Home > UCILR > Vol. 12 > Iss. 4 (March 2022)
“An odd fact of the U.S. legal system for public companies is that every crime is also securities fraud: If a company does a bad thing, and regulators find out about it, then the bad-thing regulators can punish it for doing the bad thing, but the securities regulators can also punish it for not disclosing the bad thing to shareholders. . . . It is a strange combination: Generally speaking the companies do the bad things on behalf of shareholders—to make more money for them—but then the securities regulators come in and fine them for defrauding shareholders.”
Securities litigation is a virtually inevitable fact of life for any public company. Often, investors sue because the firm’s managers engaged in fraud that directly harmed the shareholders—say, by doctoring the firm’s financials, or lying about known business prospects. However, shareholders also sue their companies when those companies engage in conduct that primarily harms a different set of constituents. When a drug on the market proves to have dangerous side effects, a faulty car battery bursts into flames, or an oil rig explodes, it’s difficult to say that the most direct victims are the companies’ shareholders. Yet shareholders commonly sue under the federal securities laws based on precisely this kind of conduct, on the basis that the managers should have better disclosed the underlying facts, and investors were harmed by the resulting drop in stock price because they did not. In recent years, these cases, dubbed “event-driven securities litigation,” have become more common and have drawn increasing criticism on the grounds that they are opportunistic and generally lack merit. However, there has so far been no comprehensive examination of these lawsuits.
This paper seeks to fill the gap by investigating the prevalence and attributes of these lawsuits. In a sample from 2010 to 2015, I find that roughly 16.5% of securities class actions arise from conduct where the most direct victims are not shareholders. However, I find that these cases have roughly a 20% lower likelihood of being dismissed and settle for significantly higher amounts. These lawsuits are also more likely to be brought against large defendant firms, more likely to involve an institutional investor as a lead plaintiff, and much more likely to involve a non-SEC investigation or inquiry than cases where the primary victims are shareholders. Many of these attributes are used in the literature as proxies for merit. However, I argue that the merit of these cases is not clear-cut. Further, from a policy perspective, while these cases may have deterrence value, they may not be an optimal means to monitor corporate misconduct that harms outsiders.
Is Everything Securities Fraud?,
U.C. Irvine L. Rev.
Available at: https://scholarship.law.uci.edu/ucilr/vol12/iss4/9