This is the season for report cards and grades. The securities laws are enforced by the plaintiff’s bar and the U.S. Securities and Exchange Commission. How well are they doing? What grades do they deserve?
In terms of private litigation, 2012 saw only 53 court-approved securities class action settlements, which was a 14-year low.1 This was not unexpected because settlements follow in the wake of class action filings in earlier years, and class action filings were well down in 2009 and 2010.2 This decline seems likely to continue, as securities class action filings were also down sharply in 2012, with only 152 filings (down from 188 in 2011 and an annual average of 193 between 1997 and 2011).3
Will securities class actions become an endangered species (thereby threatening the revenues of defense law firms as well as plaintiff firms)? Such a conclusion still seems premature. Among the explanation for this year’s decline in both filings and settlements are: (1) stock prices were up in 2011 and 2012; (2) those much-sued issuers that were the product of Chinese reverse mergers have now retreated from the U.S. markets; and (3) the 2008 credit crisis is no longer producing new cases. More specifically, Chinese reverse merger class actions fell from 31 filings in 2011 to only 10 in 2012, and there were no filings in 2012 attributable to the 2008 crisis.4
Given this decline in both filings and settlements, how will private enforcers survive? One answer is that they are moving into related fields. A few (most notably, Grant & Eisenhofer) are specializing in representing opt outs. Others are pursuing LIBOR cases, which may not involve any securities law claims. Many smaller firms seem to be specializing in "M&A" class actions in state court. For example, in 2012, if a merger exceeded $500 million in value, it had a 96 percent chance of attracting deal-related litigation (and 5.4 lawsuits on average).5 Because "M&A" class actions in state court generally settle on a nonpecuniary basis, the plaintiff’s fee awards in these cases tend to be modest and in fact averaged $725,000 in 2012 (which amount may have to be shared among several law firms). Moreover, in "disclosure-only" settlements, the fee awards have been declining over the last several years and in 2012 fell to only $540,000.6 This may pay the rent for a small firm, but it will enrich no one.
Why then is the "M&A" field so overpopulated with 5.4 lawsuits for every deal in 2012? The answer probably lies in the fact that the smaller law firm does not need a large institutional client in order to become class counsel in M&A cases. Institutional lead plaintiffs are the ticket of admission for securities class actions in federal court, but not in state court. For a variety of reasons (including a lesser ability to "pay to play"), the smaller plaintiff’s firm seldom has a public pension fund or other institutional investor as its long-term ally and so is shut out from large securities class actions. In M&A litigation, it may be competing for crumbs, but the likelihood of a settlement is very high.
The best evidence of this bifurcation within the plaintiff’s bar is the growing concentration in the securities class action field. A 2011 Cornerstone Research study found that three plaintiff’s law firms accounted for 58 percent of the securities class action in that year.7 They were Robbins Geller Rudman & Dowd (which handled 35 percent of the settlements in that year), Labaton Sucharow (with 13 percent), and Bernstein Litowitz Berger & Gorssman (with 10 percent). To be sure, the plaintiff’s bar was even more concentrated in the "old days" when Milberg Weiss presided over an even smaller oligopoly, but the new barrier to entry is a direct consequence of the PSLRA and its allocation of control to a lead plaintiff.
The key implication here is not immediately obvious, but, as a practical matter, private enforcement of the securities laws boils down today to the efforts of a relative handful of plaintiff’s law firms, probably no more today than seven or eight. Other firms may bring occasional cases and break even economically, but they seldom win control of the major cases that can generate deterrence and high profits.
This point comes into even clearer focus if we look more closely at the 2012 data. The total amount paid in 2012 securities class action settlements was just over $2.9 billion.8 This was more than double 2011′s figure (approximately $1.4 billion), but only around 13 percent of the approximately $19.8 billion recovered in securities class actions in 2006 (the record year). From one perspective, this may imply that much less deterrence was generated in 2012 than in most recent years (other than 2011).
But there is another perspective. If we look not to the aggregate amounts recovered, but to the median and average settlement size, we find that the median settlement in securities class actions rose from $5.9 million in 2011 to $10.2 million in 2012—a significant 70 percent increase.9 The average settlement size also rose, from $21.6 million in 2011 to $54.7 million in 2012.10 If we exclude the three largest securities class action settlements (Enron, WorldCom and Tyco), the historical average settlement in securities class actions was $36.8 million, which is well below 2012′s figure of $54.7 million.11 From this perspective, the deterrent threat may be growing (but this ignores that the likelihood of a suit has declined, as the number of filings has fallen significantly).
