It is no surprise that federal securities class action filings increased in 2008 over the previous year’s levels given the upheaval in the financial markets last year. But the enormity of the hit the financial services sector took in terms of filings is notable and may have implications for future litigation, according to Securities Class Action Filings–2008: A Year in Review, an annual report by Stanford Law School Securities Class Action Clearinghouse, with Cornerstone Research.

Almost a whopping third of all large financial firms were a named defendant in securities class actions filed in 2008, the survey found. The financial firms named as defendants during the year represented more than half of the sector’s total market capitalization.

A total of 210 federal securities class actions were filed in 2008, a 19% increase over the 176 actions filed in 2007. Almost half of the 2008 litigation activity, or 103 actions, involved firms in the financial services sector. The subprime/liquidity crisis was associated with 97 federal securities class actions.

The maximum dollar loss (MDL) for 2008 claims was $856 billion, 27% higher than the year before. Financial services firms represented 46% of MDL in 2008.

Are You Next?

One of the most interesting points gleaned from this activity is not the number of filings itself, but a possible turn to new defendants. “The data suggests an intriguing possibility that the pool of major financial services defendants might be getting fished out. Many major financial services firms have already been sued and plaintiffs may be choosing to focus on filing amendments to existing complaints rather than initiating new ones,” remarked Professor Joseph Grundfest, director of the Stanford Law School’s clearinghouse, and a former SEC Commissioner, in prepared commentary on the report.

Grundfest hypothesized in comments to Investment Advisor that since there are very few large-cap firms left to go after, “if there is going to be activity this year, it is going to be against the smaller-cap firms.”

Another possibility is that “litigation activity against the financial sector may decline [this] year because the supply of new defendants might be drying up, not necessarily because plaintiffs believe there is less fraud.”

Grundfest’s partner in the study, Dr. John Gould, a VP at Cornerstone Research, which has offices in Boston, Washington, and elsewhere, notes a change from tradition–complaints did not spike in the second half of 2008 despite the exponential increase in market volatility

However, Gould offers a one-time explanation “that market volatility has been so large that plaintiffs found it difficult to isolate company-specific stock movements from the broader noise generated by the volatile market,” according to prepared comments on the report.

Fewer Nasdaq Firms Sued

Another instance where trends were bucked is that a larger number of companies listed on the NYSE and Amex exchanges were sued in 2008 than those listed on the Nasdaq. In 2008, 111 class actions were filed against firms listed on the NYSE/Amex compared to 68 against firms listed on Nasdaq.

Another finding rising from the fact that longstanding heavyweights were involved in 2008 litigation was that, of the companies included in the S&P 500 index, 9% were sued in a federal securities class action in 2008, compared to only 5% in 2007.

Of note is another possible trend–class actions filed in the last two years tend to have more claims under Section 11 of the Securities Act of 1933–underwriters as defendants, for example–but fewer under Section 10(b). Moreover, in complaints alleging specific accounting violations, there has been a shift in emphasis from allegations related to traditional income statement line items to those related to balance sheet components.

While at least one securities lawyer has suggested the increase in Section 11 claims is due to the landmark 2005 WorldCom decision, Grundfest told Investment Advisor he doesn’t think this was the case. Instead, plaintiffs usually have an easier time with Section 11 claims, Grundfest avers.

Under securities law, Section 10(b) involves using any manipulative or deceptive device or contrivance in contravention of such rules and regulations. Section 11 involves the ability to sue every person who signed the registration statement; every person who was a director or partner in the issuer at the time of the filing of the part of the registration statement, is being or about to become a director, person performing similar functions, or partner; every accountant, engineer, or appraiser, or any person whose profession gives authority and consent in the registration statement; and every underwriter involved in the security’s development.

David Michaels of the UCLA Law School published a paper on November 29, 2008, for the Rutgers Law Journal, relating the results of an empirical study analyzing whether and to what extent In re WorldCom, Inc. Securities Litigation impacted class action litigation brought under Section 11.

The study tests his hypothesis that WorldCom would encourage plaintiffs to increasingly turn to Section 11 “as a means to obtain settlement awards in securities class action cases.” He argues that the WorldCom decision “made it virtually impossible for outside directors to successfully assert Section 11′s ‘due diligence’ defense–an affirmative defense.”

Michaels believes that plaintiffs would in the future likely assert more Section 11 class actions relative to Rule 10b-5 (fraud) actions, and that is what appeared to happen in the past two years, according to the Stanford research.


Elizabeth D. Festa is a freelance business writer based in Washington, D.C. She can be reached by e-mail at elizabeth.d.festa@comcast.net.