Do Investors Benefit from Securities Fraud Class Actions?

A recent study from the U.S. Chamber Institute for Legal Reform (ILR) answers this question with a resounding NO. The ILR study joins mounting academic criticism of the claim by plaintiffs’ attorneys that securities fraud class action lawsuits benefit shareholders by winning billions of dollars in settlements.

First, the ILR study “conservatively” estimates that during an eighteen-year time span, the filing of securities fraud class action lawsuits caused shareholder value to drop by more than $701 billion compared to only $109 billion in aggregate settlement recovery. Put another way, shareholders lost more than six times the settlement amount actually received from the filing of a securities fraud class action.

This $701 billion in lost shareholder value purports to capture the wealth loss experienced by shareholders from the stock price drop after the filing of the lawsuit. Because this $701-billion loss does not account for any stock price drop attributed to the anticipation of a filing of a lawsuit, the study believes the number is a conservative estimate of the wealth loss experienced by shareholders. Further, the $109 billion in expected settlement recovery does not account for the plaintiffs’ attorneys’ fees paid from these funds, which the study estimates will average 18%.

Second, the study also found that when settlements are paid in securities fraud class action lawsuits, the proceeds are not properly allocated to the shareholders who would be legally entitled to damages if the case were fully litigated. The study determined that the largest beneficiaries of class settlements had traded the stock hundreds of times during the class period. The study reviewed the plans of allocation for the 50 largest settlements in its sample and found that all 50 plans failed to net the respective plaintiff’s gains from selling at allegedly inflated prices against the plaintiff’s losses. Put another way, all 50 plans of allocation failed to properly calculate the net harm suffered by each plaintiff and provided many plaintiffs with a disproportionate gain. Further, this frequent trading of the stock indicates that these shareholders were not relying on the integrity of the market price, which is the central underpinning of the fraud-on-the-market theory used to prove reliance in securities fraud class actions, and should not be legally entitled to any damages if the case were fully litigated.

The overall conclusion of the ILR study was that “private securities class actions significantly harm investors and the economy, and they do not provide an efficient mechanism to compensate victims of alleged wrongdoing.”

Of course, the entire structure of securities fraud class actions could change when the United State Supreme Court issues its opinion in Halliburton Co. v. Erica P. John Fund, Inc., the subject of a recent post in this blog. Stay tuned.