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Companies looking to settle a securities class action suit had better brace themselves because chances are it is going to cost them a lot more than they expected. Last year, the average price of settling a securities fraud case rose 68 percent to $24.3 million, compared with $16.6 million in 2001, according to a new study by Stanford Law School’s Securities Class Action Clearinghouse and Cornerstone Research. The 2002 figure represents a total of about $2.4 billion in settlements in 98 cases; in 2001, 95 cases were settled for about $1.6 billion. Securities lawyers on both sides of the issue say this is just the beginning. Last year’s numbers “are going to be dwarfed by the numbers you’ll see this year,” said Jay Eisenhofer, a partner with Grant & Eisenhofer, a plaintiffs’ firm based in Wilmington, Del. Already this year, he pointed out, there have been two massive settlements: one for $300 million against Oxford Health Plans and another for $600 million against Lucent Technologies. Eisenhofer said there were “numerous other huge cases” in the pipeline that will settle for amounts in that range or higher. “You’ll see numbers that were unheard of a couple of years ago,” he said. Depending on whom you ask, the reasons for this upsurge in settlement amounts differ markedly. The plaintiffs’ bar blames rampant fraud during the heyday of the high-tech boom, touching every type of business, from the start-up dot-coms to the nation’s largest companies. Defense lawyers, on the other hand, claim that a few mega-settlements skew the findings. Take those out, they say, and the average settlement amount drops to around what it has been in previous years. The principal author of the study, Laura Simmons, agreed. Before last year, she said, only the Cendant Corp. settlement for $3.2 billion exceeded $300 million. She said that last year’s increase in the number of very large settlements, including the Bank of America settlement for $490 million and the Waste Management settlement for $457 million, boosted the average. Not only are settlement amounts sharply up, but the cost of settling a securities fraud suit has doubled from 1997 to 2001, according to National Economic Research Associates (NERA), an economic analysis and consulting firm in New York. Both sides of the debate point to a controversial 1995 law that radically changed the landscape for securities class action suits as the driving force behind this phenomenon, but for very different reasons. That law, the Private Securities Litigation Reform Act, was designed to deter frivolous and abusive class action “strike suits” against companies, as well as create uniformity in the way courts handle securities fraud complaints. It did so with an array of changes to the law, the most important of which is a heightened “fraud-plus” pleading standard. Plaintiffs’ lawyers say the reform act went too far in protecting corporate executives who, knowing they probably would not get caught, found the temptation to illicitly line their pockets irresistible. Because of the reform act, “the risk-award ratio [for securities fraud] was completely out of whack during the boom market,” said Samuel Rudman, a partner in the Melville, N.Y., office of Cauley, Geller, Bowman, Coates & Rudman. He said the cases in the news were just the tip of the iceberg. “There are twice as many cases out there that we don’t know about and will never know about.” But, he added, he was not surprised. “People are by nature greedy,” he said. On the other side of the table, Mark Gitenstein, a partner in the Washington, D.C., office of Mayer Brown Rowe & Maw who helped draft the reform act and lobbied for its passage, attributed the increase to an entirely different cause. The act actually contemplated an increase in average settlement amounts, he said, because the number of nuisance value cases would go down. “Prior to 1995, a lot of low-value cases that should have been dismissed ended up settling instead,” Gitenstein said. “The reform act was intended to screen out worthless cases and force settlements of cases with merit,” he said. Indeed, according to NERA, nearly 30 percent of securities fraud cases are dismissed on the defendant’s motion, compared with about 12 percent before the reform act. Some plaintiffs’ lawyers agreed: “Because of the higher pleading standard, cases are much more tested than before,” Grant & Eisenhofer’s Eisenhofer said. “It stands to reason that the cases that survive a motion to dismiss are more serious.” As an example, he cited the Global Crossing litigation, in which his firm is lead plaintiff’s counsel. He said that the firm conducted more than 150 interviews over the course of a nine-month investigation, all without discovery, which is stayed under the act pending the motion to dismiss. Eisenhofer said that the increasing involvement of institutional investors in the post-reform act era is also a factor. Institutional investors are lead plaintiffs in securities fraud cases about a third of the time, according to the study. “There’s a lot more client control, which results in stronger cases,” he said. “You see that reflected in settlement.” FACTORS BOOSTING COSTS Of course, settlement amounts are also affected by the particular characteristics of the case. The Stanford study flagged several factors that tend to boost settlement amounts. The most important by far, Simmons said, is the plaintiffs’ estimated damages. Because of the extreme volatility in the stock market over the last couple of years, where stocks that previously sold for hundreds of dollars a share crashed into the single digits, estimated damages have soared, Simmons said. This in turn has hiked up the cost of settlement. Other noteworthy factors include government involvement, financial restatements, size of the company being sued and the presence of additional defendants. A corresponding action by the Securities and Exchange Commission will result in a higher settlement amount because it “tends to indicate the case has merit,” Simmons said. “A lot of securities class actions suits are filed simply because of a drop in stock price,” she added. Similarly, Simmons said, a restatement of the company’s financial records will also add to settlement costs because it attests to the seriousness of the case. But the absence of a restatement does not necessarily get a company off the hook. Two recent mega-settlements — the Oxford Health Plans settlement and another for $490 million involving Bank of America — did not involve restatements. Finally, a company’s total assets including insurance coverage, and the presence of additional defendants such as accountants or investment banks, jack up settlement amounts simply because pockets are deeper, Simmons said. Some lawyers found the study’s findings encouraging. “There’s a body of criticism that there’s no relationship between the merits of a case and the settlement amount,” said Eisenhofer. “The fact that that seems to be changing is good.”

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