The average value of a securities class action settlement ($54.7 million in 2012) exceeded the median value of such a settlement ($10.2 million in 2012) by an over five-to-one ratio. This disparity shows the increased significance of the "mega-settlement." For present purposes, let’s arbitrarily define a mega-settlement as a settlement of over $100 million. On this basis, mega-settlements (of which there were 12 in 2012) accounted for 74 percent of the $2.9 billion paid in securities class action settlements in 2012.12 This is nowhere near a record ("mega-settlements" accounted for 95 percent of all amounts paid in 2006), but it is well above the 2010 level of 60 percent and the 2011 level of 41 percent. Because "mega-settlements" accounted for only 11 percent of all securities class action settlements (but 74 percent of the total proceeds),13 it becomes apparent that securities class actions are being litigated today on two very different tracks. On the "mega-settlement" track, the estimated damages are typically over a billion dollars (or more); the plaintiff is a large public pension fund, and the plaintiff’s law firm is probably one of seven or eight firms capable of funding a case this large and carrying it on a contingent fee basis for three to five years to a "mega settlement." Yet, because the median securities class action settlement over the years 1996 to 2011 averaged only $8.3 million,14 we know that these large "mega settlements" were counterbalanced by a much larger number of modest settlements in the $2 to $3 million range to bring down the median to $8.3 million. To see this, recall that 89 percent and 95 percent of all securities class actions in 2012 and 2011, respectively, were not "mega settlements."15 These smaller cases will typically not have a large institutional lead plaintiff, will be litigated by smaller law firms, will settle within two years of filing, often before the motion to dismiss is decided, and the settlement will be significantly based on a litigation cost differential favoring the plaintiffs. Whether or not these are "nuisance actions" can be debated, but they generate little compensation and less deterrence.
One other point needs to be made about 2012′s results. According to Cornerstone Research, over 91 percent of the $2.9 billion in securities class action settlements in 2012 came in accounting fraud cases.16 This was up from 73 percent in 2011, but identical with the percentages in 2010 and 2008. As a generalization, securities class actions tend to elicit substantial settlements mainly in accounting cases. But in 2012, filings in new accounting cases fell sharply, decreasing from 78 in 2011 to 45 in 2012, the lowest number in recent years.17
Bottom line: 2012 was a good year for the "big league" plaintiff’s law firms able to carry "mega settlements" to culmination, and those firms merit a high grade. For the smaller firms, most limped through 2012, with only one or two negotiating a truly substantial settlement. The "best in the class" award for 2012 must go to the Bernstein, Litowitz firm, which just received a $152 million fee award for its settlement of the Bank of America class action.18 Still, gather ye rosebuds while ye may, as the plaintiff’s bar needs to worry about where future cases will come from.
For the SEC, 2012 was a year of high enforcement activity, with 714 settlements, up by 6.6 percent from 670 in 2011 and the highest number since 2007.19 Still, this number is well short of the much higher number of settlements in 2003 to 2005.20 In addition, there were some offsetting trends. Although (1) the total number of settlements with individuals rose by 14 percent from 2011, up to 537, the highest level since 2005, and (2) the median settlement value for settlements with individuals rose to $221,000, a post-SOX high,21 corporate settlements were down, and the median settlement in corporate cases fell from $1.4 million in 2011 to $1.0 million in 2012.22
Why is the SEC seemingly becoming tougher on individuals, but softer on corporations, at the same time? The only coherent answer is that the aggregate data on SEC settlements makes little sense, unless and until it is unpacked and classified into subcategories based on the allegation in the SEC’s complaints. The SEC has become significantly more active in three categories: (1) insider trading cases (where the number of settlements nearly doubled in 2012, up to 118 in that year from 61 in 2011); (2) Ponzi schemes (where the number of settlements rose from 34 in 2010, to 54 in 2011, to 63 in 2012); and (3) financial services misrepresentations and misappropriations (where the number of settlements has risen from 97 in 2010, to 138 in 2011, to 151 in 2012).23 Offsetting these increases, however, has been a steady decline in the number of settlements involving public company misstatements (such as the Enron and WorldCom cases). While the 2012 data on this score has symptomatically not been publicly reported, one study finds that the number of corporate settlements involving public company misstatements (including cooked books) "fell from an average of 33 cases per year in the pre-Schapiro era to 17 cases per year in the Schapiro era."24 Similarly, the mean number of settlements with individuals in cases involving public company misstatements "dropped from 109 to 79 cases" if one compares the pre-Schapiro era to the Schapiro era.25
What explains this? Certainly, former SEC Chair Mary Schapiro never directed the SEC’s Enforcement staff to stop suing large companies for misstating their financial results. But some reasons seem obvious for a shift in enforcement activity away from public companies to Ponzi schemes, insider trading, and broker-dealer fraud: First, Bernie Madoff nearly destroyed the SEC, and the SEC cannot let such a mistake happen again. Thus, Ponzi schemes and similar broker fraud cases get a priority that may not be deserved on the merits. Second, in insider trading cases, the SEC is often able to free ride on the enforcement efforts of the Department of Justice and the FBI, and these cases also earn the SEC headlines. Third, cases involving misappropriations or misstatements by brokers are generally smaller cases that do not greatly tax the SEC’s strained manpower or expend scarce resources. Thus, these lower cost actions are more feasible for the SEC.
