Author: Susan Friedman, Esq.
Turning the clock back
In 2018, on the heels of a number of settlements with large institutional investors who opted out of the securities class action litigation and brought direct actions against a real estate investment trust, the forecast by industry analysts and the legal community was that the playing field for securities litigation would expand.1
Although attorneys for plaintiffs had mixed views about the changing terrain, over time many highlighted direct actions as an effective and expedited method of increasing returns on investment particularly for institutional investors.2
Analyzing the math of opting out of securities class actions in favor of direct actions, class action recoveries on average return 2% of losses and can take up to six years to recover monies. In comparison, plaintiff attorneys claim that opt-out/direct action claims frequently result in more than 10 times this 2% average and are paid immediately upon resolution.2 Further, class actions with identified opt-outs tend to settle at later stages in the litigation after a class certification ruling has been issued by the Court.3 Additionally, direct action plaintiffs control the litigation as well as the amount and timing of settlements.2 Noting here that settlement and judgment amounts are rarely publicly disclosed in direct action cases. This lack of information makes a true comparison of recoveries, from direct actions versus remaining in the securities class action, a futile effort.3
Recent research advises that the direct action road is more well-traveled
According to a recently released study by Cornerstone Research, class members opting out of securities class action settlements has slowly, but steadily, been on the rise.3
Opt-outs occur when at least one putative (existing) class member removes itself from the class frequently, but not always, to pursue a separate direct action against the defendants who generally are board directors and officers plus the entity/corporation.
The researchers analyzed a database of 2,061 securities class action settlements from 1996 through June 2022 which included 287 securities class action settlements from 2019 through the first half of 2022.3 Overall, from the entire time period studied, 5.6% (115 out of 2,061) of the settlements had at least one opt-out. In comparison, the most recent time period studied (2019 through June 2022) indicated that 33 out of 287 settlements had at least one identified opt-out which represents 11.5% which is a significant leap from 2.9% opt-outs from 1996 to 2005 and 5.8% opt outs from 2008 to 2018.3
Further, the study noted that as the securities class action settlements increased in size, the probability of one or more opt-outs increased as well.3 In support of this correlation, the research for the 2019 to the first half of 2022 period, had opt-outs in 29% of cases with settlements over $20 million, 62.5% of cases with settlements over $100 million, and 100% for the only two cases with settlements over $500 million.3
In this same regard, those opting-out of the largest securities class action settlements frequently bring one or more separate direct action lawsuits. Shareholders typically opt-out of a class settlement to protect their rights to bring such direct actions against substantially the same defendants and allegations set forth in the original securities class action.
Cornerstone found that direct action plaintiffs were most commonly institutional investors. This included hedge funds, mutual funds, pension funds and other investment management firms. Institutional investors as stakeholders are laser focused on securing the largest return on their investment possible. They have access to analytics, established relationships with plaintiff law firms who conduct risk-reward analyses, and the financial resources to pay for litigation they commence — all of which are taken into consideration along with the size of their ownership interests.3 In short, if institutional investors believe that they can receive a larger return they will bring a direct action.
Evaluation of the research yielded the conclusion that the securities class action case settlement environment is ripe for opt-outs where the potential damages are substantial, the allegations are complex, and the defendant issuers have a greater ability to pay a potential settlement or judgment. These three traits were common to cases with at least one identified opt-out, particularly where an institutional investor opted out.3
Deconstructing the characteristics common to opt-outs:
- they tend to have higher simplified metrics of potential class action damages;
- the complexity of allegations considers the number of years in the class period, the amount of time between filing and settling the class action, the presence of Section 11 or 12 claims (private right of action, misstatements, materially false and misleading statements or omissions), non-common stock purchasers in the class (bond, options, or other securities), SEC action and criminal charges; and
- a corporate defendant's financial health is measured by the size of its assets, market capitalization and whether the defendant issuer was in bankruptcy or otherwise financially distressed.3
Looking onto the crystal ball
As the severity of securities class actions climbs so will opt-outs as investors seek to maximize their returns and control the fate of their claims. We add yet another exposure to the overflowing list of risks confronting board directors and corporate officers. Admittedly, today opt-outs may represent a fraction of the securities class action territory, but the numbers are consistently escalating.
Although generally applicable to larger corporations involving larger settlements and institutional shareholders, these losses no doubt impact directors and officers (D&O) liability insurance overall. Further, it is not out of the realm of possibility that this phenomenon may begin to spiral downward to other size companies. Seeing into the future and considering all of the factors, it is vital for companies to be cognizant of the heightened exposure created by opt-outs and prepare for this risk from a defense and settlement perspective.
Cornerstone's research enables us to identify the conditions under which class members are more likely to opt-out and bring direct actions which is extremely valuable. This information prompts us to review the D&O program structure, coverage terms and conditions, adequacy of limits of liability, and probability of exposure inclusive of the dollar amount of damages.
As the litigation landscape evolves, Gallagher's Management Liability Practice evolves with it. Our goal is to provide actionable solutions and decision making tools to meet your needs as business circumstances and the legal environment change. Our analytical tools and modelling for quantitative analysis are industry acclaimed. Informed decision making is the foundation of designing a D&O program that truly mitigates risk and protects your leadership and organization.
As always, Gallagher Management Liability specialists stand ready to assist.