How does a Securities Class Action with Accounting Allegations Differ from other Securities Actions?
A securities class action suit with accounting allegations means the company did not comply with standard methods of accounting when its financial statements were released. Throughout 2005 to 2010, the largest settlements made in 19 out of 20 securities class action cases involved accounting. Increased public awareness about accounting practices, along with a recent change in the accounting regulatory system, may explain these large settlements.
Being more complex, accounting cases take more time to resolve and are less likely to be dismissed. The end result is typically a larger settlement amount. By the end of 2010, only 36% of accounting cases were dismissed as compared to 60% of the security class actions not involving accounting.
Accounting cases also bring higher than average settlements. During 2005 to 2010, only 67% of all accounting cases were settled, but they fetched 92% of all total settlement dollars. The years 2006 and 2007 saw case settlements over $1 billon dollars. The median settlement for accounting cases is $10.1 million versus $5.9 million for non-accounting cases; therefore, defendants will pay more to get these cases settled. The year 2010 had the lowest amount of accounting cases with only 26% as opposed to a 44% average over the past five years.
The Securities and Exchange Commission (SEC) has become involved in many securities class actions. Approximately one-third of settled accounting cases had actions brought against them from the SEC, but only 12% for other types of non-accounting cases. Higher class action settlements occur with SEC involvement. Cases settled from 2005 to 2010 with SEC action resulted in a median settlement of $23.3 million and without SEC action, resulted in a median of $7.5 million.
Restatements and write-downs of assets are two types of accounting events which can misrepresent true value. Financial statement restatements are less likely to be dismissed than a case involving a write-down of assets. Median settlements for both were $10.5 million. Cases for more than $100 million involved restatements, while the median settlement for write-downs was $6 million. Write-down cases are often more difficult to prove; therefore, causing these types of cases to result in a much lower settlement.
Internal control is the process that provides efficient operation and reliability of a company’s financial reporting. It also includes compliance with laws and regulations. By law companies, and their independent auditors, must state the competency of their internal controls. (ı)
Recently, allegations made by plaintiffs of poor internal controls have been on the rise. Cases increased from 40% in 2009 to 67% in 2010. The largest increase came from cases where plaintiffs alleged internal control weaknesses, but without the company’s acknowledgement of the weaknesses. The number of companies that acknowledge weakness is declining from 18% in 2005 to 9% in 2010. It’s difficult to say whether this is due to improved company measures or the imposed law.
Settlements for accounting cases where the company announced internal control weaknesses had a median settlement amount of $13.5 million. Settlements were less at $9.3 million in cases where no company weaknesses were acknowledged. Cases with no plaintiff allegations of weakness had a median settlement of $9 million dollars.
Understanding the differences in securities cases with accounting allegations is very important to the outcome of your case. It will influence litigation strategy, costs, and your ultimate settlement amount.
ı. Section 404 Sarbanes Oxley (SOX)