by James Goldfarb, Brendan T. Mangan, Ted Snyder, and Cameron Matheson

The number of securities class actions filed last year fell for the fourth year in a row. But these time-consuming, costly litigations still target 5 percent of all S&P 500 companies in an average year, and settlement costs rose in 2022. Those and other insights emerge from annual surveys published by NERA Economic Consulting and Cornerstone Research, two economic-consulting firms.[1] In this post, we summarize the data and trends revealed in those reports. The information highlighted here provides some perspective and benchmarks in terms of industries targeted, litigation length, potential offramps (mainly moving to dismiss or settling), and settlement costs. We conclude with some key takeaways.

By the Numbers …

The number of securities-class-action complaints filed in 2022 declined for the fourth consecutive year.

• The drop is mainly attributable to 61 percent fewer merger-objection lawsuits and 8 percent fewer Rule 10b-5 lawsuits compared to 2021. Merger-objection lawsuits challenge the adequacy of disclosure in the merger-solicitation (proxy) materials; the plaintiffs generally seek better deal terms. Rule 10b-5 lawsuits are suits brought pursuant to Section 10(b) of the Exchange Act of 1934 and SEC Rule 10b-5 for material misstatements made with deceitful intent in connection with the purchase or sale of a security.
• The number of lawsuits alleging Rule 10b-5 violations was the lowest since 2014. Still, 83 percent of 2022 core federal filings alleged Rule 10b-5 violations. “Core” federal filings refer to non-merger-objection actions.
• Merger-objection lawsuits, a cottage industry pre-COVID, seem to have run their course, dropping 69 percent from 2021. M&A activity declined only 15 percent in that period.
• Although the overall number of filings dropped, lawsuits alleging violations of the Securities Act of 1933 increased 43 percent to their highest level since 2008. Claims brought under the 1933 Act include claims for violating Section 11 (alleging materially misleading statements in a registration statement), Section 12(a)(2) (alleging materially misleading statements in a prospectus or oral communication), and Section 15 (control-person liability).
• More than a fifth of all core filings included Section 11 allegations, a surge attributable to 2021’s heavy volume of initial public offerings (IPOs) and special purpose acquisition corporation (SPAC) transactions. A cooler transactions environment presages fewer 1933 Act lawsuits.
• 14 percent of core federal filings in 2022 alleged Section 12(a) violations, up from 6 percent in 2021. Cryptocurrency-related claims drove that spike.
• State court Section 11 filings held steady at 12. That is half the 2020 number and one quarter the 2019 number. The ratio of federal-to-state Section 11 filings is trending higher. The adoption of forum-selection clauses in corporate charters might explain the decline in state court-filed 1933 Act lawsuits.[2]
• Lawsuits arising from IPOs continue to dominate federal court dockets (31 versus the next closest type, merger and spinoff suits, at 4). In the state courts, 1933 Act claims arose from IPOs, SEOs, and mergers and spinoffs in equal measure.
• Courts in the Second and Ninth Circuits continued to see the highest volume of filings, 73 and 59 in 2022, respectively. The Third Circuit was a distant third at 16 filings.

Among the “trendier” securities litigation subjects in recent years …

• SPAC, cryptocurrency, and COVID-related actions accounted for 34 percent of all core federal filings, with 24, 23, and 20 filings, respectively, in 2022. But SPAC-related filings fell from 33 in 2021.
• Cryptocurrency and COVID-related actions appear to be dismissed faster than other federal core filings, although that observation is based on only a few years’ data. SPAC-related lawsuits appear to be dismissed slower than other federal core filings.
• 73 percent of cryptocurrency-related actions filed in 2016-20 included allegations concerning cryptocurrency issuances. In 2021-22, only 32 percent did.[3] Consistent with that, the lineup of defendants is expanding to include exchanges and miners, in addition to issuers.
• Cybersecurity-related filings dropped to four actions from seven in 2021. Cannabis-related filings also fell, continuing a downward trend. Only one environment-related filing was made in 2022, down from 10 in the previous three years.

