Report: Surging securities class actions over corporate M&A, 'adverse events,' a growing 'litigation racket'

By Jonathan Bilyk | Oct 25, 2018

Andrew Pincus, of Mayer Brown LLP, answers a question at the U.S. Chamber of Commerce Institute for Legal Reform Summit XX conference Oct. 24, 2018, in Washington, D.C.   Jonathan Bilyk

WASHINGTON (Legal Newsline) - Saying the trend carries substantial costs for investors and the entire economy, a new report is calling for reforms to tamp down on the growing surge in the number of so-called securities class action lawsuits filed against companies over mergers, acquisitions or stock price drops.

"The current securities class action litigation racket is plainly inflicting serious harm on investors, companies, capital markets and our entire economy,” the report asserted.

The report was designed to draw public attention to an “abusive” system of largely meritless legal actions “spinning out of control,” said Andrew J. Pincus, an attorney with Mayer Brown LLP in Washington, D.C., who prepared the report for the U.S. Chamber of Commerce’s Institute for Legal Reform.

For decades, corporate actions have generated securities-related class action lawsuits, ostensibly led by investors, seeking to redress some alleged injustices committed against the company’s shareholders. Traditionally, Pincus said, those lawsuits centered on allegations of financial irregularities, which impacted investors’ bottom lines.

Perceived abuses in those lawsuits led Congress to enact reforms in the 1990s. However, in recent years, securities class action litigation has found new life, as the attention of litigious shareholders has turned now toward corporate mergers and acquisitions, as well as what Pincus described as lawsuits based on “adverse events” befalling a business.

Last year, the report noted, the number of securities class action filings increased more than 50 percent from 2016 nationwide, affecting nearly 8.4 percent, or one in 12 of all U.S. publicly traded companies.

And the report said the number of such filings is on a pace to eclipse even those record numbers, more than double the 20-year average, as more than 200 such cases were filed in the first half of this year.

Pincus said nearly every recent high-value corporate merger or acquisition, with an estimated value of $100 million or more, has been targeted by such legal actions. From 2003-2008, less than half of such deals were challenged in court.

“No one could seriously contend that virtually every single large transaction involving a public company involves fraud,” the report said. “By itself, the huge percentage of deals targeted demonstrates that suits are filed without any regard to the underlying merits.

“For some plaintiffs’ lawyers, the filing of a lawsuit has become a Pavlovian response to the announcement of a deal.”

Typically, Pincus said the lawsuits have centered on allegations one or both companies involved in the deal somehow misled shareholders, or did not provide investors with the informational disclosures required before putting the question to shareholders for a vote. The plaintiffs then may seek an injunction from the court, effectively placing the deal on hold until the lawsuit may be resolved in some way.

And the way most companies have chosen to resolve the lawsuits is to agree to issue more disclosures to satisfy the claims, and then wave enough money at the plaintiffs’ lawyers to persuade them to drop the action, Pincus said.

He cited a study authored by Matthew D. Cain, of the U.S. Securities and Exchange Commission, and University of California Berkeley law professor Steven Davidoff Solomon, which indicated more than 70 percent of all M&A class actions from 2003-2011 resulted in settlements. And of those settlements, only about 5 percent resulted in any money going to shareholders.

Yet, the study noted, attorneys in those settled cases reaped average attorney fees of $749,000.

While settling such M&A lawsuits may end particular legal actions blocking particular mergers and acquisitions, Pincus said it only incentivizes plaintiffs lawyers in ever greater numbers to bring yet more challenges against more deals.

“There’s a huge amount of money being drained out of the system,” Pincus said, while discussing his report at the ILR’s annual Summit XX legal reform conference in Washington, D.C.

“It’s a tax on every deal, just to move things forward.”

The growth of these lawsuits has even come despite attempts by some courts to crack down on the litigation tactic. In Delaware, for instance, where such actions had typically been launched, given the large numbers of corporations registered in that state, judges on the state’s chancery courts have since 2016 refused to grant so-called “disclosure only” settlements, which allow attorneys to collect fees, while providing little of any real value to shareholders.

In response, plaintiffs’ lawyers largely have shifted their M&A challenges from state courts to federal courts.

While 80 percent of M&A challenges were filed in state courts in 2015, just two years later, in 2017, 87 percent of all M&A challenges had originated in federal courts, according to the ILR report.

And in these cases, Pincus noted, plaintiffs’ lawyers had shifted their tactics slightly. Now, he said, rather than the straightforward disclosure-only settlements, the defendant companies move to “unilaterally add new disclosures to address the supposed ‘deficiencies’ alleged in the class action.” With the lawsuit then formally “mooted,” the defendants pay the plaintiffs’ lawyer a so-called “mootness fee,” an off-the-record payment designed to end the action.

“The federal court gambit is working out well for the plaintiffs’ bar: they have been able to replicate their … practice of quick resolutions accompanied by payments of attorneys’ fees, although the mechanism is slightly different,” the ILR report said.

Pincus said the tactic has caught the eye of judges, as noted in a recent decision from former U.S. Seventh Circuit Court of Appeals Judge Richard Posner, who labeled such actions “no better than a racket” and said lawsuits providing such “worthless benefits” to investors “should be dismissed out of hand.”

Pincus said it remains to be seen what actions, if any, the federal judiciary may take to rein in the practice.

At the same time, Pincus said a growing number of companies in recent years have also been targeted by class actions, ostensibly from shareholders, after the company has suffered some kind of negative event, such as a customer data breach, which drives down its stock prices and causes investors to lose money.

“The plaintiffs’ lawyers filing these securities class actions typically contend that the defendant company’s statements before the adverse event occurred misrepresented the risk that an oil platform would explode, that its products would be the subject of tort litigation, or that its systems containing employee or customer information would be hacked,” the ILR report said. “There has been a parade of such claims, with more on the horizon.”

Pincus noted biotech, pharmaceutical and other medical companies, and especially “new smaller companies” have become prime targets for such lawsuits.

The motivation behind such events-based securities litigation is roughly the same as the M&A securities litigation: A quick settlement from a company looking to put the adverse event behind them and get it out of the news, said Pincus.

“… Litigation of the securities class action threatens the company with continuing harm substantially more damaging than the typical financial reporting securities claim,” the ILR report said. “The plaintiffs’ lawyer will focus on the underlying adverse event – and only tangentially on the alleged false statement or omission that occurred months or years earlier – which will keep the adverse event in the public eye, even if the company has settled any legal claims arising out of that event.

“That creates additional pressure to settle the securities claim, regardless of the merits.”

Pincus asserted the continued rise of such litigation only serves to hurt investors and shareholders, shifting money that should be available to shareholders to the pockets of lawyers on both sides. The report, for instance, pointed to ILR data indicating “the mere filing of lawsuits like securities class actions wipes out, on average, 3.5 percent of the defendant company’s equity value.”

To address the issue, the ILR report urged federal lawmakers to enact a series of reforms, specifically to “prohibit abusive practices” and “deter the filing of meritless cases,” and ultimately, reduce the number of cases brought by lawyers seeking to “pressure defendants to enter into unjustified and unwarranted settlements.”  

The U.S. Chamber Institute for Legal Reform owns Legal Newsline.

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