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Study Of Shareholder Class Action Litigation Finds Unprecedented Settlement Values In 2004, With Some Plaintiffs Also Winning Corporate Reforms

Mean settlement value up 33%

NERA Economic Consulting’s annual study of securities class action litigation reveals a new era of unprecedented settlements, with some of the nation’s larger corporations making bigger-than-ever payments to shareholders in compensation for losses in the recent bear market. In a new trend, many of these companies are also instituting corporate governance reforms as part of their settlements.

“Shareholder class actions are being used in new ways to improve corporate governance... to obtain specific corporate governance reforms,” according to the NERA Economic Consulting report titled “Recent Trends in Shareholder Class Action Litigation: Bear Market Cases Bring Big Settlements.”

The NERA study of securities class action filings, settlements and investor losses in 2004 found that securities class action filings against WorldCom, Raytheon and Bristol-Myers Squibb produced three of the eight largest class action settlements of all time – with a combined value of over $3.3 billion, more than twice the combined value of the largest settlements of 2003 made by Lucent Technologies, Rite Aid, DaimlerChrysler and Oxford Health Plan.

According to NERA, these top-ranking settlements contributed to a 33% increase in mean settlement value to $27.1 million in 2004, up from $20.3 million in 2003. Of the 119 settlements made last year, nine were valued at $100 million or more; 16 settlements exceeded $50 million.

Fueling the trend, according to the report, are payouts to investors battered in the recent bear market. “We find that these higher settlements can be explained by higher investor losses, the single most powerful publicly available predictor of settlement value,” write the report‘s co-authors, NERA Economic Consulting economists Elaine Buckberg, Todd Foster, Ronald Miller and Stephanie Plancich. Investor losses ballooned from $140 million in the average suit settling in 1996 to $2.5 billion in 2003 before dropping to $1.7 billion in 2004.

“WorldCom, Raytheon and Bristol-Myers Squibb ranked first, twenty-third and third in investor losses, among settled cases. Considering the amount of investor losses, the size of these settlements is less surprising,” according to the authors.

Meanwhile, the 2002 Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act was found to have no statistically significant effect on settlement values.

The authors predict the trend towards giant settlements will only continue. “Increasing numbers of cases with class periods ending in the bear market of 2000-2002 are reaching settlement . . . As a result several more years of higher average settlements are likely.”

Despite these rising settlement values, federal class action filings were essentially flat in 2004 at 238, compared with 234 in 2003, despite the passage of SOX, which some expected to have an impact on filings.

Corporate Reform

The real impact of SOX appears to have been on the trend toward incorporating corporate governance reforms into shareholder class action settlements. Since the passage of that legislation, at least nine settlements have incorporated such reforms, including cases involving AON Corporation, HCA Inc. and Ingersoll-Rand Company, among others.

Ingersoll-Rand, for example, settled a suit by agreeing to make corporate reforms in lieu of a cash payment. However, most often reforms appear to be a trade-off for a lower cash settlement. Two exceptions are the cases of Honeywell Inc. and Mattel Inc., which produced higher cash settlements than NERA’s proprietary model predicts, as well as governance improvements. Honeywell’s settlement required the company to pay $100 million to shareholders in addition to ensuring the independence of outside auditors and shareholders and adopting provisions relating to compensation of officers and directors.

Among other findings of the NERA study:

Over a five-year period, the average public corporation faces a 10% probability that it will face at least one class action lawsuit.

The annual likelihood of facing a shareholder class action suit has risen 23% since the passage of the 1995 Private Securities Litigation Reform Act (PSLRA).

Settlements in 2002-2004 have been substantially higher than in the prior post-PSLRA years of 1996-2001, averaging $23.6 million versus $13.5 million in those prior years, coinciding with higher investor losses in suits settled during the latter period.

Median investor losses for cases with class periods ending during the 2000-2002 collapse of the stock market bubble were $381 million, more than 75% higher than the median for any prior year.

On average, a 1.0% increase in investor losses results in a 0.4% increase in the size of an expected settlement, according to NERA’s settlement prediction model.

Despite the trend toward giant settlements in 2004, dollar values of typical settlements are actually continuing to fall, according to NERA. The 2004 median settlement fell to $5.3 million, down 4% from $5.5 million in 2003 and 12% less than $6.0 million in 2002. Over 70% of settlements were valued at $10 million or less and over 44% of settlements fell under $5 million.

Other types of securities in a class action mean higher settlement values. The inclusion of bonds more than doubles settlement values on average. The inclusion of options adds one third on average.

Larger companies make bigger settlements. For each 1.0% increase in a company’s market capitalization on the day after the end of a class period, the typical settlement will increase 0.1%. If a defendant firm is in bankruptcy or has a stock price less than $1 per share on the settlement date, the settlement will be approximately one third lower.

Cases involving accounting issues, accounting irregularities or restatements result in 20% higher settlement values on average.

Plaintiffs’ legal fees requests have decreased as a share of settlements.

NERA’s report is available on the firm’s website at www.nera.com/trends2004.

NERA Economic Consulting is an international firm of economists. We provide economic analysis and advice to corporations, governments, law firms, regulatory agencies, trade associations and international agencies. Our global team of more than 500 professionals operates in 18 offices across North and South America, Europe, Asia and Australia.