Facebook’s IPO faltered last year, sparking talk of the dotcom booms and busts, and another big class action payout for disgruntled investors. But IBA Global Insight finds this hitherto lucrative area of litigation in decline.
On 4 November 2012, computer games developer Craig Harris had a surprise waiting for him in his letterbox at his San Francisco Bay Area home – a gift card for $9.
Puzzled, he read the accompanying letter. To his surprise, he had won compensation from Lowe’s Companies Inc, the United States’s second largest home improvement store, over a drywall product that the chain had sold.
‘I had to Google what the lawsuit was,’ he says. He discovered that he was part of a class action litigation – Glen Vereen v Lowe’s Home Centers, Inc – that alleged Lowe’s sold defective Chinese drywall. Plaintiffs claimed that when they’d bought the substance from the store and applied it on their homes, it had emitted gasses and chemicals that were potentially harmful. And it corroded metal surfaces. While Lowe’s denied it had done anything wrong, it settled for $7.75m – $6.5m for victims such as Harris and $2.1m for the legal team that brought the case.
Harris was unimpressed, saying that he did not even remember shopping at Lowe’s. Later that day, he tweeted a message that offered other users of the social media platform a share of his windfall.
‘The class action securities fraud market is a business, just like any other, and the 2011 settlements data indicate the plaintiffs and their counsel are coming off a weak year’ ’
Professor Joseph Grundfest
Director of Stanford Law School Securities Class Action Clearinghouse
Critics say that such low-settlement lawsuits show that the class action industry has peaked and may even be in decline. One UK lawyer quipped: ‘Class actions are not what they used to be.’ And Lowe’s is certainly a world away from the cases brought in the late 1970s and early 1980s when the field was dominated by mass tort. Those settlements resulted in huge payouts on personal injury from asbestos and, later, silicone breast implants.
One area that had until recently seen rapid growth is securities litigation. At the end of November 2012, thousands of investors began receiving their share of the record payments for the eight-year legal wrangle that followed the end of the dotcom boom and bust. The giant, multidistrict lawsuit that became known as the Initial Public Offering Securities Litigation settled for $586m in September 2009. It involved over 300 investor groups that had put money into the first internet boom companies when they came to market with their initial public offerings (IPOs) in the late 1990s.
The plaintiffs successfully claimed that individual investors had lost out during the stock market flotations because they were left with a disproportionate share of losses when the market collapsed. Institutional investors, they said, were kept better informed and bailed out of stocks before their value fell. There was poor disclosure, too much hype and not enough understanding of how to value companies based on the new paradigm of e-commerce. In retrospect, it seems impossible that the boom ever happened.
‘It’s easy to say that everyone got it wrong in the dotcom years’ says Joost Schutte, partner at De Brauw Blackstone Westbroek in the Netherlands and an IBA spokesperson on IPOs, ‘but valuing such technology shares is still not easy, as the Facebook IPO in May demonstrated.’
Disgruntled investors brought a similar class action lawsuit against Facebook last year because of a sharp drop in its share price soon after its IPO [see Faltering Facebook IPO sparks class action – tinyurl.com/IBAfacebook].And, while there was talk of a return to unrealistic market exuberance, Schutte doubts that this single action heralds a return to the sort of claims the market saw during the dizzy heights of the late 1990s.
A new tone of realism has entered both the IPO market and the class action industry since then. Attorney Stanley Bernstein of Bernstein Liebhard, the veteran chair of the plaintiff’s executive committee in the dotcom litigation, told Thomson Reuters news agency at the time: ‘The evils that caused the 100 perc ent and 200 per cent pops on IPOs in the days of dotcom have basically been eliminated as a result of our litigation.’
Bernstein also claimed in the same interview that institutions had failed to learn all the lessons from the debacle. But the figures may suggest otherwise. The number of securities class action settlements approved in 2011 is the lowest in more than a decade. An annual report on the topic by Cornerstone Research – Securities Class Action Settlements – 2011 Review and Analysis – showed that there were 65 court-approved securities class action settlements in the year, which were valued at about $1.4bn in total.
That means that the number of settlements is down 25 per cent on 2010 and down more than 35 per cent on the average for the past decade. The figures on how much they are worth show an even steeper drop. The value of settlements has plummeted almost 60 per cent in 2011 from $3.2bn in 2010.
