisis. Strip out those cases and barring any new event, Grundfest expects the number of class-action filings will continue to remain low.