Bull Market Is A Bust For Securities Class Action Business

Jan 28 2014, 1:01am CST | by

It’s one of the strangest phenomena among the many strange things that humans do. When the stock market goes up, corporate fraudsters slack off. Instead of using a rising market to dump even more over-hyped stock on gullible investors, they shrink their illegal schemes.

That, at least, is one conclusion from the most recent Cornerstone Research review of securities class actions. Federal cases increased slightly to 165 last year, but one measure of the magnitude of fraud committed fell to its lowest level since 1998. Perhaps because of this relative dearth of opportunities, plaintiff lawyers were quicker on the trigger, with the median lag time between the end of the class period and the filing of a thoroughly researched, good-faith claim for damages dropping to 15 days. That’s one of the lowest lag times observed by Cornerstone, and 25 percent of the cases were filed  within five days of when corporate fraud reared its ugly head.

Cornerstone compiles the report each year in collaboration with the Stanford Securities Class Action Clearinghouse. The data provide an interesting window into an extremely lucrative business based on the idea that each time a stock price falls, fraudulent activity is to blame. What the data really show is “fraud” tends to rise when the stock market falls, and recede when the market goes up.

Class-action filings hit a recent peak of 233 in 2008, for example, including 100 related to financial firms. They fell to 152 in 2011 and rose to 165 last year.

The maximum dollar loss, or change in market value from the highest stock price during the class period to the price after the class period ended — usually the date of the announcement that caused the company’s stock price to fall — fell to $279 billion. That was the lowest since 1998 and well below the $816 billion in 2008.

Another factor limiting opportunities for lawyers accusing corporate executives of fraud is the number of publicly traded U.S. companies shrank by 46% since 1998. But the likelihood of getting sued also shrank, to one in 29 companies, or 3.4%, down from an average of 5.9% since the studies began.

If securities plaintiff lawyers are to be believed, their litigation serves as a deterrent to fraud. So maybe they’ve had an effect since 2008. But that doesn’t explain why fraud erupted that year, after plunging iin 2005 and 2006. Over the long haul, it looks like corporate fraud never really goes away, it just swings with the stock market.

Securities-fraud lawyers may face even tougher times ahead if the Supreme Court takes away their most powerful tool in Halliburton v. Erica P. John Fund. That case challenges the “fraud on the market” theory, under which all investors are presumed to have relied on a faulty market price to their detriment when a stock’s price subsequently falls. This theory is illogical for several reasons, the biggest one being the most obvious: Other than index funds, most investors buy a stock because they think the market price is wrong.

There were good reasons to doubt the fraud on the market theory when the Supreme Court embraced it in 1988. The court’s conservatives may finally accept the conclusions of modern finance theory and kill it this spring. Stock prices will continue to fall unexpectedly, but lawyers will no longer be able to claim that everybody who bought high and sold low was the victim of corporate fraud.

Source: Forbes Business

 
 

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