‘The class action securities fraud market is a business, just like any other, and the 2011 settlements data indicate the plaintiffs and their counsel are coming off a weak year,’ says Professor Joseph Grundfest, director of Stanford Law School Securities Class Action Clearinghouse who worked with Cornerstone on the research. ‘The softness in the data suggests the plaintiffs have been settling a smaller number of cases at a lower price point than in the past.’
Shifting the goalposts
Legislation has shaped the way that the class action industry operates in the US. One major piece of legislation that has come into effect over the past decade is the Class Action Fairness Act (CAFA) of 2005. Prior to that Act, many class actions were brought under state law. While this is still possible under the Securities Act of 1933, in most jurisdictions cases are often removed to the federal court using the provisions in CAFA where sophisticated commercial disputes are more commonly heard.
CAFA has also restricted the practice of so-called ‘coupon settlements’. In those cases, a defending company could easily fob off a nuisance claim that was unlikely to make it to trial by giving the plaintiffs non-cash settlements. The company saved on legal fees and potentially high payouts, while the claimants got something for their efforts.
While CAFA still allows companies to take the coupon route, it now requires a fairness test on the proposed settlement, and, just as importantly, the plaintiff counsel’s fees have to be approved by court. Even though that has not prevented lawyers bringing cases where their fees are disproportionate to the compensation their clients receive, CAFA has generally been welcomed as putting the breaks on that practice. Companies often offer products, services, or gift cards – such as the one received by Craig Harris – to settle such cases.
Ten years earlier, the Private Securities Litigation Reform Act 1995 (PSLRA) was credited with affecting the way that class action suits could be brought under federal securities laws – provisions that are effectively strengthened by the fact that CAFA has moved many cases away from state courts since 2005.
Again, PSLRA was designed to put a cap on frivolous securities lawsuits. Prior to PSLRA, plaintiffs needed very little evidence of fraud to launch a case and would use pre-trial discovery to obtain the kind of proof that the prosecutors hoped might be there. This created a low barrier to litigation, so claimants had little to lose in launching weak or even completely spurious cases.
To defend against such a case could prove expensive and organisations often found it cheaper to settle than fight and win. PSLRA demanded that plaintiffs produce proof of fraud before they can bring their suit. It is now much harder to bring spurious cases, but critics argue that PSLRA has also made more difficult to file legitimate ones too.
He says that lawyers are likely to debate whether the fall is a result of plaintiffs bringing weaker or smaller claims, or whether regulation has begun to favour defendants in the legal process. ‘[It may be] some combination of the two,’ he says, ‘but the reality appears clear – the really big litigation bucks were not in the class action securities fraud markets in 2011.’
There is plenty of support to the argument that recent legislation has favoured defendants [see Shifting the goalposts box, page 24]. ‘Legislation has changed the dynamic of the way cases are brought,’ says David Keyko, litigation partner at Pillsbury in New York. ‘In the past, whichever group claimed first became the lead plaintiff and their lawyers were the counsel. Now, the class action groups have a choice who leads the case, and that means lawyers take care looking at which of those claims are good ones to invest money in.’
But proof of loss has made it more onerous on people bringing cases, he says. Today, claimants have to show that the losses that they have suffered have arisen intentionally. ‘That’s difficult,’ Keyko says. ‘If you have to prove “loss causation,” it means that bad behaviour must have caused the loss, not a drop in the stock market, for example.’
There are other problems for claimants too, such as the lack of symmetry in disclosure. There is very little discovery from the defendant. That means that once a case is filed, assuming that it is not refused – as about 25 per cent of all class action cases are – the defendant can request written documentation and files in both paper and electronic formats.
‘Plaintiffs can make defendants spend vast amounts of money getting electronic records,’ Keyko says, ‘and oftentimes this drives a settlement.’ While insurance tends to cover defendant legal costs, there is no such cover for plaintiffs. That may be why so few class action cases ever go to trial.
Another reason for the drop in the number of cases could be recent case law. In 2009, the Supreme Court reinforced a decision in Bell Atlantic Corp v Twombly, which had tightened up the evidence needed in a plea for federal civil actions.
Terrorism brings progress
After the terrorist strike in the US on 11 September 2001, the authorities arrested Javaid Iqbal, a Pakistani Muslim they said was of ‘high interest’ to their investigations. Iqbal filed an action against federal agents alleging that the arrest orchestrated by the former attorney general John Ashcroft and others was unconstitutional.
