A rigorous new academic study provides further evidence that pension funds make more effective plaintiffs than individuals when pursuing securities fraud claims.
Securities class actions led by institutional lead plaintiffs are more likely than other cases to survive defendants’ motions to dismiss and to force management to improve their corporate governance, according to the new research, conducted by four business professors around the country. The study also indicates that institutional investors achieve larger settlements – even when taking into account that they tend to gravitate to larger cases.
“Institutional Monitoring through Shareholder Litigation,” forthcoming in the Journal of Financial Economics, adds to a growing body of academic research that examines the impact of changes wrought by Congress in the Private Securities Litigation Reform Act of 1995, or PSLRA. Several researchers exploring the mechanics and economics of class actions filed under the PSLRA have found that institutional plaintiffs benefit all investors, most notably when state and local government pension funds are the lead plaintiffs.
“Institutional investors now run half of the securities fraud lawsuits,” said Jeffrey C. Block, a partner in the Boston office of Berman DeValerio. “As the study demonstrates, their involvement has led to increased recoveries for investors and positive corporate governance changes at the companies they are suing.”
The PSLRA directed federal courts to select as lead plaintiffs the investors with the largest losses in their stock holdings. As a result, the number of institutional investors appointed as lead plaintiffs has grown steadily, from a negligible amount in the 1990s to 48 percent of all cases filed last year, according to PricewaterhouseCoopers’ “2008 Securities Litigation Study.” When large cases settle, institutional investors are also increasingly in the role of lead plaintiff. According to RiskMetrics Group, institutional investors last year were lead plaintiffs in 82 percent of securities cases with the 100 largest post-PSLRA settlements, up sharply from 56 percent in 2005.
At the New York University School of Law, a researcher led a 2005 study that determined public funds are able to recover a larger percentage of potential damages for the class. Another study that year out of the St. John’s University School of Law found that participation by public funds can reduce fee requests and awards. There is also some evidence that institutions can more successfully effect corporate governance changes than can individuals who file class actions.
And institutions, which are more sophisticated than individuals, may be better monitors of litigation and generate better results overall, because they are less prone to settling quickly for smaller amounts.
The new study’s authors present a daunting array of statistical regression analyses to make their case. The paper examined 1,811 class actions filed between January 1996 and July 2005. Of those, 286 were filed by institutions, including public and union pension funds, mutual funds, hedge funds and endowments. The authors are Professors C.S. Agnes Cheng of Louisiana State University, Henry He Huang of Prairie View A&M University in Texas, Yinghua Li of Purdue University and Gerald Lobo of the University of Houston.
Within three years of a lawsuit being filed in court, they found that the defendant company is far more likely to increase the number of independent members of its corporate board when an institution was the lead plaintiff. This “suggests that securities litigation does not automatically lead to governance improvement. Rather, it is the institutional involvement that drives, either directly or indirectly, governance changes,” the authors concluded.
Also, cases are more often successful when an institution is lead plaintiff. In such cases, the action survived the defendants’ motion to dismiss 84 percent of the time, compared with just 56 percent for lawsuits with individuals as lead plaintiffs. The presence of an institutional lead plaintiff plays “a significant role in defeating the defendant firm’s motion to dismiss,” the study said.
“Our evidence indicates that institutional investors’ involvement in securities litigation enhances not only investors’ success in seeking financial recovery, but also the quality of defendant firms’ corporate governance,” the study said. Institutions, the researchers added, can view litigation as an effective tool “to discipline management and to secure the long-term health of the firms.”
Among the paper’s other findings is that, at least through 2005, a relatively small group of institutional investors continued to shoulder the load in litigation: twenty-seven institutions – primarily public funds – were lead plaintiffs in three or more cases during the time period analyzed.
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