What’d I do wrong …

• Allegations about misrepresentations in financial documents were alleged in 89 percent of the 2022 core federal filings; accounting violations in 24 percent. Those levels have been consistent for several years.
• Announced restatements of company financial statements featured in 9 percent of cases, three times the 2021 rate and well above the recent annual average. Internal-control weaknesses were alleged in 13 percent of cases, nearly double the 2021 pace but below the 18 percent pace in 2018-20.
• Insider-trading allegations dropped by two-thirds, appearing in only 2 percent of 2022 core federal filings. Allegations of false forward-looking statements dropped 10 percent.[4]

You will be named …

• On average, 3 percent of S&P 500 companies are named as securities class-action defendants each year. But in the last three years, the percentage has been well below the average. In 2022, it was 3.8 percent.
• On average, more than 5 percent of companies in the consumer-discretionary, financial/real estate, healthcare, communications, and utilities sectors will be named as defendants. For consumer staples, energy, materials, and industrials, that figure is below 5 percent, on average. The communications sector includes media, social media, and IT companies.
• In 2022, core federal filings increased in the following sectors: consumer discretionary, financials/real estate, healthcare, industrials, communications, and utilities. Healthcare and communications companies were targeted the most, with 7.8 and 6 percent of those companies named, respectively. No energy/materials companies or consumer staples companies were named as defendants for the first time in seven and eight years, respectively.
• Consumer noncyclical, communications, technology, and financial companies tend to be named the most; utilities, basic materials, energy, and industrials the least. In the past two years, consumer cyclicals have outpaced financials. In 2022, 11 lawsuits were filed in the financial sector. The annual average, 1997-2021, is 30.
• Non-U.S. issuers fared better in 2022. Only 34 of the 156 core federal filings in 2022 were against firms headquartered outside the U.S., a figure below the annual average of 41.

Make your move …

• It pays to challenge the adequacy of a securities class action at the pleading stage. From 2013 through 2022, motions to dismiss were filed in 96 percent of federal securities class actions. Plaintiffs voluntarily dismissed the action 18 percent of the time and settled 8 percent of the time. Courts ruled in 73 percent of cases, dismissing the case in whole or in part 80 percent of the time: 54 percent without prejudice, 7 percent with prejudice; 19 percent were partially granted. Courts denied motions to dismiss in their entirety only 20 percent of the time.
• Opposing a class certification motion does not pay off as well.
• Class certification motions are filed in only 17 percent of cases; the bulk of cases having resolved through dismissal or settlement before class certification.
• When filed, only 60 percent of class certification motions get decided. The remaining 40 percent of cases settle before the court decides the motion.
• Of the class certification motions that are decided, 86 percent are granted, and the remainder are denied with or without prejudice or denied in part.
• The median time from filing to a class-certification decision is 2.7 years. 65 percent of class-certification motions are decided within three years of the filing of the first complaint. Nearly all are decided within five years.

How (and when) does this end …

• Securities class actions rarely reach trial. From 1997 to 2022, 46 percent of core federal securities lawsuits settled, 43 percent were dismissed,[5] 5 percent were remanded, 0.4 percent went to trial, and 10 percent are pending. Of the pending 10 percent, 81 percent were filed between 2020 and 2022, 19 percent between 2013 and 2019, and 1 percent (two cases) between 1997 and 2012.
• Cases typically resolve by dismissal or settlement within three years.
• On average, 50 percent of dismissed cases are dismissed within three years.
• The percentage of the cases filed in a given year that resolve through dismissal is greater than the percentage that resolve through settlement.
• The longer a case is pending, the more likely it will resolve by settlement.

How much is this going to cost if I settle …

• Since 2013, annual median investor losses – as derived by NERA – have ranged from $358 million in 2017 to $972 million in 2022. The losses in 2022 were 33 percent higher than in 2021.
• The median ratio of settlement amount to investor losses ranged from 1.5 percent in 2015 to 2.5 percent in 2017. For 2020, 2021, and 2022 the median ratio of the settlement amount to investor losses was 1.8 percent.
• Average and median settlement values increased by more than 50 percent compared to 2021. The average settlement value increased by over 70 percent to $38 million, and the median settlement value increased by over 50 percent to $13 million. However, 2021 was a relatively low year.