The central question that eventually came before the Supreme Court in Ashcroft v Iqbal was whether the respondent pleaded factual matter as it was set out under Twombly. Specifically, did his complaint contain a ‘short and plain statement of the claim showing that the plaintiff is entitled to relief’?
Iqbal had claimed that the federal agencies had subjected him to tough treatment and imprisonment on account of his race, religion and national origin. They were, he argued, in breach the First and Fifth Amendments. The Supreme Court ruled that his complaint had to be more than conceivable; it had to be plausible. Following Twombly, it had to be backed up by factual allegations. They rejected his claims.
The ruling has been important in class actions for two reasons. It clarified that Twombly should be applied beyond antitrust cases. And, it set new tests for plausibility standards in pleas. In particular, it has greatly cut down on a plaintiff’s ability to obtain discovery by pleading unsupported allegations.
Despite these barriers and the lower level of settlements, the industry is diversifying. There is nothing to say that a class action suit has to be big to be successful. At its simplest, it is just a device that allows a large number of people with a common interest to sue or be sued as a group. Such actions are now brought in everything from consumer disputes such as Lowe’s, to employment disagreements, medical disputes and even against foreign companies trading in the US.
In fact, globalisation is a major trend in the class action industry in two ways. First, US plaintiffs continue to pursue foreign companies over securities fraud allegations. This is despite a landmark US Supreme Court decision in 2010, which many believed would reduce the number of securities suits against non-US companies.
‘It’s easy to say that everyone got it wrong in the dotcom years, but valuing such technology shares is still not easy, as the Facebook IPO demonstrated ’
Partner at De Brauw Blackstone Westbroek
Robert Patton, a senior consultant at NERA Economic Consulting, found, paradoxically, that US filings against foreign companies hit a record high shortly after the ruling in Morrison v National Australia Bank was handed down. Some of these suits were brought against US-listed Chinese businesses that have been hit with a series of allegations over accounting and reporting irregularities. But commentators that have focused on those companies have often missed the underlying reason why Morrison is likely to have a limited impact on the volume of litigation in future. ‘Morrison says you can’t make a claim in a US securities class action based on trading outside the US,’ says Patton, ‘but if you look at the actions against foreign companies before Morrison, there is always at least some US trading during the class period.’
In other words, most of the cases could have been brought under Morrison anyway. ‘That may be why we haven’t seen a noticeable decline in filings against non-US companies post-Morrison, even if you ignore the Chinese-company filings,’ Patton says. ‘However, some of the actions brought post-Morrison may be smaller in scope than they would have been before the decision.’
Moreover, US lawyers are finding foreign jurisdictions where the laws are becoming more amenable to class action-style lawsuits. One such country is the United Kingdom. Historically, the UK has seen class actions primarily in the area of competition litigation – particularly around alleged cartel and price-fixing practices by large businesses.
The area of private enforcement in the UK is much more recent. In fact, the first consumer case to be brought in the UK was settled in 2008 – Consumers’ Association v JJB Sports PLC. A limited number of consumers received £20 compensation each over the price they’d paid for replica soccer shirts.
‘The process is tightly controlled and judicially managed in Europe,’ says Ingrid Gubbay, off-counsel for the London branch of the US firm Hausfeld & Co and the lawyer who brought the case on behalf of the Consumers’ Association. In the US, claimants can join an action at many different points in the process. But that does not apply in the UK. ‘Here, if you’re not in at the beginning, then your are not in full stop,’ she says.
In the case against JJB Sports, the claimants estimated that the company had sold over one million shirts for £39, so the damages could have been substantial. But because of the opt-in rule, only a small number of claimants joined the action and it was reported that JJB set aside only £100,000 to cover the payments.
That system could be about to change. The Department for Business, Innovation and Skills is currently consulting on the issue. ‘What the consultation is trying to do is to address the gap between the top companies who are already bringing large-scale class actions, and those SMEs and consumers at the lower end who currently cannot,’ she says. If the proposals are passed into UK law, the industry is sure to grow – and there are similar moves afoot in Europe.
While the class action industry in the US may have matured, newer markets and opportunities are continuing to present themselves. And even if the Initial Public Offering Securities Litigation settlement will in time come to be seen as the high watermark for class action payouts, the number of people throughout the globe eligible to join smaller actions looks set to rise.
Arthur Piper is a freelance journalist. He can be contacted at firstname.lastname@example.org