Securities Fraud Class Action Lawsuits Serve a Public Benefit

Lawyers at Johnson Fistel have been on both sides of securities fraud class actions.  Indeed, Johnson Fistel is currently defending the founder of a publicly traded company in a class action alleging the company and its insiders made false statements in the offering documents.  Thus, Johnson Fistel knows well the benefits and detriments associated with securities fraud class actions.

With that knowledge base, Johnson Fistel often investigates whether there are any indications of securities fraud when share prices of publicly traded companies plummet shortly after insiders cause the company to disclose previously undisclosed bad news.  Indications of securities fraud include contemporaneous SEC investigations, insider selling, restatement of financial statements, officer resignations, auditor resignations, etc.  Some have questioned the benefit of these investigations even when there are indications of securities fraud.  Recently, the Motley Fool published an article titled What’s With All These Lawsuits on this subject which is misleading and factually incorrect.

The overriding theme of the article is that when law firms issue press releases announcing investigations into possible violations of securities laws, it really is not as bad as it sounds and it’s just law firms trying to make a quick buck.  The author of the article does not appear to be a lawyer and the content of the article demonstrates that he does not fully understand federal class actions filed pursuant to the Private Securities Litigation Reform Act of 1995 (PSLRA).  Here are some points that the author ignores or gets wrong.

  1. The news of a class action lawsuit almost always occurs after the stock has already plummeted following (a) an investigation by the SEC, (b) the company’s issuance of a restatement whereby the company admits that its prior financial statements are inaccurate and cannot be relied upon, and/or (c) public revelations that correct allegedly false misstatements made by the company often times when insiders were selling their own personally held shares for a profit at a time when the stock price was artificially high and sometimes when the insiders were causing the company to buy back its own shares to further artificially inflate the stock price.
  2. The article states: “It’s too easy for lawyers to argue that there’s fraud behind every event that causes the stock price to drop.”  This statement is not accurate.  The allegations in the securities fraud class action complaints are subjected to the highest level of scrutiny after Congress passed the PSLRA.  Unlike every other lawsuit for fraud, the lawyers are not entitled to conduct discovery into the wrongdoing until a federal judge finds sufficient allegations of fraud alleged with particularity and denies the defendants’ motion to dismiss the case.  Thus, the lawyers usually have to rely upon insiders who are willing to blow the whistle on the wrongdoing.
  3. The article further states: “The biggest problem with securities class actions is that most of the time, any payouts come from the company itself.”  This statement is also not accurate.  The overwhelming majority of the payouts comes from insurance companies; the company and the insiders who personally profit at the expense of the class almost always pay nothing beyond the insurance deductible.
  4. The article further states: “The law firms that file these suits tend to take significant percentages of any victory in contingency fees.”  Again, this statement is not accurate.  The law firms only get paid if they recover something for the benefit of the class and never get a majority of the class recovery.  The law firms generally apply for a portion of the class recovery ranging from 13-33%.  And the law firms only get paid after notice is given to the class, class members have an opportunity to scrutinize the settlement terms, class members are afforded an opportunity to object to the settlement or the fees paid to the lawyers, and a federal judge finds that the fees are fair, adequate, and reasonable in light of the benefit the lawyers have conferred upon the class.

Class actions serve a public purpose and are critical to maintaining honesty in the securities markets.  As one court recognized nearly two decades ago: “To open the newspaper today is to receive a daily dose of scandal, from Adelphia to Enron and beyond.” Small v. Fritz, 30 Cal.4th 167, 181 (2003).  Fraud continues unabated.  “Corruption, embezzlement, fraud, these are all characteristics which exist everywhere. It is regrettably the way human nature functions, whether we like it or not.”  Alan Greenspan.

Congress enacted federal securities laws to (1) penalize officers and directors who make false and misleading statements about the financial condition of their company and (2) provide a remedy to injured investors.  Investors who purchase stock at artificially inflated prices face devastating consequences when the truth is inevitably revealed and the stock price plummets.  It’s no exaggeration to say that some investors could even lose their life savings.