In contrast, cases involving public company misstatements force the SEC to take on a major adversary and face costly litigation. The opponent in these cases is not an isolated broker who has cheated a client or an insider trading defendant who is desperate to settle in the hopes of avoiding criminal prosecution. Those smaller defendants cannot afford protracted litigation, and some may not be able to afford counsel at all, but the defendant in a case challenging a company’s financial reporting will typically be indemnified and will hire the cream of the corporate and securities bar.
This is not to say that the SEC will never sue a major financial institution, but it tends to settle cheaply when it does. In fairness, the SEC did sue and settle with both Goldman Sachs in 2009 and Citigroup Global Markets in 2011. The Citigroup settlement (for $285 million) was the SEC’s largest settlement in 2012, but Judge Jed S. Rakoff still found it neither fair nor reasonable.26 Rakoff may well be reversed by the Second Circuit for refusing to give the SEC adequate deference, but nothing will make that settlement look impressive. Even if it is upheld, it should embarrass the SEC.
The problem here is less that the SEC has been captured or is politically compromised, but more that it simply lacks the ability to handle the large, factually complex case. In such cases, it must either decline to sue or settle cheaply, allowing the defendant to neither "admit nor deny" the charges against them. The declining number of cases brought against corporations and individuals in "public company announcement" cases is evidence of this pattern. Although corporations generally settle SEC enforcement actions, they do so principally motivated by a strong desire to avoid a "rolling page one" story day after day. In contrast, individuals often do not settle these same cases because for them even a civil settlement of a fraud case might be career-ending, and in these cases the SEC has been far less successful.27
This claim that the SEC lacks the budget or manpower (and possibly the trial experience) to litigate the factually complex case leads logically to a related claim that the defense bar knows and exploits this fact. This interpretation is supported by the recent settlement of the Bank of America class action involving its acquisition of Merrill Lynch. There, the Bernstein, Litowitz firm negotiated a multibillion dollar class settlement with Bank of America, in a case essentially involving the same allegations as the SEC made in its 2009 enforcement action against the Bank, which settlement Rakoff originally refused to approve.28 But, as Southern District Court Judge Kevin Castel expressly noted last month in dealing with the fee awards, Bernstein, Litowitz only reached the point of settlement after undertaking extraordinary litigation efforts that carried it close to trial. Specifically, the court found that there had been 61 depositions conducted and over 3.8 million documents produced over the course of the litigation that began in 2009 and continued to 2013.29 It seems very doubtful that the SEC, or any other federal agency, could undertake litigation that burdensome, using its own staff. Indeed, plaintiff law firms are only able to undertake such an effort by relying on short-term contract attorneys to deal with document discovery and production crises.
This problem will only get worse as e-discovery places increased burdens on the litigation process. To be sure, the SEC can handle an insider trading case, where the allegations are focused on a limited number of events extending over a briefer period (and where the SEC often free rides on a DOJ criminal prosecution). But truly complex factual cases against a major financial institution are probably beyond the SEC’s practical capacity. Thus, it settles cheaply. The SEC’s proposed settlement with Philip Falcone and Harbinger Capital Partners, announced last week by the defendants, illustrates just how weakly the SEC must settle when a well-financed defendant resists stubbornly.30 There, the proposed settlement involves no injunctive relief, allows Falcone to continue to control Harbinger Capital, a public company, and carves out the nine investment advisers owned by Harbinger Capital from the ban on Falcone’s association with investment advisers.31
The irony here should not be missed. In the Citigroup case, the SEC is insisting that Rakoff must enjoin Citigroup (which is already subject to multiple SEC injunctions), but in the Falcone case, the SEC appears to be waiving any injunction against an arguably more culpable controlling person who will retain control of a public company that will continue to serve investors as an investment advisor. This disparity is hard to rationalize. The message of the Falcone settlement to the defense bar is clear: Be Stubborn, Resist, and Eventually the SEC Will Yield.