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Takeaways

In terms of trends …

• Risks to the general economy present risks to corporations. When the tide goes out, you can see who is swimming without a bathing suit. Indeed, during times of financial stress, investors turn to litigation to generate revenue. So expect securities litigation volume to be impacted by whether the economy avoids a recession, lands softly, or crashes.
• Within the financial services sector, disruptors, particularly in digital assets and fintech fields, may receive more scrutiny from the plaintiffs’ bar than legacy financial institutions. Cryptocurrency-related litigation is likely to increase as the market shakes out and regulators, including the SEC, continue to apply intense regulatory and enforcement pressure.
• ESG-related litigation probably will increase as shareholders, consumers, and regulators pressure issuers to make disclosures around environmental, social, and governance issues.
• Cybersecurity-related litigation is less trendy but quite costly. Three of the four 2022 cybersecurity-related filings involved market capitalization drops greater than $10 billion, measured from the highest share price during the class period to the share price immediately following the disclosure of the alleged misconduct. (What Cornerstone refers to as Maximum Dollar Loss, or MDL.)
• SPAC-related litigation and litigation arising from IPOs is softening, reflecting the softer market for new issuances. A reversal of that trend would portend more litigation.
• Merger-objection litigation appears to be in retreat, a legacy of the 2016 Delaware Chancery Court decision in Trulia (heightening judicial review of disclosure-only settlements) and the 2019 Northern District of Illinois decision in Akorn (heightening judicial review of mootness fee dismissals). Acquisition premiums reflecting the risk of merger-objection litigation might be adjusted accordingly.  

In terms of corporate and transactional law …

• Corporations might benefit from forum-selection clauses, which provide greater predictability that 1933 Act claims will be adjudicated in federal, not state, court. However, those clauses have not been uniformly enforced by state courts.
• D&O insurance rates might become more competitive. The number of securities class actions is trending down. The average 2022 settlement was lower than the average settlement in 2016, 2018, and 2020. Of course, D&O rates could vary by sector (industrials vs. healthcare vs. crypto).

When in doubt …

• Be aggressive and file a motion to dismiss aimed at the pleadings. The odds are good for defendants.
• If the case survives a motion to dismiss, carefully consider the costs and benefits of opposing class certification. The settlement price point is higher when a class is certified. And courts typically grant class certification motions. Indeed, class certification decisions have trended against defendants in the last several years, especially for companies that trade on major exchanges.

Footnotes

[1] “Securities class actions,” as used here, refers to lawsuits alleging violations of Section 11 or 12(a)(2) of the Securities Act of 1933, Section 10(b) and Rule 10b-5 of the Exchange Act of 1934, or Section 14 of the 1934 Act. The last category is sometimes called “merger-objection” lawsuits.

[2] “Forum-selection clauses” require shareholders to bring 1933 Act cases in federal court. The federal-to-state filing ratio tightened in the immediate aftermath of Cyan, the 2018 Supreme Court decision holding that 1933 Act claims could not be removed to federal court. But two years later in Sciabacucchi, the Delaware Supreme Court upheld the enforceability of forum-selection clauses. State courts have been receptive to forum-selection clauses.

[3] Cornerstone does not indicate what “allegations concerning cryptocurrency issuances” entails. It might mean allegations that an issuer failed to register with the SEC the coin or token offered as a security. NERA counted 25 cryptocurrency-related lawsuits in 2022, 16 of which centered on unregistered securities allegations, up from one such filing in 2021. The reason for the apparent discrepancy is unclear.

[4] NERA had the following tally:  accounting issues (22 percent), missed earnings guidance (23 percent), misled future performance (33 percent), regulatory issues (26 percent), merger-integration issues (16 percent), and environmental issues (1 percent).

[5] Cornerstone does not indicate if that figure refers to dismissal on a contested motion, voluntary dismissals, or both. The figures for merger lawsuits, 2012-2021, is 93 percent dismissed, 6 percent settled.

James Goldfarb, Brendan T. Mangan and Ted Snyder are Partners and Cameron Matheson is Of Counsel at Davis Wright Tremaine LLP. This post first appeared on the firm’s blog.

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