Legal Newsline

Monday, December 9, 2019

Rising shareholder class actions an 'important issue'

By Carrie Salls | May 25, 2016


LOS ANGELES (Legal Newsline) – With a Cornerstone Research report recently revealing that the number of accounting securities class action lawsuits went up again in 2015, Dorsey & Whitney LLP partner Thomas O. Gorman told Legal Newsline that “firms would be well advised to carefully evaluate their compliance programs and internal controls to ensure they are effective.”

“This is a very important issue because it impacts investments and stock prices across the board,” Gorman said.

The report found that accounting case filings involving company announcements of internal control weaknesses were the highest in 10 years. In 2015, 86 percent of accounting case settlements involved allegations of internal control weaknesses, also the highest proportion in the last 10 years, Cornerstone reported.

According to the report, 2015 was the third consecutive year that the number of accounting-related filings increased. Specifically, the report found that there were 71 securities class action filings with accounting allegations in 2015.

According to Cornerstone Research, cases are considered accounting cases if they involve allegations related to Generally Accepted Accounting Principles (GAAP) violations, auditing violations or weaknesses in internal control over financial reporting.

Gorman points to a post-market-crisis focus on these accounting claims, as well as “an at-best weak economic recovery” as driving factors for the increase.

“In the post-Sarbanes-Oxley era, these types of claims dwindled, at least in part because of the legislative reforms but also in the wake of a series of high-profile SEC enforcement actions,” Gorman said.

“Post market crisis, the SEC and the private bar again began to focus on these claims. That focus, coupled with an at-best weak economic recovery, is probably fostering the increase in claims. This is particularly true for firms in areas where the economic recovery has been limited.”

Gorman said the Securities and Exchange Commission and class action attorneys are bringing larger numbers of financial fraud cases that include a variety of claims.

“Typically the cases involve efforts to boost the revenue by things like ‘channel stuffing,’ premature recognition of revenue and sham sales,” Gorman said. “An alternate approach is to suppress the expenses by things such as improperly capitalizing them, which has the same effect as boosting revenue directly.”

Cornerstone reported that the Disclosure Dollar Loss (DDL) Index rose to $34.8 billion for accounting cases filed in 2015, the second largest amount in the last seven years.

The district encompassed by U.S. Court of Appeals for the Ninth Circuit, which includes California, saw the most accounting cases in 2015, with 37 percent of cases filed there. The number of accounting cases against companies with headquarters outside the United States increased 43 percent to its second highest level in the last 10 years. Also, the report indicated that accounting cases against companies headquartered in China increased 75 percent from 2014 to 2015.

For settled cases with GAAP allegations, settlement amounts were highest for write-downs. Following a significant decline in 2014, the report found that the proportion of accounting settlement dollars represented by financial firms led all sectors in 2015, with 11 settlements in this sector averaging more than $133 million.

Gorman expects the trend of accounting claim increases to continue, given the current financial environment, especially in economic areas where the recovery may be faltering. 

“In addition, look for the expertise of the regulators to increase as they continue to focus on these claims,” Gorman said.

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Organizations in this Story

Dorsey & Whitney LLPU.S. Securities and Exchange Commission