Following two years of decline, the number of companies sued in U.S. securities fraud class action lawsuits increased by 43% in 2007, according to a joint study released this week by Stanford Law School and Cornerstone Research. Filings increased by an even greater 87% in the courts encompassing New York and the other courts within the federal Second Circuit. The finance sector bore the brunt of the proliferating litigation as 47 companies were sued in 2007, more than quadrupling the 11 such companies sued in 2006. Moreover, the share of cases in which an underwriter was named as a defendant surged from 4% in 2006 to 11 percent in 2007.

The substantial rise in securities class action filings followed quickly on the heels of the collapse of the subprime mortgage market and coincided with an uptick in stock market price volatility. Indeed, the report observes that, on average, a 10 point increase in the quarterly average S&P 500 Implied Volatility Index is associated with 12 additional litigations per quarter.

The report regards the subprime crisis as a non-recurring event, which, if excluded, would suggest a “core litigation rate” that is well below historical norms. At the same time, however, the report acknowledges that such “one time” events have occurred each of the past several years. In 2006, securities fraud class action filings were driven by the options backdating scandals. Before that, the IPO allocation cases dominated securities fraud lawsuits and before that, the massive frauds and bankruptcies at Enron, WorldCom and others took center stage in the wake of the Internet bubble-burst. In short, while the nature and cause of shocks to the stock market may differ, such shocks are common and recurring. As the subprime crisis reverberates into 2008, stock market volatility remains, and oil prices reached $100 per barrel in the first week of January, the trend of increased securities fraud litigation can be expected to persist. 

While the report identifies several countervailing considerations for 2008, none appears significant enough to quell the rise of securities lawsuits over the next several quarters. Most notably, the report points out that the U.S. Supreme Court’s 2007 decision in Tellabs Inc. v. Makor Issues & Rights, has made it more difficult for plaintiffs to adequately demonstrate fraudulent intent.1 Class action plaintiffs are likely to give pause following the November 27, 2007 verdict for defendant JDS Uniphase in a rare securities class action to go to a jury. The report also notes the retirement and guilty plea by leading plaintiffs’ lawyer William Lerach.

In sum, the data from 2007 indicate that public companies, their officers, directors, and advisers, particularly in the finance sector, can expect to face a continued threat of securities class action litigation well into 2008.