So what is the answer? As I have previously suggested, the SEC should do what the FDIC, and other federal banking agencies, have been recently doing very successfully: hiring private counsel to handle the cases that are too big or burdensome for it. The FDIC has this year filed at least 12 lawsuits against failed financial institutions and their officers and directors, and it has obtained aggregate settlements of over $600 million.32 In December 2012, it won a jury verdict for $169 million against former officers of IndyMac.33 The SEC’s enforcement staff will never do that.
Bottom Line: The SEC is still in denial. It will not admit that it cannot handle complex cases, will not refer to private counsel, and so must settle on a basis that often seems inadequate. In grading, the professor should always try to encourage and motivate the student to greater efforts. Thus, the SEC’s report card should say: "You are working hard and trying your best, but you need to learn from your peers. Until you develop a coherent strategy for dealing with the new reality, your grade must be: B-."
John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.
1. See Ellen M. Ryan and Laura E. Simmons, "Securities Class Action Settlements: 2012 Review and Analysis" (Cornerstone Research 2013) at p.2.
2. Id. In 2009 and 2010, securities class action filings averaged approximately 148 per year, down from the approximately 200 class actions filed in 2007 and 2008.
3. See Cornerstone Research, "Securities Class Action Filings: 2012 Year in Review" at p.1.
5. See Robert Daines and Olga Koumrian, "Shareholder Litigation Involving Mergers and Acquisitions" (Cornerstone Research 2013), at Fig. 2.
6. Id. at p.9, Fig. 9.
7. See Ellen M. Ryan and Laura E. Simmons, "Securities Class Action Settlements: 2011 Review and Analysis" (Cornerstone Research 2012) at p.17.
8. Ryan and Simmons, supra note 1, at p.2, Fig. 2.
9. Id. at 3.
10. Id. This was an increase of over 150 percent.
12. Id. at 4.
13. Id. at p.4, Fig. 3.
14. Id. at p.3, Fig. 2.
15. Id. at p.4, Fig. 3.
16. See Cornerstone Research, " Accounting Class Action Settlements Continue to Represent a Large Share of Total Settlement Dollars" (April 10, 2013).
18. See In re Bank of America Corp. Securities, Derivative and ERISA Litig., 2013 U.S. Dist. LEXIS 57463 (S.D.N.Y. April 11, 2013) (noting fee award of $152.4 million).
19. See Jorge Baez, Dr. Elaine Buchberg, and Dr. James A. Overdahl, SEC Settlement Trends: 2H12 Update (NERA, Jan. 14, 2013) at p.1.
20. Id. at p.5, Exhibit 3. For example, 2003 saw 889 SEC settlements.
21. Id. at p.1.
23. Id. at p.5, Exhibit 4.
24. Id. at 21.
26. See SEC v. Citigroup Global Capital Markets, 827 F.Supp.2d 336 (S.D.N.Y. 2011), stayed on appeal, 673 F.3d 158 (2d Cir. 2012).
27. The SEC has recently lost cases against Brian Stoker of Citigroup, Bruce Bent of the Primary Reserve Fund, and abandoned its case against Edward Steffelin, who worked with JP Morgan. Its case against Fabrice Tourre of Goldman Sachs (the "Fabulous Fab") proceeds on at a snail’s pace.
28. Compare In re Bank of America Corp. Securities, Derivative and ERISA Litig., supra note 18, with SEC v. Bank of America, 653 F.Supp.2d 507 (S.D.N.Y. 2009).
29. In re Bank of America Corp. Securities, Derivative and ERISA Litig., supra note 18, at *1-2.
30. There were actually two distinct cases, SEC v. Philip A. Falcone, et al., 12 Civ. 5027 (PAC), and SEC v. Harbinger Capital Partners, et al., 12 Civ. 5028 (PAC). For a brief review of the proposed settlement, see Ben Protess, "Hedge Fund Manager and SEC Reach Deal," The New York Times, May 10, 2013 at B-1.
31. I am here relying on Harbinger Capital’s Form 10-Q, filed on May 9, 2013, which I was provided by defense counsel.
32. See Cornerstone Research, "FDIC Lawsuit Filings in 2013 at High Levels According to Latest Report by Cornerstone Research," (May 8, 2013); see also Abe Chernin, Catherine J. Galley, Yesim C. Richardson, Joseph T. Schertler, "Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions" (Cornerstone, April 2013) (noting that the FDIC typically concentrates its focus on the senior executives of the largest financial institutions that failed and focuses on these cases with the largest losses).
33. Id. at 12.